FS ENERGY AND POWER FUND 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 theSEC , including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K. The forward-looking 47
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Table of Contents 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 aDelaware statutory trust under theDelaware Statutory Trust Act onSeptember 16, 2010 and formally commenced investment operations onJuly 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 forU.S. federal income tax purposes, and intends to qualify annually, as a RIC under Subchapter M of the Code. InNovember 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 FS/EIG investment advisory agreement, we have agreed to pay FS/EIG Advisor an annual base management fee based on the average weekly value of our gross assets 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 following seven investment themes: (i) basin-on-basin competition inU.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 emergingU.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 withinthe 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. 48 -------------------------------------------------------------------------------- Table of Contents 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 theSEC . 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;
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Table of Contents •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
•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 SarbanesOxley 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 withState 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 inUkraine and sanctions imposed onRussia in response. The impact of these events on theU.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 50 -------------------------------------------------------------------------------- Table of Contents 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 afterMarch 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 inUkraine 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
Total Portfolio Activity
The following tables present certain selected information regarding our
portfolio investment activity for the years ended
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 %
51-------------------------------------------------------------------------------- Table of Contents The following table summarizes the composition of our investment portfolio at cost and fair value as ofDecember 31, 2022 and 2021: December 31, 2022 December 31, 2021 Amortized Percentage Amortized Percentage Cost(1) Fair Value of Portfolio Cost(1) Fair Value 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 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.
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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
6.8%
Funded Direct Originations 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 December 31, 2021
Percentage of Percentage of
Portfolio Composition by Strategy Fair Value Portfolio Fair Value 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 December 31, 2021
Percentage Percentage
Investment Rating Fair Value of Portfolio FairValue 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.
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Results of Operations
Comparison of the Years Ended
Revenues
Our investment income for the years endedDecember 31, 2022 , 2021 and 2020 was as follows: Year Ended December 31, 2022 2021 2020 Percentage of Percentage of Percentage of Amount Total Income Amount Total Income Amount 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 endedDecember 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 endedDecember 31, 2022 compared to the year endedDecember 31, 2021 was primarily due to the rising interest rate environment. The decrease in the amount of PIK income for the year endedDecember 31, 2022 compared to the year endedDecember 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 endedDecember 31, 2021 compared to the year endedDecember 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 endedDecember 31, 2022 compared to the year endedDecember 31, 2021 was primarily due to an increase in prepayment fees. The increase in the amount of fee income for the year endedDecember 31, 2021 compared to the year endedDecember 31, 2020 was primarily due to an increase in prepayment and amendment fees. The increase in the amount of dividend income for the year endedDecember 31, 2022 compared to the years endedDecember 31, 2021 and 2020 was primarily due to the increase in dividends paid with respect to our investments in certain common equities andSustainable Infrastructure Investments, LLC . 54 -------------------------------------------------------------------------------- Table of Contents Expenses Our operating expenses for the years endedDecember 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
The following table reflects selected expense ratios as a percent of average net
assets for the years ended
Year Ended
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 ($0.19 per share) for the years endedDecember 31, 2022 , 2021 and 2020, respectively.
Net Realized Gains or Losses
Our net realized gains (losses) on investments, foreign currency, swap contracts and debt extinguishment for the years endedDecember 31, 2022 , 2021 and 2020 were as follows: Year Ended December 31, 2022 2021 2020 Net realized gain (loss) on investments(1)$ 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) We sold investments and received principal repayments of$457,619 and$413,370 , respectively, during the year endedDecember 31, 2022 ,$482,932 and$515,459 , respectively, during the year endedDecember 31, 2021 and$992,178 and$83,350 , respectively, during the year endedDecember 31, 2020 . 55
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Table of Contents 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 endedDecember 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
(698) - (6,551)
Net change in unrealized appreciation (depreciation) on foreign currency
(45) (12) 5
Total net change in unrealized appreciation (depreciation)
During the year endedDecember 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 endedDecember 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 endedDecember 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
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 ofDecember 31, 2022 , we had$481,655 in cash, which we held in custodial accounts. As ofDecember 31, 2022 , we also had broadly syndicated investments that could be sold to create additional liquidity. As ofDecember 31, 2022 , we had six senior secured loan investments with aggregate unfunded commitments of$25,891 and unfunded commitments of$7,625 inU.S. dollars and$858 in Canadian dollars to contribute capital toSustainable 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. OnFebruary 14, 2023 , the JPMorgan Facility matured, and we repaid and terminated the facility with cash. In addition, the Senior Secured Notes mature onAugust 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. 56 -------------------------------------------------------------------------------- Table of Contents Financing Arrangements
The following table presents a summary of information with respect to our
outstanding financing arrangements as of
Type of Amount Amount
Arrangement(1) Arrangement Rate(2) Outstanding 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
(4) On
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 forU.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-levelU.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 nondeductibleU.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 endingOctober 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 noU.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 ourU.S. shareholders, onDecember 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 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 a return of an investor's investment rather than a return of earnings or gains derived from our investment activities and will be made after deducting 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. 57 -------------------------------------------------------------------------------- Table of Contents 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 aU.S. shareholder. Although our board of trustees has not declared or resumed regular cash distributions to shareholders for any period afterMarch 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
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 theFinancial 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 58 -------------------------------------------------------------------------------- Table of Contents 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.
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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.
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