FSK

Business Context and Reporting Period

Company: FS KKR Capital Corp. (NYSE: FSK)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2019
Business Overview: FS KKR Capital Corp. 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 debt investments (senior secured and second lien loans) in private U.S. middle-market companies. It is managed by FS/KKR Advisor, LLC, a joint venture between FS Investments and KKR Credit.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Investment income increased significantly to $779 million in 2019 from $394 million in 2018, primarily driven by the acquisition of Corporate Capital Trust, Inc. (CCT) in December 2018, which expanded the asset base.
• Expense Increase: Total operating expenses rose to $362 million in 2019 from $185 million in 2018. This increase is attributed to higher management fees due to the larger asset base and increased interest expense ($170 million vs. $84 million) resulting from higher debt levels.
• Realized and Unrealized Gains/Losses: The Company reported a net realized and unrealized loss of $164 million in 2019, compared to a gain of $364 million in 2018. The 2018 gain was heavily influenced by a $717 million change in unrealized appreciation from merger accounting related to the CCT acquisition. In 2019, results were impacted by mark-to-market declines in certain debt investments.
• Portfolio Composition: The portfolio consists of 210 portfolio companies as of year-end 2019. Direct originations represent 88.2% of total investments at fair value.

Guidance, Outlook, Risks, and Unusual Items

• Regulatory Change: Effective June 15, 2019, stockholders approved a reduction in the asset coverage requirement from 200% to 150%, allowing the Company to increase its maximum debt-to-equity ratio from 1.0x to 2.0x.
• Stock Repurchases: The Company repurchased 25.2 million shares in 2019 at an average price of $6.08 per share under a $200 million program authorized in December 2018.
• Distributions: The Company declared distributions of $0.76 per share in 2019. No portion of distributions paid in 2019 represented a return of capital.
• Key Risks:
  • Interest Rate Risk: 64.8% of the portfolio is variable-rate debt. Rising rates increase interest income but also increase borrowing costs.
  • Liquidity: Investments are primarily in private companies and are illiquid. The Company relies on cash flows, borrowings, and asset sales to meet obligations.
  • Valuation Uncertainty: A significant portion of the portfolio (Level 3 assets) is valued using unobservable inputs, requiring significant management judgment.
  • LIBOR Transition: The phase-out of LIBOR by 2021 creates uncertainty regarding future benchmark rates for variable-rate investments and borrowings.

Investor Verification Checklist

• Asset Coverage Compliance: Verify the current asset coverage ratio remains above the 150% threshold required for distributions and senior securities issuance.
• Non-Accrual Status: Review the 2.8% of investments on non-accrual status and the specific portfolio companies involved to assess credit quality deterioration.
• Debt Maturity Profile: Analyze the maturity schedule of the $4.2 billion debt outstanding to assess refinancing risks, particularly for notes maturing in 2022.
• Level 3 Valuations: Scrutinize the fair value determinations for the $6.1 billion in Level 3 investments, as these rely on unobservable inputs and management assumptions.
• PIK Interest Impact: Assess the impact of Paid-in-Kind (PIK) interest on taxable income versus cash flow, as this may require distributions funded by borrowings or asset sales.