FS KKR Capital Corp. 2022 Form 10-K Summary
Business context and reporting period
FS KKR Capital Corp. (NYSE: FSK) is an externally managed, non-diversified business development company and regulated investment company. It invests primarily in senior secured and second-lien loans, asset-based finance, subordinated debt and equity securities of private middle-market companies. The filing covers the fiscal year ended December 31, 2022; fourth-quarter information is presented in the selected quarterly data.
FS/KKR Advisor, LLC manages the Company. At year-end, FSK had 197 portfolio companies, total assets of $16.1 billion and investment assets at fair value of $15.4 billion. The portfolio was concentrated in software and services, capital goods, health care equipment and services, commercial and professional services, and insurance.
Key financial metrics
| Metric | 2022 | 2021 |
|---|---|---|
| Total investment income | $1,635 million | $1,081 million |
| Net investment income | $865 million, or $3.05 per share | $584 million, or $2.76 per share |
| Net realized gains | $182 million | $164 million |
| Net change in unrealized appreciation/depreciation | $(950) million | $770 million |
| Net increase in net assets from operations | $92 million, or $0.32 per share | $1,515 million, or $7.16 per share |
| Net investment income margin | Approximately 52.9% of investment income | Approximately 54.0% |
| Net assets at year-end | $7,012 million | $7,730 million |
| NAV per share | $24.89 | $27.17 |
| Cash and foreign currency | $251 million | $377 million |
| Debt outstanding, net | $8,694 million | $9,142 million |
| Asset coverage | 180% | 184% |
| Cash distributions per share | $2.66 | $2.47 |
| Total return based on NAV | 1.40% | 18.47% |
| Total return based on market value | (4.61)% | 41.45% |
Cash flow from operating activities was $1.107 billion, compared with $(639) million in 2021. Financing activities used $1.233 billion, primarily reflecting net debt repayments and distributions. The Company had $2.559 billion of available borrowing capacity at year-end, subject to borrowing-base and other limitations.
Investment income included $163 million of paid-in-kind interest and $74 million of non-cash discount accretion, meaning approximately $237 million of 2022 investment income was non-cash. The weighted average annual yield was 12.0% on accruing debt investments and 11.2% on all debt investments. Approximately 69.6% of portfolio investments at fair value were variable-rate debt investments, while 8.6% were fixed-rate debt investments.
Material changes versus the prior comparable period
- Investment income increased 51%, principally due to higher benchmark rates and the larger asset base following the 2021 FSKR merger.
- Net investment income increased 48%, but net expenses increased to $770 million from $497 million. Interest expense rose to $365 million from $231 million, and subordinated incentive fees rose to $159 million from $77 million, partly offset by incentive fee waivers of $60 million in 2022.
- Net unrealized depreciation of investments was $981 million, primarily due to widening credit spreads, compared with $728 million of unrealized appreciation in 2021. This drove the decline in NAV from $27.17 to $24.89 per share.
- Investment purchases declined to $4.642 billion from $13.826 billion, while sales and repayments declined to $4.741 billion from $5.575 billion. Net portfolio activity was negative $99 million versus positive $8.251 billion in 2021, which included merger-acquired investments.
- The fair value of the investment portfolio declined to $15.377 billion from $16.101 billion, despite amortized cost increasing to $16.314 billion from $16.057 billion.
- Portfolio credit ratings weakened modestly: investments rated 1 declined to 75% of fair value from 78%, while ratings 2, 3 and 4 represented 19%, 3% and 3%, respectively, versus 15%, 5% and 2% in 2021. Investments on non-accrual increased to 2.4% of fair value from 1.9%.
- The Company repurchased 2.811 million shares for $56 million at an average price of $19.91. The board renewed the repurchase program with $54 million of remaining authorization.
Guidance, outlook, risks and unusual items
The filing does not provide formal earnings or distribution guidance. Management stated that the investment strategy remains focused on current income, principal protection and long-term capital appreciation through predominantly directly originated, senior secured lending. A $0.70 per-share quarterly distribution was declared on February 21, 2023, payable in April 2023.
- Management identified an environment of capital-market disruption and economic uncertainty, including inflation, higher interest rates, wider credit spreads, recession risk, geopolitical uncertainty, the Russia-Ukraine conflict and continuing effects of COVID-19.
- Higher rates benefited floating-rate portfolio income but also increased borrowing costs and may pressure portfolio-company coverage ratios, defaults and fair values. The filing estimates that a 100-basis-point rate increase would increase annual net interest income by approximately $72 million, assuming no defaults or prepayments.
- Most investments lack readily available market prices. Level 3 investments were $13.385 billion, or approximately 87% of total investments at fair value. Valuations depend on subjective assumptions such as discount rates, projected cash flows and EBITDA multiples. Deloitte identified Level 3 valuation as a critical audit matter.
- The Company had $952.4 million of unfunded debt commitments, $475.3 million of unfunded equity and other commitments, and a $560.2 million unfunded commitment to COPJV. Management stated that available cash, borrowing capacity and liquid investments were sufficient to fund these commitments, but actual funding requirements may differ.
- COPJV generated $219.3 million of net investment income but reported a $155.6 million net realized and unrealized loss in 2022. FSK’s investment in COPJV was valued at $1.428 billion at year-end.
- Subsequent amendments transitioned certain facilities from LIBOR to Term SOFR and extended the revolving periods of the Darby Creek and Dunlap facilities only to April 26, 2023, while increasing the post-reinvestment-period margin to Term SOFR plus 2.90%.
- The Company was in compliance with all financing covenants at December 31, 2022 and reported no material legal proceedings. Management and Deloitte concluded that internal control over financial reporting was effective, and Deloitte issued unqualified audit opinions.
Most important facts for investors to verify
- Whether the elevated 2022 yield and net investment income are sustainable as benchmark rates change and incentive fee waivers expire.
- The performance, non-accrual status and recovery prospects of investments rated 3 or 4, including heavily marked-down and PIK-bearing positions.
- The sensitivity of NAV and portfolio fair values to wider credit spreads, higher discount rates and weaker portfolio-company earnings.
- The maturity and refinancing plan for the $8.7 billion of senior securities, particularly 2024 and 2025 debt maturities and facilities with near-term revolving-period expirations.
- The liquidity needed to fund $2.0 billion of reported unfunded commitments and the effect of such funding on leverage and distributions.
- The accuracy and sensitivity of Level 3 valuations, which represent the substantial majority of the investment portfolio.
- The tax characterization of distributions and the Company’s ability to maintain BDC and RIC status while satisfying distribution and asset-coverage requirements.