FSK

FS KKR Capital Corp. 10-Q Summary: Quarter Ended March 31, 2020

Business Context and Reporting Period

FS KKR Capital Corp. (NYSE: FSK) is an externally managed, non-diversified, closed-end management investment company regulated as a Business Development Company (BDC) and taxed as a Regulated Investment Company (RIC). The company focuses on generating current income and long-term capital appreciation primarily through senior secured loans, second lien loans, and subordinated debt of private middle-market U.S. companies. This report covers the three-month period ended March 31, 2020, a period significantly impacted by the onset of the COVID-19 pandemic, which caused market disruptions and increased credit risk across the portfolio.

Key Financial Metrics

Material Changes vs. Prior Period

• Significant Unrealized Losses: The company reported a net decrease in net assets of $703 million, driven primarily by a $695 million net change in unrealized depreciation on investments. Management attributes this decline to mark-to-market adjustments resulting from market uncertainty and the economic impact of the COVID-19 pandemic.
• Realized Losses: Net realized losses on investments increased to $126 million in Q1 2020 compared to $15 million in Q1 2019, reflecting sales and repayments at values below amortized cost.
• Investment Income: Total investment income decreased slightly to $179 million from $195 million. Interest income declined due to repayments of higher-yielding assets, the impact of falling LIBOR rates on floating-rate loans, and an increase in non-accrual assets.
• Expense Reduction: Total operating expenses decreased to $81 million from $100 million. This reduction was largely due to the elimination of the subordinated income incentive fee ($24 million in Q1 2019 vs. $0 in Q1 2020) because the company did not exceed the hurdle rate for the quarter.
• Portfolio Quality: The percentage of investments on non-accrual status increased to 3.9% from 2.8% at year-end 2019. The weighted average annual yield on accruing debt investments decreased to 9.0% from 9.7%.

Guidance, Outlook, and Risks

• COVID-19 Impact: Management states that the pandemic has negatively impacted portfolio companies and is expected to continue to do so. This has led to increased funding costs, limited access to capital markets, and reduced investment originations. The company expects further adverse effects on investment income and potential impairments.
• Liquidity and Capital Resources: As of March 31, 2020, the company held $193 million in cash and had $574 million available under financing arrangements. The company maintains sufficient liquidity to fund unfunded commitments totaling approximately $797 million ($373 million debt, $215 million equity/other, and $210 million to a joint venture).
• Financing Activity: In a subsequent event (April 30, 2020), the company issued $250 million of 8.625% notes due 2025 to refinance existing debt and for general corporate purposes. Additionally, the Senior Secured Revolving Credit Facility was amended to reset minimum shareholders' equity tests.
• Distributions: The company declared a quarterly cash distribution of $0.15 per share on April 28, 2020, payable in July 2020. This represents a reduction from the $0.19 per share paid in the first quarter of 2020 and 2019.
• Risks: Key risks include the duration and magnitude of the economic downturn caused by the pandemic, the ability of portfolio companies to service debt, potential further declines in asset values, and the company's reliance on leverage which increases financial risk.

Key Facts for Investor Verification

• NAV Decline: Verify the magnitude of the NAV decline from $7.64 to $6.09 per share and the specific portfolio companies contributing most to the $695 million unrealized depreciation.
• Non-Accrual Status: Review the list of specific portfolio companies placed on non-accrual status (increased to 3.9% of the portfolio) and the likelihood of recovery or restructuring.
• Distribution Sustainability: Assess the sustainability of the reduced $0.15 quarterly distribution given the significant operating loss and the potential for distributions to exceed earnings (return of capital).
• Asset Coverage: Monitor the asset coverage ratio (currently 171%) to ensure it remains above the 150% regulatory minimum required for BDCs, especially given the decline in asset values.
• Debt Maturity Profile: Review the maturity schedule of the $4.258 billion in outstanding debt to assess refinancing risks in a potentially constrained credit market.