Beneficial ownershipSenior Securities
We are permitted, under specified conditions, to issue multiple classes of debt and one class of shares senior to our common shares if our asset coverage, as applicable to us under the 1940 Act, is determinedat least equal to 200% immediately after each such issuance. In addition, while any senior securities remain outstanding, we must make provisions to prohibit any distribution to our shareholders or the repurchase of such securities or shares unless we meet the applicable asset coverage ratios at the time of the distribution or repurchase. We may also borrow amounts up to 5% of the value of our total assets for temporary purposes without regard to asset coverage. For a discussion of the risks associated with leverage, see "Item 1A. Risk Factors—Risks Related to Debt Financing" and "Item 1A. Risk Factors—Risks Related to Business Development Companies."
Code of Ethics
We and FS/EIG Advisor have each adopted a code of ethics pursuant to Rule 17j-1 promulgated under the 1940 Act and Rule 204A-1 of the Advisers Act, respectively, that, among other things, establishes procedures for personal investments and restricts certain personal securities transactions. Personnel subject to the code may invest in securities for their personal investment accounts, including securities that may be purchased or held by us, so long as such investments are made in accordance with each code's pre-clearance and other requirements. Each code of ethics is available on our website at www.fsinvestments.com and on the EDGAR Database on the SEC's Internet site at www.sec.gov. Shareholders may also obtain a copy of each code of ethics, after paying a duplicating fee, by electronic request at the following e-mail address: publicinfo@sec.gov, or by writing the SEC's Public Reference Section, at 100 F Street, N.E, Washington, D.C. 20549.
Compliance Policies and Procedures
We and FS/EIG Advisor have adopted and implemented written policies and procedures reasonably designed to prevent violation of the federal securities laws and are required to review these compliance policies and procedures annually for their adequacy and the effectiveness of their implementation. Our chief compliance officer and the chief compliance officer of FS/EIG Advisor are responsible for administering these policies and procedures.
Proxy Voting Policies and Procedures
We have delegated our proxy voting responsibility to FS/EIG Advisor. The proxy voting policies and procedures of FS/EIG Advisor are set forth below. The guidelines are reviewed periodically by FS/EIG Advisor and our non-interested trustees, and, accordingly, are subject to change.
As an investment adviser registered under the Advisers Act, FS/EIG Advisor has a fiduciary duty to act solely in the best interests of its clients. As part of this duty, it recognizes that it must vote client securities in a timely manner free of conflicts of interest and in the best interests of its clients.
These policies and procedures for voting proxies for the investment advisory clients of FS/EIG Advisor are intended to comply with Section 206 of, and Rule 13d-3206(4)-6 promulgated under, the Advisers Act.
Personnel of FS/EIG Advisor and its affiliates will vote proxies relating to our securities in the best interest of its clients. Such personnel will review on a case-by-case basis each proposal submitted for a shareholder vote to determine its impact on the portfolio securities held by its clients. Although FS/EIG Advisor will generally vote against proposals that may have a negative impact on its clients' portfolio securities, it may vote for such a proposal if there exist compelling long-term reasons to do so.
The proxy voting decisions are made by the senior personnel of FS/EIG Advisor and its affiliates who are responsible for monitoring each of its clients' investments. To ensure that its vote is not the product of a conflict of interest, it will require that: (a) anyone involved in the decision-making process disclose to its chief compliance officer any potential conflict that he or she is aware of and any contact that he or she has had with any interested party regarding a proxy vote; and (b) employees involved in the decision making process or vote administration are prohibited from revealing how FS/EIG Advisor intends to vote on a proposal in order to reduce any attempted influence from interested parties.
Shareholders may obtain information, without charge, regarding how FS/EIG Advisor voted proxies with respect to our portfolio securities by making a written request for proxy voting information to: Chief Compliance Officer, FS Energy and Power Fund, 201 Rouse Boulevard, Philadelphia, Pennsylvania 19112 or by calling us collect at (215) 495-1150.
Other
We will be periodically examined by the SEC for compliance with the 1940 Act.
We are required to provide and maintain a bond issued by a reputable fidelity insurance company to protect us against larceny and embezzlement. Furthermore, as a BDC, we are prohibited from protecting any trustee or officer against any liability to us or our shareholders arising from willful misconduct, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of such person's office.
Exchange Act and Sarbanes-Oxley Act Compliance
We are subject to the reporting and disclosure requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act, including the filing of quarterly, annual and current reports, proxy statements and other required items. In addition, we are subject to the Sarbanes-Oxley Act, which imposes a wide variety of regulatory requirements on publicly held companies and their insiders. Many of these requirements affect us. For example:
•pursuant to Rule 13a-14 promulgated under the Exchange Act, our chief executive officer and includeschief financial officer are required to certify the accuracy of the financial statements contained in our periodic reports;
•pursuant to Item 307 of Regulation S-K, our periodic reports are required to disclose our conclusions about the effectiveness of our disclosure controls and procedures; and
•pursuant to Rule 13a-15 promulgated under the Exchange Act, our management will be required to prepare a report regarding its assessment of our internal control over financial reporting.
The Sarbanes-Oxley Act requires us to review our current policies and procedures to determine whether we comply with the Sarbanes-Oxley Act and the regulations promulgated thereunder. We monitor our compliance with all regulations that are adopted under the Sarbanes-Oxley Act and take actions necessary to ensure that we are in compliance therewith.
Taxation as a RIC
We have elected to be treated as a RIC under Subchapter M of the Code. As a RIC, we generally will not have to pay corporate-level U.S. federal income taxes on any ordinary income or capital gains that we distribute as dividends to our shareholders. To qualify for and maintain our qualification as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements (as described below). In addition, in order to maintain RIC tax treatment, we must distribute to our shareholders, for each tax year, dividends of an amount at least equal to 90% of our "investment company taxable income," which is generally the sum of our net ordinary income plus the excess, if any, of realized net short-term capital gains over realized net long-term capital losses, determined without regard to any deduction for distributions paid, or the Annual Distribution Requirement.
If we:
•qualify as a RIC; and
•satisfy the Annual Distribution Requirement,
then we will not be subject to U.S. federal income tax on the portion of our income or capital gains we distribute (or are deemed to distribute) as dividends to our shareholders. We will be subject to U.S. federal income tax at the regular corporate rates on any income or capital gains not distributed (or deemed distributed) as dividends to our shareholders.
As a RIC, we will be subject to a 4% nondeductible federal excise tax on certain undistributed income unless we distribute dividends in a timely manner to our shareholders generally of an amount at least equal to the sum of (1) 98% of our net ordinary income (taking into account certain deferrals and elections) for the calendar year, (2) 98.2% of our capital gain net income, which is the excess of capital gains over capital losses (as adjusted for certain ordinary losses) for the one-year period ending October 31 of that calendar year and (3) 100% of any net ordinary income and capital gain net income recognized for the preceding years that were not distributed during such years and on which we paid no U.S. federal income tax, or the Excise Tax Avoidance Requirement. Any distribution declared by us during October, November or December of any calendar year, payable to shareholders of record on a specified date in such a month and actually paid during January of the following calendar year, will be treated as if it had been paid by us, as well as received by our U.S. shareholders on December 31 of the calendar year in which the distribution was declared. We generally will endeavor in each tax year to avoid any material U.S. federal excise tax on our earnings.
We have previously incurred, and may incur in the future, such excise tax on a portion of our income and capital gains. While we intend to distribute income and capital gains to minimize exposure to the 4% excise tax, we may not be able to, or may choose not to, distribute amounts sufficient to avoid the imposition of the tax entirely. In that event, we generally will be liable for the excise tax only on the amount by which we do not meet the Excise Tax Avoidance Requirement.
In order to qualify as a RIC for U.S. federal income tax purposes, we must, among other things:
•continue to qualify as a BDC under the 1940 Act at all times during each tax year;
•derive in each tax year at least 90% of our gross income from dividends, interest, payments with respect to certain securities, loans, gains from the sale of stock or other securities, or foreign currencies, net income from certain "qualified publicly-traded partnerships (which generally are partnerships that are traded on an established securities market or readily tradable on a secondary market (or the substantial equivalent thereof), other than partnerships that derive 90% of their income from interest, dividends and other permitted RIC income)," or other income derived with respect to our business of investing in such stock or other securities, or the 90% Income Test; and
•diversify our holdings so that at the end of each quarter of the tax year:
◦at least 50% of the value of our assets consists of cash, cash equivalents, U.S. government securities, securities of other RICs, and other securities if such other securities of any one issuer do not represent more than 5% of the value of our assets or more than 10% of the outstanding voting securities of such issuer; and
◦no more than 25% of the value of our assets is invested in the securities, other than U.S. government securities or securities of other RICs, of one issuer, of two or more issuers that are controlled, as determined under applicable Code rules, by us and that are engaged in the same or similar or related trades or businesses or of certain "qualified publicly-traded partnerships," or the Diversification Tests.
A RIC is limited in its ability to deduct expenses in excess of its investment powercompany taxable income. If our expenses in a given tax year exceed our investment company taxable income, we may experience a net operating loss for that tax year. However, a RIC is not permitted to carry forward net operating losses to subsequent tax years and such net operating losses do not pass through to its shareholders. In addition, deductible expenses can be used only to offset investment company taxable income, not net capital gain. A RIC may not use any net capital losses (that is, the excess of realized capital losses over realized capital gains) to offset its investment company taxable income, but may carry forward such net capital losses, and use them to offset future capital gains, indefinitely. Due to these limits on deductibility of expenses and net capital losses, we may for tax purposes have aggregate taxable income for several years that we are required to distribute and that is taxable to our shareholders even if such taxable income is greater than the net income we actually earn during those years.
For U.S. federal income tax purposes, we may be required to recognize taxable income in circumstances in which we do not receive a corresponding payment in cash. For example, if we hold debt instruments that are treated under applicable tax rules as having original issue discount (such as debt instruments with PIK interest or, in certain cases, increasing interest rates or debt instruments that were issued with warrants), we must include in income each tax year a portion of the original issue discount that accrues over the life of the obligation, regardless of whether cash representing such income is received by us in the same tax year. We may also have to include in income other amounts that we have not yet received in cash, such as deferred loan origination fees that are paid after origination of the loan or are paid in non-cash compensation such as warrants or stock. We anticipate that a portion of our income may constitute original issue discount or other income required to be included in taxable income prior to receipt of cash.
We invest a portion of our net assets in below investment grade instruments. Investments in these types of instruments may present special tax issues for us. U.S. federal income tax rules are not entirely clear about issues such as when we may cease to accrue interest, original issue discount or market discount, when and to what extent deductions may be taken for bad debts or worthless instruments, how payments received on instruments in default should be allocated between principal and income and whether exchanges of debt obligations in a bankruptcy or workout context are taxable. We will address these and other issues to the extent necessary in order to seek to ensure that we distribute sufficient income to avoid any material U.S. federal income or excise tax.
Because any original issue discount or other amounts accrued will be included in our investment company taxable income for the year of the accrual, we may be required to make a distribution to our shareholders in order to satisfy the Annual Distribution Requirement, even though we will not have received any corresponding cash amount. As a result, we may have difficulty meeting the Annual Distribution Requirement necessary to maintain RIC tax treatment under Subchapter M of the Code. We may have to sell or otherwise dispose of some of our investments at times and/or at prices we would not consider advantageous, raise additional debt or equity capital or forgo new investment opportunities for this purpose. If we are not able to obtain cash from other sources, we may fail to qualify for RIC tax treatment and thus become subject to corporate-level U.S. federal income tax.
Although we do not presently expect to do so, we are authorized to borrow funds and to sell or otherwise dispose of assets in order to satisfy distribution requirements. However, under the 1940 Act, we are not permitted to make distributions to our shareholders while our debt obligations and other senior securities are outstanding unless certain "asset coverage" tests are met. See "—Regulation—Senior Securities." Moreover, our ability to sell or otherwise dispose of assets to meet the Annual Distribution Requirement, or the Excise Tax Avoidance Requirement, may be limited by (1) the illiquid nature of our portfolio and/or (2) other requirements relating to our status as a RIC, including the Diversification Tests. If we sell or otherwise dispose of assets in order to meet the Annual Distribution Requirement or the Excise Tax Avoidance Requirement, we may make such dispositions at times that, from an investment standpoint, are not advantageous.
To satisfy the Diversification Tests at the close of each quarter of our tax year, we will generally have invested no more than 25% of the value of our total assets in MLPs and certain other "qualified publicly traded partnerships". As a limited partner in the MLPs in which we seek to invest, we will be deemed to have received our share of income, gains, losses, deductions, and credits from those MLPs. Historically, a significant portion of income from MLPs has been offset by tax deductions. As a result, this income has been significantly lower than cash distributions paid by MLPs. The percentage of an MLP's income and gains which is offset by tax deductions, losses and credits will fluctuate over time for various reasons. A significant slowdown in acquisition activity or capital spending by MLPs held in our portfolio could result in a reduction of accelerated depreciation generated by new acquisitions, which may result in an increase in our investment company taxable income that we are required to distribute to shareholders to satisfy the Annual Distribution Requirement or the Excise Tax Avoidance Requirement or to eliminate our liability for U.S. federal income tax. If our income from our investments in MLPs exceeds the cash distributions received from such investments, we may need to obtain cash from other sources in order to satisfy the Annual Distribution Requirement. If we are unable to obtain cash from other sources, we may fail to qualify for RIC tax treatment and become subject to corporate-level U.S. federal income tax. We may also recognize for
U.S. federal income tax purposes gain in excess of cash proceeds upon the sale of an interest in an MLP. Any such gain may need to be distributed (or deemed distributed) in order to avoid liability for corporate-level U.S. federal income taxes on such gain.
A portfolio company in which we invest may face financial difficulties that require us to work-out, modify or otherwise restructure our investment in the portfolio company. Any such transaction could, depending upon the specific terms of the transaction, result in unusable capital losses and future non-cash income. Any such transaction could also result in our receiving assets that give rise to non-qualifying income for purposes of the 90% Income Test or otherwise would not count toward satisfying the Diversification Tests.
Some of the income that we might otherwise earn, such as fees for providing managerial assistance, certain fees earned with respect to our investments, income recognized in a work-out or restructuring of a portfolio investment, or income recognized from an equity investment in an operating partnership, may not satisfy the 90% Income Test. To manage the risk that such income might disqualify us as a RIC for failure to satisfy the 90% Income Test, one or more subsidiary entities treated as U.S. corporations for entity-level tax purposes may be employed to earn such income and (if applicable) hold the related asset. Such subsidiary entities will be required to pay U.S. federal income tax on their earnings, which ultimately will reduce the yield to our shareholders on such fees and income.
Competition
Our primary competitors for investments include other BDCs and investment funds (including private equity funds, mezzanine funds and CLO funds). In addition, alternative investment vehicles, such as hedge funds, have begun to invest in areas in which they have not traditionally invested, including making investments in middle market private U.S. companies. We also compete with traditional financial services companies such as commercial banks. We believe we will be able to compete with these entities for financing opportunities on the basis of, among other things, the experience of FS/EIG Advisor’s senior management team.
Many of our competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do. For example, some competitors may have a lower cost of capital and access to funding sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments than we have. These characteristics could allow our competitors to consider a wider variety of investments, establish more relationships and offer better pricing and more flexible structuring than us. Furthermore, many of our competitors have greater experience operating under, or are not subject to, the regulatory restrictions that the 1940 Act imposes on us as a BDC. For additional information concerning the competitive risks we face, see “Item 1A. Risk Factors—Risks Related to Our Business and Structure—We may face increasing competition for investment opportunities, which could delay deployment of our capital, reduce returns and result in losses.”
Employees
We do not currently have any employees. Each of our executive officers is a principal, officer or employee of FS/EIG Advisor or its affiliates, which manages and oversees our investment operations. In the future, FS/EIG Advisor may retain additional investment personnel based upon its needs.
Available Information
For so long as our bylaws require, we will distribute to all shareholders of record our quarterly report on Form 10-Q within 60 days after the end of each fiscal quarter and our annual report on Form 10-K within 120 days after the end of each fiscal year. We also file with or submit to the SEC annual, quarterly and current periodic reports, proxy statements and other information meeting the informational requirements of the Exchange Act. This information is available free of charge by calling us collect at (215) 495-1150 or on our website at www.fsinvestments.com. Information contained on our website is not incorporated into this annual report on Form 10-K and such information should not be considered to be part of this annual report on Form 10-K.
Shareholders also may inspect and copy these reports, proxy statements and other information, as well as this annual report on Form 10-K and related exhibits and schedules, from the EDGAR database on the SEC's web site at www.sec.gov. Shareholders also can obtain copies of such information, after paying a duplicating fee, by sending a request by e-mail to publicinfo@sec.gov.
Item 1A. Risk Factors.
Investing in our common shares involves a number of significant risks. In addition to the other information contained in this annual report on Form 10-K, investors should consider carefully the following information before making an investment in our common shares. If any of the following events occur, our business, financial condition and results of operations could be materially and adversely affected. In such case, the net asset value of our common shares could decline or the value of our debt or equity investments may decline, and investors may lose all or part of their investment.
Summary of Risk Factors
The following is a summary of the principal risk factors associated with an investment in us. Further details regarding each risk included in the below summary list can be found further below.
Risks Related to Our Business and Structure
•If our investment advisory agreement with our investment adviser, FS/EIG Advisor, were to be terminated, or if FS/EIG Advisor were to lose any members of its investment team, our ability to achieve our objectives could be significantly harmed.
•The inability of FS/EIG Advisor to generate investment opportunities through relationships with private equity sponsors, investment banks and commercial banks could adversely affect our business.
•We operate in a highly competitive market for investment opportunities.
•Our board of trustees may change our investment policy or modify or waive our operating policies.
•The SBCA Act allows us to incur additional leverage.
•Failure to safeguard the security of our data could compromise our ability to conduct business.
Risks Related to FS/EIG Advisor and its Respective Affiliates
•FS/EIG Advisor and its affiliates face conflicts of interest as a result of arrangements between us and FS/EIG Advisor and related to obligations FS/EIG Advisor and its affiliates have to our affiliates and to other clients.
•We may be obligated to pay FS/EIG Advisor incentive compensation even if we incur a net loss.
•We may face additional competition because employees of FS/EIG Advisor are not prohibited from raising money for or managing another entity that makes the same types of investments that we target.
Risks Related to Business Development Companies and RICs
•Failure to maintain our status as a BDC would reduce our operating flexibility.
•Our ability to acquire investments may be adversely affected if we cannot obtain debt or equity financing.
•The requirement that we invest a sufficient portion of our assets in qualifying assets could preclude us from investing in accordance with our current business strategy; conversely, the failure to invest a sufficient portion of our assets in qualifying assets could result in our failure to maintain our status as a BDC.
Risks Related to Our Investments
•Inflation may adversely affect the business, results of operations and financial condition of our portfolio companies.
•Under normal circumstances, 80% of our total assets are required to be invested in securities of Energy companies, and therefore, we are subject to specific risks related to investments in the Energy sector.
•Our investments in prospective portfolio companies may be risky, and we could lose all of our investment.
•If our portfolio is concentrated in a single or limited number of investments at any given time, our performance may be significantly adversely affected by the unfavorable performance of a small number of such investments or a substantial write-down of the value of any one investment.
•There may be circumstances where our debt investments could be subordinated to claims of other creditors.
•Declines in market values or fair market values of our investments could result in significant net unrealized depreciation of our portfolio, which in turn would reduce our net asset value.
•A significant portion of our investment portfolio does not have a readily available market price and is and will be recorded at fair value in accordance with policies and procedures approved by our board of trustees and, as a result, there is and will be uncertainty as to the value of our portfolio investments.
•We are exposed to risks associated with changes in interest rates.
•Our investments may include original issue discount and PIK instruments.
•We may, from time to time, enter into derivative transactions which expose us to certain risks.
Risks Related to Debt Financing
•We currently incur indebtedness to make investments, which magnifies the potential for gain or loss on amounts invested in our common shares and may increase the risk of investing in our common shares.
•The agreements governing our debt financing arrangements contain various covenants which, if not complied with, could have a material adverse effect on our ability to meet our investment obligations.
Risks Related to an Investment in Our Common Shares
•Our common shares are not listed on an exchange or quoted through a quotation system, and may never be.
•We are not obligated to complete a liquidity event by a specified date.
•Only a limited number of common shares may be repurchased pursuant to our share repurchase program, if any.
•We may pay distributions from borrowings or the sale of assets.
•The timing of our repurchase offers, if any, may be at a time that is disadvantageous to our shareholders.
•A shareholder's interest in us will be diluted if we issue additional common shares.
•Certain provisions of our declaration of trust and bylaws could deter takeover attempts.
General Risk Factors
•Future economic downturns could impair our portfolio companies and harm our operating results.
•Future disruptions or instability in capital markets could negatively impact the valuation of our investments and our ability to raise capital.
•Events outside of our control, including public health crises, could negatively affect our portfolio companies and our results of operations.
•If a period of capital market disruption and instability continues for an extended period of time, there is a risk that investors in our equity securities may not receive distributions consistent with historical levels or at all, or that our distributions may not grow over time and a portion of our distributions may be a return of capital.
•Economic sanction laws in the United States and other jurisdictions may prohibit us and our affiliates from transacting with certain countries, individuals and companies.
Risks Related to Our Business and Structure
Our ability to achieve our investment objectives depends on FS/EIG Advisor’s ability to manage and support our investment process. If our agreement with FS/EIG Advisor were to be terminated, or if FS/EIG Advisor were to lose any members of its investment team, our ability to achieve our investment objectives could be significantly harmed.
Because we have no employees, we depend on the investment expertise, skill and network of business contacts of FS/EIG Advisor. FS/EIG Advisor evaluates, negotiates, structures, executes, monitors and services our investments. Our future success depends to a significant extent on the continued service of FS/EIG Advisor, as well as its investment team. The departure of any members of FS/EIG Advisor’s investment team could have a material adverse effect on our ability to achieve our investment objectives.
Our ability to achieve our investment objectives depends on FS/EIG Advisor’s ability to identify, analyze, invest in, finance and monitor companies that meet our investment criteria. FS/EIG Advisor’s capabilities in structuring the investment process, providing competent, attentive and efficient services to us, and facilitating access to financing on acceptable terms depend on the employment of investment professionals in an adequate number and of adequate sophistication to match the corresponding flow of transactions. To achieve our investment objectives, FS/EIG Advisor may need to hire, train, supervise and manage new investment professionals to participate in our investment selection and monitoring process. FS/EIG Advisor may not be able to find investment professionals in a timely manner or at all. Failure to support our investment process could have a material adverse effect on our business, financial condition and results of operations.
In addition, the FS/EIG investment advisory agreement has termination provisions that allow the parties to terminate the agreement without penalty. The FS/EIG investment advisory agreement may be terminated at any time, without penalty, by FS/EIG Advisor, upon 60 days’ written notice to us. If the FS/EIG investment advisory agreement is terminated, it may adversely affect the quality of our investment opportunities. In addition, in the event such agreement is terminated, it may be difficult for us to replace FS/EIG Advisor. Furthermore, the termination of the FS/EIG investment advisory agreement may adversely impact the terms of any existing or future financing arrangement, which could have a material adverse effect on our business, financial condition and results of operations.
FS/EIG Advisor has a limited track record of acting as an investment adviser to a BDC, and any failure by FS/EIG Advisor to manage and support our investment process may hinder the achievement of our investment objectives.
FS/EIG Advisor is jointly operated by an affiliate of FS and EIG and has limited prior experience acting as an investment adviser to a BDC. The 1940 Act and the Code impose numerous constraints on the operations of BDCs that do not apply to other investment vehicles. FS/EIG Advisor’s limited experience in managing a portfolio of assets under the constraints of the 1940 Act and the Code may hinder FS/EIG Advisor’s ability to take advantage of attractive investment opportunities and, as a result, may adversely affect our ability to achieve our investment objectives. The track records and achievements of affiliates of, and funds advised or managed by, FS or EIG are not necessarily indicative of the future results FS/EIG Advisor will achieve as a joint investment adviser. Accordingly, we can offer no assurance that we will replicate the historical performance of other investment companies with which FS and EIG have been affiliated, and we caution that our investment returns could be lower than the returns achieved by such other companies.
Because our business model depends to a significant extent upon relationships with issuers, private equity sponsors, investment banks and commercial banks, the inability of FS/EIG Advisor to maintain or develop these relationships, or the failure of these relationships to generate investment opportunities, could adversely affect our business.
If FS/EIG Advisor fails to maintain its existing relationships with issuers, private equity sponsors, investment banks and commercial banks on which it relies to provide us with potential investment opportunities or develop new relationships with other issuers, sponsors or sources of investment opportunities, we may not be able to grow our investment portfolio. In addition, individuals with whom FS/EIG Advisor has relationships generally are not obligated to provide us with investment opportunities, and, therefore, there is no assurance that such relationships will generate investment opportunities for us.
Our financial condition and results of operations depend on our ability to manage future growth effectively.
Our ability to achieve our investment objectives depends on our ability to acquire suitable investments and monitor and administer those investments, which depends, in turn, on our investment adviser’s ability to identify, invest in and monitor companies that meet our investment criteria.
Accomplishing this result on a cost‑effective basis is largely a function of the structuring of our investment process and the ability of FS/EIG Advisor to provide competent, attentive and efficient services to us. Our executive officers and the members of FS/EIG Advisor’s investment committee have substantial responsibilities in connection with their roles at FS, EIG and the other entities affiliated with FS and EIG, as well as responsibilities under the FS/EIG investment advisory agreement. They may also be called upon to provide significant managerial assistance to certain of our portfolio companies. These demands on their time, which will increase as the number of investments grows, may distract them or slow the rate of investment. In order to grow, FS/EIG Advisor will need to hire, train, supervise, manage and retain new personnel. However, we cannot assure you that FS/EIG Advisor will be able to do so effectively. Any failure to manage our future growth effectively could have a material adverse effect on our business, financial condition and results of operations.
We operate in a highly competitive market for investment opportunities, which could reduce returns and result in losses.
A number of entities compete with us to make the types of investments that we plan to make and we believe that recent market trends, including sustained periods of low interest rates, have increased the number of competitors seeking to invest in loans to private, middle market companies in the United States. We compete with public and private funds, commercial and investment banks, commercial financing companies and, to the extent they provide an alternative form of financing, private equity and hedge funds. Many of our competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do. For example, we believe some of our competitors have access to funding sources that are not available to us. In addition, some of our competitors could have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish more relationships than us. Furthermore, many of our competitors are not subject to the regulatory restrictions that the 1940 Act imposes on us as a BDC or the source of income, asset diversification and distribution requirements we must satisfy to maintain our qualification as a RIC. The competitive pressures we face could have a material adverse effect on our business, financial condition, results of operations and cash flows. As a result of this competition, we can provide no assurance that we will be able to take advantage of attractive investment opportunities that arise from time to time, and we can provide no assurance that we will be able to identify and make investments that are consistent with our investment objective. The amount of capital in the private debt markets and overall competition for loans could result in short-term returns for us that are lower than our long-term targets. In the event these conditions continue for an extended amount of time, they could have a material adverse effect on our business, financial condition and results of operations.
Identifying, structuring and consummating investments involves competition among capital providers and market and transaction uncertainty. FS/EIG Advisor can provide no assurance that it will be able to identify a sufficient number of suitable
investment opportunities or to avoid prepayment of existing investments to satisfy our investment objectives, including as necessary to effectively structure credit facilities or other forms of leverage. The loan origination market is very competitive, which can result in loan terms that are more favorable to borrowers, and conversely less favorable to lenders, such as lower interest rates and fees, weaker borrower financial and other covenants, borrower rights to cure defaults, and other terms more favorable to borrowers than current or historical norms. Increased competition could cause us to make more loans that are “cov-lite” in nature and, in a distressed scenario, there can be no assurance that these loans will retain the same value as loans with a full package of covenants. As a result of these conditions, the market for leveraged loans could become less advantageous than expected for us, and this could increase default rates, decrease recovery rates or otherwise harm our returns. The risk of prepayment is also higher in the current competitive environment if borrowers are offered more favorable terms by other lenders. The financial markets have experienced substantial fluctuations in prices and liquidity for leveraged loans. Any further disruption in the credit and other financial markets could have substantial negative effects on general economic conditions, the availability of required capital for companies and the operating performance of such companies. These conditions also could result in increased default rates and credit downgrades, and affect the liquidity and pricing of the investments made by us. Conversely, periods of economic stability and increased competition among capital providers could increase the difficulty of locating investments that are desirable for us.
With respect to the investments we make, we do not seek to compete based primarily on the interest rates we offer, and we believe that some of our competitors could make loans with interest rates that will be lower than the rates we offer. In the secondary market for acquiring existing loans, we compete generally on the basis of pricing terms. With respect to all investments, we could lose some investment opportunities if we do not match our competitors’ pricing, terms and structure. However, if we match our competitors’ pricing, terms and structure, we could experience decreased net interest income, lower yields and increased risk of credit loss. We could also compete for investment opportunities with accounts managed or sponsored by FS/EIG Advisor or its affiliates. Although FS/EIG Advisor allocates opportunities in accordance with its allocation policy, allocations to such other accounts will reduce the amount and frequency of opportunities available to us and thus not necessarily be in the best interests of us and our security holders. Moreover, the performance of investments will not be known at the time of allocation.
Our board of trustees may change our investment policy by providing our shareholders with 60 days’ prior notice, or may modify or waive our current operating policies and strategy without prior notice or shareholder approval, the effects of which may be adverse.
Our investment policy is to invest, under normal circumstances, at least 80% of our total assets in securities of Energy companies. This investment policy may be changed by our board of trustees if we provide our shareholders with at least 60 days’ prior notice. In addition, our board of trustees has the authority to modify or waive our current operating policies, investment criteria and strategy without prior notice and without shareholder approval. We cannot predict the effect any changes to our investment policy, current operating policies, investment criteria and strategy would have on our business, net asset value, operating results and the value of our common shares. However, the effects might be adverse, which could negatively impact our ability to pay distributions to shareholders and cause shareholders to lose all or part of their investment. Finally, because our common shares are not expected to be listed on a national securities exchange for the foreseeable future, shareholders will be limited in their ability to sell their common shares in response to any changes in our investment policy, operating policies, investment criteria or strategy.
If we, our affiliates and our and their respective third-party service providers are unable to maintain the availability of electronic data systems and safeguard the security of data, our ability to conduct business may be compromised, which could impair our liquidity, disrupt our business, damage our reputation or otherwise affect our business.
Cybersecurity refers to the combination of technologies, processes, and procedures established to protect information technology systems and data from unauthorized access, attack, or damage. We, our affiliates and our and their respective third-party service providers are subject to cybersecurity risks. Our business operations rely upon secure information technology systems for data processing, storage and reporting. We depend on the effectiveness of the information and cybersecurity policies, procedures and capabilities maintained by our affiliates and our and their respective third-party service providers to protect their computer and telecommunications systems and the data that reside on or are transmitted through them. Cybersecurity risks have significantly increased in recent years and, while we have not experienced any material losses relating to cyber attacks or other information security breaches, we could suffer such losses in the future. Our, our affiliates and our and their respective third-party service providers’ computer systems, software and networks may be vulnerable to unauthorized access, computer viruses or other malicious code and other events that could have a security impact, as well as cyber-attacks that do not have a security impact but may nonetheless cause harm, such as causing denial-of-service attacks (i.e., efforts to make network services unavailable to intended users) on websites, servers or other online systems. If one or more of such events occur, it potentially could jeopardize confidential and other information, including nonpublic personal information and sensitive business data, processed and stored in, and transmitted through, computer systems and networks, or otherwise cause interruptions or malfunctions in our operations or the operations of our affiliates and our and their respective third-party service providers. This could result in significant losses, reputational damage, litigation, regulatory fines or penalties, or otherwise adversely affect our business, financial condition or results of operations.
Substantial costs may be incurred in order to prevent any cyber incidents in the future. The costs related to cyber or other security threats or disruptions may not be fully insured or indemnified by other means. Privacy and information security laws and regulation changes, and compliance with those changes, may result in cost increases due to system changes and the development of new administrative processes. In addition, we may be required to expend significant additional resources to modify our protective measures and to investigate and remediate vulnerabilities or other exposures arising from operational and security risks. There is no assurance that any efforts to mitigate cybersecurity risks undertaken by us, our affiliates, or our or their respective third-party service providers will be effective. If we fail to comply with the relevant laws and regulations, we could suffer financial losses, a disruption of our business, liability to investors, regulatory intervention or reputational damage.
Changes in laws or regulations governing our operations or the operations of our business partners may adversely affect our business or cause us to alter our business strategy.
We, our portfolio companies and our business partners are subject to regulation at the local, state and federal level. New legislation may be enacted, amended or repealed or new interpretations, rulings or regulations could be adopted, including those governing the types of investments we are permitted to make and the deductibility of interest expense by our portfolio companies, potentially with retroactive effect. For example, certain provisions of the Dodd-Frank Act, which influences many aspects of the financial services industry, have been amended or repealed and the Code has been substantially amended and reformed. Changes in laws or regulations governing the operations of those with whom we do business, including selected broker-dealers and other financial representatives selling our common shares, could also have a material adverse effect on our business, financial condition and results of operations. New or repealed legislation, interpretations, rulings or regulations could require changes to certain business practices of us or our portfolio companies, negatively impact the operations, cash flows or financial condition of us or our portfolio companies, impose additional costs on us or our portfolio companies or otherwise adversely affect our business or the business of our portfolio companies.
In addition, any changes to the laws and regulations governing our operations, including with respect to permitted investments, may cause us to alter our investment strategy to avail ourselves of new or different opportunities or make other changes to our business. Such changes could result in material differences to our strategies and plans as set forth in this annual report on Form 10-K and may result in our investment focus shifting from the areas of expertise of FS/EIG Advisor to other types of investments in which FS/EIG Advisor may have less expertise or little or no experience. Thus, any such changes, if they occur, could have a material adverse effect on our results of operations and the value of a shareholder's investment.
The Small Business Credit Availability Act, or the SBCA Act, allows us to incur additional leverage.
On March 23, 2018, the SBCA Act became law. The SBCA Act, among other things, amends Section 61(a) of the 1940 Act to add a new Section 61(a)(2) which reduces the asset coverage requirements for senior securities applicable to BDCs from 200% to 150% provided that certain disclosure and approval requirements are met. Before the reduced asset coverage requirements under Section 61(a)(2) are effective with respect to us, the application of that section of the 1940 Act must be approved by either (1) a “required majority,” as defined in Section 57(o) of the 1940 Act, of our board of trustees or (2) a majority of votes cast at a special or annual meeting of our shareholders. If we choose to seek such approval, we may be able to incur substantial additional indebtedness, and, therefore the risk of an investment in us may increase. See “Risks Related to Debt Financing—We currently use borrowed funds to make investments and are exposed to the typical risks associated with leverage.”
As a public company, we are subject to regulations not applicable to private companies, such as provisions of the Sarbanes-Oxley Act. Efforts to comply with such regulations will involve significant expenditures, and non-compliance with such regulations may adversely affect us.
As a public company, we are subject to regulations not applicable to private companies, including provisions of the Sarbanes-Oxley Act and the related rules and regulations promulgated by the SEC. Our management is required to report on our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act and rules and regulations of the SEC thereunder. We are required to review on an annual basis our internal control over financial reporting, and on a quarterly and annual basis, to evaluate and disclose changes in our internal control over financial reporting.
We incur significant expenses in connection with our compliance with the Sarbanes-Oxley Act and other regulations applicable to public companies, which may negatively impact our financial performance and our ability to make distributions. Compliance with such regulations also requires a significant amount of our management’s time and attention. For example, we cannot be certain as to the timing of the completion of our Sarbanes-Oxley mandated evaluations, testings and remediation actions, if any, or the impact of the same on our operations, and we may not be able to ensure that the process is effective or that our internal control over financial reporting are or will be deemed effective in the future. In the event that we are unable to maintain an effective system of internal control and maintain compliance with the Sarbanes-Oxley Act and related rules, we may be adversely affected.
We may invest in derivatives or other assets that expose us to certain risks, including market risk, liquidity risk and other risks similar to those associated with the use of leverage.
We may invest in derivatives and other assets that are subject to many of the same types of risks related to the use of leverage. In October 2020, the SEC adopted Rule 18f-4 under the 1940 Act regarding the ability of a BDC to use derivatives and other transactions that create future payment or delivery obligations. Under Rule 18f-4, BDCs that use derivatives are subject to a value-at-risk leverage limit, a derivatives risk management program and testing requirements and requirements related to board reporting. These requirements apply unless the BDC qualifies as a “limited derivatives user,” as defined under Rule 18f-4. Under Rule 18f-4, a BDC may enter into an unfunded commitment agreement (which may include delayed draw and revolving loans) that will not be deemed to be a derivatives transaction, such as an agreement to provide financing to a portfolio company, if the BDC has, among other things, a reasonable belief, at the time it enters into such an agreement, that it will have sufficient cash and cash equivalents to meet its obligations with respect to all of its unfunded commitment agreements, in each case as it becomes due. Collectively, these requirements may limit our ability to use derivatives and/or enter into certain other financial contracts.
We have adopted updated policies and procedures in compliance with Rule 18f-4. We expect to qualify as a “limited derivatives user.” Future legislation or rules may modify how we treat derivatives and other financial arrangements for purposes of our compliance with the leverage limitations of the 1940 Act. Future legislation or rules may modify how leverage is calculated under the 1940 Act and, therefore, may increase or decrease the amount of leverage currently available to us under the 1940 Act, which may be materially adverse to us and our investors.
We may experience fluctuations in our quarterly results.
We could experience fluctuations in our quarterly operating results due to a number of factors, including our ability or inability to make investments in companies that meet our investment criteria, the interest rate payable on the debt securities we acquire, the level of our expenses, variations in and the timing of the recognition of realized and unrealized gains or losses, the degree to which we encounter competition in our markets and general economic conditions. As a result of these factors, results for any previous period should not be relied upon as being indicative of performance in future periods.
We and FS/EIG Advisor could be the target of litigation.
We and FS/EIG Advisor could become the target of securities class action litigation or other similar claims if our common share price fluctuates significantly or for other reasons. The proceedings could continue without resolution for long periods of time and the outcome of any such proceedings could materially adversely affect our business, financial condition, and/or operating results. Any litigation or other similar claims could consume substantial amounts of our management’s time and attention, and that time and attention and the devotion of associated resources could, at times, be disproportionate to the amounts at stake. Litigation and other claims are subject to inherent uncertainties, and a material adverse impact on our financial statements could occur for the period in which the effect of an unfavorable final outcome in litigation or other similar claims becomes probable and reasonably estimable. In addition, we could incur expenses associated with defending ourselves against litigation and other similar claims, and these expenses could be material to our earnings in future periods.
Risks Related to FS/EIG Advisor and its Respective Affiliates
There may be conflicts of interest related to obligations FS/EIG Advisor’s senior management and investment teams have to our affiliates and to other clients.
The members of the senior management and investment teams of FS/EIG Advisor serve or may serve as officers, directors or principals of entities that operate in the same or a related line of business as we do, or of investment vehicles managed by the same personnel. For example, the officers, managers and other personnel of FS/EIG Advisor serve and may serve in the future in similar capacities for the investment advisers to the other funds managed or advised by FS, and may serve in similar or other capacities for the investment advisers to future investment vehicles affiliated with FS Investments. In serving in these multiple and other capacities, they may have obligations to other clients or investors in those entities, the fulfillment of which may not be in our best interests or in the best interest of our shareholders. Our investment objectives may overlap with the investment objectives of such investment funds, accounts or other investment vehicles. For example, we rely on FS/EIG Advisor to manage our day-to-day activities and to implement our investment strategy. FS/EIG Advisor and certain of its affiliates are presently, and plan in the future to continue to be, involved with activities which are unrelated to us. As a result of these activities, FS/EIG Advisor, its employees and certain of its affiliates will have conflicts of interest in allocating their time between us and other activities in which they are or may become involved, including the management of other entities affiliated with FS Investments. FS/EIG Advisor and its employees will devote only as much of its or their time to our business as FS/EIG Advisor and its employees, in their judgment, determine is reasonably required, which may be substantially less than their full time.
FS/EIG Advisor and its affiliates, including our officers and some of our trustees, face conflicts of interest caused by compensation arrangements with us and our affiliates, which could result in actions that are not in the best interests of our shareholders.
FS/EIG Advisor and its affiliates receive substantial fees from us in return for their services, and these fees could influence the advice provided to us. Among other matters, the compensation arrangements could affect their judgment. In addition, the decision to utilize leverage has increased our assets and, as a result, has increased the amount of base management fees payable to FS/EIG Advisor.
We may be obligated to pay FS/EIG Advisor incentive compensation even if we incur a net loss due to a decline in the value of our portfolio.
The FS/EIG investment advisory agreement entitles FS/EIG Advisor to receive incentive compensation on income regardless of any capital losses. In such case, we may be required to pay FS/EIG Advisor incentive compensation for a fiscal quarter even if there is a decline in the value of our portfolio or if we incur a net loss for that quarter.
Any incentive fee payable by us that relates to our net investment income may be computed and paid on income that may include interest that has been accrued but not yet received. If a portfolio company defaults on a loan that is structured to provide accrued interest, it is possible that accrued interest previously included in the calculation of the incentive fee will become uncollectible. FS/EIG Advisor is not under any obligation to reimburse us for any part of the incentive fee it received that was based on accrued income that we never received as a result of a default by an entity on the obligation that resulted in the accrual of such income, and such circumstances would result in our paying an incentive fee on income we never received.
For U.S. federal income tax purposes, we are required to recognize taxable income (such as deferred interest that is accrued as original issue discount) in some circumstances in which we do not receive a corresponding payment in cash and to make distributions with respect to such income to maintain our status as a RIC. Under such circumstances, we may have difficulty meeting the Annual Distribution Requirement necessary to maintain RIC tax treatment under the Code. This difficulty in making the required distribution may be amplified to the extent that we are required to pay an incentive fee with respect to such accrued income. As a result, we may have to sell some of our investments at times and/or at prices we would not consider advantageous, raise additional debt or equity capital, or forgo new investment opportunities for this purpose. If we are not able to obtain cash from other sources, we may fail to qualify for RIC tax treatment and thus become subject to corporate-level income tax.
The time and resources that individuals employed by FS/EIG Advisor devote to us may be diverted, and we may face additional competition due to the fact that individuals employed by FS/EIG Advisor are not prohibited from raising money for or managing another entity that makes the same types of investments that we target.
Neither FS/EIG Advisor nor persons providing services to us on behalf of FS/EIG Advisor are prohibited from raising money for and managing another investment entity that makes the same types of investments as those we target. As a result, the time and resources that these individuals may devote to us may be diverted. In addition, we may compete with any such investment entity for the same investors and investment opportunities.
Our incentive fee may induce FS/EIG Advisor to make, and EIG to recommend, speculative investments.
The incentive fee payable by us to FS/EIG Advisor may create an incentive for it to enter into investments on our behalf that are risky or more speculative than would be the case in the absence of such compensation arrangement. The way in which the incentive fee payable to FS/EIG Advisor is determined may encourage it to use leverage to increase the return on our investments. In addition, the fact that our base management fee is payable based upon our gross assets, which would include any borrowings for investment purposes, may encourage FS/EIG Advisor to use leverage to make additional investments. Under certain circumstances, the use of leverage may increase the likelihood of default, which would disfavor holders of our common shares. Such a practice could result in our investing in more speculative securities than would otherwise be in our best interests, which could result in higher investment losses, particularly during cyclical economic downturns. In addition, since EIG will receive a portion of the advisory fees paid to FS/EIG Advisor, EIG may have an incentive to recommend investments that are riskier or more speculative.
FS/EIG Advisor’s liability is limited under the FS/EIG investment advisory agreement, and we are required to indemnify FS/EIG Advisor against certain liabilities, which may lead it to act in a riskier manner on our behalf than it would when acting for its own account.
Pursuant to the FS/EIG investment advisory agreement, FS/EIG Advisor and its officers, managers, partners, members (and their members, including the owners of their members), agents, employees, controlling persons and any other person or entity affiliated with FS/EIG Advisor will not be liable to us for their acts under the FS/EIG investment advisory agreement, absent willful misfeasance, bad faith or gross negligence in the performance of their duties. We have agreed to indemnify, defend and protect FS/EIG Advisor and its officers, managers, partners, members (and their members, including the owners of their members), agents,
employees, controlling persons and any other person or entity affiliated with FS/EIG Advisor with respect to all damages, liabilities, costs and expenses resulting from acts of FS/EIG Advisor not arising out of willful misfeasance, bad faith or gross negligence in the performance of their duties under the FS/EIG investment advisory agreement. These protections may lead FS/EIG Advisor to act in a riskier manner when acting on our behalf than it would when acting for its own account.
Risks Related to Business Development Companies
The requirement that we invest a sufficient portion of our assets in qualifying assets could preclude us from investing in accordance with our current business strategy; conversely, the failure to invest a sufficient portion of our assets in qualifying assets could result in our failure to maintain our status as a BDC.
As a BDC, we may not acquire any assets other than “qualifying assets” unless, at the time of such acquisition, at least 70% of our total assets are qualifying assets. Therefore, we may be precluded from investing in what we believe are attractive investments if such investments are not qualifying assets. Similarly, these rules could prevent us from making additional investments in existing portfolio companies, which could result in the dilution of our position, or could require us to dispose of investments at an inopportune time to comply with the 1940 Act. If we were forced to sell non-qualifying investments in the portfolio for compliance purposes, the proceeds from such sale could be significantly less than the current value of such investments. Conversely, if we fail to invest a sufficient portion of our assets in qualifying assets, we could lose our status as a BDC, which would have a material adverse effect on our business, financial condition and results of operations.
Failure to maintain our status as a BDC would reduce our operating flexibility.
If we do not remain a BDC, we might be regulated as a closed-end investment company under the 1940 Act, which would subject us to substantially more regulatory restrictions under the 1940 Act and correspondingly decrease our operating flexibility.
Regulations governing our operation as a BDC and a RIC will affect our ability to raise, and the way in which we raise, additional capital or borrow for investment purposes, which may have a negative effect on our growth.
As a result of our need to satisfy the Annual Distribution Requirement in order to maintain RIC tax treatment under Subchapter M of the Code, we may need to periodically access the capital markets to raise cash to fund new investments. We may issue "senior securities," as defined in the 1940 Act, including issuing preferred shares, borrowing money from banks or other financial institutions or issuing debt securities only in amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200% after such incurrence or issuance. Our ability to issue certain other types of securities is also limited. Under the 1940 Act, we are also generally prohibited from issuing or selling our shares at a price per share, after deducting underwriting commissions, that is below our net asset value per share, without first obtaining approval for such issuance from our shareholders and our independent trustees. Compliance with these limitations on our ability to raise capital may unfavorably limit our investment opportunities and may reduce our ability in comparison to other companies to profit from favorable spreads between the rates at which we can borrow and the rates at which we can lend.
We expect to continue to borrow for investment purposes. If the value of our assets declines, we may be unable to satisfy the asset coverage test, which would prohibit us from paying distributions and as a result could cause us to be subject to corporate-level tax on our income and capital gains, regardless of the amount of distributions paid. If we cannot satisfy the asset coverage test, we may be required to sell a portion of our investments and, depending on the nature of our debt financing, repay a portion of our indebtedness at a time when such sales may be disadvantageous.
Our ability to enter into transactions with our affiliates is restricted.
We are prohibited under the 1940 Act from participating in certain transactions with certain of our affiliates without the prior approval of a majority of the independent members of our board of trustees and, in some cases, the SEC. Any person that owns, directly or indirectly, 5% or more of our outstanding voting securities will be our affiliate for purposes of the 1940 Act and we will generally be prohibited from buying or selling any securities from or to such affiliate, absent the prior approval of our board of trustees. The 1940 Act also prohibits certain "joint" transactions with certain of our affiliates, which could include investments in the same portfolio company (whether at the same or different times), without prior approval of our board of trustees and, in some cases, the SEC. In an order dated June 4, 2013, the SEC granted exemptive relief permitting us, subject to the satisfaction of certain conditions, to co-invest in certain privately negotiated investment transactions with our co-investment affiliates. Similarly, pursuant to the EIG Order we are permitted to participate in co-investment transactions with certain other EIG advised funds. If a person acquires more than 25% of our voting securities, we will be prohibited from buying or selling any security from or to such person or certain of that person's affiliates, or entering into prohibited joint transactions with such persons to the extent not covered by our exemptive relief, absent the prior approval of the SEC. Similar restrictions limit our ability to transact business with our officers or trustees or their affiliates. As a result of these restrictions, we may be prohibited from buying or selling any security from or to any portfolio
company of a fund managed by FS/EIG Advisor without the prior approval of the SEC, which may limit the scope of investment opportunities that would otherwise be available to us.
We are uncertain of our sources for funding our future capital needs; if we cannot obtain debt or equity financing on acceptable terms, our ability to acquire investments and to expand our operations will be adversely affected.
Any working capital reserves we maintain may not be sufficient for investment purposes, and we may require debt or equity financing to operate. We may also need to access the capital markets to refinance existing debt obligations to the extent maturing obligations are not repaid with cash flows from operations. In order to maintain RIC tax treatment, we must make distributions to our shareholders each tax year on a timely basis generally of an amount at least equal to 90% of our investment company taxable income, determined without regard to any deduction for distributions paid, and the amounts of such distributions will therefore not be available to fund investment originations or to repay maturing debt. In addition, with certain limited exceptions, we are only allowed to borrow amounts or issue debt securities or preferred shares, which we refer to collectively as "senior securities," such that our asset coverage, as calculated pursuant to the 1940 Act, equals at least 200% immediately after such borrowing, which, in certain circumstances, may restrict our ability to borrow or issue debt securities or preferred shares. In the event that we develop a need for additional capital in the future for investments or for any other reason, and we cannot obtain debt or equity financing on acceptable terms, or at all, our ability to acquire investments and to expand our operations will be adversely affected. As a result, we would be less able to allocate our portfolio among various issuers and sub-sectors and achieve our investment objectives, which may negatively impact our results of operations and reduce our ability to make distributions to our shareholders.
Risks Related to Our Investments
Inflation may adversely affect the business, results of operations and financial condition of our portfolio companies.
Certain of our portfolio companies are in industries that may be impacted by inflation. If such portfolio companies are unable to pass any increases in their costs of operations along to their customers, it could adversely affect their operating results and impact their ability to pay interest and principal on our loans, particularly if interest rates rise in response to inflation. In addition, any projected future decreases in our portfolio companies’ operating results due to inflation could adversely impact the fair value of those investments. Any decreases in the fair value of our investments could result in future realized or unrealized losses and therefore reduce our net assets resulting from operations.
Our investments in prospective portfolio companies may be risky, and we could lose all or part of our investment.
Our investments in senior secured and unsecured debt, select equity investments and other investments issued by private Energy companies may be risky.
Senior Debt. There is a risk that any collateral pledged by portfolio companies in which we have taken a security interest may decrease in value over time or lose its entire value, may be difficult to sell in a timely manner, may be difficult to appraise and may fluctuate in value based upon the success of the business and market conditions, including as a result of the inability of the portfolio company to raise additional capital. To the extent our debt investment is collateralized by the securities of a portfolio company's subsidiaries, such securities may lose some or all of their value in the event of the bankruptcy or insolvency of the portfolio company. Also, in some circumstances, our security interest may be contractually or structurally subordinated to claims of other creditors. In addition, deterioration in a portfolio company's financial condition and prospects, including its inability to raise additional capital, may be accompanied by deterioration in the value of the collateral for the loan. Loans that are under-collateralized involve a greater risk of loss. In addition, second lien secured loans are granted a second priority security interest in collateral, which means that any realization of collateral will generally be applied to pay first lien secured loans in full before second lien secured loans are paid. Consequently, the fact that a loan is secured does not guarantee that we will receive principal and interest payments according to the senior debt's terms, or at all, or that we will be able to collect on the loan should we be forced to enforce our remedies.
Unsecured Debt. Our unsecured debt investments will generally rank junior in priority of payment to senior debt and will generally be unsecured. This may result in a heightened level of risk and volatility or a loss of principal, which could lead to the loss of the entire investment. These investments may involve additional risks that could adversely affect our investment returns. To the extent interest payments associated with such debt are deferred, such debt may be subject to greater fluctuations in valuations, and such debt could subject us and our shareholders to non-cash income. Because we will not receive any principal repayments prior to the maturity of some of our unsecured debt investments, such investments will be of greater risk than amortizing loans.
Equity and Equity-Related Investments. We expect to make select equity investments in income-oriented preferred or common equity interests, which may include interests in MLPs. In addition, when we invest in senior secured loans and notes or unsecured debt, we may acquire warrants to purchase equity securities. In connection with certain of our debt investments or any restructurings of these debt investments, we may on occasion receive equity interests, including warrants or options, as additional
consideration or otherwise in connection with a restructuring. The equity interests we receive may not appreciate in value and, in fact, may decline in value. Accordingly, we may not be able to realize gains from our equity interests, and any gains that we do realize on the disposition of any equity interests may not be sufficient to offset any other losses we experience.
Net Profits Interests, Royalty Interests or VPPs. We may invest in energy-specific non-operating investments including net profits interests, royalty interests or VPPs. Net profits interests and royalty interests are contractual agreements whereby the holders of such interests are entitled to a portion of the mineral production, or proceeds therefrom. A VPP is a type of structured investment whereby the owner sells a specific volume of production in a field or property to an investor and the investor receives a specific quota of production on a monthly basis in either raw output or proceeds therefrom. We will not have any operational control over these investments and our receipt of payments is contingent on the producer's ability to meet its supply obligations, which can make these types of investments highly speculative.
Non-U.S. Securities. We may invest in non-U.S. securities, which may include securities denominated in U.S. dollars or in non-U.S. currencies and securities of companies in emerging markets, to the extent permitted by the 1940 Act. Because evidences of ownership of such securities usually are held outside the United States, we would be subject to additional risks if we invested in non-U.S. securities, which include possible adverse political and economic developments, seizure or nationalization of foreign deposits and adoption of governmental restrictions which might adversely affect or restrict the payment of principal and interest on the non-U.S. securities to investors located outside the country of the issuer, whether from currency blockage or otherwise. Because non-U.S. securities may be purchased with and payable in foreign currencies, the value of these assets as measured in U.S. dollars may be affected unfavorably by changes in currency rates and exchange control regulations.
Investments in Asset-Based Opportunities. We may invest in asset-based opportunities through joint ventures, investment platforms, private investment funds or other business entities that provide one or more of the following services: origination or sourcing of potential investment opportunities, due diligence and negotiation of potential investment opportunities and/or servicing, development and management (including turnaround) and disposition of investments. Such investments may be in or alongside existing or newly formed operators, consultants and/or managers that pursue such opportunities and may or may not include capital and/or assets contributed by third party investors. Such investments may include opportunities to direct-finance physical assets, such as airplanes and ships, and/or operating assets, such as financial service entities, as opposed to investment securities, or to invest in origination and/or servicing platforms directly. In valuing our investments, we rely primarily on information provided by operators, consultants and/or managers. Valuations of illiquid securities involve various judgments and consideration of factors that may be subjective. There is a risk that inaccurate valuations could adversely affect the value of our common shares. We may not be able to promptly withdraw our investment in these asset-based opportunities, which may result in a loss to us and adversely affect our investment returns.
In addition, we invest in securities that are rated below investment grade by rating agencies or that would be rated below investment grade if they were rated. Below investment grade securities, which are often referred to as "junk," have predominantly speculative characteristics with respect to the Shares. issuer's capacity to pay interest and repay principal. They may also be difficult to value and illiquid.
If our portfolio is concentrated in a single or limited number of investments at any given time, our performance may be significantly adversely affected by the unfavorable performance of a small number of such investments or a substantial write-down of the value of any one investment.
We may from time to time hold securities of a single portfolio company that comprise more than 5% of our total assets and/or more than 10% of the outstanding voting securities of the portfolio company. For that reason, we are classified as a non-diversified management investment company under the 1940 Act. As of December 31, 2022, we had an investment in a single portfolio company, which represented approximately 15.3% of our total investment portfolio, by fair value. A consequence of the concentration of a small number of investments at any given time is that the aggregate income and returns we realize may be significantly adversely affected by the unfavorable performance of a single or small number of such investments or a substantial write-down of the value of any one investment.
Our portfolio companies may incur debt that ranks equally with, or senior to, our investments in such companies.
Our portfolio companies may have, or may be permitted to incur, other debt that ranks equally with, or senior to, the debt in which we invest. By their terms, such debt instruments may entitle the holders to receive payment of interest or principal on or before the dates on which we are entitled to receive payments with respect to the debt instruments in which we invest. Also, in the event of insolvency, liquidation, dissolution, reorganization or bankruptcy of a portfolio company, holders of debt instruments ranking senior to our investment in that portfolio company would typically be entitled to receive payment in full before we receive any proceeds. After repaying such senior creditors, such portfolio company may not have any remaining assets to use for repaying its obligation to us. In the case of debt ranking equally with debt instruments in which we invest, we would have to share on an equal basis any
distributions with other creditors holding such debt in the event of an insolvency, liquidation, dissolution, reorganization or bankruptcy of the relevant portfolio company.
There are no Sharesmay be circumstances where our debt investments could be subordinated to claims of other creditors or we could be subject to optionslender liability claims.
If one of our portfolio companies were to go bankrupt, depending on the facts and circumstances, including the extent to which we actually provided managerial assistance to that portfolio company, a bankruptcy court might recharacterize our debt investment and subordinate all or a portion of our claim to that of other creditors. In situations where a bankruptcy carries a high degree of political significance, our legal rights may be subordinated to other creditors. We may also be subject to lender liability claims for actions taken by us with respect to a borrower's business or in instances where we exercise control over the borrower or render significant managerial assistance.
We generally will not control our portfolio companies.
We do not expect to control most of our portfolio companies, even though we may have board representation or board observation rights, and our debt agreements with such portfolio companies may contain certain restrictive covenants. As a result, we are
currently exercisable or exercisable within 60 days of April 1, 2022. | | | | | | | | |
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Name and Address of Beneficial Owner(1)
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Shares | | | Percentage (%)(2) | |
Interested Trustees:
| | | | | | | | |
Michael C. Forman(3)
| | | 446,793.656 | | | | | * |
R. Blair Thomas
| | | — | | | | — | |
Independent Trustees:
| | | | | | | | |
Sidney R. Brown(4)
| | | 64,870.090 | | | | | * |
Gregory P. Chandler(5)
| | | 29,461.414 | | | | | * |
Richard I. Goldstein
| | | 43,992.788 | | | | | * |
Kathleen A. McGinty
| | | — | | | | — | |
Charles P. Pizzi
| | | 22,003.792 | | | | | * |
Pedro A. Ramos
| | | — | | | | — | |
Executive Officers:
| | | | | | | | |
Eric Long
| | | — | | | | — | |
Edward T. Gallivan, Jr.
| | | 5,171.140 | | | | | * |
David Weiser
| | | — | | | | — | |
James Beach
| | | 2,114.739 | | | | | * |
Stephen S. Sypherd(6)
| | | 7,920.475 | | | | | * |
James F. Volk
| | | 2,212.759 | | | | | * |
All Trustees and Executive Officers as a group (14 persons)
| | | 624,540.853 | | | | | * |
(1) | The address of each of the beneficial owners set forth above is c/o FS Energy and Power Fund, 201 Rouse Boulevard, Philadelphia, Pennsylvania 19112.
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Item 13. | Certain Relationships and Related Transactions, and Trustee Independence.
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Certain Relationships and Related Party Transactions
The Company has procedures in place for the review, approval and monitoring of transactions involving the Company and certain persons relatedsubject to the Company. For example,risk that a portfolio company in which we invest may make business decisions with which we disagree and the Company’s Codemanagement of Business Conduct and Ethics generally prohibits any employee, officersuch company, as representatives of the holders of their common equity, may take risks or trustee from engagingotherwise act in any transaction whereways that do not serve our interests as debt investors. Due to the lack of liquidity for our investments in non-traded companies, we may not be able to dispose of our interests in our portfolio companies as readily as we would like or at an appropriate valuation. As a result, a portfolio company may make decisions that could decrease the value of our portfolio holdings.
Second priority liens on collateral securing debt investments that we make to our portfolio companies may be subject to control by senior creditors with first priority liens. If there is a conflict between such individual’s personal interest anddefault, the interestsvalue of the Company. Waiverscollateral may not be sufficient to repay in full both the Codefirst priority creditors and us.
Certain debt investments that we make in portfolio companies may be secured on a second priority basis by the same collateral securing first priority debt of Business Conductsuch companies. The first priority liens on the collateral will secure the portfolio company's obligations under any outstanding senior debt and Ethics formay secure certain other future debt that may be permitted to be incurred by such company under the agreements governing the loans. The holders of obligations secured by the first priority liens on the collateral will generally control the liquidation of and be entitled to receive proceeds from any executive officer or memberrealization of the Board must be approved by the Board and are publicly disclosed as required by applicable law and regulations.collateral to repay their obligations in full before us. In addition, the Audit Committeevalue of the collateral in the event of liquidation will depend on market and economic conditions, the availability of buyers and other factors. There can be no assurance that the proceeds, if any, from the sale or sales of all of the collateral would be sufficient to satisfy the debt obligations secured by the second priority liens after payment in full of all obligations secured by the first priority liens on the collateral. If such proceeds are not sufficient to repay amounts outstanding under the debt obligations secured by the second priority liens, then we, to the extent not repaid from the proceeds of the sale of the collateral, will only have an unsecured claim against such company's remaining assets, if any.
We may also make unsecured debt investments in portfolio companies, meaning that such investments will not benefit from any interest in collateral of such companies. Liens on any such portfolio company’s collateral, if any, will secure the portfolio company’s obligations under its outstanding secured debt and may secure certain future debt that is permitted to be incurred by the portfolio company under its secured debt agreements. The holders of obligations secured by such liens will generally control the liquidation of, and be entitled to receive proceeds from, any realization of such collateral to repay their obligations in full before us. In addition, the value of such collateral in the event of liquidation will depend on market and economic conditions, the availability of buyers and other factors. There can be no assurance that the proceeds, if any, from sales of such collateral would be sufficient to satisfy our unsecured debt obligations after payment in full of all secured debt obligations. If such proceeds were not sufficient to repay the outstanding secured debt obligations, then our unsecured claims would rank equally with the unpaid portion of such secured creditors’ claims against the portfolio company’s remaining assets, if any.
The rights we may have with respect to the collateral securing the debt investments we make in our portfolio companies with senior debt outstanding may also be limited pursuant to the terms of one or more intercreditor agreements that we enter into with the holders of senior debt. Under such an intercreditor agreement, at any time that obligations that have the benefit of the first priority liens are outstanding, any of the following actions that may be taken in respect of the collateral will be at the direction of the holders of the obligations secured by the first priority liens: the ability to cause the commencement of enforcement proceedings against the collateral; the ability to control the conduct of such proceedings; the approval of amendments to collateral documents; releases of liens on the collateral; and waivers of past defaults under collateral documents. We may not have the ability to control or direct such actions, even if our rights are adversely affected.
Declines in market values or fair market values of our investments could result in significant net unrealized depreciation of our portfolio, which, in turn, would reduce our net asset value.
Under the 1940 Act, we are required to reviewcarry our investments at market value or, if there is no readily available market value, at fair value, in accordance with policies and approveprocedures approved by our board of trustees. While most of our investments will not be publicly traded, applicable accounting standards require us to assume as part of our valuation process that our investments are sold in a principal market to market participants (even if we plan on holding an investment through its maturity) and impairments of the market values or fair market values of our investments, even if unrealized, must be reflected in our financial statements for the applicable period as unrealized depreciation, which could result in significant reductions to our net asset value for a given period.
A significant portion of our investment portfolio does not have a readily available market price and is and will be recorded at fair value in accordance with policies and procedures approved by our board of trustees and, as a result, there is and will be uncertainty as to the value of our portfolio investments.
Under the 1940 Act, we are required to carry our portfolio investments at market value or, if there is no readily available market value, at fair value in accordance with policies and procedures approved by our board of trustees. There is not a public market for the securities of certain of the companies in which we invest. Many of our investments are not publicly-traded or actively-traded on a secondary market but are, instead, traded on a privately negotiated over-the-counter secondary market for institutional investors or are not traded at all. As a result, FS/EIG Advisor, with oversight from our board of trustees, will value these securities quarterly at fair value.
Pursuant to Rule 2a-5 under the 1940 Act, our board has designated FS/EIG Advisor to perform, subject to board oversight, fair value determinations of our investments. Certain factors that may be considered in determining the fair value of our investments include dealer quotes for securities traded on the secondary market for institutional investors, the nature and realizable value of any collateral, the portfolio company’s earnings and its ability to make payments on its indebtedness, the markets in which the portfolio company does business, comparison to comparable companies, discounted cash flows and other relevant factors. Because such valuations, and particularly valuations of private securities and private companies, are inherently uncertain, may fluctuate over short periods of time and may be based on estimates, our determinations of fair value may differ materially from the values that would have been used if a ready market for these securities existed. Due to this uncertainty, our fair value determinations may cause our net asset value on a given date to materially understate or overstate the value that we may ultimately realize upon the sale of one or more of our investments.
We are exposed to risks associated with changes in interest rates.
Because we intend to use debt to finance investments, our net investment income will depend, in part, upon the difference between the rate at which we borrow funds and the rate at which we invest those funds. As a result, we can offer no assurance that a significant change in market interest rates will not have a material adverse effect on our net investment income. In periods of rising interest rates when we have debt outstanding, our cost of funds will increase, which could reduce our net investment income. We expect that our long-term fixed-rate investments will be financed primarily with equity and long-term debt. We may use interest rate risk management techniques in an effort to limit our exposure to interest rate fluctuations. These techniques may include various interest rate hedging activities to the extent permitted by the 1940 Act. These activities may limit our ability to participate in the benefits of lower interest rates with respect to the hedged portfolio. 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. Also, we have limited experience in entering into hedging transactions, and we will initially have to develop such expertise or arrange for such expertise to be provided.
We have and may continue to structure the majority of our debt investments with floating interest rates to position our portfolio for rate increases. However, there can be no assurance that this will successfully mitigate our exposure to interest rate risk. For example, in rising interest rate environments, payments under floating rate debt instruments generally will rise and there may be a significant number of issuers of such floating rate debt instruments that will be unable or unwilling to pay such increased interest costs and may otherwise be unable to repay their loans. Rising interest rates could also cause portfolio companies to shift cash from other productive uses to the payment of interest, which may have a material adverse effect on their business and operations and could, over time, lead to increased defaults. Investments in floating rate debt instruments may also decline in value in response to rising interest rates if the interest rates of such investments do not rise as much, or as quickly, as market interest rates in general. Similarly, during periods of rising interest rates, our fixed rate investments may decline in value because the fixed rate of interest paid thereunder may be below market interest rates.
On March 5, 2021, the United Kingdom’s Financial Conduct Authority publicly announced that all transactionsU.S. Dollar LIBOR settings will either cease to be provided by any administrator or no longer be representative (i) immediately after December 31, 2021 for one-week and two-month U.S. Dollar LIBOR settings and (ii) immediately after June 30, 2023 for the remaining U.S. Dollar
LIBOR settings. Although most U.S. dollar LIBOR rates will continue to be published through June 30, 2023, the FCA no longer compels panel banks to continue to contribute to LIBOR and the Federal Reserve Board, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation have encouraged banks to cease entering into new contracts that use U.S. dollar LIBOR as a reference rate. The U.S. Federal Reserve, in conjunction with related personsthe Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions, supports replacing U.S.-dollar LIBOR with the Secured Overnight Financing Rate, or SOFR, a new index calculated by short-term repurchase agreements backed by Treasury securities.
Some regulators have prohibited the use of any LIBOR benchmarks in new contracts and have required that regulated entities transition existing contracts to another benchmark prior to June 30, 2023. Although settings of such LIBOR benchmarks may continue to be available, such prohibitions and requirements may adversely affect the value of floating-rate debt securities in our portfolio or issued by us. Moreover, at this time, no consensus exists as to what rate or rates will become accepted alternatives to LIBOR. The transition away from LIBOR to alternative reference rates is complex and could have a material adverse effect on our business, financial condition and results of operations, including as a result of any changes in the pricing of our investments, changes to the documentation for certain of our investments and the pace of such changes, disputes and other actions regarding the interpretation of current and prospective loan documentation or modifications to processes and systems.
In anticipation of the cessation of LIBOR, we may need to renegotiate any credit agreements extending beyond June 30, 2023 with our portfolio companies that utilize LIBOR as a factor in determining the interest rate or rely on certain fallback provisions that could cause interest rates to shift to a base rate plus a margin. Any such renegotiations may have a material adverse effect on our business, financial condition and results of operations, including as a result of changes in interest rates payable to us by our portfolio companies.
Alteration of the terms of a debt instrument or a modification of the terms of other types of contracts to replace an interbank offered rate with a new reference rate could result in a taxable exchange and the realization of income and gain/loss for U.S. federal income tax purposes. The Internal Revenue Service, or IRS, has issued final regulations regarding the tax consequences of the transition from interbank offered rates to new reference rates in debt instruments and non-debt contracts. Under the final regulations, alteration or modification of the terms of a debt instrument to replace an operative rate that uses a discontinued interbank offered rate with a qualified rate (as defined in Item 404the final regulations), add a qualified rate as a fallback rate to a contract whose operative rate uses a discontinued interbank offered rate or replace a fallback rate that uses a discontinued interbank offered rate with a qualified rate would not be taxable. The IRS may provide additional guidance, with potential retroactive effect.
Furthermore, a rise in the general level of Regulation S-K promulgatedinterest rates can be expected to lead to higher interest rates applicable to our debt investments. Accordingly, an increase in interest rates would make it easier for us to meet or exceed the incentive fee hurdle rate and may result in a substantial increase of the amount of incentive fees payable to FS/EIG Advisor with respect to pre-incentive fee net investment income.
A covenant breach by our portfolio companies may harm our operating results.
A portfolio company's failure to satisfy financial or operating covenants imposed by us or other lenders could lead to defaults and, potentially, termination of its loans and foreclosure on its secured assets, which could trigger cross-defaults under other agreements and jeopardize a portfolio company's ability to meet its obligations under the Exchange Act). Priordebt or equity securities that we hold. We may incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms, which may include the waiver of certain financial covenants, with a defaulting portfolio company.
Our portfolio companies may be highly leveraged.
Some of our portfolio companies may be highly leveraged, which may have adverse consequences to these companies and to us as an investor. These companies may be subject to restrictive financial and operating covenants and the leverage may impair these companies' ability to finance their future operations and capital needs. As a result, these companies' flexibility to respond to changing business and economic conditions and to take advantage of business opportunities may be limited. Further, a leveraged company's income and net assets will tend to increase or decrease at a greater rate than if borrowed money were not used.
Investing in middle-market companies involves a number of significant risks, any one of which could have a material adverse effect on our operating results.
Investments in middle-market companies involve some of the same risks that apply generally to investments in larger, more established companies. However, such investments have more pronounced risks in that they:
•may have limited financial resources and may be unable to meet the obligations under their debt and equity securities that we hold, which may be accompanied by a deterioration in the value of any collateral pledged under such securities
and a reduction in the likelihood of us realizing any guarantees we may have obtained in connection with our investment;
•have shorter operating histories, narrower product lines and smaller market shares than larger businesses, which tends to render them more vulnerable to competitors' actions and changing market conditions, as well as general economic downturns;
•are more likely to depend on the management talents and efforts of a small group of persons; therefore, the death, disability, resignation or termination of one or more of these persons could have a material adverse impact on our portfolio company and, in turn, on us;
•generally have less predictable operating results, may from time to time be parties to litigation, may be engaged in rapidly changing businesses with products subject to a substantial risk of obsolescence, and may require substantial additional capital to support their operations, finance expansion or maintain their competitive position. In addition, our executive officers, trustees and members of FS/EIG Advisor may, in the ordinary course of business, be named as defendants in litigation arising from our investments in the portfolio companies; and
•may have difficulty accessing the capital markets to meet future capital needs, which may limit their ability to grow or to repay their outstanding indebtedness upon maturity.
We may not realize gains from our equity investments.
Certain investments that we may make may include equity related securities, such as rights and warrants that may be converted into or exchanged for shares or the cash value of the shares. In addition, we may make direct equity investments in portfolio companies. The equity interests we receive may not appreciate in value and, in fact, may decline in value. Accordingly, we may not be able to realize gains from our equity interests, and any gains that we do realize on the disposition of any equity interests may not be sufficient to offset any other losses we experience. We may also be unable to realize any value if a portfolio company does not have a liquidity event, such as a sale of the business, recapitalization or public offering, which would allow us to sell the underlying equity interests. We may be unable to exercise any put rights we acquire which grant us the right to sell our equity securities back to the portfolio company for the consideration provided in our investment documents if the issuer is in financial distress.
An investment strategy focused primarily on privately-held companies presents certain challenges, including the lack of available information about these companies.
Our investments are primarily in privately-held companies. Investments in private companies pose significantly greater risks than investments in public companies. First, private companies have reduced access to the capital markets, resulting in diminished capital resources and the ability to withstand financial distress. As a result, these companies, which may present greater credit risk than public companies, may be unable to meet the obligations under their debt and equity securities that we hold. Second, the investments themselves often may be illiquid. The securities of many of the companies in which we invest are not publicly-traded or actively-traded on the secondary market and are, instead, traded on a privately negotiated over-the-counter secondary market for institutional investors. In addition, such securities may be subject to legal and other restrictions on resale. As such, we may have difficulty exiting an investment promptly or at a desired price prior to maturity or outside of a normal amortization schedule. In addition, in a restructuring, we may receive substantially different securities than our original investment in a portfolio company, including securities in a different part of the capital structure. These investments may also be difficult to value because little public information generally exists about private companies, requiring an experienced due diligence team to analyze and value the potential portfolio company. Finally, these companies often may not have third-party debt ratings or audited financial statements. We must therefore rely on the ability of FS/EIG Advisor to obtain adequate information through due diligence to evaluate the creditworthiness and potential returns from investing in these companies. These companies and their financial information will generally not be subject to the Sarbanes-Oxley Act and other rules and regulations that govern public companies. If we are unable to uncover all material information about these companies, or receive timely information, we may not make a fully informed investment decision, and we may lose money on our investments.
A lack of liquidity in certain of our investments may adversely affect our business.
We invest in certain companies whose securities are not publicly-traded or actively-traded on the secondary market and are, instead, traded on a privately-negotiated over-the-counter secondary market for institutional investors, and whose securities are subject to legal and other restrictions on resale or are otherwise less liquid than publicly-traded securities. The illiquidity of certain of our investments may make it difficult for us to sell these investments when desired. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the value at which we had previously recorded these investments. The reduced liquidity of our investments may make it difficult for us to dispose of them at a favorable price, and, as a result, we may suffer losses.
We may not have the funds or ability to make additional investments in our portfolio companies.
We may not have the funds or ability to make additional investments in our portfolio companies. After our initial investment in a portfolio company, we may be called upon from time to time to provide additional funds to such company or have the opportunity to increase our investment through the exercise of a warrant to purchase common stock. There is no assurance that we will make, or will have sufficient funds to make, follow-on investments. Any decisions not to make a follow-on investment or any inability on our part to make such an investment may have a negative impact on a portfolio company in need of such an investment, may result in a missed opportunity for us to increase our participation in a successful operation or may reduce the expected return on the investment.
Our investments may include original issue discount and PIK instruments.
To the extent that we invest in original issue discount or PIK instruments and the accretion of original issue discount or PIK interest income constitutes a portion of our income, we will be exposed to risks associated with the requirement to include such non-cash income in taxable and accounting income prior to receipt of cash, including the following:
•The higher interest rates on PIK instruments reflect the payment deferral and increased credit risk associated with these instruments, and PIK instruments generally represent a significantly higher credit risk than coupon loans;
•Original issue discount and PIK instruments may have unreliable valuations because the accruals require judgments about collectability of the deferred payments and the value of any associated collateral;
•An election to defer PIK interest payments by adding them to the principal on such instruments increases our future investment income which increases our gross assets and, as such, increases FS/EIG Advisor’s future base management fees which, thus, increases FS/EIG Advisor’s future income incentive fees at a compounding rate;
•Market prices of PIK instruments and other zero coupon instruments are affected to a greater extent by interest rate changes, and may be more volatile than instruments that pay interest periodically in cash. While PIK instruments are usually less volatile than zero coupon debt instruments, PIK instruments are generally more volatile than cash pay securities;
•The deferral of PIK interest on an instrument increases the loan-to-value ratio, which is a measure of the riskiness of a loan, with respect to such instrument;
•Even if the conditions for income accrual under GAAP are satisfied, a borrower could still default when actual payment is due upon the maturity of such loan;
•For accounting purposes, cash distributions to investors representing original issue discount income do not come from paid-in capital, although they may be paid from the offering proceeds. Thus, although a distribution of original issue discount income may come from the cash invested by investors, the 1940 Act does not require that investors be given notice of this fact;
•Tax legislation requires that income be recognized for tax purposes no later than when recognized for financial reporting purposes;
•The required recognition of PIK interest for U.S federal income tax purposes may have a negative impact on liquidity, as it represents a non-cash component of our investment company taxable income, income that may require cash distributions to shareholders in order to maintain our ability to be subject to tax as a RIC; and
•Original issue discount may create a risk of non-refundable cash payments to FS/EIG Advisor based on non-cash accruals that may never be realized.
We may from time to time enter into total return swaps, credit default swaps, fixed priced swaps or other derivative transactions which expose us to certain risks, including credit risk, market risk, commodity risk, liquidity risk and other risks similar to those associated with the use of leverage.
We may from time to time enter into total return swaps, credit default swaps or other derivative transactions that seek to modify or replace the investment performance of a particular reference security or other asset. These transactions are typically individually negotiated, non-standardized agreements between two parties to exchange payments, with payments generally calculated by reference to a notional amount or quantity. Swap contracts and similar derivative contracts are not traded on exchanges; rather, banks and dealers act as principals in these markets. These investments may present risks in excess of those resulting from the referenced security or other asset. Because these transactions are not an acquisition of the referenced security or other asset itself, the investor has no right directly to enforce compliance with the terms of the referenced security or other asset and has no voting or other consensual rights of ownership with respect to the referenced security or other asset. In the event of insolvency of a counterparty, we
will be treated as a general creditor of the counterparty and will have no claim of title with respect to the referenced security or other asset.
A total return swap is a contract in which one party agrees to make periodic payments to another party based on the change in the market value of the referenced security or other assets underlying the total return swap during a specified period, in return for periodic payments based on a fixed or variable interest rate.
A total return swap is subject to market risk, liquidity risk and risk of imperfect correlation between the value of the total return swap and the debt obligations underlying the total return swap. In addition, we may incur certain costs in connection with a total return swap that could in the aggregate be significant.
A credit default swap is a contract in which one party buys or sells protection against a credit event with respect to an issuer, such as an issuer’s failure to make timely payments of interest or principal on its debt obligations, bankruptcy or restructuring during a specified period. Generally, if we sell credit protection using a credit default swap, we will receive fixed payments from the swap counterparty and if a credit event occurs with respect to the applicable issuer, we will pay the swap counterparty par for the issuer’s defaulted debt securities and the swap counterparty will deliver the defaulted debt securities to us. Generally, if we buy credit protection using a credit default swap, we will make fixed payments to the counterparty and if a credit event occurs with respect to the applicable issuer, we will deliver the issuer’s defaulted securities underlying the swap to the swap counterparty and the counterparty will pay us par for the defaulted securities. Alternatively, a credit default swap may be cash settled and the buyer of protection would receive the difference between the par value and the market value of the issuer’s defaulted debt securities from the seller of protection.
Credit default swaps are subject to the credit risk of the underlying issuer. If we are selling credit protection, there is a risk that we will not properly assess the risk of the underlying issuer, a credit event will occur and we will have to pay the counterparty. If we are buying credit protection, there is a risk that we will not properly assess the risk of the underlying issuer, no credit event will occur and we will receive no benefit for the premium paid.
A fixed price swap is a contract between two parties in which settlements are made at a specified time based on the difference between the fixed priced specified in the contract and the referenced settlement price. When the referenced settlement price is less than the price specified in the contract, one party receives an amount from the second party based on the price difference multiplied by the volume. Similarly, when the referenced settlement price exceeds the price specified in the contract, one party pays the second party an amount based on the price difference multiplied by the volume.
A fixed price swap is subject to commodity risk of the underlying commodity. If we are purchasing fixed price swaps for oil, there is a risk the fixed price we paid to enter the contract for oil will be more than the price of oil at the specified settlement date, and we will owe the counterparty the difference in price multiplied by the volume of the contracted volume.
A derivative transaction is also subject to the risk that a counterparty will default on its payment obligations thereunder or that we will not be able to meet our obligations to the counterparty. In some cases, we may post collateral to secure our obligations to the counterparty, and we may be required to post additional collateral upon the occurrence of certain events such as a decrease in the value of the reference security or other asset. In some cases, the counterparty may not collateralize any of its obligations to us.
Derivative investments effectively add leverage to a portfolio by providing investment exposure to a security or market without owning or taking physical custody of such security or investing directly in such market. In addition to the risks described above, such arrangements are subject to risks similar to those associated with the use of leverage. See “—Risks Related to Debt Financing.”
Prepayments of our debt investments by our portfolio companies could adversely impact our results of operations and reduce our return on equity.
We are subject to the risk that the investments we make in our portfolio companies may be repaid prior to maturity. When this occurs, we will generally reinvest these proceeds in temporary investments, pending their future investment in new portfolio companies. These temporary investments will typically have substantially lower yields than the debt being prepaid and we could experience significant delays in reinvesting these amounts. Any future investment in a new portfolio company may also be at lower yields than the debt that was repaid. As a result, our results of operations could be materially adversely affected if one or more of our portfolio companies elect to prepay amounts owed to us. Additionally, prepayments, net of prepayment fees, could negatively impact our return on equity.
We may invest through joint ventures, partnerships or other special purpose vehicles and our investments through these vehicles may entail greater risks, and investments in which we have a non-controlling interest may involve risks specific to third-party management of those investments.
We may co-invest with third parties through partnerships, joint ventures or other entities, such as SIIJV, thereby acquiring jointly-controlled or non-controlling interests in certain investments in conjunction with participation by one or more third parties in such investment. We may have interests or objectives that are inconsistent with those of the third-party partners or co-venturers. Although we may not have full control over these investments, and therefore may have a limited ability to protect our position therein, we expect that we will negotiate appropriate rights to protect our interests. Nevertheless, such investments may involve risks not present in investments where a third party is not involved, including the possibility that a third-party partner or co-venturer may have financial difficulties, resulting in a negative impact on such investment, may have economic or business interests or goals which are inconsistent with ours, or may be in a position to take (or block) action in a manner contrary to our investment objectives or the increased possibility of default by, diminished liquidity or insolvency of, the third party, due to a sustained or general economic downturn. Third-party partners or co-venturers may opt to liquidate an investment at a time during which such liquidation is not optimal for us. In addition, we may in certain circumstances be liable for the actions of our third-party partners or co-venturers. In those circumstances where such third parties involve a management group, such third parties may receive compensation arrangements relating to such investments, including incentive compensation arrangements.
Energy Company Risks
Our investment policy is to invest, under normal circumstances, at least 80% of our total assets in securities of Energy companies. This investment policy may not be changed without at least 60 days' prior notice to holders of our common shares of any such change. The revenues, income (or losses) and valuations of Energy companies can fluctuate suddenly and dramatically due to a number of factors.
Because our investment policy is to invest, under normal circumstances, at least 80% of our total assets in securities of Energy companies, our portfolio will not be well allocated among various industries.
As there can be a correlation in the valuation of the securities in our portfolio, a decline in value of the securities of one company may be accompanied by a decline in the valuations of the securities of other companies within the Energy industry that we may hold in our portfolio. A decline in value of the securities of such issuers or a downturn in the Energy sector might have a more severe impact on us than on an entity that is more broadly allocated among various industries.
An increase or decrease in commodity supply or demand may adversely affect our business.
A decrease in the production of natural gas, natural gas liquids, crude oil, coal or other energy commodities, a decrease in the volume of such commodities available for transportation, mining, processing, storage or distribution, or a sustained decline in demand for such commodities may adversely impact the financial performance or prospects of Energy companies in which we may invest. Energy companies are subject to supply and demand fluctuations in the markets they serve which will be impacted by a wide range of factors, including fluctuating commodity prices, weather, increased conservation or use of alternative fuel sources, increased governmental or environmental regulation, depletion of natural gas, natural gas liquids, crude oil or coal production, rising interest rates, declines in domestic or foreign production of natural gas, natural gas liquids and crude oil, accidents or catastrophic events, economic conditions and economic sanctions, among others.
An increase or decrease in commodity pricing may adversely affect our business.
The return on our prospective investments in Energy companies will be dependent on the margins received by those companies for the exploration, development, production, gathering, transportation, processing, storing, refining, distribution, mining, generation or marketing of natural gas, natural gas liquids, crude oil, refined products, coal or power. These margins may fluctuate widely in response to a variety of factors including global and domestic economic conditions, weather conditions, natural disasters, the supply and price of imported energy commodities, the production and storage levels of energy commodities in certain regions or in the world, political instability, terrorist activities, transportation facilities, energy conservation, domestic and foreign governmental regulation and taxation, the availability of local, intrastate and interstate transportation systems and economic sanctions. Volatility of commodity prices may also make it more difficult for Energy companies in which we may invest to raise capital to the extent the market perceives that their performance may be directly or indirectly tied to commodity prices.
Cyclicality within the Energy sector may adversely affect our business.
Industries within the Energy sector are cyclical with fluctuations in commodity prices and demand for commodities driven by a variety of factors. The highly cyclical nature of the industries within the Energy sector may lead to volatile changes in commodity prices, which may adversely affect the earnings of Energy companies in which we may invest.
A prolonged continuation of depressed oil and natural gas prices could have a material adverse effect on us.
Prices for oil and natural gas, which historically have been volatile and may continue to be volatile, may be subject to large fluctuations in response to relatively minor changes in the supply of and demand for oil and natural gas. A prolonged continuation of depressed oil and natural gas prices would adversely affect the credit quality and performance of certain of our debt and equity investments in Energy companies. A decrease in credit quality and performance would, in turn, negatively affect the fair value of these investments, which would consequently negatively affect our net asset value. Should a prolonged period of depressed oil and natural gas prices occur, it is likely that our portfolio companies’ abilities to satisfy financial or operating covenants imposed by us or other lenders will be adversely affected, thereby negatively impacting their financial condition and their ability to satisfy their debt service and other obligations to us. Likewise, should a prolonged period of depressed oil and natural gas prices occur, it is likely that our portfolio companies’ cash flow and profit generating capacities would also be adversely affected thereby negatively impacting their ability to pay us dividends or distributions on certain of our investments.
Changes in international, foreign, federal, state or local government regulation may adversely affect our business.
Energy companies are subject to significant international, foreign, federal, state and local government regulation, including how facilities are constructed, maintained and operated, environmental and safety controls, and the prices they may charge for the products and services they provide. Various governmental authorities have the power to enforce compliance with these regulations and the permits issued under them, and violators are subject to administrative, civil and criminal penalties, including civil fines, injunctions or both. For example, many state and federal environmental laws provide for civil penalties as well as regulatory remediation, thus adding to the potential liability an Energy company may face. More extensive laws, regulations or enforcement policies could be enacted in the future which would likely increase compliance costs and may adversely affect the financial performance of Energy companies in which we may invest.
In particular, changes to laws and increased regulations or enforcement policies as a result of oil spills may adversely affect the financial performance of Energy companies. Additionally, changes to laws and increased regulation or restrictions on the use of hydraulic fracturing may adversely impact the ability of Energy companies to economically develop oil and natural gas resources and, in turn, reduce production for such commodities. Any such changes or increased regulations or policies may adversely affect the performance of Energy companies in which we may invest.
Energy companies are subject to various operational risks.
Energy companies are subject to various operational risks, such as failed drilling or well development, unscheduled outages, disruption of operations, mining, drilling or installation accidents, inability to timely and effectively integrate newly acquired assets, unanticipated operation and maintenance expenses, lack of proper asset integrity, underestimated cost projections, inability to renew or increased costs of rights of way, failure to obtain the necessary permits to operate and failure of third-party contractors to perform their contractual obligations. Thus, some Energy companies may be subject to construction risk, acquisition risk or other risks arising from their specific business strategies.
Energy companies that focus on exploration and production are subject to numerous reserve and production related risks.
Exploration and production businesses are subject to overstatement of the quantities of their reserves based upon any reserve estimates that prove to be inaccurate, the possibility that no commercially productive oil, natural gas or other energy reservoirs will be discovered as a result of drilling or other exploration activities, the curtailment, delay or cancellation of exploration activities as a result of unexpected conditions or miscalculations, title problems, pressure or irregularities in formations, equipment failures or accidents, adverse weather conditions, compliance with environmental and other governmental requirements and cost of, or shortages or delays in the availability of, drilling rigs and other exploration equipment, and operational risks and hazards associated with the development of the underlying properties, including natural disasters, blowouts, explosions, fires, leakage of crude oil, natural gas or other resources, mechanical failures, cratering and pollution.
Competition between Energy companies may adversely affect our business.
The Energy companies in which we may invest face substantial competition in acquiring assets, expanding or constructing assets and facilities, obtaining and retaining customers and contracts, securing trained personnel and operating their assets. Many of their competitors may have superior financial and other resources.
Inability by companies in which we may invest to make accretive acquisitions may adversely affect our business.
The ability of Energy companies in which we may invest to grow and, where applicable, to increase dividends or distributions to their equity holders can be highly dependent on their ability to make acquisitions of infrastructure assets that result in an increase in free cash flow. In the event that such companies are unable to make such accretive acquisitions because they are unable to identify attractive acquisition candidates or negotiate acceptable purchase contracts, because they are unable to raise financing for such acquisitions on economically acceptable terms, or because they are outbid by competitors, their future growth and ability to make or raise dividends or distributions will be limited and their ability to repay their debt and make payments to preferred equity holders may be weakened. Furthermore, even if these companies do consummate acquisitions that they believe will be accretive, the acquisitions may instead result in a decrease in free cash flow.
A significant accident or event that is not fully insured could adversely affect the operations and financial condition of Energy companies in which we may invest.
The operations of Energy companies in which we may invest are subject to many hazards inherent in the transporting, processing, storing, distributing, mining, generating or marketing of natural gas, natural gas liquids, crude oil, coal, refined products, power or other commodities, or in the exploring, managing or producing of such commodities, including: damage to pipelines, storage tanks, vessels or related equipment and surrounding properties caused by hurricanes, tornadoes, floods, fires and other natural disasters or by acts of terrorism; inadvertent damage from construction or other equipment; leaks of natural gas, natural gas liquids, crude oil, refined products or other commodities; cyber attacks; and fires and explosions. Further, since the September 11th terrorist attacks, the U.S. government has issued warnings that energy assets and facilities, specifically U.S. pipeline infrastructure, may be targeted in future terrorist attacks. These risks could result in substantial losses due to personal injury or loss of life, severe damage to and destruction of property and equipment and pollution or other environmental damage and may result in the curtailment or suspension of their related operations. Not all Energy companies are fully insured against all risks inherent to their businesses. If a significant accident or event occurs that is not fully insured, it could adversely affect the Energy company's operations and financial condition. In addition, any increased governmental regulation to mitigate such risks (including regulations related to recent oil spills or hydraulic fracturing), could increase insurance premiums and other operating costs for Energy companies in which we may invest.
Energy reserves naturally deplete as they are produced over time and this may adversely affect our business.
Energy reserves naturally deplete as they are produced over time. Many Energy companies are either engaged in the production of natural gas, natural gas liquids, crude oil or coal, or are engaged in transporting, storing, distributing and processing these items or their derivatives on behalf of shippers. To maintain or grow their revenues, these companies or their customers need to maintain or expand their reserves through exploration of new sources of supply, through the development of existing sources or through acquisitions. The financial performance of Energy companies in which we may invest may be adversely affected if they, or the companies to whom they provide services, are unable to cost-effectively acquire additional reserves sufficient to replace the depleted reserves. If an Energy company fails to add reserves by acquiring or developing them, its reserves and production will decline over time as the reserves are produced. If an Energy company is not able to raise capital on favorable terms, it may not be able to add to or maintain its reserves.
Certain Energy companies are dependent on their parents or sponsors for a majority of their revenues and may be subject to affiliate party risk.
Certain Energy companies in which we may invest are dependent on their parents or sponsors for a majority of their revenues. Any failure by an Energy company's parent or sponsor to satisfy its payments or obligations would impact the Energy company's revenues and cash flows and ability to make debt service payments and/or distributions.
Changing economic, regulatory and political conditions in some countries, including political and military conflicts, may adversely affect the businesses in which we invest.
Changing economic, regulatory and political conditions in some countries, including political and military conflicts, have from time to time resulted in attacks on vessels, mining of waterways, piracy, terrorism, labor strikes, boycotts and government inspections or requisitioning of vessels. These types of events could impact the delivery of commodities or impact pricing of commodities.
Risks Related to Our Investments in MLPs
An investment in MLP units involves certain risks which differ from an investment in the common stock of a corporation. Holders of MLP units have limited control and voting rights on matters affecting the partnership. In addition, there are certain tax risks associated with an investment in MLP units. See "—Risks Related to U.S. Federal Income Tax."
An MLP's cash flow, and consequently its distributions, are subject to operational and general energy industry risks, which may result in disparate quarterly distributions.
A portion of the cash flow received by us may be derived from investments in the equity securities of MLPs. The amount of cash that an MLP has available for distributions and the tax character of such distributions depend upon the amount of cash generated by the MLP's operations. Cash available for distribution will vary from quarter to quarter and is largely dependent on factors affecting the MLP's operations and factors affecting the Energy industry in general. In addition to the risk factors described above, other factors which may reduce the amount of cash an MLP has available for distribution in a given quarter include increased operating costs, maintenance capital expenditures, acquisition costs, expansion, construction or exploration costs and borrowing costs.
Investments in MLPs may have limited liquidity.
Although common units of some MLPs may trade on public exchanges, certain of these securities may trade less frequently, particularly those with smaller capitalizations. Securities with limited trading volumes may display volatile or erratic price movements. As a result, these securities may be difficult to dispose of at a fair price at the times when we believe it is desirable to do so. These securities are also more difficult to value, and our judgment as to value will often be given greater weight than market quotations, if any exist. Investment of our capital in securities that are less actively-traded, or over time experience decreased trading volume, may restrict our ability to take advantage of other market opportunities. In addition, many MLP units are privately held.
Investments in MLPs are susceptible to interest rate fluctuation risks.
Interest rate risk is the risk that securities will decline in value because of changes in market interest rates. The yields of equity and debt securities of MLPs are susceptible in the short-term to fluctuations in interest rates and, like treasury bonds, the prices of these securities typically decline when interest rates rise. Accordingly, our net asset value may be impacted by an increase in interest rates. Further, rising interest rates could adversely impact the financial performance of MLPs in which we invest by increasing their costs of capital. This may reduce their ability to execute acquisitions or expansion projects in a cost-effective manner.
Investments in MLPs are subject to certain tax risks.
MLPs are not subject to tax at the partnership level. Rather, each partner is allocated a share of the MLP’s income, gains, losses, deductions, and expenses. A change in current tax law, or a change in the underlying business of a given MLP could result in the MLP being treated as a corporation for U.S. federal tax purposes, which would result in such MLP being required to pay U.S. federal income tax on its taxable income. Such treatment also would have the effect of reducing the amount of cash available for distribution by the affected MLP.
Our investments in MLPs may be subject to additional fees and expenses, including management and incentive fees, and, as a result, our investments in MLPs may achieve a lower rate of return than our other investments.
MLPs are subject to additional fees, some of which are paid regardless of the performance of its assets. We will pay certain management fees to the adviser entity of any MLP in which we invest. FS/EIG Advisor will also earn its base management fee from us based on our gross assets, including our investment in any such MLP; therefore, we will be paying both FS/EIG Advisor's base management fee and any management fees charged by an MLP. As a result, our investment returns attributable to MLPs in which we invest may be lower than other investments we select. In addition, because the fees received by an MLP adviser are typically based on the managed assets of the MLP, including the proceeds of any leverage it may incur, the MLP adviser has a financial incentive to utilize leverage, which may create a conflict of interest between the MLP adviser and us as a shareholder in the MLP.
Risks Related to Debt Financing
We currently use borrowed funds to make investments and are exposed to the typical risks associated with leverage.
Borrowings and other types of financing, also known as leverage, magnify the potential for gain or loss on amounts invested and, therefore, increases the risks associated with investing in our securities. Our and our special-purpose financing subsidiaries' lenders and debt holders have fixed dollar claims on our and their assets that are superior to the claims of our shareholders. If the value of our assets increases, then leverage would cause the net asset value to increase more sharply than it would have had we not leveraged. Conversely, if the value of our assets decreases, leverage would cause net asset value to decline more sharply than it otherwise would have had we not leveraged. Similarly, any increase in our income in excess of consolidated interest payable on the borrowed funds would cause our net investment income to increase more than it would without the leverage, while any decrease in our income would cause net investment income to decline more sharply than it would have had we not borrowed. Such a decline could negatively affect our ability to make distributions to shareholders. Leverage is generally considered a speculative investment technique.
The agreements governing our financing arrangements contain various covenants which, if not complied with, could accelerate repayment under the applicable arrangement, thereby materially and adversely affecting our liquidity, financial condition, results of operations and our ability to pay distributions to our shareholders.
The agreements governing these financing arrangements contain various default provisions and operational covenants which, if triggered, could result in the termination of the respective financing arrangements and the acceleration of any amounts outstanding thereunder, which could require us or our subsidiaries to liquidate positions at a time and/or at a price which is disadvantageous to us. This could result in losses and impact our ability to meet our investment objectives and pay distributions to shareholders. There can be no assurance that we or our subsidiaries will comply with the covenants in our debt arrangements in the future. The failure to negotiate a waiver or amendment with the applicable lenders, pay off in full the applicable facility or otherwise come into compliance with those or other covenants could, subject to applicable notice, grace and cure periods, result in an event of default allowing for the acceleration of the repayment of obligations due under the financing arrangements. We may be unable to satisfy our obligations upon an event of default and we may not be able to refinance our borrowings under the financing arrangements on commercially reasonable terms or at all. Our or our subsidiaries’ failure to comply with the covenants set forth in the financing arrangements could materially and adversely affect our liquidity, financial condition and results of operations.
Our and our subsidiaries’ failure to comply with the covenants set forth in the financing arrangements could also materially and adversely affect our ability to pay distributions to our shareholders. We cannot assure shareholders that we or our subsidiaries will be able to borrow funds under any such financing arrangements at any particular time or at all. See Note 9 to our consolidated financial statements contained in this annual report on Form 10-K for a more detailed discussion of the terms of our financing arrangements.
If we borrow money, the potential for gain or loss on amounts invested in us will be magnified and may increase the risk of investing in us.
The use of borrowings, also known as leverage, increases the volatility of investments by magnifying the potential for gain or loss on invested equity capital. If we use leverage to partially finance our investments, through borrowing from banks and other lenders, shareholders will experience increased risks of investing in our common shares. If the value of our assets increases, leverage would cause the net asset value attributable to our common shares to increase more sharply than it would have had we not leveraged. Conversely, if the value of our assets decreases, leverage would cause net asset value to decline more sharply than it otherwise would have had we not leveraged. Similarly, any increase in our income in excess of interest payable on the borrowed funds would cause our net income to increase more than it would without the leverage, while any decrease in our income would cause net income to decline more sharply than it would have had we not borrowed. Such a decline could negatively affect our ability to make common share distribution payments. Leverage is generally considered a speculative investment technique. In addition, the decision to utilize leverage will increase our assets and, as a result, will increase the amount of base management fees payable to FS/EIG Advisor. See “Risks Related to FS/EIG Advisor and its Respective Affiliates—FS/EIG Advisor and its affiliates, including our officers and some of our trustees, face conflicts of interest caused by compensation arrangements with us and our affiliates, which could result in actions that are not in the best interests of our shareholders.”
Illustration. The following table illustrates the effect of leverage on returns from an investment in our common shares assuming various annual returns, net of expenses. The calculations in the table below are hypothetical and actual returns may be higher or lower than those appearing below. The calculation assumes (i) $2,374,097 in total average assets, (ii) a weighted average cost of funds of 8.13%, (iii) $457,075 in borrowings outstanding, and (iv) $1,917,022 in average shareholders' equity. In order to compute the "Corresponding return to shareholders," the "Assumed Return on Our Portfolio (net of expenses)" is multiplied by the assumed total average assets to obtain an assumed return to us. From this amount, the interest expense is calculated by multiplying the assumed weighted average cost of funds times the assumed borrowings outstanding, and the product is subtracted from the assumed return to us in order to determine the return available to shareholders. The return available to shareholders is then divided by our shareholders' equity to determine the "Corresponding return to shareholders." Actual interest payments may be different.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Assumed Return on Our Portfolio (net of expenses) | | (10)% | | (5)% | | 0% | | 5% | | 10% |
Corresponding return to shareholders | | (14.32)% | | (8.13)% | | (1.94)% | | 4.25% | | 10.45% |
Similarly, assuming (i) approximately $2,374,097 in total average assets, (ii) a weighted average cost of funds of approximately 8.13% and (iii) $457,075 in borrowings outstanding, our assets would need to yield an annual return (net of expenses) of approximately 1.56% in order to cover the annual interest payments on our outstanding borrowings.
Risks Related to U.S. Federal Income Tax
We will be subject to corporate-level income tax if we are unable to qualify as a RIC under Subchapter M of the Code or to satisfy RIC distribution requirements.
To qualify for and maintain RIC tax treatment under Subchapter M of the Code, we must meet the following annual distribution, income source and asset diversification requirements. See "Item 1. Business—Taxation as a RIC."
•The Annual Distribution Requirement for RIC tax treatment will be satisfied if we distribute to our shareholders each tax year, dividends of an amount at least equal to the sum of 90% of our “investment company taxable income,” which is generally the sum of our net ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, determined without regard to any deduction for dividends paid. Because we may use debt financing, we are subject to an asset coverage ratio requirement under the 1940 Act and may in the future become subject to certain financial covenants under loan and credit agreements that could, under certain circumstances, restrict us from making distributions necessary to satisfy the Annual Distribution Requirement. If we are unable to obtain cash from other sources, we could fail to qualify for RIC tax treatment and thus become subject to corporate-level income tax.
•The income source requirement will be satisfied if we obtain at least 90% of our gross income for each tax year from dividends, interest, gains from the sale of securities or similar sources.
•The asset diversification requirement will be satisfied if we meet certain asset diversification requirements at the end of each quarter of our tax year. To satisfy this requirement, at least 50% of the value of our assets must consist of cash, cash equivalents, U.S. government securities, securities of other RICs and other securities if such securities of any one issuer do not represent more than 5% of the value of our assets or more than 10% of the outstanding voting securities of such issuer; and no more than 25% of the value of our assets can be invested in the securities, other than U.S. government securities or securities of other RICs, of one issuer, of two or more issuers that are controlled, as determined under applicable Code rules, by us and that are engaged in the same or similar or related trades or businesses or of certain "qualified publicly traded partnerships." Failure to meet these requirements may result in our having to dispose of certain investments quickly in order to prevent the loss of RIC status. Because most of our investments will be in private companies, and therefore will be relatively illiquid, any such dispositions could be made at disadvantageous prices and could result in substantial losses.
We must satisfy these tests on an ongoing basis in order to maintain RIC tax treatment, and may be required to make distributions to shareholders at times when it would be more advantageous to invest cash in our existing or other investments, or when we do not have funds readily available for distribution. Compliance with the RIC tax requirements may hinder our ability to operate solely on the basis of maximizing profits and the value of our shareholders’ investments. If we fail to qualify for or maintain RIC tax treatment for any reason and are subject to corporate income tax, the resulting corporate taxes could substantially reduce our net assets, the amount of income available for distribution and the amount of our distributions.
Some of our investments may be subject to corporate-level income tax.
We may invest in certain debt and equity investments through taxable subsidiaries and the taxable income of these taxable subsidiaries will be subject to federal and state corporate income taxes. We may invest in certain foreign debt and equity investments which could be subject to foreign taxes (such as income tax, withholding and value added taxes).
We may have difficulty paying our required distributions if we recognize income before or without receiving cash representing such income.
For U.S. federal income tax purposes, we may be required to recognize taxable income in circumstances in which we do not receive a corresponding payment in cash. For example, our investments may include debt obligations that are treated under applicable tax rules as having original issue discount (such as debt instruments with PIK interest or, in certain cases, increasing interest rates or debt obligations that were issued with warrants). To the extent original issue discount or PIK interest constitutes a portion of our income, we must include in taxable income each tax year a portion of the original issue discount or PIK interest that accrues over the life of the instrument, regardless of whether cash representing such income is received by us in the same tax year. We may also have to include in income other amounts that we have not yet received in cash, such as deferred loan origination fees that are paid after origination of the loan or are paid in non-cash compensation such as warrants or stock. We anticipate that a portion of our income may constitute original issue discounts or other income required to be included in taxable income prior to receipt of cash. Further, we may elect to amortize market discounts and include such amounts in our taxable income in the current tax year, instead of upon disposition, as not making the election would limit our ability to deduct interest expenses for tax purposes.
Because any original issue discount or other amounts accrued will be included in our investment company taxable income for the tax year of the accrual, we may be required to make a distribution to our shareholders in order to satisfy the Annual Distribution Requirement, even though we will not have received any corresponding cash amount. As a result, we may have difficulty meeting the Annual Distribution Requirement necessary to maintain RIC tax treatment under Subchapter M of the Code. We may have to sell some of our investments at times and/or at prices we would not consider advantageous, raise additional debt or equity capital or forgo new investment opportunities for this purpose. If we are not able to obtain cash from other sources, we may fail to qualify for or maintain RIC tax treatment and thus become subject to corporate-level income tax.
Furthermore, we may invest in the equity securities of non-U.S. corporations (or other non-U.S. entities classified as corporations for U.S. federal income tax purposes) that could be treated under the Code and U.S. Treasury regulations as “passive foreign investment companies” and/or “controlled foreign corporations.” The rules relating to investment in these types of non-U.S. entities are designed to ensure that U.S. taxpayers are either, in effect, taxed currently (or on an accelerated basis with respect to corporate level events) or taxed at increased tax rates at distribution or disposition. In certain circumstances, these rules also could require us to recognize taxable income or gains where we do not receive a corresponding payment in cash and, unless the income and gains are related to our business of investing in stocks and securities, all or a portion of such taxable income and gains may not be considered qualifying income for purposes of the 90% Income Test.
We may be adversely affected if an MLP or other non-corporate business structure in which we invest is treated as a corporation, rather than a partnership, for U.S. federal income tax purposes.
Our ability to meet our investment objectives will depend on the level of taxable income and distributions and dividends we receive from the MLPs and other Energy company securities in which we may invest, a factor over which we have no control. The benefit we derive from an investment in MLPs is largely dependent on the MLPs being treated as partnerships for U.S. federal income tax purposes. As a partnership, an MLP has no tax liability at the entity level. If, as a result of a change in current law or a change in an MLP's business, an MLP is treated as a corporation for U.S. federal income tax purposes, such MLP would be obligated to pay U.S. federal income tax on its income at the corporate tax rate. If an MLP were classified as a corporation for U.S. federal income tax purposes, the amount of cash available for distribution would be reduced and distributions received by us would be taxed under U.S. federal income tax laws applicable to corporate distributions (as dividend income, return of capital or capital gain). Therefore, treatment of an MLP as a corporation for U.S. federal income tax purposes would result in a reduction in the after-tax return to us, likely causing a reduction in the value of our common shares. In addition, if we receive a Schedule K-1 from an MLP after having mailed a Form 1099-DIV to our shareholders, and our estimates with respect to the applicable MLP are determined to have been materially incorrect, we may be required to mail an amended Form 1099-DIV to our shareholders.
We may be adversely affected if an MLP or other non-corporate business structure in which we invest is unable to take advantage of certain tax deductions for U.S. federal income tax purposes and our income from investments in MLPs may exceed the cash received from such investments.
As a limited partner in the MLPs in which we seek to invest, we will receive our share of income, gains, losses, deductions and credits from those MLPs. Historically, a significant portion of income from MLPs has been offset by tax deductions. As a result, this income has been significantly lower than cash distributions paid by MLPs. We will incur a current tax liability on our share of an MLP's income and gains that is not offset by tax deductions, losses, and credits, or our net operating loss carryforwards, if any. The percentage of an MLP's income and gains which is offset by tax deductions, losses, and credits will fluctuate over time for various reasons. A significant slowdown in acquisition activity or capital spending by MLPs held in our portfolio could result in a reduction of accelerated depreciation generated by new acquisitions, which may result in an increase in our net ordinary income that we are required to distribute to shareholders to maintain our status as a RIC and to eliminate our liability for U.S. federal income tax. If our income from our investments in MLPs exceeds the cash distributions received from such investments, we may need to obtain cash from other sources in order to satisfy the Annual Distribution Requirement. If we are unable to obtain cash from other sources, we may fail to qualify for or maintain RIC tax treatment and become subject to corporate-level federal income tax. We may also recognize gain in excess of cash proceeds upon the sale of an interest in an MLP. Any such gain may need to be distributed or deemed distributed in order to avoid liability for corporate-level federal income taxes on such gain.
Our portfolio investments may present special tax issues.
Investments in below-investment grade debt instruments and certain equity securities may present special tax issues for us. U.S. federal income tax rules are not entirely clear about issues such as when we may cease to accrue interest, original issue discount or market discount, when and to what extent deductions may be taken for bad debts or worthless debt in equity securities, how payments received on obligations in default should be allocated between principal and interest income, as well as whether exchanges of debt instruments in a bankruptcy or workout context are taxable. Such matters could cause us to recognize taxable income for U.S. federal income tax purposes, even in the absence of cash or economic gain, and require us to make taxable distributions to our shareholders to maintain our RIC status or preclude the imposition of either U.S. federal corporate income or excise taxation.
Additionally, because such taxable income may not be matched by corresponding cash received by us, we may be required to borrow money or dispose of other investments to be able to make distributions to our shareholders. These and other issues will be considered by us, to the extent determined necessary, in order that we minimize the level of any U.S. federal income or excise tax that we would otherwise incur. See “Item 1. Business—Taxation as a RIC.”
Legislative or regulatory tax changes could adversely affect investors.
At any time, the federal income tax laws governing RICs or the administrative interpretations of those laws or regulations may be amended. Any of those new laws, regulations or interpretations may take effect retroactively and could adversely affect the taxation of us or our shareholders. Therefore, changes in tax laws, regulations or administrative interpretations or any amendments thereto could diminish the value of an investment in our shares or the value or the resale potential of our investments.
Risks Related to an Investment in Our Common Shares
Our common shares are not listed on an exchange or quoted through a quotation system, and will not be for the foreseeable future, if ever. Therefore, shareholders will have limited liquidity and may not receive a full return of invested capital upon selling common shares.
Our common shares are illiquid assets for which there is not a secondary market and it is not expected that any will develop in the foreseeable future. There can be no assurance that we will complete a liquidity event. A liquidity event (which we define ascould include (1) a listing of the Company’s Sharesour common shares on a national securities exchange, (2) the sale of all or substantially all of the Company’sour assets either on a complete portfolio basis or individually followed by a liquidation or (3) a merger or another transaction approved by the Boardour board of trustees in which the Company’sour shareholders likely will receive cash or shares of a publicly traded company),publicly-traded company, including potentially a company that is an affiliate of us.
In addition, any shares repurchased pursuant to our share repurchase program may be purchased at a price which may reflect a discount from the purchase price a shareholder paid for the common shares being repurchased. If our common shares are listed, we cannot assure shareholders that a public trading market will develop. In addition, a liquidity event involving a listing of our common shares on a national securities exchange may include certain restrictions on the ability of shareholders to sell their common shares. Further, even if we do complete a liquidity event, shareholders may not receive a return of all future transactionsof their invested capital.
See "Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities—Share Repurchase Program, De Minimis Account Liquidation and Distributions" for a detailed description of our share repurchase program.
We are not obligated to complete a liquidity event by a specified date; therefore, it will be difficult for an investor to sell his or her common shares.
A liquidity event could include (1) a listing of our common shares on a national securities exchange, (2) the sale of all or substantially all of our assets either on a complete portfolio basis or individually followed by a liquidation, or (3) a merger or another transaction approved by our board of trustees in which our shareholders likely will receive cash or shares of a publicly-traded company, including potentially a company that is an affiliate of us. However, there can be no assurance that we will complete a liquidity event by a specified date or at all. If we do not successfully complete a liquidity event, liquidity for an investor's common shares will be limited to our share repurchase program, which we have no obligation to maintain.
Only a limited number of common shares may be repurchased pursuant to our share repurchase program, if any, and, to the extent shareholders are able to sell their common shares under our share repurchase program, shareholders may not be able to recover the amount of their investment in those shares.
Our share repurchase program includes numerous restrictions that limit shareholders' ability to sell their common shares. We intend to limit the number of common shares repurchased pursuant to our share repurchase program as follows: (1) we intend to limit the number of common shares to be repurchased during any calendar year to the number of common shares we can repurchase with affiliatesthe proceeds we receive from the issuance of our common shares under our distribution reinvestment plan, although at the discretion of our board of trustees, we may also use cash on hand, cash available from borrowings and cash from the liquidation of securities investments as of the Companyend of the applicable period to repurchase common shares; (2) we intend to limit the number of common shares to be repurchased in any calendar year to 10% of the weighted average number of common shares outstanding in the prior calendar year, or 2.5% in each calendar quarter (though the actual number of common shares that we offer to repurchase may be less in light of the limitations noted above); (3) unless shareholders tender all of their common shares, shareholders must tender at least 25% of the number of common shares they have purchased and generally must maintain a minimum balance of $5,000 subsequent to submitting a portion of their common shares for repurchase by us; and (4) to the extent that the number of common shares tendered for repurchase
exceeds the number of common shares that we are able to repurchase, we will repurchase common shares on a pro rata basis, not on a first-come, first-served basis. Furthermore, the maximum number of common shares to be repurchased for any repurchase offer may further be limited by the terms of our financing arrangements. See Note 9 to our consolidated financial statements contained in this annual report on Form 10-K for a discussion of the terms of our financing arrangements. In addition, we will have no obligation to repurchase common shares if the repurchase would violate the restrictions on distributions under federal law or Delaware law, which prohibits distributions that would cause a trust to fail to meet statutory tests of solvency. Any of the foregoing limitations may prevent us from accommodating all repurchase requests made in any year.
Our share repurchase program is currently suspended. In addition, in the future, our board of trustees may amend, suspend or terminate the share repurchase program upon 30 days' notice. In March 2020, our board of trustees determined to suspend for an indefinite period of time our share repurchase program and will reassess our ability to recommence such program in future periods. We will notify shareholders of such developments (1) in our quarterly reports or (2) by means of a separate mailing to shareholders, accompanied by disclosure in a current or periodic report under the Exchange Act. In addition, although we have adopted a share repurchase program generally, we have discretion to not repurchase common shares, to suspend the share repurchase program and to cease repurchases. Further, the share repurchase program has many limitations and should not be relied upon as a method to sell common shares promptly or at a desired price.
There is a risk that investors in our common shares may not receive distributions or that our distributions may not grow over time.
We cannot assure shareholders that we will achieve investment results that will allow us to make a specified level of cash distributions or year-to-year increases in cash distributions. All distributions will be paid at the discretion of our board of trustees and will depend on our earnings, our net investment income, our financial condition, maintenance of our RIC status, compliance with applicable BDC regulations and such other factors as our board of trustees may deem relevant from time to time. In addition, due to the asset coverage test applicable to us as a BDC, we may be limited in our ability to make distributions. See “Item 1. Business—Regulation—Senior Securities.”
Our distribution proceeds have exceeded and in the future may exceed our earnings. Therefore, portions of the distributions that we have made represented, and may make in the future may represent, a return of capital to shareholders, which lowers their tax basis in their common shares.
We may pay all or a substantial portion of our distributions from the proceeds of our continuous public offering or from borrowings in anticipation of future cash flow, which may constitute a return of shareholders’ capital and will lower such shareholders’ tax basis in their common shares. A return of capital generally is a return of a shareholder’s investment rather than a return of earnings or gains derived from our investment activities and will be made after deducting the fees and expenses payable in connection with the offering, including any fees payable to FS/EIG Advisor. Moreover, a return of capital will generally not be taxable, but will reduce each shareholder’s cost basis in our common shares, and will result in a higher reported capital gain or lower reported capital loss when the common shares on which such return of capital was received are sold.
We may pay distributions from borrowings or the sale of assets to the extent our cash flows from operations, net investment income or earnings are not sufficient to fund declared distributions.
We may fund distributions from the uninvested proceeds of our continuous public offering and borrowings, and we have not established limits on the amount of funds we may use from such sources to make any such distributions. We have paid and may continue to pay distributions from the sale of assets to the extent distributions exceed our earnings or cash flows from operations.
The timing of our repurchase offers pursuant to our share repurchase program, if any, may be at a time that is disadvantageous to our shareholders.
If and when we make quarterly repurchase offers pursuant to our share repurchase program, we may offer to repurchase common shares at a price that is lower than the price that investors paid for common shares in our offering. As a result, to the extent investors have the ability to sell their common shares to us as part of our share repurchase program, the price at which an investor may sell common shares may be lower than what an investor paid in connection with the purchase of common shares in our offering.
In addition, in the event an investor chooses to participate in our share repurchase program, the investor will be required to provide us with notice of intent to participate prior to knowing what the repurchase price will be on terms no less favorable thanthe repurchase date. Although an investor will have the ability to withdraw a repurchase request prior to the expiration date of such tender offer, to the extent an investor seeks to sell common shares to us as part of our share repurchase program, the investor will be required to do so without knowledge of what the repurchase price of our common shares will be on the repurchase date.
A shareholder's interest in us will be diluted if we issue additional common shares, which could be obtained fromreduce the overall value of an unaffiliated third party and must be approved byinvestment in us.
Our investors do not have preemptive rights to any common shares we issue in the future. Our declaration of trust authorizes us to issue 700,000,000 common shares. Pursuant to our declaration of trust, a majority of our entire board of trustees may amend our declaration of trust to increase the Board,number of authorized common shares without shareholder approval. After an investor purchases common shares, our board of trustees may elect to sell additional common shares in the future, issue equity interests in private offerings or issue share-based awards to our independent trustees or employees of FS/EIG Advisor. To the extent we issue additional equity interests after an investor purchases our common shares, an investor's percentage ownership interest in us will be diluted. In addition, depending upon the terms and pricing of any additional offerings and the value of our investments, an investor may also experience dilution in the book value and fair value of their common shares.
Certain provisions of our declaration of trust and bylaws could deter takeover attempts and have an adverse impact on the value of our common shares.
Our declaration of trust and bylaws, as well as certain statutory and regulatory requirements, contain certain provisions that may have the effect of discouraging a third party from attempting to acquire us. Our board of trustees may, without shareholder action, authorize the issuance of shares in one or more classes or series, including preferred shares; and our board of trustees may, without shareholder action, amend our declaration of trust to increase the number of our common shares, of any class or series, that we have authority to issue. In addition, a trustee may be removed only by vote of at least two-thirds of the votes entitled to be cast. These anti-takeover provisions may inhibit a change of control in circumstances that could give the holders of our common shares the opportunity to realize a premium over the value of our common shares.
General Risk Factors
Future economic recessions or downturns could impair our portfolio companies and harm our operating results.
Many of our portfolio companies may be susceptible to economic slowdowns or recessions and may be unable to repay our loans or meet other obligations during these periods. Therefore, our non-performing assets are likely to increase, and the value of our portfolio is likely to decrease during these periods. Adverse economic conditions may also decrease the value of any collateral securing our debt investments and the value of our equity investments. Economic slowdowns or recessions could lead to losses of value in our portfolio and a decrease in our revenues, net income, net worth and assets. Unfavorable economic conditions also could increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us on terms we deem acceptable. These events could prevent us from increasing investments and harm our operating results. Economic downturns or recessions may also result in a portfolio company’s failure to satisfy financial or operating covenants imposed by us or other lenders. This could lead to defaults and, potentially, acceleration of the time when the loans are due and foreclosure on its assets representing collateral for its obligations, which could trigger cross defaults under other agreements and jeopardize our portfolio company’s ability to meet its obligations under the debt that we hold and the value of any equity securities we own. We may incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms with a defaulting portfolio company. In addition, if one of our portfolio companies were to go bankrupt, even though we may have structured our interest as senior debt or preferred equity, depending on the facts and circumstances, including the extent to which we actually provided managerial assistance to that portfolio company, a bankruptcy court might recharacterize our debt or equity holding and subordinate all or a portion of our claim to those of other creditors.
Future disruptions or instability in capital markets could negatively impact the valuation of our investments and our ability to raise capital.
From time to time, the global capital markets may experience periods of disruption and instability, which could be prolonged and which could materially and adversely impact the broader financial and credit markets, have a negative impact on the valuations of our investments and reduce the availability to us of debt and equity capital. For example, between 2008 and 2009, instability in the global capital markets resulted in disruptions in liquidity in the debt capital markets, significant write-offs in the financial services sector, the re-pricing of credit risk in the broadly syndicated credit market and the failure of major domestic and international financial institutions. In particular, the financial services sector was negatively impacted by significant write-offs as the value of the assets held by financial firms declined, impairing their capital positions and abilities to lend and invest. While market conditions have recovered from the events of 2008 and 2009, there have been continuing periods of volatility. For example, continued uncertainty surrounding the negotiation of trade deals between Britain and the European Union following the United Kingdom’s exit from the European Union and uncertainty between the United States and other countries with respect to trade policies, treaties, and tariffs, among other factors, have caused disruption in the global markets. There can be no assurance that market conditions will not worsen in the future.
While most of our investments are not publicly traded, applicable accounting standards require us to assume as part of our valuation process that our investments are sold in a principal market to market participants (even if we plan on holding an investment through its maturity) and impairments of the market values or fair market values of our investments, even if unrealized, must be reflected in our financial statements for the applicable period, which could result in significant reductions to our net asset value for the period. With certain limited exceptions, we are only allowed to borrow amounts or issue debt securities if our asset coverage, as calculated pursuant to the 1940 Act, equals at least 200% immediately after such borrowing. Equity capital may also be difficult to raise during periods of adverse or volatile market conditions because, subject to some limited exceptions, as a BDC, we are generally not able to issue additional shares of our common shares at a price less than net asset value without first obtaining approval for such issuance from our shareholders and our independent trustees. If we are unable to raise capital or refinance existing debt on acceptable terms, then we may be limited in our ability to make new commitments or to fund existing commitments to our portfolio companies. Significant changes in the capital markets may also affect the pace of our investment activity and the potential for liquidity events involving our investments. Thus, the illiquidity of our investments may make it difficult for us to sell such investments to access capital if required, and as a result, we could realize significantly less than the value at which we have recorded our investments if we were required to sell them for liquidity purposes.
Events outside of our control, including public health crises, could negatively affect our portfolio companies and our results of operations.
Periods of market volatility have occurred and could continue to occur in response to pandemics or other events outside of our control. We, FS/EIG Advisor, and the portfolio companies in which we invest in could be affected by force majeure events (i.e., events beyond the control of the party claiming that the event has occurred, such as acts of God, fire, flood, earthquakes, outbreaks of an infectious disease, pandemic or any other serious public health concern, war, terrorism, labor strikes, major plant breakdowns, pipeline or electricity line ruptures, failure of technology, defective design and construction, accidents, demographic changes, government macroeconomic policies, social instability, etc.). Some force majeure events could adversely affect the ability of a party (including us, FS/EIG Advisor, a portfolio company or a counterparty to us, FS/EIG Advisor, or a portfolio company) to perform its obligations until it is able to remedy the force majeure event. In addition, force majeure events, such as the cessation of the operation of equipment for repair or upgrade, could similarly lead to the unavailability of essential equipment and technologies. These risks could, among other effects, adversely impact the cash flows available from a portfolio company, cause personal injury or loss of life, including to a senior manager of FS/EIG Advisor or its affiliates, damage property, or instigate disruptions of service. In addition, the cost to a portfolio company or us of repairing or replacing damaged assets resulting from such force majeure event could be considerable. It will not be possible to insure against all such events, and insurance proceeds received, if any, could be inadequate to completely or even partially cover any loss of revenues or investments, any increases in operating and maintenance expenses, or any replacements or rehabilitation of property. Certain events causing catastrophic loss could be either uninsurable, or insurable at such high rates as to adversely impact us, FS/EIG Advisor, or portfolio companies, as applicable. Force majeure events that are incapable of or are too costly to cure could have permanent adverse effects. Certain force majeure events (such as war or an outbreak of an infectious disease) could have a broader negative impact on the world economy and international business activity generally, or in any of the countries in which we invest or our portfolio companies operate specifically. Such force majeure events could result in or coincide with: increased volatility in the global securities, derivatives and currency markets; a decrease in the reliability of market prices and difficulty in valuing assets; greater fluctuations in currency exchange rates; increased risk of default (by both government and private issuers); further social, economic, and political instability; nationalization of private enterprise; greater governmental involvement in the economy or in social factors that impact the economy; less governmental regulation and supervision of the securities markets and market participants and decreased monitoring of the markets by governments or self-regulatory organizations and reduced enforcement of regulations; limited, or limitations on, the activities of investors in such markets; controls or restrictions on foreign investment, capital controls and limitations on repatriation of invested capital; inability to purchase and sell investments or otherwise settle security or derivative transactions (i.e., a market freeze); unavailability of currency hedging techniques; substantial, and in some periods extremely high, rates of inflation, which can last many years and have substantial negative effects on credit and securities markets as well as the economy as a whole; recessions; and difficulties in obtaining and/or enforcing legal judgments.
The COVID-19 pandemic has resulted in and may continue to result in adverse consequences for us and our portfolio companies. While many countries, including the United States, have relaxed or eliminated the early public health restrictions adopted in response to the COVID-19 pandemic, the outbreak of new, worsening strains of COVID-19 may result in a resurgence in the number of reported cases and hospitalizations. Such increases in cases could lead to the re-introduction of restrictions and business shutdowns in certain states, counties and cities in the United States and globally. In addition to these developments having adverse consequences for us and our portfolio companies, the operations of FS/EIG Advisor have been, and could continue to be, adversely impacted, including through quarantine measures and travel restrictions imposed on its personnel or service providers based or temporarily located in affected countries, or any related health issues of such personnel or service providers. Any potential impact to our results of operations will depend to a large extent on future developments and new information that could emerge regarding the duration and severity of the COVID-19 pandemic and the actions taken by authorities and other entities to contain the spread of
COVID-19 and its variants or treat its impact, all of which are beyond our control. These potential impacts, while uncertain, could adversely affect our and our portfolio companies’ operating results.
We are currently operating in a period of capital markets disruption and economic uncertainty.
The success of our activities is affected by general economic and market conditions, including, among others, interest rates, availability of credit, inflation rates, economic uncertainty, changes in laws, and trade barriers. These factors could affect the level and volatility of securities prices and the liquidity of our investments. Volatility or illiquidity could impair our profitability or result in losses. These factors also could adversely affect the availability or cost of our leverage, which would result in lower returns. In addition, the U.S. capital markets have experienced extreme volatility and disruption following the global outbreak of COVID-19 and its variants. Some economists and major investment banks have expressed concern that the continued spread of the virus globally could lead to a prolonged period of world-wide economic downturn. Disruptions in the capital markets have increased the spread between the yields realized on risk-free and higher risk securities, resulting in illiquidity in parts of the capital markets.
These and future market disruptions and/or illiquidity would be expected to have an adverse effect on our business, financial condition, results of operations and cash flows. Unfavorable economic conditions also would be expected to increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us. These events have limited and could continue to limit our investment originations, limit our ability to grow and have a material negative impact on our operating results and the fair values of our debt and equity investments.
If a period of capital market disruption and instability continues for an extended period of time, there is a risk that investors in our equity securities may not receive distributions consistent with historical levels or at all or that our distributions may not grow over time and a portion of our distributions may be a return of capital.
In the past, our board of trustees has suspended declaring regular cash distributions to shareholders until such time that our board of trustees and FS/EIG Advisor believe that market conditions and our financial condition support the resumption of such distributions. Our future ability to pay regular distributions consistent with our historical range or to pay distributions fully in cash rather than in common shares might be adversely affected by the impact of one or more of the risk factors described in this annual report on Form 10-K, including the COVID-19 pandemic. If we are unable to satisfy the asset coverage test applicable to us under the 1940 Act as a business development company or if we violate certain covenants under our existing or future credit facilities or other leverage, we may also be limited in our ability to make distributions. If we declare a distribution and if more shareholders opt to receive cash distributions rather than participate in our dividend reinvestment plan, we may be forced to sell some of our investments in order to make cash distribution payments. To the extent we make distributions to shareholders that include a return of capital, such portion of the distribution essentially constitutes a return of the shareholder’s investment. Although such return of capital may not be taxable, such distributions would generally decrease a shareholder’s basis in our common shares and may therefore increase such shareholder’s tax liability for capital gains upon the future sale of such stock. A return of capital distribution may cause a shareholder to recognize a capital gain from the sale of our common shares even if the shareholder sells its shares for less than the original purchase price.
Our business, results of operations and financial condition could be adversely affected by disruptions in the global oil and energy markets and declines in the price of oil, and the ultimate effect of these events on our business would be highly uncertain and cannot be predicted.
A prolonged continuation of depressed oil and natural gas prices would adversely affect the credit quality and performance of certain of our investments in Energy companies. A decrease in credit quality and performance would, in turn, negatively affect the fair value of these investments, which would consequently negatively affect our net asset value. Should a prolonged period of depressed oil and natural gas prices or other disruptions in the energy markets occur, it is likely that the ability of our portfolio companies to satisfy financial or operating covenants imposed by us or other lenders will be adversely affected, thereby negatively impacting their financial condition and their ability to satisfy their debt service and other obligations to us. Likewise, should a prolonged period of depressed oil and natural gas prices or other disruptions in the energy markets occur, it is likely that our portfolio companies’ cash flow and profit generating capacities would also be adversely affected thereby negatively impacting their ability to pay us amounts owed or dividends or distributions, as applicable. Moreover, any decline in oil and natural gas prices and other disruptions in the energy markets could have a material adverse impact on our or our portfolio companies’ business, results of operations or financial condition.
Global economic, political and market conditions, including downgrades of the U.S. credit rating and Russia’s invasion of Ukraine, may adversely affect our business, results of operations and financial condition.
The current global financial market situation, as well as various social and political tensions in the United States and around the world (including Russia’s invasion of Ukraine), may contribute to increased market volatility, may have long-term effects on the
United States and worldwide financial markets and may cause economic uncertainties or deterioration in the United States and worldwide. The impact of downgrades by rating agencies to the U.S. government’s sovereign credit rating or its perceived creditworthiness as well as potential government shutdowns and uncertainty surrounding transfers of power could adversely affect the U.S. and global financial markets and economic conditions. Since 2010, several European Union countries have faced budget issues, some of which may have negative long-term effects for the economies of those countries and other European Union countries. There is concern about national-level support for the Euro and the accompanying coordination of fiscal and wage policy among European Economic and Monetary Union member countries. In addition, the fiscal policy of foreign nations, such as Russia and China, may have a severe impact on the worldwide and U.S. financial markets. The United Kingdom’s decision to leave the European Union (the so-called “Brexit”) led to volatility in global financial markets. On December 24, 2020, a trade agreement was concluded between the European Union and the United Kingdom (the “TCA”), which was provisionally applied as of January 1, 2021 and entered into force on May 1, 2021 following ratification by the EU. Although the TCA covers many issues, it leaves decisions on equivalence and adequacy to be determined by each of the U.K. and E.U. unilaterally in due course. As such, there remains uncertainty as to the scope, nature and terms of the relationship between the United Kingdom and the European Union and the effect and implications of the TCA, and the actual and potential consequences of Brexit. Additionally, trade wars and volatility in the U.S. repo market, the U.S. high yield bond markets, the Chinese stock markets and global markets for commodities may affect other financial markets worldwide. And while recent government stimulus measures worldwide have reduced volatility in the financial markets, volatility may return as such measures are phased out, and the long-term impacts of such stimulus on fiscal policy and inflation remain unknown.
Any of the above factors, including sanctions, export controls, tariffs, trade wars and other governmental actions, could have a material adverse effect on our business, financial condition, cash flows and results of operations and could cause the value of our common shares and/or debt securities to decline. We cannot predict the effects of these or similar events in the future on the U.S. and global economies and securities markets or on our investments. We monitor developments in economic, political and market conditions and seek to manage our investments in a manner consistent with achieving our investment objective, but there can be no assurance that we will be successful in doing so.
The Russian invasion of Ukraine and sanctions on Russian energy exports may have a material adverse impact on us and our portfolio companies.
The conflict between Russia and Ukraine could lead to disruption, instability and volatility in global markets and commodity prices, economies and industries that could negatively impact our business, results of operations and financial condition. The conflict has already resulted in significant volatility in certain equity, debt and currency markets, material increases in certain commodity prices, and economic uncertainty. The conflict may escalate and its resolution is unclear.
The U.S. government, the European Union and other governments have imposed severe sanctions against Russia and Russian interests and threatened additional sanctions and controls, which could contribute to a shortage of raw materials and commodities. Sanctions and export control laws and regulations are complex, frequently changing, and increasing in number, and compliance with them may impose additional legal compliance costs or business risks associated with our operations. Sanctions on Russian energy exports have disrupted crude oil markets, reducing supply and propelling spot prices above $100 per barrel for the first time since 2014. Global energy market participants have increased production to respond to the oil supply deficit, but commodity supply and price outlook remains uncertain. High gas prices may also result in short- or longer-term consumer switching to alternative energy solutions, such as coal and nuclear.
Changes to United States tariff and import/export regulations may have a negative effect on our portfolio companies.
There have been significant changes to United States trade policies, treaties and tariffs, and in the future there may be additional significant changes. These and any future developments, and continued uncertainty surrounding trade policies, treaties and tariffs, may have a material adverse effect on global economic conditions and the stability of global financial markets, and may significantly reduce global trade and, in particular, trade between the impacted nations and the United States. Any of these factors could depress economic activity and restrict our portfolio companies’ access to suppliers or customers and could have material adverse effects on our business, financial condition and results of operations.
Economic sanction laws in the United States and other jurisdictions may prohibit us and our affiliates from transacting with certain countries, individuals and companies.
Economic sanction laws in the United States and other jurisdictions may prohibit us or our affiliates from transacting with certain countries, individuals and companies. In the United States, the U.S. Department of the Treasury’s Office of Foreign Assets Control administers and enforces laws, executive orders and regulations establishing U.S. economic and trade sanctions, which prohibit, among other things, transactions with, and the provision of services to, certain non-U.S. countries, territories, entities and individuals. These types of sanctions may significantly restrict or completely prohibit investment activities in certain jurisdictions, and
if we, our portfolio companies or other issuers in which we invest were to violate any such laws or regulations, we may face significant legal and monetary penalties.
The Foreign Corrupt Practices Act, or FCPA, and other anti-corruption laws and regulations, as well as anti-boycott regulations, may also apply to and restrict our activities, our portfolio companies and other issuers of our investments. If an issuer or we were to violate any such laws or regulations, such issuer or we may face significant legal and monetary penalties. The U.S. government has indicated that it is particularly focused on FCPA enforcement, which may increase the risk that an issuer or we become the subject of such actual or threatened enforcement. In addition, certain commentators have suggested that private investment firms and the funds that they manage may face increased scrutiny and/or liability with respect to the activities of their underlying portfolio companies. As such, a violation of the FCPA or other applicable regulations by us or an issuer of our portfolio investments could have a material adverse effect on us. We are committed to complying with the FCPA and other anti-corruption laws and regulations, as well as anti-boycott regulations, to which it is subject. As a result, we may be adversely affected because of its unwillingness to enter into transactions that violate any such laws or regulations.
Item 1B. Unresolved Staff Comments.
Not applicable.
Item 2. Properties.
We do not own any real estate or other physical properties materially important to our operation. Our headquarters are located at 201 Rouse Boulevard, Philadelphia, Pennsylvania, 19112. We believe that our office facilities are suitable and adequate for our business as it is presently conducted.
Item 3. Legal Proceedings.
We are not currently subject to any material legal proceedings, and, to our knowledge, no material legal proceedings are 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 any such proceedings will have a material adverse effect on our financial condition or results of operations.
Item 4. Mine Safety Disclosures.
Not applicable.
PART II
Many of the amounts and percentages presented in Part II have been rounded for convenience of presentation and all dollar amounts, excluding per share amounts, are presented in thousands unless otherwise noted.
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information
There is currently no market for our common shares, and we do not expect that a market for our common shares will develop in the foreseeable future. In November 2016, we closed our continuous public offering of common shares to new investors. Following the closing of our continuous public offering, we have continued to issue shares pursuant to our distribution reinvestment plan.
Set forth below is a chart describing the classes of our securities outstanding as of February 28, 2023:
| | | | | | | | | | | | | | | | | | | | |
(1) | | (2) | | (3) | | (4) |
Title of Class | | Amount Authorized | | Amount Held by Us or for Our Account | | Amount Outstanding Exclusive of Amount Under Column (3) |
Common Shares | | 700,000,000 | | — | | 452,787,008 |
As of February 28, 2023, we had 86,281 record holders of our common shares.
Share Repurchase Program, De Minimis Account Liquidation and Distributions
In March 2020, in light of difficult market conditions and in an effort to preserve our liquidity, our board of trustees determined to suspend for an indefinite period of time our share repurchase program and will reassess our ability to recommence such program in future periods. As a result, no common shares were purchased pursuant to our share repurchase program and there were no de minimis account liquidations during the year ended December 31, 2022.
Although our board of trustees has not declared or resumed regular cash distributions to shareholders for any period after March 31, 2020, our board of trustees has since declared three cash distributions in 2020, four cash distributions in 2021 and four cash distributions in 2022, each in the amount of $0.03 per share. FS/EIG Advisor and our board of trustees expect that future regular cash distributions to shareholders will remain suspended until such time that our board of trustees and FS/EIG Advisor believe that market conditions and our financial condition support the resumption of such distributions. Our board of trustees has and will continue to evaluate our ability to pay any distributions in the future. There can be no assurance that we will be able to pay distributions in the future. The timing and amount of any future distributions to shareholders are subject to applicable legal restrictions and the sole discretion of our board of trustees. In addition, prior to its maturity, the JPMorgan Facility restricted our ability to make certain discretionary cash dividends and distributions and other restricted payments. See Note 9 to our consolidated financial statements contained in this annual report on Form 10-K for a discussion of the terms of the JPMorgan Facility.
The following table reflects the cash distributions per share that we have declared on our common shares during the years ended December 31, 2022, 2021 and 2020:
| | | | | | | | | | | | | | |
| | Distribution |
For the Year Ended December 31, | | Per Share | | Amount |
2020 | | $ | 0.1733 | | | $ | 75,656 | |
2021 | | $ | 0.1200 | | | $ | 53,264 | |
2022 | | $ | 0.1200 | | | $ | 53,938 | |
See "Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—RIC Tax Treatment and Distributions" and Note 5 to our consolidated financial statements contained in this annual report on Form 10-K for additional information regarding our distributions and our distribution reinvestment plan, including certain related tax considerations.
Item 6. Reserved
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
(in thousands, except share and per share amounts)
The information contained in this section should be read in conjunction with our consolidated financial statements and the related notes thereto included elsewhere in this annual report on Form 10-K.
Forward-Looking Statements
Some of the statements in this annual report on Form 10-K constitute forward-looking statements because they relate to future events or our future performance or financial condition. The forward-looking statements contained in this annual report on Form 10-K may include statements as to:
•our future operating results;
•our business prospects and the prospects of the companies in which we may invest, including our and their ability to achieve our respective objectives as a result of the current COVID-19 pandemic;
•the impact of the investments that we expect to make;
•the ability of our portfolio companies to achieve their objectives;
•our current and expected financing arrangements and investments;
•changes in the general interest rate environment;
•the adequacy of our cash resources, financing sources and working capital;
•the timing and amount of cash flows, distributions and dividends, if any, from our portfolio companies;
•our contractual arrangements and relationships with third parties;
•actual and potential conflicts of interest with the other funds managed by FS/EIG Advisor, FS Investments, EIG, or any of their respective affiliates;
•the dependence of our future success on the general economy and its effect on the industries in which we may invest;
•general economic and political trends and other external factors, including the current COVID-19 pandemic and related disruptions caused thereby;
•our use of financial leverage;
•the ability of FS/EIG Advisor to locate suitable investments for us and to monitor and administer our investments;
•the ability of FS/EIG Advisor or its affiliates to attract and retain highly talented professionals;
•our ability to maintain our qualification as a RIC and as a BDC;
•the impact on our business of the Dodd-Frank Act, as amended, and the rules and regulations issued thereunder;
•the effect of changes to tax legislation on us and the portfolio companies in which we may invest and our and their tax position; and
•the tax status of the enterprises in which we may 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 annual report on Form 10-K involve risks and uncertainties. Our actual results could differ materially from those implied or expressed in the forward-looking statements for any reason, including the factors set forth in ‘‘Item 1A. Risk Factors.’’ Other factors that could cause actual results to differ materially include:
i.changes in the economy;
ii.geo-political risks;
iii.risks associated with possible disruption in our operations or the economy generally due to terrorism or natural disasters or pandemics; and
iv.future changes in laws or regulations and conditions in our operating areas.
We have based the forward-looking statements included in this annual report on Form 10-K on information available to us on the date of this annual report on Form 10-K. Except as required by the federal securities laws, we undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise. Shareholders are advised to consult any additional disclosures that we may make directly to shareholders or through reports that we may file in the future with the SEC, including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K. The forward-looking
statements and projections contained in this annual report on Form 10-K are excluded from the safe harbor protection provided by Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act.
Overview
We were formed as a Delaware statutory trust under the Delaware Statutory Trust Act on September 16, 2010 and formally commenced investment operations on July 18, 2011. We are an externally managed, non-diversified, closed-end management investment company that has elected to be regulated as a BDC under the 1940 Act and has elected to be treated for U.S. federal income tax purposes, and intends to qualify annually, as a RIC under Subchapter M of the Code. In November 2016, we closed our continuous public offering of common shares to new investors.
Our investment activities are managed by FS/EIG Advisor and supervised by our board of trustees, a majority of
whom are independent. Under the
Independent Trustees.Compensation of the Investment Adviser
PursuantFS/EIG investment advisory agreement, we have agreed to the Investment Advisory and Administrative Services Agreement, thepay FS/EIG Advisor is entitled to an annual base management fee based on the average weekly value of the Company’sour gross assets (gross assets equals total assets as set forth on the Company’s consolidated balance sheets) during the most recently completed calendar quarter and an incentive fee based on our performance.
Our investment policy is to invest, under normal circumstances, at least 80% of our total assets in securities of Energy companies. This investment policy may not be changed without at least 60 days’ prior notice to holders of our common shares of any such change.
Our investment objective is to generate current income and long-term capital appreciation. We pursue our investment objective by focusing on the Company’s performance. following seven investment themes: (i) basin-on-basin competition in U.S. shale, (ii) globalization of natural gas, (iii) coal retirements and the evolving energy generation mix, (iv) renewables focused on power grid parity, (v) export infrastructure for emerging U.S. producers, (vi) market liberalization opening new markets and (vii) midstream infrastructure connecting new supplies. However, we may pursue other investment opportunities if we believe it is in our best interests and consistent with our investment objectives.
Within the above investment themes, we intend to focus on the following investment categories in an effort to generate returns for our investors with an acceptable level of risk.
Direct Originations: Through FS/EIG Advisor, we intend to directly source investment opportunities across the Energy industry. Such investments are typically originated and structured through a negotiated process in which we directly participate and are not generally available to the broader market. These investments may include both debt and equity components. We believe directly originated investments may offer higher returns and more favorable protections than broadly syndicated transactions.
Broadly Syndicated Loan and Bond Transactions: Although our primary focus is to invest in directly originated transactions, in certain circumstances we will also invest in the broadly syndicated loan and high yield bond markets. Broadly syndicated loans and bonds are generally more liquid than our directly originated investments and provide a complement to our less liquid strategies.
In the case of broadly syndicated investments, we generally intend to capitalize on market inefficiencies by investing in loans, bonds, and other asset classes where the market price of such investment reflects a lower value than we believe is warranted based on our fundamental analysis, providing us with an opportunity to earn an attractive return on our investment.
The majority of our portfolio is comprised of income-oriented securities, which principally refers to debt securities and income-oriented preferred and common equity interests, of privately-held Energy companies within the United States. Generally, we expect to invest primarily in directly originated investments and primary market transactions, as this will provide us with the ability to tailor investments to best match a project’s or company’s needs with our investment objectives. We intend to weight our portfolio towards senior secured debt and directly originated preferred equity investments, which we believe offer opportunities for superior risk-adjusted returns and income generation. Our debt investments may take the form of corporate or project loans or bonds, may be secured or unsecured and may, in some cases, be accompanied by yield enhancements. These yield enhancements are typically expected to include royalty interests in mineral, oil and gas properties, warrants, options, net profits interests, cash flow participations or other forms of equity participation that can provide additional consideration or “upside” in a transaction. Our preferred equity investments are mostly directly originated and may take the form of perpetual or redeemable securities, typically with a current income component and minimum base returns. In addition, certain income-oriented preferred or common equity interests may include interests in master limited partnerships and a portion of our portfolio may be comprised of derivatives, including the use of total return swaps, credit default swaps and other commodity swap contracts. In connection with certain of our debt investments or any restructuring of these debt investments, we may on occasion receive equity interests, including warrants or options, as additional consideration or otherwise in connection with a restructuring. FS/EIG Advisor will seek to tailor our investment focus as market conditions evolve.
Revenues
The principal measure of our financial performance is net increase or decrease in net assets resulting from operations, which includes net investment income, net realized gain or loss on investments, foreign currency, swap contracts and debt extinguishment, net change in unrealized appreciation or depreciation on investments, net change in unrealized gain or loss on foreign currency and net change in unrealized appreciation or depreciation on swap contracts. Net investment income is the difference between our income from interest, dividends, fees and other investment income and our operating and other expenses. Net realized gain or loss on investments is the difference between the proceeds received from dispositions of portfolio investments and their amortized cost, including the respective realized gain or loss on foreign currency for those foreign denominated investment transactions. Net realized gain or loss on foreign currency is the portion of realized gain or loss attributable to foreign currency fluctuations. Net realized gain or loss on swap contracts is the portion of realized gain or loss attributable to the difference between the fixed price specified in the contract and the referenced settlement price. Net change in unrealized appreciation or depreciation on investments is the net change in the fair value of our investment portfolio, including the respective unrealized gain or loss on foreign currency for those foreign denominated investments. Net change in unrealized gain or loss on foreign currency is the net change in the value of receivables or accruals due to the impact of foreign currency fluctuations. Net change in unrealized appreciation or depreciation on swap contracts is the net change in the value of receivables or accruals due to the impact of the difference between the fixed price specified in the contract and the referenced settlement price.
We principally generate revenues in the form of interest income on the debt investments we hold. We also generate revenues in the form of dividends and other distributions on the equity or other securities we may hold. In addition, we may generate revenues in the form of non-recurring commitment, closing, origination, structuring or diligence fees, fees for providing managerial assistance, consulting fees, prepayment fees and performance-based fees.
Expenses
Our primary operating expenses include the payment of management and incentive fees and other expenses under the FS/EIG investment advisory agreement, interest expense from financing arrangements and other indebtedness, and other expenses necessary for our operations. The management and incentive fees compensate FS/EIG Advisor for its work in identifying, evaluating, negotiating, executing, monitoring and servicing our investments.
FS/EIG Advisor oversees our day-to-day operations, including the provision of general ledger accounting, fund accounting, legal services, investor relations, certain government and regulatory affairs activities, and other administrative services. FS/EIG Advisor also performs, or oversees the performance of, our corporate operations and required administrative services, which includes being responsible for the financial records that we are required to maintain and preparing reports for our shareholders and reports filed with the SEC. In addition, FS/EIG Advisor assists us in calculating our net asset value, overseeing the preparation and filing of tax returns and the printing and dissemination of reports to our shareholders, and generally overseeing the payment of our expenses and the performance of administrative and professional services rendered to us by others.
We reimburse FS/EIG Advisor for expenses necessary to perform services related to our administration and operations, including FS/EIG Advisor’s allocable portion of the compensation and related expenses of certain personnel of FS Investments and EIG providing administrative services to us on behalf of FS/EIG Advisor, and for transactional expenses for prospective investments, such as fees and expenses associated with performing due diligence reviews of investments that do not close, often referred to as "broken deal" costs. We reimburse FS/EIG Advisor no less than quarterly for all costs and expenses incurred by FS/EIG Advisor in performing its obligations and providing personnel under the FS/EIG investment advisory agreement. The amount of this reimbursement is set at the lesser of (1) FS/EIG Advisor’s actual costs incurred in providing such services and (2) the amount that we estimate would be required to pay alternative service providers for comparable services in the same geographic location. FS/EIG Advisor allocates the cost of such services to us based on factors such as time allocations and other reasonable metrics. Our board of trustees reviews the methodology employed in determining how the expenses are allocated to us and assesses the reasonableness of such reimbursements for expenses allocated to us based on the breadth, depth and quality of such services as compared to the estimated cost to us of obtaining similar services from third-party service providers known to be available. In addition, our board of trustees considers whether any single third-party service provider would be capable of providing all such services at comparable cost and quality. Finally, our board of trustees compares the total amount paid to FS/EIG 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 FS/EIG 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 FS/EIG Advisor.
We bear all other expenses of our operations and transactions, including (without limitation) fees and expenses relating to:
•corporate and organization expenses related to offerings of our common shares, subject to limitations included in the FS/EIG investment advisory agreement;
•the cost of calculating our net asset value, including the cost of any third-party pricing or valuation services;
•the cost of effecting sales and repurchases of our common shares and other securities;
•investment advisory fees;
•fees payable to third parties relating to, or associated with, making investments and valuing investments, including fees and expenses associated with performing due diligence reviews of prospective investments;
•interest payments on our debt or related obligations;
•transfer agent and custodial fees;
•research and market data (including news and quotation equipment and services, and any computer hardware and connectivity hardware (e.g. telephone and fiber optic lines) incorporated into the cost of obtaining such research and market data);
•fees and expenses associated with marketing efforts;
•federal and state registration fees;
•federal, state and local taxes;
•annual fees of the Delaware trustee;
•fees and expenses of our trustees not also serving in an executive officer capacity for us or FS/EIG Advisor;
•costs of proxy statements, shareholders’ reports and notices and other filings;
•our fidelity bond, trustees and officers/errors and omissions liability insurance and other insurance premiums;
•direct costs such as printing, mailing, long distance telephone and staff;
•fees and expenses associated with accounting, corporate governance, government and regulatory affairs activities, independent audits and outside legal costs;
•costs associated with our reporting and compliance obligations under the 1940 Act and applicable federal and state securities laws, including compliance with the Sarbanes‑Oxley Act;
•brokerage commissions for our investments;
•costs associated with our chief compliance officer; and
•all other expenses incurred by FS/EIG Advisor in connection with administering our business, including expenses incurred by FS/EIG Advisor in performing administrative services for us and administrative personnel paid by FS/EIG Advisor, to the extent they are not controlling persons of FS/EIG Advisor or any of its affiliates, subject to the limitations included in the FS/EIG investment advisory agreement.
In addition, we have contracted with State Street to provide various accounting and administrative services, including, but not limited to, preparing preliminary financial information for review by FS/EIG Advisor, preparing and monitoring expense budgets, maintaining accounting and corporate books and records, processing trade information provided by us and performing testing with respect to RIC compliance.
For information regarding our fee offset with FS/EIG Advisor, see Note 4 to our consolidated financial statements contained in this annual report on Form 10-K.
COVID-19 and Energy Market Developments
Events in recent years such as the rapid spread of the COVID-19 pandemic, global lockdowns and ongoing negotiations regarding production levels between oil producing countries, have, at times, resulted in lower demand for crude oil and, as a result, lower commodity prices. Although the energy markets have had a notable recovery in 2021 and 2022, volatility in the energy markets may persist, recur or worsen, as a result of these events or other macroeconomic events, such as the current conflict in Ukraine and sanctions imposed on Russia in response. The impact of these events on the U.S. and global economies (including energy markets), has negatively impacted, and could continue to negatively impact, the business operations of some of our portfolio companies. Many of our portfolio companies are performing well, and energy markets are currently experiencing relatively stable conditions. However, we expect that certain of our portfolio companies may continue to experience economic distress for the foreseeable future and could become insolvent or otherwise significantly limit business operations if subjected to prolonged economic distress, including as a result of depressed commodity prices or other declines in the energy markets. These developments could result in a further decrease in the value of our investments.
These events have previously had adverse effects on our investment income and we expect that such adverse effects may continue for some time. These adverse effects have required and may again require us to restructure certain of our investments, which could result in further reductions to our investment income or in impairments on our investments. In addition, disruptions in the capital markets have resulted in illiquidity in certain market areas at times. These market disruptions and illiquidity have had and may
continue to have an adverse effect on our business, financial condition, results of operations and cash flows. Unfavorable economic conditions caused by these events may increase our funding costs and limit our access to the capital markets. These events have previously limited our investment originations, which may continue for the immediate future, and have also previously had a material negative impact on our operating results for a period of time. In addition, the growth of non-income producing equity investments as a percentage of the portfolio has materially reduced the value of collateral available to secure our financing arrangements. Consequently, this has adversely impacted our liquidity, may cause us to fall out of compliance with certain portfolio requirements under the 1940 Act that are tied to the value of our investments and, in each case, may continue to do so in the future.
In light of such difficult market conditions and in an effort to preserve our liquidity, our board of trustees determined to suspend for an indefinite period of time our share repurchase program and will reassess our ability to recommence such program in future periods. Although our board of trustees has not declared or resumed regular cash distributions to shareholders for any period after March 31, 2020, our board of trustees has since declared three cash distributions in 2020, four cash distributions in 2021 and four cash distributions in 2022, each in the amount of $0.03 per share. FS/EIG Advisor and our board of trustees expect that future regular cash distributions to shareholders will remain suspended until such time that our board of trustees and FS/EIG Advisor believe that market conditions and our financial condition support the resumption of such distributions. Our board of trustees has and will continue to evaluate our ability to pay any distributions in the future. There can be no assurance that we will be able to pay distributions in the future.
We will continue to carefully monitor the energy markets and any other new or ongoing events that may affect our business and the business of our portfolio companies, including the current conflict in Ukraine and government responses thereto. Because the full effects of these events are not capable of being known at this time, we cannot estimate the impacts on our future financial condition, results of operations or cash flows.
Portfolio Investment Activity for the Years Ended December 31, 2022 and 2021
Total Portfolio Activity
The following tables present certain selected information regarding our portfolio investment activity for the years ended December 31, 2022 and 2021:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | For the Year Ended December 31, |
Net Investment Activity | | 2022 | | 2021 |
Purchases | | $ | 376,779 | | | $ | 1,010,496 | |
Sales and Repayments | | (870,989) | | | (998,391) | |
Net Portfolio Activity | | $ | (494,210) | | | $ | 12,105 | |
| | | | | | | | |
| | For the Year Ended December 31, |
| | 2022 | | 2021 |
New Investment Activity by Asset Class | | Purchases | | Percentage | | Purchases | | Percentage |
Senior Secured Loans—First Lien | | $ | 146,104 | | | 39 | % | | $ | 423,495 | | | 42 | % |
Senior Secured Loans—Second Lien | | 110,150 | | | 29 | % | | 18,750 | | | 2 | % |
Senior Secured Bonds | | — | | | — | | | 169,298 | | | 17 | % |
Unsecured Debt | | 73,069 | | | 19 | % | | 334,396 | | | 33 | % |
Preferred Equity | | — | | | — | | | 11,942 | | | 1 | % |
| | | | | | | | |
Equity/Other | | 47,456 | | | 13 | % | | 52,615 | | | 5 | % |
Total | | $ | 376,779 | | | 100 | % | | $ | 1,010,496 | | | 100 | % |
The following table summarizes the composition of our investment portfolio at cost and fair value as of December 31, 2022 and 2021:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | December 31, 2022 | | December 31, 2021 |
| | Amortized Cost(1) | | Fair Value | | Percentage of Portfolio | | Amortized Cost(1) | | Fair Value | | Percentage of Portfolio |
Senior Secured Loans—First Lien | | $ | 702,842 | | | $ | 706,646 | | | 35 | % | | $ | 832,257 | | | $ | 812,335 | | | 34 | % |
Senior Secured Loans—Second Lien | | 143,153 | | | 143,270 | | | 7 | % | | 83,322 | | | 84,083 | | | 3 | % |
Senior Secured Bonds | | 10,064 | | | 10,074 | | | 0 | % | | 77,266 | | | 81,646 | | | 3 | % |
Unsecured Debt | | 253,675 | | | 241,418 | | | 12 | % | | 425,715 | | | 397,068 | | | 17 | % |
Preferred Equity | | 425,182 | | | 400,414 | | | 20 | % | | 515,711 | | | 497,288 | | | 21 | % |
Sustainable Infrastructure Investments, LLC | | 54,514 | | | 51,098 | | | 2 | % | | 54,514 | | | 50,770 | | | 2 | % |
Equity/Other | | 333,510 | | | 494,195 | | | 24 | % | | 364,272 | | | 472,033 | | | 20 | % |
Total | | $ | 1,922,940 | | | $ | 2,047,115 | | | 100 | % | | $ | 2,353,057 | | | $ | 2,395,223 | | | 100 | % |
_________________________
(1) Amortized cost represents the original cost adjusted for the amortization of premiums and/or accretion of discounts, as applicable, on investments.
The following table presents certain selected information regarding the composition of our investment portfolio as of December 31, 2022 and 2021:
| | | | | | | | | | | | | | |
| | December 31, 2022 | | December 31, 2021 |
Number of Portfolio Companies | | 63 | | 71 |
% Variable Rate (based on fair value) | | 36.8% | | 35.1% |
% Fixed Rate (based on fair value) | | 17.0% | | 22.3% |
% Income Producing Preferred Equity and Equity/Other Investments (based on fair value) | | 28.9% | | 14.1% |
% Non-Income Producing Preferred Equity and Equity/Other Investments (based on fair value) | | 17.3% | | 28.5% |
Weighted Average Purchase Price of Debt Investments (as a % of par value) | | 97.5% | | 98.5% |
% of Investments on Non-Accrual (based on fair value) | | 10.8% | | 10.4% |
Gross Portfolio Yield Prior to Leverage (based on amortized cost) | | 7.3% | | 5.5% |
Gross Portfolio Yield Prior to Leverage (based on amortized cost)—Excluding Non-Income Producing Assets | | 9.3% | | 7.8% |
Although our board of trustees has not declared or resumed regular cash distributions to shareholders for any period after March 31, 2020, our board of trustees has since declared three cash distributions in 2020, four cash distributions in 2021 and four cash distributions in 2022, each in the amount of $0.03 per share. FS/EIG Advisor and our board of trustees expect that future regular cash distributions to shareholders will remain suspended until such time that our board of trustees and FS/EIG Advisor believe that market conditions and our financial condition support the resumption of such distributions. Our board of trustees has and will continue to evaluate our ability to pay any distributions in the future.There can be no assurance that we will be able to pay distributions in the future and any annualized distribution rate provided in this report may not be representative of the actual distribution rate for any period. Based on the distributions declared during 2022 of $0.12 per share, and the price at which we issued shares pursuant to our distribution reinvestment plan of $3.95 per share as of December 31, 2022, the annualized distribution rate to shareholders as of December 31, 2022 was 3.04%. Based on the distributions declared in 2021 of $0.12 per share and the price at which we issued shares pursuant to our distribution reinvestment plan of $3.65 per share as of December 31, 2021, the annualized distribution rate to shareholders as of December 31, 2021 was 3.29%. For the years ended December 31, 2022 and 2021, our total return was 11.39% and 14.22%, respectively, and our total return without assuming reinvestment of distributions was 11.29% and 14.15%, respectively.
Our estimated gross portfolio yield and annualized distribution rate to shareholders do not represent actual investment returns to shareholders. Our gross annual portfolio yield and distribution rate to shareholders are subject to change and in the future may be greater or less than the rates set forth above. See "Item 1A. Risk Factors" for a discussion of the uncertainties, risks and assumptions associated with these statements.
Direct Originations
We define Direct Originations as any investment where FS/EIG Advisor or its affiliates negotiate the terms of the transaction beyond just the price, which, for example, may include negotiating financial covenants, maturity dates or interest rate terms. These Direct Originations include participation in other originated transactions where there may be third parties involved, or a bank acting as an intermediary, for a closely held club, or similar transactions.
The following table presents certain selected information regarding our Direct Originations as of December 31, 2022 and 2021:
| | | | | | | | | | | | | | |
Characteristics of All Direct Originations held in Portfolio | | December 31, 2022 | | December 31, 2021 |
Number of Portfolio Companies | | 40 | | 43 |
% of Investments on Non-Accrual (based on fair value) | | 14.4% | | 15.4% |
Total Cost of Direct Originations | | $1,387,547 | | $1,586,099 |
Total Fair Value of Direct Originations | | $1,537,417 | | $1,621,482 |
% of Total Investments, at Fair Value | | 75.1% | | 67.7% |
Gross Portfolio Yield Prior to Leverage (based on amortized cost) of Funded Direct Originations | | 6.8% | | 5.1% |
Gross Portfolio Yield Prior to Leverage (based on amortized cost) of Funded Direct Originations—Excluding Non-Income Producing Assets | | 9.7% | | 8.4% |
Portfolio Composition by Strategy
The table below summarizes the composition of our investment portfolio by strategy and enumerates the percentage, by fair value, of the total portfolio assets in such strategies as of December 31, 2022 and 2021:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | December 31, 2022 | | December 31, 2021 |
Portfolio Composition by Strategy | | Fair Value | | Percentage of Portfolio | | Fair Value | | Percentage of Portfolio |
Direct Originations | | $ | 1,537,417 | | | 75 | % | | $ | 1,621,482 | | | 68 | % |
Broadly Syndicated/Other | | 509,698 | | | 25 | % | | 773,741 | | 32 | % |
Total | | $ | 2,047,115 | | | 100 | % | | $ | 2,395,223 | | | 100 | % |
See Note 7 to our consolidated financial statements contained in this annual report on Form 10-K for additional information
regarding our investment portfolio.
Portfolio Asset Quality
In addition to various risk management and monitoring tools, FS/EIG Advisor uses an investment rating system to characterize and monitor the expected level of returns on each investment in our portfolio. FS/EIG Advisor uses an investment rating scale of 1 to 5. The following is a description of the conditions associated with each investment rating:
| | | | | | | | |
Investment Rating | | Summary Description |
1 | | Investment exceeding expectations and/or capital gain expected. |
2 | | Performing investment generally executing in accordance with the portfolio company’s business plan—full return of principal and interest expected. |
3 | | Performing investment requiring closer monitoring. |
4 | | Underperforming investment—some loss of interest or dividend possible, but still expecting a positive return on investment. |
5 | | Underperforming investment with expected loss of interest and some principal. |
The following table shows the distribution of our investments on the 1 to 5 investment rating scale at fair value as of December 31, 2022 and 2021:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | December 31, 2022 | | December 31, 2021 |
Investment Rating | | Fair Value | | Percentage of Portfolio | | Fair Value | | Percentage of Portfolio |
1 | | $ | — | | | — | | | $ | — | | | — | |
2 | | 1,426,668 | | | 70 | % | | 1,771,346 | | 74 | % |
3 | | 336,097 | | | 16 | % | | 232,319 | | 10 | % |
4 | | 255,580 | | | 13 | % | | 284,055 | | | 12 | % |
5 | | 28,770 | | | 1 | % | | 107,503 | | | 4 | % |
Total | | $ | 2,047,115 | | | 100 | % | | $ | 2,395,223 | | | 100 | % |
The amount of the portfolio in each grading category may vary substantially from period to period resulting primarily from changes in the composition of the portfolio as a result of new investment, repayment and exit activities. In addition, changes in the grade of investments may be made to reflect our expectation of performance and changes in investment values.
Results of Operations
Comparison of the Years Ended December 31, 2022, 2021 and 2020
Revenues
Our investment income for the years ended December 31, 2022, 2021 and 2020 was as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2022 | | 2021 | | 2020 |
| | Amount | | Percentage of Total Income | | Amount | | Percentage of Total Income | | Amount | | Percentage of Total Income |
Interest income | | $ | 125,158 | | | 68 | % | | $ | 112,201 | | | 74 | % | | $ | 190,177 | | | 85 | % |
Paid-in-kind interest income | | 19,925 | | | 11 | % | | 27,816 | | | 19 | % | | 30,396 | | | 14 | % |
Fee income | | 11,928 | | | 6 | % | | 2,517 | | | 2 | % | | 1,287 | | | 1 | % |
Dividend income | | 27,956 | | | 15 | % | | 8,173 | | | 5 | % | | 66 | | | 0 | % |
Total investment income(1) | | $ | 184,967 | | | 100 | % | | $ | 150,707 | | | 100 | % | | $ | 221,926 | | | 100 | % |
____________________________
(1) Such revenues represent $158,257, $111,722 and $161,239 of cash income earned as well as $26,710, $38,985 and $60,687 in non-cash portions relating to accretion of discount and PIK interest for the years ended December 31, 2022, 2021 and 2020, respectively. Cash flows related to such non-cash revenues may not occur for a number of reporting periods or years after such revenues are recognized.
The level of interest income we receive is generally related to the balance of income-producing investments, multiplied by the weighted average yield of our investments. We may experience volatility in the amount of interest income that we earn as the accrual status of existing portfolio investments may fluctuate due to restructuring activity in the portfolio.
The increase in the amount of interest income for the year ended December 31, 2022 compared to the year ended December 31, 2021 was primarily due to the rising interest rate environment. The decrease in the amount of PIK income for the year ended December 31, 2022 compared to the year ended December 31, 2021 was primarily due to certain investments being placed on non-accrual and the divestiture of certain investments earning PIK income.
The decrease in the amount of interest income and PIK income for the year ended December 31, 2021 compared to the year ended December 31, 2020 was primarily due to a combination of factors including certain investments being placed on non-accrual, an increase in the portfolio's allocation to non-income producing assets as a result of restructurings and an increase in repayments on higher-yielding debt which was reinvested into assets with lower yields.
Fee income is transaction based, and typically consists of prepayment fees and structuring fees. As such, future fee income is generally dependent on new direct origination investments and the occurrence of events at existing portfolio companies resulting in such fees.
The increase in the amount of fee income for the year ended December 31, 2022 compared to the year ended December 31, 2021 was primarily due to an increase in prepayment fees. The increase in the amount of fee income for the year ended December 31, 2021 compared to the year ended December 31, 2020 was primarily due to an increase in prepayment and amendment fees.
The increase in the amount of dividend income for the year ended December 31, 2022 compared to the years ended December 31, 2021 and 2020 was primarily due to the increase in dividends paid with respect to our investments in certain common equities and Sustainable Infrastructure Investments, LLC.
Expenses
Our operating expenses for the years ended December 31, 2022, 2021 and 2020 were as follows:
| | | | | | | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2022 | | 2021 | | 2020 |
Management fees | | $ | 44,559 | | | $ | 41,561 | | | $ | 49,029 | |
Administrative services expenses | | 5,626 | | | 5,713 | | | 6,579 | |
Share transfer agent fees | | 2,985 | | | 2,918 | | | 2,728 | |
Accounting and administrative fees | | 731 | | | 692 | | | 787 | |
Interest expense | | 55,716 | | | 54,122 | | | 75,101 | |
Trustees' fees | | 742 | | | 787 | | | 789 | |
| | | | | | |
Expenses associated with our independent audit and related fees | | 614 | | | 450 | | | 451 | |
Legal fees | | 752 | | | 18 | | | 1,581 | |
Printing fees | | 554 | | | 488 | | | 736 | |
Other | | 3,185 | | | 2,138 | | | 2,404 | |
Total operating expenses | | 115,464 | | | 108,887 | | | 140,185 | |
Less: Management fee offset | | (2,619) | | | (1,439) | | | (706) | |
Net operating expenses before taxes | | 112,845 | | | 107,448 | | | 139,479 | |
Federal income and excise taxes | | 2,353 | | | — | | | — | |
Total net expenses, including federal income and excise taxes | | $ | 115,198 | | | $ | 107,448 | | | $ | 139,479 | |
The following table reflects selected expense ratios as a percent of average net assets for the years ended December 31, 2022, 2021 and 2020:
| | | | | | | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2022 | | 2021 | | 2020 |
Ratio of operating expenses and federal income and excise taxes to average net assets | | 6.78 | % | | 6.96 | % | | 8.20 | % |
Ratio of management fee offset to average net assets | | (0.15) | % | | (0.09) | % | | (0.04) | % |
Ratio of net operating expenses and federal income and excise taxes to average net assets | | 6.63 | % | | 6.87 | % | | 8.16 | % |
Ratio of interest expense and federal income and excise taxes to average net assets | | (3.34) | % | | (3.46) | % | | (4.40) | % |
Ratio of net operating expenses, excluding certain expenses, to average net assets | | 3.29 | % | | 3.41 | % | | 3.76 | % |
Interest expense may increase or decrease our expense ratios relative to comparative periods depending on changes in benchmark interest rates such as LIBOR or SOFR, utilization rates and the terms of our financing arrangements, among other factors.
Management Fee Offset
Structuring, upfront or certain other fees received by FS/EIG Advisor or its members which were offset against management fees due to FS/EIG Advisor from us were $2,619, $1,439 and $706 for the years ended December 31, 2022, 2021 and 2020, respectively. See Note 4 to our consolidated financial statements contained in this annual report on Form 10-K for a discussion of the management fee offset for the years ended December 31, 2022, 2021 and 2020.
Net Investment Income
Our net investment income totaled $69,769 ($0.16 per share), $43,259 ($0.09 per share) and $82,447 ($0.19 per share) for the years ended December 31, 2022, 2021 and 2020, respectively.
Net Realized Gains or Losses
Our net realized gains (losses) on investments, foreign currency, swap contracts and debt extinguishment for the years ended December 31, 2022, 2021 and 2020 were as follows:
| | | | | | | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2022 | | 2021 | | 2020 |
Net realized gain (loss) on investments(1) | | $ | 37,383 | | | $ | (273,439) | | | $ | (1,222,667) | |
Net realized gain (loss) on foreign currency | | (202) | | | (28) | | | — | |
Net realized gain (loss) on swap contracts | | (2,785) | | | — | | | 20,250 | |
Net realized gain (loss) on debt extinguishment | | (929) | | | — | | | 2,591 | |
Total net realized gain (loss) | | $ | 33,467 | | | $ | (273,467) | | | $ | (1,199,826) | |
______________
(1) We sold investments and received principal repayments of $457,619 and $413,370, respectively, during the year ended December 31, 2022, $482,932 and $515,459, respectively, during the year ended December 31, 2021 and $992,178 and $83,350, respectively, during the year ended December 31, 2020.
Net Change in Unrealized Appreciation (Depreciation) on Investments, Swap Contracts and Foreign Currency
Our net change in unrealized appreciation (depreciation) on investments, swap contracts and foreign currency for the years ended December 31, 2022, 2021 and 2020 were as follows:
| | | | | | | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2022 | | 2021 | | 2020 |
Net change in unrealized appreciation (depreciation) on investments | | $ | 82,009 | | | $ | 436,095 | | | $ | 249,140 | |
Net change in unrealized appreciation (depreciation) on swap contracts | | (698) | | | — | | | (6,551) | |
Net change in unrealized appreciation (depreciation) on foreign currency | | (45) | | | (12) | | | 5 | |
Total net change in unrealized appreciation (depreciation) | | $ | 81,266 | | | $ | 436,083 | | | $ | 242,594 | |
During the year ended December 31, 2022, the net change in unrealized appreciation (depreciation) on our investments was primarily driven by the performance of our directly originated assets and certain of our upstream equity/other investments and the conversion of unrealized appreciation to realized gains. During the year ended December 31, 2021, the net change in unrealized appreciation (depreciation) on our investments was primarily driven by the performance of our directly originated assets and certain of our upstream equity/other investments and the conversion of unrealized depreciation to realized losses. During the year ended December 31, 2020, the net change in unrealized appreciation (depreciation) on our investments was primarily driven by the conversion of unrealized depreciation to realized losses and the performance of certain upstream equity/other investments.
Net Increase (Decrease) in Net Assets Resulting from Operations
For the years ended December 31, 2022, 2021 and 2020, the net increase (decrease) in net assets resulting from operations was $184,502 ($0.41 per share), $205,875 ($0.46 per share) and $(874,785) ($(2.00) per share), respectively.
This "Results of Operations" section should be read in conjunction with "COVID-19 and Energy Market Developments" above.
Financial Condition, Liquidity and Capital Resources
Overview
As of December 31, 2022, we had $481,655 in cash, which we held in custodial accounts. As of December 31, 2022, we also had broadly syndicated investments that could be sold to create additional liquidity. As of December 31, 2022, we had six senior secured loan investments with aggregate unfunded commitments of $25,891 and unfunded commitments of $7,625 in U.S. dollars and $858 in Canadian dollars to contribute capital to Sustainable Infrastructure Investments, LLC. We maintain sufficient cash on hand, available borrowings and/or liquid securities to fund such unfunded commitments and other contractual commitments should the need arise.
On February 14, 2023, the JPMorgan Facility matured, and we repaid and terminated the facility with cash. In addition, the Senior Secured Notes mature on August 15, 2023, unless repurchased or redeemed in accordance with their terms prior to such date. We intend on maintaining sufficient cash on hand and/or seeking new financing arrangements, subject to market conditions, to repay the maturing financing arrangements. For additional information regarding our financing arrangements, see Note 9 to our consolidated financial statements included herein.
We generate cash primarily from the issuance of shares under our distribution reinvestment plan and from cash flows from fees, interest and dividends earned from our investments as well as principal repayments and proceeds from sales of our investments. To seek to enhance our returns, we may also seek to employ leverage as market conditions permit and at the discretion of FS/EIG Advisor, but unless and until we elect otherwise, as permitted by the 1940 Act, in no event will leverage employed exceed 50% of the value of our assets, as required by the 1940 Act. See “—Financing Arrangements.”
Prior to investing in securities of portfolio companies, we invest the net proceeds from the issuance of shares under our distribution reinvestment plan as well as from sales and paydowns of existing investments primarily in cash, cash equivalents, including money market funds, U.S. government securities, repurchase agreements and high-quality debt instruments maturing in one year or less from the time of investment, consistent with our BDC election and our election to be taxed as a RIC.
In light of difficult market conditions, we took several steps in 2020 to seek to enhance our liquidity by, among other things, suspending our share repurchase program, suspending regular cash distributions and reducing leverage by paying down borrowings. The share repurchase program and regular cash distributions currently remain suspended.
This “Financial Condition, Liquidity and Capital Resources” section should be read in conjunction with “COVID-19 and Energy Market Developments” above and “—Financing Arrangements” below.
Financing Arrangements
The following table presents a summary of information with respect to our outstanding financing arrangements as of December 31, 2022:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Arrangement(1) | | Type of Arrangement | | Rate(2) | | Amount Outstanding | | Amount Available | | Maturity Date |
JPMorgan Facility | | Term Loan | | L+3.00% | | $ | 305,676 | | | $ | — | | | February 16, 2023(4) |
Senior Secured Notes(3) | | Bond | | 7.50% | | 457,075 | | | — | | | August 15, 2023 |
Total | | | | | | $ | 762,751 | | | $ | — | | | |
________________________
(1) The carrying amount outstanding under the facility approximates its fair value, unless otherwise noted.
(2) LIBOR is subject to a 0.00% floor.
(3) As of December 31, 2022, the fair value of the Senior Secured Notes was approximately $458,908.
(4) On February 14, 2023, the JPMorgan Facility matured, and we repaid and terminated the JPMorgan Facility.
For additional information regarding our financing arrangements, see Note 9 to our consolidated financial statements contained in this annual report on Form 10-K.
RIC Tax Treatment and Distributions
We have elected to be treated for U.S. federal income tax purposes, and intend to qualify annually, as a RIC under Subchapter M of the Code. As a RIC, we generally do not have to pay corporate-level U.S. federal income taxes on any ordinary income or capital gains that we distribute as dividends to our shareholders. To maintain our qualification as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements. In addition, in order to maintain RIC tax treatment, we must distribute to our shareholders, for each tax year, dividends generally of an amount at least equal to 90% of our “investment company taxable income,” which is generally the sum of our net ordinary income plus the excess, if any, of realized net short-term capital gains over realized net long-term capital losses, determined without regard to any deduction for dividends paid. In addition, we may, in certain cases, satisfy the Annual Distribution Requirement by distributing dividends relating to a tax year after the close of such tax year under the "spillover dividend" provisions of Subchapter M of the Code. If we distribute a spillover dividend, such dividend will be included in a shareholder's gross income for the tax year in which the spillover distribution is paid. We intend to make sufficient distributions to our shareholders to maintain our RIC tax treatment each tax year. We will also be subject to nondeductible U.S. federal excise taxes on certain undistributed income unless we distribute in a timely manner to our shareholders of an amount at least equal to the sum of (1) 98% of our net ordinary taxable income (taking into account certain deferrals and elections) for the calendar year, (2) 98.2% of our capital gain net income, which is the excess of capital gains over capital losses (adjusted for certain ordinary losses), for the one-year period ending October 31 of that calendar year and (3) 100% of any ordinary income and capital gain net income recognized for the preceding years that were not distributed during such years and on which we paid no U.S. federal income tax. Any distribution declared by us during October, November or December of any calendar year, payable to our shareholders of record on a specified date in such a month and actually paid during January of the following calendar year, will be treated as if it had been paid by us, as well as received by our U.S. shareholders, on December 31 of the calendar year in which the distribution was declared.
In general, when we pay regular cash distributions, we intend to declare them on a quarterly or monthly basis and pay them on a monthly basis. We will calculate each shareholder’s specific distribution amount for the period using record and declaration dates and each shareholder’s distributions will begin to accrue on the date that common shares are issued to such shareholder. From time to time, we may also pay special interim distributions in arrears,the form of cash or common shares at the discretion of our board of trustees. The timing and amount of any future distributions to shareholders are subject to applicable legal restrictions and the sole discretion of our board of trustees.
Our distribution proceeds have exceeded and in the future may exceed our earnings. Therefore, portions of the distributions that we have made represented, and may make in the future may represent, a return of capital to shareholders, which lowers their tax basis in their common shares.A return of capital generally is calculateda 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 the fees and expenses payable in connection with our continuous public offering, including any fees payable to FS/EIG Advisor. Moreover, a return of capital will generally not be taxable, but will reduce each shareholder’s cost basis in our common shares, and will result in a higher reported capital gain or lower reported capital loss when the common shares on which such return of capital was received are sold. Each year a statement on Form 1099-DIV identifying the sources of the distributions will be mailed to our shareholders.
We intend to make any regular distributions in the form of cash, out of assets legally available for distribution, unless shareholders elect to receive their cash distributions in additional common shares under our distribution reinvestment plan. Any distributions reinvested under the plan will nevertheless remain taxable to a U.S. shareholder.
Although our board of trustees has not declared or resumed regular cash distributions to shareholders for any period after March 31, 2020, our board of trustees has since declared three cash distributions in 2020, four cash distributions in 2021 and four cash distributions in 2022, each in the amount of $0.03 per share. FS/EIG Advisor and our board of trustees expect that future regular cash distributions to shareholders will remain suspended until such time that our board of trustees and FS/EIG Advisor believe that market conditions and our financial condition support the resumption of such distributions. Our board of trustees has and will continue to evaluate our ability to pay any distributions in the future. There can be no assurance that we will be able to pay distributions in the future. The timing and amount of any future distributions to shareholders are subject to applicable legal restrictions and the sole discretion of our board of trustees. In addition, prior to its termination, the JPMorgan Facility restricted our ability to make certain discretionary cash dividends and distributions and other restricted payments. See Note 9 to our consolidated financial statements contained in this annual report on Form 10-K for a discussion of the terms of the JPMorgan Facility.
The following table reflects the cash distributions per share that we have declared on our common shares during the years ended December 31, 2022, 2021 and 2020:
| | | | | | | | | | | | | | |
| | Distribution |
For the Year Ended December 31, | | Per Share | | Amount |
2020 | | $ | 0.1733 | | | $ | 75,656 | |
2021 | | $ | 0.1200 | | | $ | 53,264 | |
2022 | | $ | 0.1200 | | | $ | 53,938 | |
See Note 5 to our consolidated financial statements contained in this annual report on Form 10-K for additional information regarding our distributions, including a reconciliation of our GAAP-basis net investment income to our tax-basis net investment income, the components of accumulated earnings on a tax basis and deferred taxes.
Critical Accounting Policies and Estimates
Our financial statements are prepared in conformity with GAAP, which requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Management has utilized available information, including our past history, industry standards and the current economic environment, among other factors, in forming the estimates and judgments, giving due consideration to materiality. Actual results may differ from these estimates. In addition, other companies may utilize different estimates, which may impact the comparability of our results of operations to those of companies in similar businesses. Understanding our accounting policies and the extent to which we use management judgment and estimates in applying these policies is integral to understanding our financial statements. We describe our most significant accounting policies in Note 2 to our consolidated financial statements contained in this annual report on Form 10-K. 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. We evaluate our critical accounting estimates and judgments required by our policies on an ongoing basis and update them as necessary based on changing conditions. We have identified one of our accounting policies, valuation of portfolio investments, as critical because it involves significant judgments and assumptions about highly complex and inherently uncertain matters, and the use of reasonably different estimates and assumptions could have a material impact on our reported results of operations or financial condition. As we execute our operating plans, we will describe additional critical accounting policies in the notes to our future financial statements in addition to those discussed below.
Valuation of Portfolio Investments
Our board of trustees is responsible for overseeing the valuation of our portfolio investments at fair value as determined in good faith pursuant to FS/EIG Advisor’s valuation policy. As permitted by Rule 2a-5 of the 1940 Act, our board of trustees has designated FS/EIG Advisor as our valuation designee, with day-to-day responsibility for implementing the portfolio valuation process set forth in FS/EIG Advisor’s valuation policy.
Accounting Standards Codification Topic 820, Fair Value Measurements and Disclosure, or ASC Topic 820, issued by the Financial Accounting Standards Board, or 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.
FS/EIG Advisor determines the fair value of our investment portfolio each quarter. Securities that are publicly-traded with readily available market prices will be valued at the reported closing price on the valuation date. Securities that are not publicly-traded with readily available market prices will be valued at fair value as determined in good faith by FS/EIG Advisor. In connection with that determination, FS/EIG Advisor will prepare portfolio company valuations which are based on relevant inputs, including, but not limited to, indicative dealer quotes, values of like securities, recent portfolio company financial statements and forecasts, and valuations prepared by independent third-party pricing and valuation services.
With respect to investments for which market quotations are not readily available, a multi-step valuation process is undertaken each quarter, as described below:
•our quarterly fair valuation process begins with FS/EIG Advisor facilitating the delivery of updated quarterly financial and other information relating to each investment to an independent third-party pricing or valuation service;
•the independent third-party pricing or valuation service then reviews and analyzes the information, along with relevant market and economic data, and determines proposed valuations for each portfolio company or investment according to the valuation methodologies in FS/EIG Advisor’s valuation policy and communicates the information to FS/EIG Advisor in the form of a valuation range for Level 3 assets;
•FS/EIG Advisor then reviews the preliminary valuation information for each portfolio company or investment and provides feedback about the accuracy, completeness and timeliness of the valuation-related inputs considered by the independent third-party pricing or valuation service and any suggested revisions thereto prior to the independent third-party pricing or valuation service finalizing its valuation range;
•FS/EIG Advisor then provides the valuation committee with its valuation determinations and valuation-related information for each portfolio company or investment, along with any applicable supporting materials; and other information that is relevant to the fair valuation process as required by FS/EIG Advisor's board reporting obligations;
•the valuation committee meets with FS/EIG Advisor to receive the relevant quarterly reporting from FS/EIG Advisor and to discuss any questions from the valuation committee in connection with the valuation committee’s role in overseeing the fair valuation process; and
•following the completion of its fair value oversight activities, the valuation committee (with the assistance of FS/EIG Advisor) provides our board of trustees with a report regarding the quarterly valuation process.
Determination of fair value involves subjective judgments and estimates. Accordingly, the notes to our consolidated financial statements refer to the uncertainty with respect to the possible effect of such valuations and any change in such valuations on our consolidated financial statements. In making its determination of fair value, FS/EIG Advisor may use any independent third-party pricing or valuation services for which it has performed the appropriate level of due diligence. However, FS/EIG Advisor is not required to determine fair value in accordance with the valuation provided by any single source, and may use any relevant data, including information sourced by FS/EIG Advisor or provided by any independent third-party pricing or valuation service that FS/EIG Advisor deems to be reliable in determining fair value under the circumstances. Below is a description of factors that FS/EIG Advisor and any independent third-party valuation services may consider when determining the fair value of our investments.
The valuation methods utilized for each portfolio company may vary depending on industry and company-specific considerations. Typically, the first step is to make an assessment as to the enterprise value of the portfolio company’s business in order to establish whether the portfolio company’s enterprise value is greater than the amount of its debt as of the valuation date. This analysis helps to determine a risk profile for the applicable portfolio company and its related investments, and the appropriate valuation methodology to utilize as part of the security valuation analysis. The enterprise valuation may be determined using a market or income approach.
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, FS/EIG Advisor may incorporate these factors into discounted cash flow models to arrive at fair value. Various methods may be used to determine the appropriate discount rate in a discounted cash flow model. Other factors that may be considered include the borrower’s ability to adequately service its debt, the fair market value of the borrower in relation to the face amount of its outstanding debt and the quality of collateral securing the debt investments.
For convertible debt securities, fair value generally approximates the fair value of the debt plus the fair value of an option to purchase the underlying security (i.e., the security into which the debt may convert) at the conversion price. To value such an option, a standard option pricing model may be used.
Our equity interests in portfolio companies for which there is no liquid public market are valued at fair value. Generally, the value of our equity interests in public companies for which market quotations are readily available is based upon the most recent closing public market price. Portfolio securities that carry certain restrictions on sale are typically valued at a discount from the public market value of the security.
When we receive warrants or other equity securities at nominal or no additional cost in connection with an investment in a debt security, the cost basis in the investment will be allocated between the debt securities and any such warrants or other equity securities received at the time of origination. FS/EIG Advisor subsequently values these warrants or other equity securities received at their fair value.
Swap contracts typically are valued at their daily prices obtained from an independent third party. The aggregate settlement values and notional amounts of the swap contracts are not recorded in the statements of assets and liabilities. Fluctuations in the value of the swap contracts are recorded in the statements of assets and liabilities as gross assets and gross liabilities and in the statements of operations as unrealized appreciation (depreciation) until closed, when they will be recorded as net realized gain (loss).
See Note 8 to our consolidated financial statements contained in this annual report on Form 10-K for additional information regarding the fair value of our financial instruments.
Contractual Obligations
We have entered into an agreement with FS/EIG Advisor to provide us with investment advisory and administrative services. Payments for investment advisory services under the FS/EIG investment advisory agreement are equal to 1.75% of the average weekly value of our gross assets and an incentive fee based on our performance. Base management fees are generally paid on a quarterly basis in arrears. See Note 4 to our consolidated financial statements contained in this annual report on Form 10-K for a discussion of this agreement and for the amount of fees and expenses accrued under this agreement during the years ended December 31, 2022, 2021 and 2020.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
We are subject to financial market risks, including changes in interest rates. As of December 31, 2022, 36.8% of our portfolio investments (based on fair value) paid variable interest rates, 17.0% paid fixed interest rates, 28.9% were income producing preferred equity and equity/other investments and the remaining 17.3% consisted of non-income producing preferred equity and equity/other investments. A rise in the general level of interest rates can be expected to lead to higher interest rates applicable to any variable rate investments we hold and to declines in the value of any fixed rate investments we hold. However, many of our variable rate investments provide for an interest rate floor, which may prevent our interest income from increasing until benchmark interest rates increase beyond a threshold amount. To the extent that a substantial portion of our investments may be in variable rate investments, an increase in interest rates beyond this threshold would make it easier for us to meet or exceed the hurdle rate applicable to the subordinated incentive fee on income, and may result in a substantial increase in our net investment income and the amount of incentive fees payable to FS/EIG Advisor with respect to our increased pre-incentive fee net investment income.
Under the indenture governing the Senior Secured Notes, we pay interest to the holders of such notes at a fixed rate. To the extent that any present or future credit facilities or other financing arrangements that we or any of our subsidiaries enter into are based on a floating interest rate, we will be subject to risks relating to changes in market interest rates. In periods of rising interest rates when we or our subsidiaries have such debt outstanding or financing arrangements in effect, our interest expense would increase, which could reduce our net investment income, especially to the extent we hold fixed rate investments.
The following table shows the effect over a twelve-month period of changes in interest rates on our interest income, interest expense and net interest income, assuming no changes in the composition of our investment portfolio, including the accrual status of our investments, and our borrowing arrangements in effect as of December 31, 2022 (dollar amounts are presented in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | |
Basis Point Change in Interest Rates | | Increase (Decrease) in Interest Income | | Increase (Decrease) in Interest Expense | | Increase (Decrease) in Net Interest Income | | Percentage Change in Net Interest Income |
Down 100 basis points | | $ | (12,767) | | | $ | (3,057) | | | $ | (9,710) | | | (11.7) | % |
No Change | | — | | | — | | | — | | | — | |
Up 100 basis points | | $ | 3,937 | | | $ | 3,057 | | | $ | 880 | | | 1.1 | % |
Up 300 basis points | | $ | 20,641 | | | $ | 9,171 | | | $ | 11,470 | | | 13.9 | % |
Up 500 basis points | | $ | 37,344 | | | $ | 15,284 | | | $ | 22,060 | | | 26.7 | % |
We expect that our long-term investments will be financed primarily with equity and debt. If deemed prudent, we may use interest rate risk management techniques in an effort to minimize our exposure to interest rate fluctuations. These techniques may include various interest rate hedging activities to the extent permitted by the 1940 Act. Adverse developments resulting from changes in interest rates or hedging transactions could have a material adverse effect on our business, financial condition and results of operations. During the years ended December 31, 2022, 2021 and 2020, we did not engage in interest rate hedging activities.
In addition, we may have risks regarding portfolio valuation and the potential inability of counterparties to meet the terms of their contracts. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates—Valuation of Portfolio Investments.”
Item 8. Financial Statements and Supplementary Data.
Index to Financial Statements
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. In connection with the preparation of our annual financial statements, management has conducted an assessment of the effectiveness of our internal control over financial reporting based on the framework set forth in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. Management's assessment included an evaluation of the design of our internal control over financial reporting and testing of the operational effectiveness of those controls. Based on this evaluation, we have concluded that, as of December 31, 2022, our internal control over financial reporting was effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance accounting principles generally accepted in the United States of America.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and the Board of Trustees of FS Energy and Power Fund
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheet of FS Energy and Power Fund (the Company), including the consolidated schedule of investments, as of December 31, 2022, the related consolidated statements of operations, changes in net assets, and cash flows for the year ended December 31, 2022, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2022, and the results of its operations, changes in its net assets, and its cash flows for the year ended December 31, 2022, in conformity with U.S. generally accepted accounting principles.
Basis for Opinion
These financial statements are the responsibility of the Company’s gross assets. Pursuantmanagement. Our responsibility is to express an opinion on the Company’s financial statements based on our audit. We are a letter dated May 13, 2020 (the “May Letter”),public accounting firm registered with the Advisor electedPublic Company Accounting Oversight Board (United States) (PCAOB) and are required to deferbe independent with respect to the payment of 74.9%Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the baseSecurities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audit included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our procedures included confirmation of investments owned as of December 31, 2022, by correspondence with the custodians, underlying investee companies and others. Our audit also included evaluating the accounting principles used and significant estimates made by management, feeas well as evaluating the overall presentation of the financial statements. We believe that our audit provides a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the account or disclosures to which it relates.
Valuation of investments using significant unobservable inputs and assumptions
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Description of the Matter | | At December 31, 2022, the fair value of the Company’s investments categorized as Level 3 investments within the fair value hierarchy (Level 3 investments) totaled $1.59 billion. Management determines the fair value of the Company’s Level 3 investments by applying the methodologies outlined in Notes 2 and 8 to the consolidated financial statements and using significant unobservable inputs and assumptions. The selection of valuation techniques and the significant observable inputs and assumptions used by management requires subjective judgments and estimates. The primary valuation techniques used by the Company include market comparables and discounted cash flows. The primary significant unobservable inputs used to measure fair value include EBITDA multiples, discount rates, market yield percentages, proved reserve multiples and production multiples. Auditing the fair value of the Company’s Level 3 investments was complex, as the unobservable inputs and assumptions used by the Company are highly judgmental, are sensitive to economic dislocations, and could have a significant effect on the fair value measurements of such investments. |
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How We Addressed the Matter in Our Audit | | To test the valuation of the Company’s Level 3 investments, we gained an understanding of the valuation techniques, significant unobservable inputs and assumptions used by the Company in determining the fair value of the Company’s Level 3 investments. For a sample of Level 3 investments, with the support of our valuation specialists, we evaluated the valuation techniques used, tested the significant unobservable inputs and assumptions, and tested the mathematical accuracy of the related valuation models. For this sample of Level 3 investments, we agreed the significant inputs and underlying data used in the Company’s valuations including deal terms, portfolio company operating results, and market yields to transaction agreements, most recently available portfolio company financial statements or other financial or operating documents, information available from third-party sources and market data, as applicable. We also involved our valuation specialists to assist in developing independent estimates of fair value for a sample of investments by using portfolio company and market information, and we compared such estimates to the Company’s fair value of these investments. We also searched for and evaluated information that corroborated or contradicted the Company’s valuations of Level 3 investments.
|
/s/ Ernst & Young LLP
We have served as auditor of one or more FS Investments investment companies since 2013.
Philadelphia, Pennsylvania
March 22, 2023
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Trustees and Shareholders of
FS Energy and Power Fund
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheet of FS Energy and Power Fund (the Company), including the consolidated schedule of investments, as of December 31, 2021, the related consolidated statements of operations, changes in net assets and cash flows for each of the two years in the period ended December 31, 2021, and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2021, and the results of its operations, changes in net assets and cash flows for each of the two years in the period ended December 31, 2021, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our procedures included confirmation of securities owned as of December 31, 2021 by correspondence with the custodians, brokers and/or the underlying investees, or by other appropriate auditing procedures where replies from the custodians, brokers and/or the underlying investees were not received. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Level 3 Fair Value Measurements
The fair value of the Company’s investments using Level 3 fair value measurements was approximately $1.62 billion as of December 31, 2021. As discussed in Notes 2 and 8 to the consolidated financial statements, the Company’s investments consist primarily of illiquid corporate debt and equity investments that were acquired directly from the issuer. Such investments include secured loans and bonds, unsecured debt, and unlisted preferred and common equity securities. The valuation techniques used in estimating the fair value of these investments may vary based on the specific characteristics of the investments and require the use of certain significant unobservable inputs.
We identified Level 3 fair value measurements as a critical audit matter due to the subjective nature of the judgments necessary for management to select valuation techniques and the use of significant unobservable inputs to estimate the fair value. Auditing the reasonableness of management’s selection of valuation techniques and the related unobservable inputs required a high degree of auditor judgment and increased audit effort, including the use of a valuation specialist.
The primary procedures we performed to address this critical audit matter included the following, among others:
a.We obtained an understanding of the relevant controls related to management’s valuation of Level 3 fair value measurements, including those related to valuation techniques and significant unobservable inputs and tested such controls for design and operating effectiveness.
b.With the assistance of our valuation specialists, we evaluated the appropriateness of the selected valuation techniques, and any changes to selected valuation techniques from prior periods, used for Level 3 fair value measurements. We also tested the related significant unobservable inputs by comparing these inputs to external sources.
c.We evaluated management’s historical ability to estimate fair value through comparison of previous estimates to the transaction price of available transactions occurring subsequent to the previous valuation date.
/s/ RSM US LLP
We served as the Company’s auditor from 2007 to September 23, 2022.
Blue Bell, Pennsylvania
March 11, 2022
FS Energy and Power Fund
Consolidated Balance Sheets
(in thousands, except share and per share amounts)
| | | | | | | | | | | | | | |
| | December 31, |
| | 2022 | | 2021 |
Assets | | | | |
Investments, at fair value | | | | |
Non-controlled/unaffiliated investments (amortized cost—$1,656,169 and $1,961,617, respectively) | | $ | 1,786,887 | | | $ | 2,037,956 | |
Non-controlled/affiliated investments (amortized cost—$94,068 and $200,189, respectively) | | 65,777 | | | 175,908 | |
Controlled/affiliated investments (amortized cost—$172,703 and $191,251, respectively) | | 194,451 | | | 181,359 | |
Total investments, at fair value (amortized cost—$1,922,940 and $2,353,057, respectively) | | 2,047,115 | | | 2,395,223 | |
Cash | | 481,655 | | | 33,879 | |
Receivable for investments sold and repaid | | 7,022 | | | 4,975 | |
Interest receivable | | 21,932 | | | 26,242 | |
Dividends receivable | | 878 | | | — | |
| | | | |
Swap income receivable | | 83 | | | — | |
Prepaid expenses and other assets | | 96 | | | 156 | |
Total assets | | $ | 2,558,781 | | | $ | 2,460,475 | |
Liabilities | | | | |
Payable for investments purchased | | $ | — | | | $ | 49,500 | |
Credit facilities payable (net of deferred financing costs of $238 and $2,036, respectively)(1) | | 305,438 | | | 284,631 | |
Secured note payable (net of deferred financing costs of $1,253 and $3,350, respectively)(1) | | 454,671 | | | 482,437 | |
Unrealized depreciation on swap contracts | | 698 | | | — | |
Swap income payable | | 26 | | | — | |
Shareholder distributions payable | | 13,543 | | | 13,388 | |
Management fees payable | | 11,185 | | | 10,466 | |
Administrative services expenses payable | | 1,086 | | | 1,324 | |
Interest payable | | 13,371 | | | 14,170 | |
Trustees' fees payable | | 164 | | | 200 | |
| | | | |
Other accrued expenses and liabilities | | 4,851 | | | 2,036 | |
Total Liabilities | | 805,033 | | | 858,152 | |
Commitments and contingencies(2) | | | | |
Shareholders' equity | | | | |
Preferred shares, $0.001 par value, 50,000,000 shares authorized, none issued and outstanding | | — | | | — | |
Common shares, $0.001 par value, 700,000,000 shares authorized, 451,465,673 and 446,089,499 shares issued and outstanding, respectively | | 451 | | | 446 | |
Capital in excess of par value | | 3,191,293 | | | 3,129,252 | |
Accumulated earnings (deficit) | | (1,437,996) | | | (1,527,375) | |
Total shareholders' equity | | 1,753,748 | | | 1,602,323 | |
Total liabilities and shareholders' equity | | $ | 2,558,781 | | | $ | 2,460,475 | |
Net asset value per common share at year end | | $ | 3.88 | | | $ | 3.59 | |
_________________________
(1) See Note 9 for a discussion of the Company's financing arrangements.
(2) See Note 10 for a discussion of the Company's commitments and contingencies.
See notes to consolidated financial statements.
68
FS Energy and Power Fund
Consolidated Statements of Operations
(in thousands, except share and per share amounts)
| | | | | | | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2022 | | 2021 | | 2020 |
Investment income | | | | | | |
From non-controlled/unaffiliated investments: | | | | | | |
Interest income | | $ | 119,003 | | | $ | 102,342 | | | $ | 177,147 | |
Paid-in-kind interest income | | 12,666 | | | 20,827 | | | 18,397 | |
Fee income | | 4,660 | | | 2,508 | | | 1,287 | |
Dividend income | | 21,804 | | | 870 | | | 66 | |
From non-controlled/affiliated investments: | | | | | | |
Interest income | | 3,219 | | | 6,889 | | | 10,144 | |
Paid-in-kind interest income | | 105 | | | 215 | | | 11,999 | |
Fee income | | 7,268 | | | — | | | — | |
Dividend income | | 5,417 | | | 1,574 | | | — | |
From controlled/affiliated investments: | | | | | | |
Interest income | | 2,936 | | | 2,970 | | | 2,886 | |
Paid-in-kind interest income | | 7,154 | | | 6,774 | | | — | |
Fee income | | — | | | 9 | | | — | |
Dividend income | | 735 | | | 5,729 | | | — | |
Total investment income | | 184,967 | | | 150,707 | | | 221,926 | |
Operating expenses | | | | | | |
Management fees | | 44,559 | | | 41,561 | | | 49,029 | |
Administrative services expenses | | 5,626 | | | 5,713 | | | 6,579 | |
Share transfer agent fees | | 2,985 | | | 2,918 | | | 2,728 | |
Accounting and administrative fees | | 731 | | | 692 | | | 787 | |
Interest expense(1) | | 55,716 | | | 54,122 | | | 75,101 | |
Trustees' fees | | 742 | | | 787 | | | 789 | |
| | | | | | |
Other general and administrative expenses | | 5,105 | | | 3,094 | | | 5,172 | |
Total operating expenses | | 115,464 | | | 108,887 | | | 140,185 | |
Less: Management fee offset(2) | | (2,619) | | | (1,439) | | | (706) | |
Net expenses | | 112,845 | | | 107,448 | | | 139,479 | |
Net investment income before taxes | | 72,122 | | | 43,259 | | | 82,447 | |
Federal income and excise taxes | | 2,353 | | | — | | | — | |
Net investment income | | 69,769 | | | 43,259 | | | 82,447 | |
Realized and unrealized gain/loss | | | | | | |
Net realized gain (loss) on investments: | | | | | | |
Non-controlled/unaffiliated | | (21,652) | | | 9,454 | | | (766,774) | |
Non-controlled/affiliated | | 43,136 | | | (282,893) | | | (428,429) | |
Controlled/affiliated | | 15,899 | | | — | | | (27,464) | |
Net realized gain (loss) on foreign currency | | (202) | | | (28) | | | — | |
Net realized gain (loss) on swap contracts | | (2,785) | | | — | | | 20,250 | |
Net realized gain (loss) on debt extinguishment | | (929) | | | — | | | 2,591 | |
Net change in unrealized appreciation (depreciation) on investments: | | | | | | |
Non-controlled/unaffiliated | | 54,379 | | | 304,707 | | | 63,204 | |
Non-controlled/affiliated | | (4,010) | | | 142,870 | | | 156,882 | |
Controlled/affiliated | | 31,640 | | | (11,482) | | | 29,054 | |
Net change in unrealized appreciation (depreciation) on swap contracts | | (698) | | | — | | | (6,551) | |
Net change in unrealized appreciation (depreciation) on foreign currency | | (45) | | | (12) | | | 5 | |
Total net realized and unrealized gain (loss) | | 114,733 | | | 162,616 | | | (957,232) | |
Net increase (decrease) in net assets resulting from operations | | $ | 184,502 | | | $ | 205,875 | | | $ | (874,785) | |
Per share information—basic and diluted | | | | | | |
Net increase (decrease) in net assets resulting from operations (Earnings per Share) | | $ | 0.41 | | | $ | 0.46 | | | $ | (2.00) | |
Weighted average shares outstanding | | 449,393,210 | | | 443,768,738 | | | 437,620,915 | |
_________________________
(1)See Note 9 for a discussion of the Company’s financing arrangements.
(2)See Note 4 for a discussion of the offset by FS/EIG Advisor, LLC, the Company's investment adviser, of certain management fees to which it was otherwise entitled during the applicable period.
See notes to consolidated financial statements.
69
FS Energy and Power Fund
Consolidated Statements of Changes in Net Assets
(in thousands)
| | | | | | | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2022 | | 2021 | | 2020 |
Operations | | | | | | |
Net investment income | | $ | 69,769 | | | $ | 43,259 | | | $ | 82,447 | |
Net realized gain (loss) on investments, foreign currency, swap contracts and debt extinguishment | | 33,467 | | | (273,467) | | | (1,199,826) | |
Net change in unrealized appreciation (depreciation) on investments | | 82,009 | | | 436,095 | | | 249,140 | |
Net change in unrealized appreciation (depreciation) on swap contracts | | (698) | | | — | | | (6,551) | |
Net change in unrealized appreciation (depreciation) on foreign currency | | (45) | | | (12) | | | 5 | |
Net increase (decrease) in net assets resulting from operations | | 184,502 | | | 205,875 | | | (874,785) | |
Shareholder distributions(1) | | | | | | |
Distributions to shareholders | | (53,938) | | | (53,264) | | | (63,272) | |
Distributions representing return of capital | | — | | | — | | | (12,384) | |
Net decrease in net assets resulting from shareholder distributions | | (53,938) | | | (53,264) | | | (75,656) | |
Capital share transactions(2) | | | | | | |
Reinvestment of shareholder distributions | | 20,861 | | | 21,135 | | | 26,236 | |
Repurchases of common shares | | — | | | — | | | (26,823) | |
Net increase (decrease) in net assets resulting from capital share transactions | | 20,861 | | | 21,135 | | | (587) | |
Total increase (decrease) in net assets | | 151,425 | | | 173,746 | | | (951,028) | |
Net assets at beginning of year | | 1,602,323 | | | 1,428,577 | | | 2,379,605 | |
Net assets at end of year | | $ | 1,753,748 | | | $ | 1,602,323 | | | $ | 1,428,577 | |
_________________________
(1) See Note 5 for a discussion of the sources of distributions paid by the Company.
(2) See Note 3 for a discussion of the Company’s capital share transactions.
See notes to consolidated financial statements.
70
FS Energy and Power Fund
Consolidated Statements of Cash Flows
(in thousands)
| | | | | | | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2022 | | 2021 | | 2020 |
Cash flows from operating activities | | | | | | |
Net increase (decrease) in net assets resulting from operations | | $ | 184,502 | | | $ | 205,875 | | | $ | (874,785) | |
Adjustments to reconcile net increase (decrease) in net assets resulting from operations to net cash provided by (used in) operating activities: | | | | | | |
Purchases of investments | | (375,192) | | | (883,097) | | | (375,782) | |
Paid-in-kind interest | | (19,925) | | | (27,816) | | | (30,396) | |
Proceeds from sales and repayments of investments | | 869,402 | | | 870,992 | | | 764,102 | |
Net realized (gain) loss on investments | | (37,383) | | | 273,439 | | | 1,222,667 | |
Net change in unrealized (appreciation) depreciation on investments | | (82,009) | | | (436,095) | | | (249,140) | |
Net change in unrealized (appreciation) depreciation on swap contracts | | 698 | | | — | | | 6,551 | |
Accretion of discount | | (6,785) | | | (11,170) | | | (30,290) | |
Amortization of deferred financing costs and discount | | 6,095 | | | 7,824 | | | 7,523 | |
(Increase) decrease in receivable for investments sold and repaid | | (2,047) | | | 2,716 | | | (6,962) | |
(Increase) decrease in interest receivable | | 4,310 | | | 463 | | | 6,802 | |
(Increase) decrease in dividends receivable | | (878) | | | — | | | — | |
(Increase) decrease in swap income receivable | | (83) | | | — | | | 395 | |
(Increase) decrease in prepaid expenses and other assets | | 60 | | | 78 | | | 32 | |
Increase (decrease) in payable for investments purchased | | (49,500) | | | 49,500 | | | (28,518) | |
Increase (decrease) in swap income payable | | 26 | | | — | | | — | |
Increase (decrease) in management fees payable | | 719 | | | 310 | | | (5,426) | |
Increase (decrease) in administrative services expenses payable | | (238) | | | 375 | | | 442 | |
Increase (decrease) in interest payable(1) | | (799) | | | (66) | | | (2,331) | |
Increase (decrease) in trustees' fees payable | | (36) | | | 8 | | | — | |
| | | | | | |
Increase (decrease) in other accrued expenses and liabilities | | 2,815 | | | 64 | | | (5,711) | |
Net cash provided by (used in) operating activities | | 493,752 | | | 53,400 | | | 399,173 | |
Cash flows from financing activities | | | | | | |
Repurchases of common shares | | — | | | — | | | (26,823) | |
Shareholder distributions paid | | (32,922) | | | (31,929) | | | (46,472) | |
Borrowings under credit facilities(1) | | 29,009 | | | 95,000 | | | 160,000 | |
Repayments of credit facilities(1) | | (10,000) | | | (225,000) | | | (480,000) | |
Repayments under senior secured notes(1) | | (31,925) | | | — | | | (11,000) | |
Deferred financing costs paid | | (138) | | | (128) | | | (2,761) | |
Net cash provided by financing activities | | (45,976) | | | (162,057) | | | (407,056) | |
Total increase (decrease) in cash | | 447,776 | | | (108,657) | | | (7,883) | |
Cash at beginning of year | | 33,879 | | | 142,536 | | | 150,419 | |
Cash at end of year | | $ | 481,655 | | | $ | 33,879 | | | $ | 142,536 | |
Supplemental disclosure | | | | | | |
Non-cash reinvestment of shareholder distributions | | $ | 20,861 | | | $ | 21,135 | | | $ | 26,236 | |
Non-cash purchases of investments | | $ | (1,587) | | | $ | (127,399) | | | $ | (311,426) | |
Non-cash sales of investments | | $ | 1,587 | | | $ | 127,399 | | | $ | 311,426 | |
Excise taxes paid | | $ | 404 | | | $ | — | | | $ | — | |
_________________________
(1)See Note 9 for a discussion of the Company's financing arrangements. During the years ended December 31, 2022, 2021 and 2020, the Company paid $50,420, $46,364 and $69,909, respectively, in interest expense on the financing arrangements and Senior Secured Notes.
See notes to consolidated financial statements.
71
FS Energy and Power Fund
Consolidated Schedule of Investments
As of December 31, 2022
(in thousands, except share amounts)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Portfolio Company(a) | | Footnotes | | Industry | | Rate(b) | | Floor(b) | | Maturity | | Principal Amount(c) | | Amortized Cost | | Fair Value(d) |
Senior Secured Loans—First Lien—40.3% | | | | | | | | | | | | | | | | |
AIRRO (Mauritius) Holdings II | | (k)(p)(s) | | Power | | L+400, 3.0% PIK (3.0% Max PIK) | | 1.5% | | 7/24/25 | | $ | 22,734 | | | $ | 20,082 | | | $ | 23,519 | |
AIRRO (Mauritius) Holdings II | | (e)(k)(p)(s) | | Power | | L+400, 3.0% PIK (3.0% Max PIK) | | 1.5% | | 7/24/25 | | 5,359 | | | 5,359 | | | 5,545 | |
Allied Downhole Technologies, LLC | | (f)(s)(u) | | Service & Equipment | | 8.0% PIK (8.0% Max PIK) | | | | 9/30/23 | | 8,436 | | | 8,436 | | | 8,436 | |
Allied Downhole Technologies, LLC | | (e)(s)(u) | | Service & Equipment | | 8.0% PIK (8.0% Max PIK) | | | | 9/30/23 | | 2,500 | | | 2,500 | | | 2,500 | |
Allied Wireline Services, LLC | | (f)(s)(u) | | Service & Equipment | | 10.0% PIK (10.0% Max PIK) | | | | 6/15/25 | | 63,888 | | | 63,888 | | | 63,888 | |
Brazos Delaware II LLC | | | | Midstream | | L+400 | | | | 5/21/25 | | 39,259 | | | 38,085 | | | 39,137 | |
Cimarron Energy Inc. | | (f)(m)(o)(s) | | Service & Equipment | | L+900 | | 1.0% | | 12/31/24 | | 7,500 | | | 6,563 | | | 3,713 | |
Compass Power Generation LLC | | | | Power | | S+425 | | 1.0% | | 4/14/29 | | 31,575 | | | 30,712 | | | 31,384 | |
Cox Oil Offshore, LLC, Volumetric Production Payments | | (g)(i)(s) | | Upstream | | 12.9% | | | | 12/31/23 | | 100,000 | | | 11,081 | | | 20,683 | |
CPV Maryland, LLC | | | | Power | | L+400 | | 1.0% | | 5/11/28 | | 14,286 | | | 14,146 | | | 14,155 | |
CPV Shore Holdings LLC | | | | Power | | L+375 | | | | 12/29/25 | | 23,601 | | | 22,760 | | | 21,935 | |
EIF Van Hook Holdings, LLC | | | | Midstream | | S+525 | | | | 9/5/24 | | 26,882 | | | 26,609 | | | 26,075 | |
FR BR Holdings LLC | | (f)(s) | | Midstream | | L+650 | | | | 12/14/23 | | 81,582 | | | 80,371 | | | 81,361 | |
FR XIII PAA Holdings HoldCo, LLC | | (s) | | Midstream | | L+750 | | 0.5% | | 10/15/26 | | 17,347 | | | 17,103 | | | 17,406 | |
GasLog Ltd. | | (k)(s) | | Midstream | | L+775 | | | | 3/31/29 | | 14,648 | | | 14,556 | | | 14,010 | |
Generation Bridge LLC | | | | Power | | L+500 | | 0.8% | | 12/1/28 | | 7,432 | | | 7,305 | | | 7,385 | |
Generation Bridge LLC | | | | Power | | L+500 | | 0.8% | | 12/1/28 | | 163 | | | 160 | | | 162 | |
GIP II Blue Holding LP | | | | Midstream | | L+450 | | 1.0% | | 9/29/28 | | 5,918 | | | 5,842 | | | 5,877 | |
Goodnight Water Solutions, LLC | | (s) | | Midstream | | S+725 | | 0.5% | | 6/3/27 | | 14,963 | | | 14,752 | | | 14,819 | |
Hamilton Intermediate Holdings, LLC | | (s) | | Power | | 16.5% PIK (16.5% Max PIK) | | | | 6/17/25 | | 30,391 | | | 31,075 | | | 31,007 | |
Medallion Midland Acquisition LP | | | | Midstream | | S+375 | | 0.8% | | 10/18/28 | | 7,920 | | | 7,886 | | | 7,862 | |
OE2 North, LLC | | (s) | | Midstream | | L+525 | | 1.0% | | 5/21/26 | | 18,659 | | | 18,579 | | | 18,847 | |
OE2 North, LLC | | (e)(s) | | Midstream | | L+525 | | 1.0% | | 5/21/26 | | 11,341 | | | 11,341 | | | 11,455 | |
Oryx Midstream Services Permian Basin LLC | | (f) | | Midstream | | L+325 | | 0.5% | | 10/5/28 | | 32,357 | | | 32,220 | | | 32,026 | |
Parkway Generation LLC | | | | Power | | S+475 | | 0.8% | | 2/18/29 | | 5,760 | | | 5,708 | | | 5,700 | |
Parkway Generation LLC | | | | Power | | S+475 | | 0.8% | | 2/18/29 | | 43,910 | | | 43,513 | | | 43,285 | |
Permian Production Holdings, LLC | | (f)(s)(t) | | Upstream | | 7.0%, 2.0% PIK (2.0% Max PIK) | | | | 11/23/25 | | 4,767 | | | 4,266 | | | 4,767 | |
Pinnacle Midland Gas Holdco LLC | | (s) | | Midstream | | L+675 | | 1.0% | | 12/9/26 | | 9,370 | | | 9,304 | | | 9,310 | |
Pinnacle Midland Gas Holdco LLC | | (e)(s) | | Midstream | | L+675 | | 1.0% | | 12/9/26 | | 2,477 | | | 2,477 | | | 2,461 | |
Plainfield Renewable Energy Holdings LLC | | (f)(s) | | Power | | 6.0%, 9.5% PIK (9.5% Max PIK) | | | | 8/22/25 | | 12,121 | | | 12,121 | | | 9,997 | |
Plainfield Renewable Energy Holdings LLC | | (f)(s) | | Power | | 10.0% PIK (10.0% Max PIK) | | | | 8/22/25 | | 3,643 | | | 3,643 | | | — | |
Plainfield Renewable Energy Holdings LLC, Letter of Credit | | (e)(s) | | Power | | 10.0% | | | | 8/22/23 | | 2,709 | | | 2,709 | | | — | |
See notes to consolidated financial statements.
72
FS Energy and Power Fund
Consolidated Schedule of Investments (continued)
As of December 31, 2022
(in thousands, except share amounts)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Portfolio Company(a) | | Footnotes | | Industry | | Rate(b) | | Floor(b) | | Maturity | | Principal Amount(c) | | Amortized Cost | | Fair Value(d) |
Potomac Energy Center, LLC | | (s) | | Power | | L+600 | | 0.5% | | 11/12/26 | | $ | 58,459 | | | $ | 57,508 | | | $ | 58,443 | |
Traverse Midstream Partners LLC | | | | Midstream | | S+425 | | 1.0% | | 9/27/24 | | 28,436 | | | 28,484 | | | 28,418 | |
Warren Resources, Inc. | | (s)(u) | | Upstream | | L+900, 1.0% PIK (1.0% Max PIK) | | 1.0% | | 5/22/24 | | 23,584 | | | 23,584 | | | 23,584 | |
Wattbridge Inc. | | (s) | | Power | | S+785 | | 1.8% | | 6/30/27 | | 42,500 | | | 42,500 | | | 41,880 | |
| | | | | | | | | | | | | | | | |
Total Senior Secured Loans—First Lien | | | | | | | | | | | | | | 727,228 | | | 731,032 | |
Unfunded Loan Commitments | | | | | | | | | | | | | | (24,386) | | | (24,386) | |
Net Senior Secured Loans—First Lien | | | | | | | | | | | | | | 702,842 | | | 706,646 | |
| | | | | | | | | | | | | | | | |
Senior Secured Loans—Second Lien—8.2% | | | | | | | | | | | | | | | | |
Aethon III BR LLC | | (f)(s) | | Upstream | | L+750 | | 1.5% | | 1/10/25 | | 20,000 | | | 19,848 | | | 20,138 | |
Citizen Energy Operating, LLC | | (f)(s) | | Upstream | | S+765 | | 1.0% | | 6/29/27 | | 39,000 | | | 38,440 | | | 38,240 | |
ERA II Minerals, LLC | | (f)(s) | | Upstream | | S+625 | | 0.8% | | 3/7/27 | | 37,000 | | | 36,601 | | | 36,656 | |
Peak Exploration & Production, LLC | | (f)(s) | | Upstream | | L+675 | | 1.5% | | 11/16/23 | | 13,545 | | | 13,528 | | | 13,394 | |
Peak Exploration & Production, LLC | | (e)(s) | | Upstream | | L+675 | | 1.5% | | 11/16/23 | | 1,505 | | | 1,505 | | | 1,488 | |
SilverBow Resources, Inc. | | (f)(k)(s) | | Upstream | | L+750 | | 1.0% | | 12/15/26 | | 14,250 | | | 14,199 | | | 14,322 | |
Tenrgys, LLC | | (f)(s) | | Upstream | | S+750, (9.5% Max PIK) | | 1.0% | | 3/17/27 | | 20,537 | | | 20,537 | | | 20,537 | |
Total Senior Secured Loans—Second Lien | | | | | | | | | | | | | | 144,658 | | | 144,775 | |
Unfunded Loan Commitments | | | | | | | | | | | | | | (1,505) | | | (1,505) | |
Net Senior Secured Loans—Second Lien | | | | | | | | | | | | | | 143,153 | | | 143,270 | |
| | | | | | | | | | | | | | | | |
Senior Secured Bonds—0.6% | | | | | | | | | | | | | | | | |
ST EIP Holdings Inc. | | (s) | | Midstream | | 6.3% | | | | 1/10/30 | | 10,526 | | | 10,064 | | | 10,074 | |
Total Senior Secured Bonds | | | | | | | | | | | | | | 10,064 | | | 10,074 | |
| | | | | | | | | | | | | | | | |
Unsecured Debt—13.7% | | | | | | | | | | | | | | | | |
Aethon United BR LP | | (f) | | Upstream | | 8.3% | | | | 2/15/26 | | 40,500 | | | 40,500 | | | 40,221 | |
Archrock Partners, L.P. | | (f)(k) | | Midstream | | 6.3% | | | | 4/1/28 | | 3,098 | | | 3,168 | | | 2,840 | |
Earthstone Energy Holdings, LLC | | (k) | | Upstream | | 8.0% | | | | 4/15/27 | | 11,400 | | | 11,400 | | | 10,920 | |
Endeavor Energy Resources, L.P. | | (f) | | Upstream | | 5.8% | | | | 1/30/28 | | 24,299 | | | 25,388 | | | 23,306 | |
Hammerhead Resources Inc. | | (f)(k)(s) | | Upstream | | 12.0% PIK (12.0% Max PIK) | | | | 7/15/24 | | 35,118 | | | 34,961 | | | 35,118 | |
Moss Creek Resources, LLC | | (f) | | Upstream | | 7.5% | | | | 1/15/26 | | 11,693 | | | 10,358 | | | 10,561 | |
NRG Energy, Inc. | | (k) | | Power | | 3.9% | | | | 2/15/32 | | 19,125 | | | 18,668 | | | 14,401 | |
Permian Resources Operating LLC | | | | Upstream | | 7.8% | | | | 2/15/26 | | 26,365 | | | 27,511 | | | 25,703 | |
Permian Resources Operating LLC | | (f) | | Upstream | | 5.9% | | | | 7/1/29 | | 5,200 | | | 5,257 | | | 4,473 | |
Ranger Oil Corp. | | (k) | | Upstream | | 9.3% | | | | 8/15/26 | | 29,772 | | | 29,633 | | | 29,678 | |
See notes to consolidated financial statements.
73
FS Energy and Power Fund
Consolidated Schedule of Investments (continued)
As of December 31, 2022
(in thousands, except share amounts)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Portfolio Company(a) | | Footnotes | | Industry | | Rate(b) | | Floor(b) | | Maturity | | Principal Amount(c) | | Amortized Cost | | Fair Value(d) |
Sitio Royalties Operating Partnership, LP | | (f)(k)(s) | | Upstream | | S+650 | | 1.5% | | 9/20/26 | | $ | 19,500 | | | $ | 19,318 | | | $ | 19,256 | |
Suburban Propane Partners LP | | (f)(k) | | Midstream | | 5.0% | | | | 6/1/31 | | 7,590 | | | 7,837 | | | 6,461 | |
Tallgrass Energy Partners, LP | | (f) | | Midstream | | 6.0% | | | | 3/1/27 | | 19,761 | | | 19,676 | | | 18,480 | |
Total Unsecured Debt | | | | | | | | | | | | | | 253,675 | | | 241,418 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Portfolio Company(a) | | Footnotes | | Industry | | Rate(b) | | Floor(b) | | Maturity | | Number of Shares | | Amortized Cost | | Fair Value(d) |
Preferred Equity—22.8%(l) | | | | | | | | | | | | | | | | |
Abaco Energy Technologies LLC, Preferred Equity | | (f)(o)(s) | | Service & Equipment | | | | | | | | 28,942,003 | | | $ | 1,447 | | | $ | 8,321 | |
Global Jet Capital Holdings, LP, Preferred Equity | | (f)(o)(s) | | Industrials | | | | | | | | 2,785,562 | | | 2,786 | | | — | |
Global Jet Capital Holdings, LP, Preferred Equity | | (f)(m)(o)(s) | | Industrials | | 9.0% PIK (9.0% Max PIK) | | | | 10/1/28 | | 18,296 | | | 12,493 | | | 9,377 | |
NGL Energy Partners, LP, Preferred Equity | | (f)(k)(m)(o)(s) | | Midstream | | 14.2% | | | | 7/2/27 | | 156,250 | | | 157,633 | | | 125,000 | |
NuStar, Preferred Equity | | (f)(k)(s) | | Midstream | | 12.8% | | | | 6/29/28 | | 2,640,311 | | | 73,114 | | | 83,590 | |
Segreto Power Holdings, LLC, Preferred Equity | | (f)(m)(n)(o)(s) | | Power | | 13.1% | | | | 6/30/25 | | 70,297 | | | 99,766 | | | 83,647 | |
USA Compression Partners, LP, Preferred Equity | | (k)(s) | | Midstream | | 9.8% | | | | 4/3/28 | | 79,336 | | | 77,943 | | | 90,479 | |
Total Preferred Equity | | | | | | | | | | | | | | 425,182 | | | 400,414 | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | Principal Amount(c) | | Cost | | Fair Value(d) |
Sustainable Infrastructure Investments, LLC—2.9% | | | | | | | | | | | | | | | | |
Sustainable Infrastructure Investments, LLC | | (k)(s)(u) | | Power | | | | | | | | $ | 60,603 | | | $ | 54,514 | | | $ | 51,098 | |
Total Sustainable Infrastructure Investments, LLC | | | | | | | | | | | | | | 54,514 | | | 51,098 | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | Number of Shares | | Amortized Cost | | Fair Value(d) |
Equity/Other—28.2% | | | | | | | | | | | | | | | | |
Abaco Energy Technologies LLC, Common Equity | | (f)(o)(s) | | Service & Equipment | | | | | | | | 6,944,444 | | | $ | 6,944 | | | $ | 1,219 | |
AIRRO (Mauritius) Holdings II, Warrants, Strike: $1.00 | | (f)(k)(o)(p)(s) | | Power | | | | | | 7/24/25 | | 35 | | | 2,652 | | | 1,630 | |
Allied Wireline Services, LLC, Common Equity | | (f)(n)(o)(s)(u) | | Service & Equipment | | | | | | | | 48,400 | | | 1,527 | | | 10,463 | |
Allied Wireline Services, LLC, Warrants | | (f)(n)(o)(s)(u) | | Service & Equipment | | | | | | | | 22,000 | | | — | | | — | |
Arena Energy, LP, Contingent Value Rights | | (f)(o)(s) | | Upstream | | | | | | 2/1/25 | | 126,632,117 | | | 351 | | | 858 | |
Ascent Resources Utica Holdings, LLC, Common Equity | | (f)(n)(o)(s) | | Upstream | | | | | | | | 148,692,948 | | | 44,700 | | | 52,340 | |
Cimarron Energy Holdco Inc., Common Equity | | (f)(o)(s) | | Service & Equipment | | | | | | | | 4,302,293 | | | 3,950 | | | — | |
Cimarron Energy Holdco Inc., Participation Option | | (f)(o)(s) | | Service & Equipment | | | | | | | | 25,000,000 | | | 1,289 | | | — | |
GWP Midstream Holdco, LLC, Common Equity | | (f)(n)(o)(s)(t) | | Midstream | | | | | | | | 105,785 | | | 6,681 | | | 5,044 | |
Harvest Oil & Gas Corp., Common Equity | | (f)(o)(t) | | Upstream | | | | | | | | 135,062 | | | 15,059 | | | 810 | |
Limetree Bay Energy, LLC, Class A Units | | (f)(o)(s)(t) | | Midstream | | | | | | | | 76,938,973 | | | 21,458 | | | 1,885 | |
Maverick Natural Resources, LLC, Common Equity | | (f)(n)(s) | | Upstream | | | | | | | | 503,176 | | | 138,208 | | | 312,372 | |
See notes to consolidated financial statements.
74
FS Energy and Power Fund
Consolidated Schedule of Investments (continued)
As of December 31, 2022
(in thousands, except share amounts)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Portfolio Company(a) | | Footnotes | | Industry | | Rate(b) | | Floor(b) | | Maturity | | Number of Shares | | Amortized Cost | | Fair Value(d) |
MB Precision Investment Holdings LLC, Class A-2 Units | | (f)(n)(o)(s) | | Industrials | | | | | | | | 1,426,110 | | | $ | 490 | | | $ | — | |
NGL Energy Partners, LP, Warrants (Par), Strike: $14.54 | | (f)(k)(o)(s) | | Midstream | | | | | | 12/31/25 | | 2,187,500 | | | 3,083 | | | 10 | |
NGL Energy Partners, LP, Warrants (Premium), Strike: $17.45 | | (f)(k)(o)(s) | | Midstream | | | | | | 12/31/25 | | 3,125,000 | | | 2,623 | | | 8 | |
NGL Energy Partners, LP, Warrants (Premium), Strike: $16.27 | | (f)(k)(o)(s) | | Midstream | | | | | | 12/31/25 | | 781,250 | | | 576 | | | 2 | |
NGL Energy Partners, LP, Warrants (Par), Strike: $13.56 | | (f)(k)(o)(s) | | Midstream | | | | | | 12/31/25 | | 546,880 | | | 630 | | | 3 | |
Permian Production Holdings, LLC, Common Equity | | (f)(n)(s)(t) | | Upstream | | | | | | | | 1,968,861 | | | 5 | | | 11,420 | |
Ridgeback Resources Inc., Common Equity | | (f)(k)(q)(s)(t) | | Upstream | | | | | | | | 9,599,928 | | | 46,599 | | | 41,851 | |
Swift Worldwide Resources Holdco Limited, Common Equity | | (f)(k)(o)(r)(s) | | Service & Equipment | | | | | | | | 3,750,000 | | | 6,029 | | | 3,131 | |
Telpico, LLC, Common Equity | | (f)(n)(o)(s)(t) | | Upstream | | | | | | | | 50 | | | — | | | — | |
Tenrgys, LLC, Common Equity | | (f)(n)(o)(s) | | Upstream | | | | | | | | 50 | | | 7,571 | | | 6,801 | |
USA Compression Partners, LP, Common Equity | | (f)(k)(o) | | Midstream | | | | | | | | 84,779 | | | 1,617 | | | 1,655 | |
USA Compression Partners, LP, Warrants (Premium), Strike: $19.59 | | (f)(k)(o)(s) | | Midstream | | | | | | 4/2/28 | | 1,586,719 | | | 714 | | | 5,711 | |
Warren Resources, Inc., Common Equity | | (f)(o)(s)(u) | | Upstream | | | | | | | | 4,415,749 | | | 20,754 | | | 36,982 | |
Total Equity/Other | | | | | | | | | | | | | | 333,510 | | | 494,195 | |
TOTAL INVESTMENTS—116.7% | | | | | | | | | | | | | | $ | 1,922,940 | | | 2,047,115 | |
LIABILITIES IN EXCESS OF OTHER ASSETS—(16.7%) | | (j) | | | | | | | | | | | | | | (293,367) | |
NET ASSETS—100.0% | | | | | | | | | | | | | | | | $ | 1,753,748 | |
Fixed Price Swap Contracts—Crude Oil(i)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Counterparty | | Type | | Settlement Index | | Period | | Bbls | | Weighted Average Price ($/Bbls) | | Unrealized Appreciation(h) | | Unrealized Depreciation(h) |
BP Energy Co. | | Fixed | | ICE Brent | | January 1, 2023 – December 31, 2023 | | 168,511 | | $80.00 | | $ | — | | | $ | 572 | |
Total Swap Contracts—Crude Oil | | | | | | | | | | | | $ | — | | | $ | 572 | |
Fixed Price Swap Contracts—Natural Gas(i)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Counterparty | | Type | | Settlement Index | | Period | | MMBtu | | Weighted Average Price ($/MMBtu) | | Unrealized Appreciation(h) | | Unrealized Depreciation(h) |
BP Energy Co. | | Fixed | | NYMEX Henry Hub | | February 1, 2023 – December 31, 2023 | | 314,818 | | $3.80 | | $ | — | | | $ | 126 | |
Total Swap Contracts—Natural Gas | | | | | | | | | | | | $ | — | | | $ | 126 | |
| | | | | | | | | | | | | | |
TOTAL SWAP CONTRACTS | | | | | | | | | | | | $ | — | | | $ | 698 | |
__________________
Bbls – Barrels
MMBtu – One million British thermal units
See notes to consolidated financial statements.
75
FS Energy and Power Fund
Consolidated Schedule of Investments (continued)
As of December 31, 2022
(in thousands, except share amounts)
__________________
(a) Security may be an obligation of one or more entities affiliated with the named company.
(b) Certain variable rate securities in the Company’s portfolio bear interest at a rate determined by a publicly disclosed base rate plus a basis point spread. As of December 31, 2022, the three-month London Interbank Offered Rate, or LIBOR, or L, was 4.77% and the Secured Overnight Financing Rate, or SOFR, or S, was 4.59%. PIK means paid-in-kind. PIK income accruals may be adjusted based on the fair value of the underlying investment. Variable rate securities with no floor rate use the respective benchmark rate in all cases.
(c) Denominated in U.S. dollars, unless otherwise noted.
(d) See Note 8 for additional information regarding the fair value of the Company’s financial instruments.
(e) Security is an unfunded commitment. The stated rate reflects the spread disclosed at the time of commitment and may not indicate the actual rate received upon funding.
(f) Security or portion thereof is pledged as collateral supporting the amounts outstanding under the Senior Secured Notes with JPMorgan Chase Bank, N.A. (see Note 9).
(g) Investment is a real property interest and is included with Senior Secured Loans—First Lien to facilitate comparison with other investments.
(h) Represents the amounts the Company would pay or receive under each swap contract if it were to settle on December 31, 2022 (see Note 6).
(i)Security held within EP Northern Investments, LLC, a wholly-owned subsidiary of the Company.
(j)Includes the effect of swap contracts.
(k) The investment is not a qualifying asset under the Investment Company Act of 1940, as amended, or the 1940 Act. A business development company may not acquire any asset other than a qualifying asset, unless, at the time the acquisition is made, qualifying assets represent at least 70% of the business development company’s total assets. As of December 31, 2022, 77.5% of the Company’s total assets represented qualifying assets.
(l)Listed investments may be treated as debt for U.S. generally accepted accounting principles, or GAAP, or tax purposes.
(m) Security was on non-accrual status as of December 31, 2022.
(n)Security held within FSEP Investments, Inc., a wholly-owned subsidiary of the Company.
(o)Security is non-income producing.
(p) Security or portion thereof held within FS Power Investments II, LLC, a wholly-owned subsidiary of the Company.
(q)Investment denominated in Canadian dollars. Amortized cost and fair value are converted into U.S. dollars as of December 31, 2022.
(r)Investment denominated in British pounds. Amortized cost and fair value are converted into U.S. dollars as of December 31, 2022.
(s)Security is classified as Level 3 in the Company’s fair value hierarchy (See Note 8).
See notes to consolidated financial statements.
76
FS Energy and Power Fund
Consolidated Schedule of Investments (continued)
As of December 31, 2022
(in thousands, except share amounts)
(t)Under the 1940 Act, the Company generally is deemed to be an “affiliated person” of a portfolio company if it owns 5% or more of the portfolio company’s voting securities and generally is deemed to “control” a portfolio company if it owns more than 25% of the portfolio company’s voting securities or it has the power to exercise control over the management or policies of such portfolio company. As of December 31, 2022, the Company held investments in portfolio companies of which it is deemed to be an “affiliated person” but is not deemed to “control”. The following table presents certain information with respect to investments in portfolio companies of which the Company was deemed to be an affiliated person as of December 31, 2022:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Portfolio Company | | Fair Value at December 31, 2021 | | Gross Additions(1) | | Gross Reductions(2) | | Net Realized Gain (Loss) | | Net Change in Unrealized Appreciation (Depreciation) | | Fair Value at December 31, 2022 | | Interest Income(3) | | PIK Income(3) | | Fee Income(3) | | Dividend Income(3) |
Senior Secured Loans—First Lien | | | | | | | | | | | | | | | | | | | | |
Limetree Bay Energy, LLC | | $ | 3,166 | | | $ | — | | | $ | (1,587) | | | $ | (12,756) | | | $ | 11,177 | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
Permian Production Holdings, LLC | | 7,889 | | | 697 | | | (3,674) | | | 551 | | | (696) | | | 4,767 | | | 570 | | | 105 | | | — | | | — | |
Senior Secured Bonds | | | | | | | | | | | | | | | | | | | | |
Great Western Petroleum, LLC | | 58,055 | | | 96 | | | (55,096) | | | 1,087 | | | (4,142) | | | — | | | 2,649 | | | — | | | 7,268 | | | — | |
Equity/Other | | | | | | | | | | | | | | | | | | | | |
Great Western Petroleum, LLC, Common Equity | | 40,731 | | | — | | | (84,871) | | | 54,081 | | | (9,941) | | | — | | | — | | | — | | | — | | | — | |
GWP Midstream Holdco, LLC, Common Equity | | — | | | 6,681 | | | — | | | — | | | (1,637) | | | 5,044 | | | — | | | — | | | — | | | — | |
Harvest Oil & Gas Corp., Common Equity | | 2,836 | | | — | | | (743) | | | — | | | (1,283) | | | 810 | | | — | | | — | | | — | | | — | |
Limetree Bay Energy, LLC, Class A Units | | 6,046 | | | 1,795 | | | — | | | — | | | (5,956) | | | 1,885 | | | — | | | — | | | — | | | — | |
Permian Production Holdings, LLC, Common Equity | | 8,829 | | | 4 | | | — | | | — | | | 2,587 | | | 11,420 | | | — | | | — | | | — | | | 1,726 | |
Ridgeback Resources Inc., Common Equity | | 48,356 | | | — | | | (12,559) | | | 173 | | | 5,881 | | | 41,851 | | | — | | | — | | | — | | | 3,691 | |
Telpico, LLC, Common Equity | | — | | | — | | | — | | | — | | | — | | | — | | | — | | | — | | | — | | | — | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| | $ | 175,908 | | | $ | 9,273 | | | $ | (158,530) | | | $ | 43,136 | | | $ | (4,010) | | | $ | 65,777 | | | $ | 3,219 | | | $ | 105 | | | $ | 7,268 | | | $ | 5,417 | |
_____________
(1) Gross additions may include increases in the cost basis of investments resulting from new portfolio investments, PIK interest, the amortization of unearned income, the exchange of one or more existing securities for one or more new securities and/or the movement of an existing portfolio company into this category from a different category.
(2) Gross reductions may include decreases in the cost basis of investments resulting from principal collections related to investment repayments or sales, the exchange of one or more existing securities for one or more new securities and/or the movement of an existing portfolio company out of this category into a different category.
(3) Interest, PIK, fee and dividend income presented for the year ended December 31, 2022.
See notes to consolidated financial statements.
77
FS Energy and Power Fund
Consolidated Schedule of Investments (continued)
As of December 31, 2022
(in thousands, except share amounts)
(u)Under the 1940 Act, the Company generally is deemed to “control” a portfolio company if it owns more than 25% of the portfolio company’s voting securities or it has the power to exercise control over the management or policies of such portfolio company. As of December 31, 2022, the Company held investments in portfolio companies of which it is deemed to be an “affiliated person” of and deemed to “control.” The following table presents certain information with respect to investments in portfolio companies of which the Company was deemed to be an affiliated person and deemed to control as ofDecember 31, 2022:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Portfolio Company | | Fair Value at December 31, 2021 | | Gross Additions(1) | | Gross Reductions(2) | | Net Realized Gain (Loss) | | Net Change in Unrealized Appreciation (Depreciation) | | Fair Value at December 31, 2022 | | Interest Income(3) | | PIK Income(3) | | | | Dividend Income(3) |
Senior Secured Loans—First Lien | | | | | | | | | | | | | | | | | | | | |
Allied Downhole Technologies, LLC(4) | | $ | 7,782 | | | $ | 654 | | | $ | — | | | $ | — | | | $ | — | | | $ | 8,436 | | | $ | — | | | $ | 654 | | | | | $ | — | |
Allied Wireline Services, LLC | | 46,339 | | | 5,808 | | | — | | | — | | | 11,741 | | | 63,888 | | | 316 | | | 5,808 | | | | | — | |
MECO IV Holdco, LLC | | 22,745 | | | 455 | | | (23,200) | | | — | | | — | | | — | | | — | | | 455 | | | | | — | |
Warren Resources, Inc. | | 23,688 | | | 237 | | | (341) | | | — | | | — | | | 23,584 | | | 2,620 | | | 237 | | | | | — | |
Sustainable Infrastructure Investments, LLC | | | | | | | | | | | | | | | | | | | | |
Sustainable Infrastructure Investments, LLC | | 50,770 | | | — | | | — | | | — | | | 328 | | | 51,098 | | | — | | | — | | | | | 735 | |
Equity/Other | | | | | | | | | | | | | | | | | | | | |
Allied Wireline Services, LLC, Common Equity | | — | | | — | | | — | | | — | | | 10,463 | | | 10,463 | | | — | | | — | | | | | — | |
Allied Wireline Services, LLC, Warrants | | — | | | — | | | — | | | — | | | — | | | — | | | — | | | — | | | | | — | |
MECO IV Holdco, LLC, Class A-1 Units | | 4,181 | | | — | | | (18,060) | | | 15,899 | | | (2,020) | | | — | | | — | | | — | | | | | — | |
Warren Resources, Inc., Common Equity | | 25,854 | | | — | | | — | | | — | | | 11,128 | | | 36,982 | | | — | | | — | | | | | — | |
| | $ | 181,359 | | | $ | 7,154 | | | $ | (41,601) | | | $ | 15,899 | | | $ | 31,640 | | | $ | 194,451 | | | $ | 2,936 | | | $ | 7,154 | | | | | $ | 735 | |
_____________
(1) Gross additions may include increases in the cost basis of investments resulting from new portfolio investments, PIK interest, the amortization of unearned income, the exchange of one or more existing securities for one or more new securities and/or the movement of an existing portfolio company into this category from a different category.
(2) Gross reductions may include decreases in the cost basis of investments resulting from principal collections related to investment advisory services provided duringrepayments or sales, the quarterly periodexchange of one or more existing securities for one or more new securities and/or the movement of an existing portfolio company out of this category into a different category.
(3) Interest, PIK and dividend income presented for the year ended MarchDecember 31, 2022.
(4) Security includes a partially unfunded commitment with amortized cost of $2,500 and fair value of $2,500.
See notes to consolidated financial statements.
78
FS Energy and Power Fund
Consolidated Schedule of Investments
As of December 31, 2021
(in thousands, except share amounts)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Portfolio Company(a) | | Footnotes | | Industry | | Rate(b) | | Floor | | Maturity | | Principal Amount(c) | | Amortized Cost | | Fair Value(d) |
Senior Secured Loans—First Liens—50.7% | | | | | | | | | | | | | | | | |
AIRRO (Mauritius) Holdings II | | (k)(p)(s) | | Power | | L+350, 3.5% PIK (3.5% Max PIK) | | 1.5% | | 7/24/25 | | $ | 22,067 | | | $ | 19,415 | | | $ | 19,229 | |
AIRRO (Mauritius) Holdings II | | (e)(k)(p)(s) | | Power | | L+350, 3.5% PIK (3.5% Max PIK) | | 1.5% | | 7/24/25 | | 14,602 | | | 14,602 | | | 12,724 | |
Allied Downhole Technologies, LLC | | (f)(s)(x) | | Service & Equipment | | 8.0% PIK (8.0% Max PIK) | | | | 9/30/22 | | 7,782 | | | 7,782 | | | 7,782 | |
Allied Downhole Technologies, LLC | | (e)(s)(x) | | Service & Equipment | | 8.0% PIK (8.0% Max PIK) | | | | 9/30/22 | | 2,500 | | | 2,500 | | | 2,500 | |
Allied Wireline Services, LLC | | (f)(s)(x) | | Service & Equipment | | 10.0% PIK (10.0% Max PIK) | | | | 6/15/25 | | 58,080 | | | 58,080 | | | 46,339 | |
ARB Midstream Operating Company, LLC | | (s) | | Midstream | | L+825 | | 1.0% | | 5/6/22 | | 625 | | | 624 | | | 625 | |
Bioenergy Infrastructure Holdings Limited | | (k)(s) | | Power | | L+725 | | 1.0% | | 12/22/22 | | 413 | | | 413 | | | 403 | |
Birch Permian LLC | | (s) | | Upstream | | L+800 | | 1.5% | | 4/12/23 | | 42,781 | | | 42,642 | | | 43,209 | |
Brazos Delaware II LLC | | | | Midstream | | L+400 | | | | 5/21/25 | | 39,685 | | | 38,112 | | | 38,738 | |
Cimarron Energy Inc. | | (f)(m)(o)(s) | | Service & Equipment | | L+900 | | 1.0% | | 12/31/24 | | 7,500 | | | 7,311 | | | 3,600 | |
Cox Oil Offshore, LLC, Volumetric Production Payments | | (i)(o)(s)(v) | | Upstream | | 0.0% | | | | 12/31/23 | | 100,000 | | | 23,342 | | | 28,987 | |
CPV Maryland, LLC | | | | Power | | L+400 | | 1.0% | | 5/11/28 | | 15,353 | | | 15,182 | | | 15,276 | |
CPV Shore Holdings LLC | | | | Power | | L+375 | | | | 12/29/25 | | 23,601 | | | 22,525 | | | 22,682 | |
EIF Van Hook Holdings, LLC | | | | Midstream | | L+525 | | | | 9/5/24 | | 30,332 | | | 29,889 | | | 29,081 | |
FR BR Holdings LLC | | (f)(s) | | Midstream | | L+650 | | | | 12/14/23 | | 82,610 | | | 80,293 | | | 83,436 | |
FR XIII PAA Holdings HoldCo, LLC | | (s) | | Midstream | | L+725 | | 0.5% | | 10/15/26 | | 29,141 | | | 28,650 | | | 30,307 | |
GasLog Ltd. | | (e)(k)(o)(s) | | Midstream | | L+775 | | | | 3/21/29 | | 15,113 | | | 15,113 | | | 15,000 | |
Generation Bridge LLC | | | | Power | | L+500 | | 0.8% | | 12/1/28 | | 7,837 | | | 7,681 | | | 7,876 | |
Generation Bridge LLC | | | | Power | | L+500 | | 0.8% | | 12/1/28 | | 163 | | | 160 | | | 164 | |
GIP II Blue Holding LP | | | | Midstream | | L+450 | | 1.0% | | 9/29/28 | | 7,481 | | | 7,372 | | | 7,477 | |
Limetree Bay Energy, LLC | | (f)(o)(s)(w) | | Midstream | | 0.0% | | | | 10/31/21 | | 26,444 | | | 14,343 | | | 3,166 | |
Lucid Energy Group II Borrower LLC | | | | Midstream | | L+425 | | 0.8% | | 11/22/28 | | 25,000 | | | 24,752 | | | 24,737 | |
MECO IV Holdco, LLC | | (s)(x) | | Upstream | | 8.0% | | | | 9/14/25 | | 22,745 | | | 22,745 | | | 22,745 | |
Medallion Midland Acquisition LP | | | | Midstream | | L+375 | | 0.8% | | 10/18/28 | | 7,980 | | | 7,941 | | | 7,954 | |
MRP CalPeak Holdings, LLC | | (s) | | Power | | L+500 | | 1.5% | | 1/27/25 | | 12,842 | | | 12,842 | | | 12,842 | |
MRP West Power Holdings II, LLC | | (s) | | Power | | L+500 | | 1.5% | | 1/27/25 | | 13,887 | | | 13,887 | | | 13,887 | |
Navitas Midstream Midland Basin LLC | | (f) | | Midstream | | L+400 | | 1.0% | | 12/13/24 | | 68,341 | | | 66,690 | | | 68,359 | |
NNE Holding LLC | | (s) | | Upstream | | L+475, 4.5% PIK (4.5% Max PIK) | | | | 12/31/23 | | 42,333 | | | 42,302 | | | 41,696 | |
OE2 North, LLC | | (s) | | Midstream | | L+525 | | 1.0% | | 5/21/26 | | 11,627 | | | 11,527 | | | 11,688 | |
OE2 North, LLC | | (e)(s) | | Midstream | | L+525 | | 1.0% | | 5/21/26 | | 18,373 | | | 18,373 | | | 18,468 | |
Oryx Midstream Services Permian Basin LLC | | (f) | | Midstream | | L+325 | | 0.5% | | 10/5/28 | | 36,000 | | | 35,825 | | | 35,817 | |
Parkway Generation LLC | | (h) | | Power | | L+475 | | 0.8% | | 2/18/29 | | 6,140 | | | 6,079 | | | 6,117 | |
Parkway Generation LLC | | (h) | | Power | | L+475 | | 0.8% | | 2/18/29 | | 43,860 | | | 43,421 | | | 43,654 | |
Permian Production Holdings, LLC | | (f)(s)(w) | | Upstream | | 7.0%, 2.0% PIK (2.0% Max PIK) | | | | 11/23/25 | | 7,889 | | | 6,692 | | | 7,889 | |
Pinnacle Midland Gas Holdco LLC | | (s) | | Midstream | | L+675 | | 1.0% | | 12/2/26 | | 5,385 | | | 5,306 | | | 5,305 | |
See notes to consolidated financial statements.
79
FS Energy and Power Fund
Consolidated Schedule of Investments (continued)
As of December 31, 2021
(in thousands, except share amounts)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Portfolio Company(a) | | Footnotes | | Industry | | Rate(b) | | Floor | | Maturity | | Principal Amount(c) | | Amortized Cost | | Fair Value(d) |
Pinnacle Midland Gas Holdco LLC | | (e)(s) | | Midstream | | L+675 | | 1.0% | | 12/2/26 | | $ | 6,462 | | | $ | 6,462 | | | $ | 6,365 | |
Plainfield Renewable Energy Holdings LLC | | (f)(s) | | Power | | 6.7%, 8.8% PIK (9.5% Max PIK) | | | | 8/22/25 | | 11,804 | | | 11,804 | | | 11,954 | |
Plainfield Renewable Energy Holdings LLC | | (f)(s) | | Power | | 10.0% PIK (10.0% Max PIK) | | | | 8/22/25 | | 3,304 | | | 3,304 | | | — | |
Plainfield Renewable Energy Holdings LLC, Letter of Credit | | (e)(o)(s) | | Power | | 10.0% | | | | 8/22/25 | | 2,709 | | | 2,709 | | | — | |
Potomac Energy Center, LLC | | | | Power | | L+600 | | 0.5% | | 11/10/26 | | 59,000 | | | 57,848 | | | 58,705 | |
Traverse Midstream Partners LLC | | | | Midstream | | SF+425 | | 1.0% | | 9/27/24 | | 31,702 | | | 31,788 | | | 31,623 | |
Warren Resources, Inc. | | (s)(x) | | Upstream | | L+900, 1.0% PIK (1.0% Max PIK) | | 1.0% | | 5/22/24 | | 23,688 | | | 23,688 | | | 23,688 | |
Total Senior Secured Loans—First Lien | | | | | | | | | | | | | | 892,016 | | | 872,094 | |
Unfunded Loan Commitments | | | | | | | | | | | | | | (59,759) | | | (59,759) | |
Net Senior Secured Loans—First Lien | | | | | | | | | | | | | | 832,257 | | | 812,335 | |
| | | | | | | | | | | | | | | | |
Senior Secured Loans—Second Lien—5.2% | | | | | | | | | | | | | | | | |
Aethon III BR LLC | | (f)(s) | | Upstream | | L+750 | | 1.5% | | 1/10/25 | | 20,000 | | | 19,792 | | | 20,200 | |
Chisholm Energy Holdings, LLC | | (f)(s) | | Upstream | | L+625 | | 1.5% | | 5/15/26 | | 17,143 | | | 17,091 | | | 17,314 | |
Olympus Energy, LLC | | (f)(s) | | Upstream | | L+750 | | 1.0% | | 7/23/26 | | 18,750 | | | 18,750 | | | 18,750 | |
Olympus Energy, LLC | | (e)(s) | | Upstream | | L+750 | | 1.0% | | 7/23/26 | | 11,250 | | | 11,250 | | | 11,250 | |
Peak Exploration & Production, LLC | | (f)(s) | | Upstream | | L+675 | | 1.5% | | 11/16/23 | | 13,545 | | | 13,512 | | | 13,438 | |
Peak Exploration & Production, LLC | | (e)(s) | | Upstream | | L+675 | | 1.5% | | 11/16/23 | | 1,505 | | | 1,505 | | | 1,493 | |
SilverBow Resources, Inc. | | (f)(k)(s) | | Upstream | | L+750 | | 1.0% | | 12/15/26 | | 14,250 | | | 14,177 | | | 14,393 | |
Total Senior Secured Loans—Second Lien | | | | | | | | | | | | | | 96,077 | | | 96,838 | |
Unfunded Loan Commitments | | | | | | | | | | | | | | (12,755) | | | (12,755) | |
Net Senior Secured Loans—Second Lien | | | | | | | | | | | | | | 83,322 | | | 84,083 | |
| | | | | | | | | | | | | | | | |
Senior Secured Bonds—5.1% | | | | | | | | | | | | | | | | |
Great Western Petroleum, LLC | | (f)(w) | | Upstream | | 12.0% | | | | 9/1/25 | | 55,096 | | | 53,913 | | | 58,055 | |
SM Energy Co. | | (k) | | Upstream | | 10.0% | | | | 1/15/25 | | 12,000 | | | 13,337 | | | 13,220 | |
ST EIP Holdings Inc. | | (s) | | Midstream | | 6.1% | | | | 1/10/30 | | 10,526 | | | 10,016 | | | 10,371 | |
Total Senior Secured Bonds | | | | | | | | | | | | | | 77,266 | | | 81,646 | |
| | | | | | | | | | | | | | | | |
Unsecured Debt—24.8% | | | | | | | | | | | | | | | | |
Aethon United BR LP | | (f) | | Upstream | | 8.3% | | | | 2/15/26 | | 40,500 | | | 40,500 | | | 43,552 | |
Archrock Partners, L.P. | | (f)(k) | | Midstream | | 6.3% | | | | 4/1/28 | | 22,239 | | | 23,141 | | | 23,221 | |
Cheniere Energy Partners LP Holdings, LLC | | (f)(k) | | Midstream | | 4.5% | | | | 10/1/29 | | 13,500 | | | 14,531 | | | 14,333 | |
Colgate Energy Partners III LLC | | (f) | | Upstream | | 5.9% | | | | 7/1/29 | | 8,000 | | | 8,110 | | | 8,251 | |
Colgate Energy Partners III LLC | | | | Upstream | | 7.8% | | | | 2/15/26 | | 23,365 | | | 24,737 | | | 25,312 | |
Endeavor Energy Resources, L.P. | | | | Upstream | | 5.8% | | | | 1/30/28 | | 31,299 | | | 33,030 | | | 33,412 | |
See notes to consolidated financial statements.
80
FS Energy and Power Fund
Consolidated Schedule of Investments (continued)
As of December 31, 2021
(in thousands, except share amounts)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Portfolio Company(a) | | Footnotes | | Industry | | Rate(b) | | Floor | | Maturity | | Principal Amount(c) | | Amortized Cost | | Fair Value(d) |
EnLink Midstream, LLC | | (k) | | Midstream | | 5.4% | | | | 6/1/29 | | $ | 6,000 | | | $ | 6,271 | | | $ | 6,145 | |
EnLink Midstream, LLC | | (f)(k) | | Midstream | | 5.6% | | | | 1/15/28 | | 5,881 | | | 6,334 | | | 6,125 | |
Hammerhead Resources Inc. | | (f)(k)(s) | | Upstream | | 12.0% PIK (12.0% Max PIK) | | | | 7/15/24 | | 64,046 | | | 63,569 | | | 64,046 | |
Moss Creek Resources, LLC | | (f) | | Upstream | | 7.5% | | | | 1/15/26 | | 11,693 | | | 10,027 | | | 10,945 | |
NRG Energy, Inc. | | (k) | | Power | | 3.9% | | | | 2/15/32 | | 11,625 | | | 11,619 | | | 11,411 | |
Ranger Oil Corp. | | (k) | | Upstream | | 9.3% | | | | 8/15/26 | | 29,772 | | | 29,603 | | | 30,926 | |
Range Resources Corp. | | (k) | | Upstream | | 8.3% | | | | 1/15/29 | | 5,000 | | | 5,643 | | | 5,584 | |
Range Resources Corp. | | (k) | | Upstream | | 9.3% | | | | 2/1/26 | | 3,000 | | | 3,256 | | | 3,237 | |
SM Energy Co. | | (k) | | Upstream | | 5.6% | | | | 6/1/25 | | 8,000 | | | 8,041 | | | 8,079 | |
Southwestern Energy Co. | | | | Upstream | | 5.4% | | | | 2/1/29 | | 18,928 | | | 19,731 | | | 20,043 | |
Suburban Propane Partners LP | | (f)(k) | | Midstream | | 5.0% | | | | 6/1/31 | | 17,690 | | | 18,359 | | | 17,919 | |
Tallgrass Energy Partners, LP | | (f) | | Midstream | | 7.5% | | | | 10/1/25 | | 13,424 | | | 14,499 | | | 14,545 | |
Tallgrass Energy Partners, LP | | (f) | | Midstream | | 6.0% | | | | 3/1/27 | | 9,000 | | | 9,414 | | | 9,369 | |
Tenrgys, LLC | | (f)(m)(n)(o)(s) | | Upstream | | L+900 | | 2.5% | | 12/23/18 | | 75,000 | | | 75,300 | | | 40,613 | |
Total Unsecured Debt | | | | | | | | | | | | | | 425,715 | | | 397,068 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Portfolio Company(a) | | Footnotes | | Industry | | Rate(b) | | Floor | | Maturity | | Number of Shares | | Amortized Cost | | Fair Value(d) |
Preferred Equity—31.0%(l) | | | | | | | | | | | | | | | | |
Abaco Energy Technologies LLC, Preferred Equity | | (f)(o)(s) | | Service & Equipment | | | | | | | | 28,942,003 | | | $ | 1,447 | | | $ | 3,965 | |
Altus Midstream LP, Series A Preferred Units | | (j)(s) | | Midstream | | 11.0% | | | | 6/28/26 | | 52,856 | | | 58,725 | | | 61,379 | |
Global Jet Capital Holdings, LP, Preferred Equity | | (f)(s) | | Industrials | | 9.0% PIK (9.0% Max PIK) | | | | 10/1/28 | | 167,176 | | | 12,305 | | | 12,204 | |
Global Jet Capital Holdings, LP, Preferred Equity | | (f)(o)(s) | | Industrials | | | | | | | | 27,856 | | | 2,786 | | | — | |
NGL Energy Partners, LP, Preferred Equity | | (f)(k)(m)(o)(s) | | Midstream | | 14.2% | | | | 7/2/27 | | 156,250 | | | 157,633 | | | 125,000 | |
NuStar, Preferred Equity | | (f)(k)(s) | | Midstream | | 12.8% | | | | 6/29/28 | | 3,910,165 | | | 105,291 | | | 124,050 | |
Segreto Power Holdings, LLC, Preferred Equity | | (f)(g)(m)(o)(s) | | Power | | 13.1% | | | | 6/30/25 | | 70,297 | | | 99,761 | | | 80,772 | |
USA Compression Partners, LP, Preferred Equity | | (k)(s) | | Midstream | | 9.8% | | | | 4/3/28 | | 79,336 | | | 77,763 | | | 89,918 | |
Total Preferred Equity | | | | | | | | | | | | | | 515,711 | | | 497,288 | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | Principal Amount(c) | | Amortized Cost | | Fair Value(d) |
Sustainable Infrastructure Investments, LLC—3.2% | | | | | | | | | | | | | | | | |
Sustainable Infrastructure Investments, LLC | | (k)(s)(x) | | Power | | | | | | | | $ | 60,603 | | | $ | 54,514 | | | $ | 50,770 | |
Total Sustainable Infrastructure Investments, LLC | | | | | | | | | | | | | | 54,514 | | | 50,770 | |
| | | | | | | | | | | | | | | | |
See notes to consolidated financial statements.
81
FS Energy and Power Fund
Consolidated Schedule of Investments (continued)
As of December 31, 2021
(in thousands, except share amounts)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Portfolio Company(a) | | Footnotes | | Industry | | Number of Shares | | Amortized Cost | | Fair Value(d) |
Equity/Other—29.5%(l) | | | | | | | | | | |
Abaco Energy Technologies LLC, Common Equity | | (f)(o)(s) | | Service & Equipment | | 6,944,444 | | | $ | 6,944 | | | $ | 642 | |
AIRRO (Mauritius) Holdings II, Warrants | | (f)(k)(o)(p)(s) | | Power | | 35 | | | 2,652 | | | 2,125 | |
Allied Wireline Services, LLC, Common Equity | | (f)(n)(o)(s)(x) | | Service & Equipment | | 48,400 | | | 1,527 | | | — | |
Allied Wireline Services, LLC, Warrants | | (f)(n)(o)(s)(x) | | Service & Equipment | | 22,000 | | | — | | | — | |
Arena Energy, LP, Contingent Value Rights | | (f)(o)(s) | | Upstream | | 126,632,117 | | | 351 | | | 1,070 | |
Ascent Resources Utica Holdings, LLC, Common Equity | | (f)(o)(q)(s) | | Upstream | | 148,692,909 | | | 44,700 | | | 34,051 | |
Cimarron Energy Holdco Inc., Common Equity | | (f)(o)(s) | | Service & Equipment | | 4,302,293 | | | 3,950 | | | — | |
Cimarron Energy Holdco Inc., Participation Option | | (f)(o)(s) | | Service & Equipment | | 25,000,000 | | | 1,289 | | | — | |
Great Western Petroleum, LLC, Common Equity | | (f)(o)(r)(s)(w) | | Upstream | | 105,785 | | | 30,790 | | | 40,731 | |
Harvest Oil & Gas Corp., Common Equity | | (f)(o)(w) | | Upstream | | 135,062 | | | 15,802 | | | 2,836 | |
Limetree Bay Energy, LLC, Class A Units | | (f)(o)(s)(w) | | Midstream | | 50,494,585 | | | 19,663 | | | 6,046 | |
Maverick Natural Resources, LLC, Common Equity | | (f)(g)(n)(o)(s) | | Upstream | | 503,176 | | | 138,208 | | | 278,760 | |
MB Precision Investment Holdings LLC, Class A-2 Units | | (f)(n)(o)(s) | | Industrials | | 1,426,110 | | | 490 | | | — | |
MECO IV Holdco, LLC, Class A-1 Units | | (f)(n)(o)(s)(x) | | Upstream | | 1,225,000 | | | 2,161 | | | 4,181 | |
NGL Energy Partners, LP, Warrants (Par) | | (f)(k)(o)(s) | | Midstream | | 2,187,500 | | | 3,083 | | | 265 | |
NGL Energy Partners, LP, Warrants (Premium) | | (f)(k)(o)(s) | | Midstream | | 3,125,000 | | | 2,623 | | | 280 | |
NGL Energy Partners, LP, Warrants (Premium) | | (f)(k)(o)(s) | | Midstream | | 781,250 | | | 576 | | | 69 | |
NGL Energy Partners, LP, Warrants (Par) | | (f)(k)(o)(s) | | Midstream | | 546,880 | | | 630 | | | 63 | |
Permian Production Holdings, LLC, Common Equity | | (f)(n)(o)(s)(w) | | Upstream | | 1,961,896 | | | 1 | | | 8,829 | |
Ranger Oil Corp., Common Equity | | (f)(o) | | Upstream | | 332,863 | | | 1,795 | | | 8,961 | |
Ridgeback Resources Inc., Common Equity | | (f)(k)(o)(s)(t)(w) | | Upstream | | 9,599,928 | | | 58,985 | | | 48,356 | |
Swift Worldwide Resources Holdco Limited, Common Equity | | (f)(k)(o)(s)(u) | | Service & Equipment | | 3,750,000 | | | 6,029 | | | 3,206 | |
USA Compression Partners, LP, Warrants (Market) | | (f)(k)(o)(s) | | Midstream | | 793,359 | | | 555 | | | 2,209 | |
USA Compression Partners, LP, Warrants (Premium) | | (f)(k)(o)(s) | | Midstream | | 1,586,719 | | | 714 | | | 3,499 | |
Warren Resources, Inc., Common Equity | | (f)(o)(s)(x) | | Upstream | | 4,415,749 | | | 20,754 | | | 25,854 | |
Total Equity/Other | | | | | | | | 364,272 | | | 472,033 | |
TOTAL INVESTMENTS—149.5% | | | | | | | | $ | 2,353,057 | | | 2,395,223 | |
LIABILITIES IN EXCESS OF OTHER ASSETS—(49.5%) | | | | | | | | | | (792,900) | |
NET ASSETS—100.0% | | | | | | | | | | $ | 1,602,323 | |
______________________
(a) Security may be an obligation of one or more entities affiliated with the named company.
(b) Certain variable rate securities in the Company’s portfolio bear interest at a rate determined by a publicly disclosed base rate plus a basis point spread. As of December 31, 2021, the three-month London Interbank Offered Rate, or LIBOR, or L, was 0.21% and the Secured Overnight Financing Rate, or SOFR, or SF, was 0.05%. PIK means paid-in-kind. PIK income accruals may be adjusted based on the fair value of the underlying investment.
(c) Denominated in U.S. dollars, unless otherwise noted.
See notes to consolidated financial statements.
82
FS Energy and Power Fund
Consolidated Schedule of Investments (continued)
As of December 31, 2021
(in thousands, except share amounts)
(d) Fair value determined by the Company’s board of trustees (see Note 8).
(e) Security is an unfunded commitment. The stated rate reflects the spread disclosed at the time of commitment and may not indicate the actual rate received upon funding.
(f) Security or portion thereof is pledged as collateral supporting the amounts outstanding under the Senior Secured Notes with JPMorgan Chase Bank, N.A. (see Note 9).
(g)Security held within FS Energy Investments, LLC, a wholly-owned subsidiary of the Company.
(h) Position or portion thereof unsettled as of December 31, 2021.
(i)Security held within EP Northern Investments, LLC, a wholly-owned subsidiary of the Company.
(j)Security held within FS Power Investments, LLC, a wholly-owned subsidiary of the Company.
(k) The investment is not a qualifying asset under the Investment Company Act of 1940, as amended, or the 1940 Act. A business development company may not acquire any asset other than a qualifying asset, unless, at the time the acquisition is made, qualifying assets represent at least 70% of the business development company’s total assets. As of December 31, 2021, 72.1% of the Company’s total assets represented qualifying assets.
(l)Listed investments may be treated as debt for U.S. generally accepted accounting principles, or GAAP, or tax purposes.
(m) Security was on non-accrual status as of December 31, 2021.
(n)Security held within FSEP Investments, Inc., a wholly-owned subsidiary of the Company.
(o)Security is non-income producing.
(p) Security or portion thereof held within FS Power Investments II, LLC, a wholly-owned subsidiary of the Company.
(q)Security held within EP American Energy Investments, Inc., a wholly-owned subsidiary of the Company.
(r) Security held within EP Synergy Investments, Inc., a wholly-owned subsidiary of the Company.
(s)Security is classified as Level 3 in the Company’s fair value hierarchy (See Note 8).
(t)Investment denominated in Canadian dollars. Amortized cost and fair value are converted into U.S. dollars as of December 31, 2021.
(u)Investment denominated in British pounds. Amortized cost and fair value are converted into U.S. dollars as of December 31, 2021.
(v) Investment is a real property interest and is included with Senior Secured Loans—First Lien to facilitate comparison with other investments.
See notes to consolidated financial statements.
83
FS Energy and Power Fund
Consolidated Schedule of Investments (continued)
As of December 31, 2021
(in thousands, except share amounts)
(w) Under the 1940 Act, the Company generally is deemed to be an “affiliated person” of a portfolio company if it owns 5% or more of the portfolio company’s voting securities and generally is deemed to “control” a portfolio company if it owns more than 25% of the portfolio company’s voting securities or it has the power to exercise control over the management or policies of such portfolio company. As of December 31, 2021, the Company held investments in portfolio companies of which it is deemed to be an “affiliated person” but is not deemed to “control”. The following table presents certain information with respect to investments in portfolio companies of which the Company was deemed to be an affiliated person as of December 31, 2021:
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Portfolio Company | | Fair Value at December 31, 2020 | | Gross Additions(1) | | Gross Reductions(2) | | | | Net Realized Gain (Loss) | | Net Change in Unrealized Appreciation (Depreciation) | | Fair Value at December 31, 2021 | | Interest Income(3) | | PIK Income(3) | | | | Dividend Income(3) |
Senior Secured Loans—First Lien | | | | | | | | | | | | | | | | | | | | | | |
Limetree Bay Energy, LLC | | $ | — | | | $ | 14,343 | | | $ | — | | | | | $ | — | | | $ | (11,177) | | | $ | 3,166 | | | $ | — | | | $ | — | | | | | $ | — | |
Permian Production Holdings, LLC | | 11,446 | | | 489 | | | (6,401) | | | | | 1,106 | | | 1,249 | | | 7,889 | | | 1,009 | | | 215 | | | | | — | |
Warren Resources, Inc.(4) | | 27,788 | | | 69 | | | (27,857) | | | | | — | | | — | | | — | | | — | | | — | | | | | — | |
Senior Secured Bonds | | | | | | | | | | | | | | | | | | | | | | |
Great Western Petroleum, LLC | | — | | | 53,913 | | | — | | | | | — | | | 4,142 | | | 58,055 | | | 5,861 | | | — | | | | | — | |
Limetree Bay Ventures, LLC | | 25,538 | | | — | | | (3,810) | | | | | (21,752) | | | 24 | | | — | | | — | | | — | | | | | — | |
Limetree Bay Ventures, LLC | | 36,308 | | | 19 | | | (5,137) | | | | | (29,021) | | | (2,169) | | | — | | | 19 | | | — | | | | | — | |
Limetree Bay Ventures, LLC | | 89,968 | | | 43,291 | | | (9,889) | | | | | (49,783) | | | (73,587) | | | — | | | — | | | — | | | | | — | |
Unsecured Debt | | | | | | | | | | | | | | | | | | | | | | |
Limetree Bay Ventures, LLC | | — | | | — | | | (6,298) | | | | | (31,516) | | | 37,814 | | | — | | | — | | | — | | | | | — | |
Limetree Bay Ventures, LLC | | — | | | — | | | (1,648) | | | | | (8,244) | | | 9,892 | | | — | | | — | | | — | | | | | — | |
Preferred Equity | | | | | | | | | | | | | | | | | | | | | | |
Limetree Bay Ventures, LLC, Preferred Equity | | — | | | — | | | — | | | | | (53,548) | | | 53,548 | | | — | | | — | | | — | | | | | — | |
Limetree Bay Ventures, LLC, Preferred Equity | | — | | | — | | | — | | | | | (86,729) | | | 86,729 | | | — | | | — | | | — | | | | | — | |
Equity/Other | | | | | | | | | | | | | | | | | | | | | | |
Great Western Petroleum, LLC, Common Equity | | — | | | 30,790 | | | — | | | | | — | | | 9,941 | | | 40,731 | | | — | | | — | | | | | — | |
Harvest Oil & Gas Corp., Common Equity | | 2,794 | | | — | | | (1,756) | | | | | — | | | 1,798 | | | 2,836 | | | — | | | — | | | | | — | |
Limetree Bay Energy, LLC, Class A Units | | — | | | 19,663 | | | — | | | | | — | | | (13,617) | | | 6,046 | | | — | | | — | | | | | — | |
Limetree Bay Ventures, LLC, Common Equity | | — | | | — | | | — | | | | | (3,406) | | | 3,406 | | | — | | | — | | | — | | | | | — | |
Lonestar Resources US Inc., Common Equity | | 2,592 | | | — | | | (2,376) | | | | | — | | | (216) | | | — | | | — | | | — | | | | | — | |
Permian Production Holdings, LLC, Common Equity | | — | | | 1 | | | — | | | | | — | | | 8,828 | | | 8,829 | | | — | | | — | | | | | 1,574 | |
Ridgeback Resources Inc., Common Equity | | 38,385 | | | — | | | — | | | | | — | | | 9,971 | | | 48,356 | | | — | | | — | | | | | — | |
Warren Resources, Inc., Common Equity(4) | | 4,460 | | | — | | | (20,754) | | | | | — | | | 16,294 | | | — | | | — | | | — | | | | | — | |
| | $ | 239,279 | | | $ | 162,578 | | | $ | (85,926) | | | | | $ | (282,893) | | | $ | 142,870 | | | $ | 175,908 | | | $ | 6,889 | | | $ | 215 | | | | | $ | 1,574 | |
_______________
(1) Gross additions may include increases in the cost basis of investments resulting from new portfolio investments, PIK interest, the amortization of unearned income, the exchange of one or more existing securities for one or more new securities and/or the movement of an existing portfolio company into this category from a different category.
(2) Gross reductions may include decreases in the cost basis of investments resulting from principal collections related to investment repayments or sales, the exchange of one or more existing securities for one or more new securities and/or the movement of an existing portfolio company out of this category into a different category.
(3) Interest, PIK and dividend income presented for the year ended December 31, 2021.
(4) The Company held this investment as of December 31, 2021 but it was deemed to “control” the portfolio company as of December 31, 2021. Transfers in or out have been presented at amortized cost.
See notes to consolidated financial statements.
84
FS Energy and Power Fund
Consolidated Schedule of Investments (continued)
As of December 31, 2021
(in thousands, except share amounts)
(x)Under the 1940 Act, the Company generally is deemed to “control” a portfolio company if it owns more than 25% of the portfolio company’s voting securities or it has the power to exercise control over the management or policies of such portfolio company. As of December 31, 2021, the Company held investments in portfolio companies of which it is deemed to be an “affiliated person” of and deemed to “control.” The following table presents certain information with respect to investments in portfolio companies of which the Company was deemed to be an affiliated person and deemed to control as of December 31, 2021:
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Portfolio Company | | Fair Value at December 31, 2020 | | Gross Additions(1) | | Gross Reductions(2) | | | | Net Realized Gain (Loss) | | Net Change in Unrealized Appreciation (Depreciation) | | Fair Value at December 31, 2021 | | Interest Income(3) | | PIK Income(3) | | Fee Income(3) | | Dividend Income(3) |
Senior Secured Loans—First Lien | | | | | | | | | | | | | | | | | | | | | | |
Allied Downhole Technologies, LLC | | $ | — | | | $ | 10,282 | | | $ | (2,500) | | | | | $ | — | | | $ | — | | | $ | 7,782 | | | $ | 2 | | | $ | 282 | | | $ | — | | | $ | — | |
Allied Wireline Services, LLC | | 53,007 | | | 5,280 | | | (207) | | | | | — | | | (11,741) | | | 46,339 | | | 276 | | | 5,280 | | | — | | | — | |
MECO IV Holdco, LLC | | — | | | 22,745 | | | — | | | | | — | | | — | | | 22,745 | | | 91 | | | 951 | | | 9 | | | — | |
Warren Resources, Inc.(4) | | — | | | 27,134 | | | (3,446) | | | | | — | | | — | | | 23,688 | | | 2,601 | | | 261 | | | — | | | — | |
Sustainable Infrastructure Investments, LLC | | | | | | | | | | | | | | | | | | | | | | |
Sustainable Infrastructure Investments, LLC | | 61,816 | | | — | | | (6,089) | | | | | — | | | (4,957) | | | 50,770 | | | — | | | — | | | — | | | 5,729 | |
Equity/Other | | | | | | | | | | | | | | | | | | | | | | |
Allied Wireline Services, LLC, Common Equity | | 1,904 | | | — | | | — | | | | | — | | | (1,904) | | | — | | | — | | | — | | | — | | | — | |
Allied Wireline Services, LLC, Warrants | | — | | | — | | | — | | | | | — | | | — | | | — | | | — | | | — | | | — | | | — | |
MECO IV Holdco, LLC, Class A-1 Units | | — | | | 2,161 | | | — | | | | | — | | | 2,020 | | | 4,181 | | | — | | | — | | | — | | | — | |
Warren Resources, Inc., Common Equity(4) | | — | | | 20,754 | | | — | | | | | — | | | 5,100 | | | 25,854 | | | — | | | — | | | — | | | — | |
| | $ | 116,727 | | | $ | 88,356 | | | $ | (12,242) | | | | | $ | — | | | $ | (11,482) | | | $ | 181,359 | | | $ | 2,970 | | | $ | 6,774 | | | $ | 9 | | | $ | 5,729 | |
_____________
(1) Gross additions may include increases in the cost basis of investments resulting from new portfolio investments, PIK interest, the amortization of unearned income, the exchange of one or more existing securities for one or more new securities and/or the movement of an existing portfolio company into this category from a different category.
(2) Gross reductions may include decreases in the cost basis of investments resulting from principal collections related to investment repayments or sales, the exchange of one or more existing securities for one or more new securities and/or the movement of an existing portfolio company out of this category into a different category.
(3) Interest, PIK, fee and dividend income presented for the year ended December 31, 2021.
(4) The Company held this investment as of December 31, 2020 and thereafter until the Advisor notified the Company thatbut it no longer intendswas deemed to defer payments. Pursuant to the May Letter, the Advisor agreed that it would take the deferred payment for any quarter upon the earlier of (1) the date provided by the Advisor in a written notice to the Company and (2) the endbe an “affiliated person” of the third full calendar quarter following the quarter in which the provisionportfolio company as of services to which such deferred payment relates. Pursuant to the May Letter, the deferred payment for any quarter was deferred without interest and could be taken in such other quarter, in whole or in part, as the Advisor determined. The Advisor has received the deferred payments for the quarters ended March 31, 2020 and June 30, 2020 and elected not to defer the base management fee for the quarters ended September 30, 2020 and December 31, 2020. Transfers in or out have been presented at amortized cost.
See notes to consolidated financial statements.
85
FS Energy and Power Fund
Notes to Consolidated Financial Statements
(in thousands, except share and per share amounts)
Note 1. Principal Business and Organization
FS Energy and Power Fund, or the Company, was formed as a Delaware statutory trust under the Delaware Statutory Trust Act on September 16, 2010 and formally commenced investment operations on July 18, 2011. The Company is an externally managed, non-diversified, closed-end management investment company that has elected to be regulated as a business development company, or BDC, under the Investment Company Act of 1940, as amended, or the 1940 Act. In addition, the Company has elected to be treated for U.S. 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 December 31, 2022, the Company had various wholly-owned financing subsidiaries, including special-purpose financing subsidiaries and subsidiaries through which it holds or expects to hold interests in certain portfolio companies. The audited consolidated financial statements include both the Company’s accounts and the accounts of its wholly-owned subsidiaries as of December 31, 2022. All significant intercompany transactions have been eliminated in consolidation. Certain of the Company’s consolidated subsidiaries are subject to U.S. federal and state income taxes.
The Company’s investment objective is to generate current income and long-term capital appreciation by investing primarily in privately-held U.S. companies in the energy and power industry. The Company’s investment policy is to invest, under normal circumstances, at least 80% of its total assets in securities of energy and power related, or Energy, companies. The Company considers Energy companies to be those companies that engage in the exploration, development, production, gathering, transportation, processing, storage, refining, distribution, mining, generation or marketing of natural gas, natural gas liquids, crude oil, refined products, coal or power, including those companies that provide equipment or services to companies engaged in any of the foregoing.
The Company is managed by FS/EIG Advisor, LLC, or FS/EIG Advisor, pursuant to an investment advisory and administrative services agreement, dated as of April 9, 2018, or the FS/EIG investment advisory agreement. FS/EIG Advisor oversees the management of the Company’s operations and is responsible for making investment decisions with respect to the Company’s portfolio. FS/EIG Advisor is jointly operated by an affiliate of Franklin Square Holdings, L.P. (which does business as FS Investments) and EIG Asset Management, LLC, or EIG.
Note 2. Summary of Significant Accounting Policies
Basis of Presentation: The accompanying audited consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP. The Company is considered an investment company under GAAP and follows the accounting and reporting guidance applicable to investment companies under Accounting Standards Codification Topic 946, Financial Services—Investment Companies. 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 audited consolidated 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.
Cash and Cash Equivalents: The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. The Company's cash and cash equivalents are maintained with high credit quality financial institutions, which are members of the Federal Deposit Insurance Corporation.
Valuation of Portfolio Investments: The Company’sboard of trustees is responsible for overseeing the valuation of the Company’s portfolio investments at fair value as determined in good faith pursuant to FS/EIG Advisor’s valuation policy. As permitted by Rule 2a-5 of the 1940 Act, the Company’s board of trustees has designated FS/EIG Advisor as the Company’s valuation designee, with day-to-day responsibility for implementing the portfolio valuation process set forth in FS/EIG Advisor’s valuation policy.
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
FS Energy and Power Fund
Notes to Consolidated Financial Statements (continued)
(in thousands, except share and per share amounts)
Note 2. Summary of Significant Accounting Policies (continued)
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.
FS/EIG Advisor determines the fair value of the Company’s investment portfolio each quarter. Securities that are publicly-traded with readily available market prices will be valued at the reported closing price on February 26,the valuation date. Securities that are not publicly-traded with readily available market prices will be valued at fair value as determined in good faith by FS/EIG Advisor. In connection with that determination, FS/EIG Advisor will prepare portfolio company valuations which are based on relevant inputs, including, but not limited to, indicative dealer quotes, values of like securities, recent portfolio company financial statements and forecasts, and valuations prepared by independent third-party pricing and valuation services.
With respect to investments for which market quotations are not readily available, a multi-step valuation process is undertaken each quarter, as described below:
•the quarterly fair valuation process begins with FS/EIG Advisor facilitating the delivery of updated quarterly financial and other information relating to each investment to an independent third-party pricing or valuation service;
•the independent third-party pricing or valuation service then reviews and analyzes the information, along with relevant market and economic data, and determines proposed valuations for each portfolio company or investment according to the valuation methodologies in FS/EIG Advisor’s valuation policy and communicates the information to FS/EIG Advisor in the form of a valuation range for Level 3 assets;
•FS/EIG Advisor then reviews the preliminary valuation information for each portfolio company or investment and provides feedback about the accuracy, completeness and timeliness of the valuation-related inputs considered by the independent third-party pricing or valuation service and any suggested revisions thereto prior to the independent third-party pricing or valuation service finalizing its valuation range;
•FS/EIG Advisor then provides the valuation committee with its valuation determinations and valuation-related information for each portfolio company or investment, along with any applicable supporting materials; and other information that is relevant to the fair valuation process;
•the valuation committee meets with FS/EIG Advisor to receive the relevant quarterly reporting from FS/EIG Advisor and to discuss any questions from the valuation committee in connection with the valuation committee’s role in overseeing the fair valuation process; and
•following the completion of its fair value oversight activities, the valuation committee (with the assistance of FS/EIG Advisor) provides the Company's board of trustees with a report regarding the quarterly valuation process.
Determination of fair value involves subjective judgments and estimates. Accordingly, the notes to the Company's consolidated financial statements refer to the uncertainty with respect to the possible effect of such valuations and any change in such valuations on the Company's consolidated financial statements. In making its determination of fair value, FS/EIG Advisor may use any independent third-party pricing or valuation services for which it has performed the appropriate level of due diligence. However, FS/EIG Advisor is not required to determine fair value in accordance with the valuation provided by any single source, and may use any relevant data, including information sourced by FS/EIG Advisor or provided by any independent third-party pricing or valuation service that FS/EIG Advisor deems to be reliable in determining fair value under the circumstances. Below is a description of factors that FS/EIG Advisor and any independent third-party valuation services may consider when determining the fair value of the Company's investments.
The valuation methods utilized for each portfolio company may vary depending on industry and company-specific considerations. Typically, the first step is to make an assessment as to the enterprise value of the portfolio company’s business in order to establish whether the portfolio company’s enterprise value is greater than the amount of its debt as of the valuation date. This analysis helps to determine a risk profile for the applicable portfolio company and its related investments, and the appropriate
FS Energy and Power Fund
Notes to Consolidated Financial Statements (continued)
(in thousands, except share and per share amounts)
Note 2. Summary of Significant Accounting Policies (continued)
valuation methodology to utilize as part of the security valuation analysis. The enterprise valuation may be determined using a market or income approach.
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, FS/EIG Advisor may incorporate these factors into discounted cash flow models to arrive at fair value. Various methods may be used to determine the appropriate discount rate in a discounted cash flow model. Other factors that may be considered include the borrower’s ability to adequately service its debt, the fair market value of the borrower in relation to the face amount of its outstanding debt and the quality of collateral securing the debt investments.
For convertible debt securities, fair value generally approximates the fair value of the debt plus the fair value of an option to purchase the underlying security (i.e., the security into which the debt may convert) at the conversion price. To value such an option, a standard option pricing model may be used.
The Company's equity interests in portfolio companies for which there is no liquid public market are valued at fair value. Generally, the value of the Company's 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 the Company receives warrants or other equity securities at nominal or no additional cost in connection with an investment in a debt security, the cost basis in the investment will be allocated between the debt securities and any such warrants or other equity securities received at the time of origination. FS/EIG Advisor subsequently values these warrants or other equity securities received at their fair value.
Swap contracts typically are valued at their daily prices obtained from an independent third party. The aggregate settlement values and notional amounts of the swap contracts are not recorded in the statements of assets and liabilities. Fluctuations in the value of the swap contracts are recorded in the statements of assets and liabilities as gross assets and gross liabilities and in the statements of operations as unrealized appreciation (depreciation) until closed, when they will be recorded as net realized gain (loss).
Revenue Recognition: Security transactions are accounted for on the trade date. The Company records interest income on an accrual basis to the extent that it expects to collect such amounts. The Company records dividend income on the ex-dividend date. Distributions received from limited liability company, or LLC, and limited partnership, or LP, investments are evaluated to determine if the distribution should be recorded as dividend income or a return of capital. The Company does not accrue as a receivable interest or dividends on loans and securities if it has reason to doubt its ability to collect such income. The Company's policy is to place investments on non-accrual status when there is reasonable doubt that interest income will be collected. The Company considers many factors relevant to an investment when placing it on or removing it from non-accrual status including, but not limited to, the delinquency status of the investment, economic and business conditions, the overall financial condition of the underlying investment, the value of the underlying collateral, bankruptcy status, if any, and any other facts or circumstances relevant to the investment. If there is reasonable doubt that the Company will receive any previously accrued interest, then the accrued interest will be written-off. Payments received on non-accrual investments may be recognized as income or applied to principal depending upon the collectability of the remaining principal and interest. Non-accrual investments may be restored to accrual status when principal and interest become current and are likely to remain current based on the Company's judgment.
Loan origination fees, original issue discount and market discount are capitalized and the Company amortizes such amounts as interest income over the respective term of the loan or security. Upon the prepayment of a loan or security, any unamortized loan origination fees and original issue discount are recorded as interest income. Structuring and other non-recurring upfront fees are recorded as fee income when earned. The Company records prepayment premiums on loans and securities as fee income when it earns such amounts. For the years ended December 31, 2022 and 2021, the Advisor notifiedCompany did not recognize any structuring or other upfront fee revenue. For the year ended December 31, 2020, the Company that it no longer intends to deferrecognized $83 in structuring or other upfront fee revenue.
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 paymentsale of any portioninvestments are calculated by using the specific identification method. The Company measures realized gains or losses by the difference between the net proceeds from the repayment or sale and the amortized cost basis of the management fee pursuantinvestment, without regard to unrealized appreciation or depreciation previously recognized, but
FS Energy and Power Fund
Notes to Consolidated Financial Statements (continued)
(in thousands, except share and per share amounts)
Note 2. Summary of Significant Accounting Policies (continued)
considering unamortized 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 and the respective unrealized gain or loss on foreign currency for any foreign denominated investments it may hold. Net change in unrealized gains or losses on foreign currency reflects the change in the value of foreign currency held, receivables or accruals during the reporting period due to the
May Letter.The incentive fee consistsimpact of two parts: (i) the capital gains incentive fee and (ii) the subordinated income incentive fee. foreign currency fluctuations.
Capital Gains Incentive Fee:Pursuant to the terms of the Investment Advisory and Administrative Services Agreement,FS/EIG investment advisory agreement, the incentive fee on capital gains is determined and payable in arrears as of the end of each calendar year (or upon termination of such agreement). Such fee equals 20.0% of the Company’s “incentive fee capital gains,” which are 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 incentive fees on capital gains. The Company will accrue for the incentive fee on capital gains, which, if earned, will be paid annually. The Company will accrue the incentive fee on capital gains based on net realized and unrealized gains; however, the fee payable to theFS/EIG Advisor will be based on realized gains and no such fee will be payable with respect to unrealized gains unless and until such gains are actually realized. Subordinated Income Incentive Fee:Pursuant to the terms of the Investment Advisory and Administrative Services Agreement, theFS/EIG investment advisory agreement, FS/EIG Advisor may also be entitled to receive a subordinated incentive fee on income. The subordinated incentive fee on income under the Investment Advisory and Administrative Services AgreementFS/EIG investment advisory agreement is calculated and payable quarterly in arrears and equals 20.0% of the Company’s “pre-incentive“pre-incentive fee net investment income” for the immediately preceding quarter subject to a hurdle rate, expressed as a rate of return on adjusted capital, equal to 1.625% per quarter, or an annualized hurdle rate of 6.5%. As a result, theFS/EIG Advisor will not earn this