Business Context and Reporting Period
FS KKR Capital Corp. (NYSE: FSK) is an externally managed, non-diversified business development company and regulated investment company focused primarily on senior secured and second-lien loans to private middle-market companies, with additional subordinated debt, asset-based finance, equity and equity-related investments. This unaudited Form 10-Q covers the three months ended March 31, 2023, with comparative results for the three months ended March 31, 2022.
Key Financial Metrics
| Metric | Q1 2023 | Q1 2022 / Prior Period |
|---|---|---|
| Total investment income | $456 million | $396 million |
| Net investment income | $229 million; $0.81 per share | $220 million; $0.77 per share |
| Net realized and unrealized gain/(loss) | $(30) million | $5 million |
| Net increase in net assets from operations | $199 million; $0.71 per share | $225 million; $0.79 per share |
| Cash flow from operating activities | $247 million | $(520) million |
| Cash and foreign currency | $250 million | $369 million at March 31, 2022 |
| Net asset value per share | $24.93 | $24.89 at December 31, 2022 |
| Net assets | $6.983 billion | $7.012 billion at December 31, 2022 |
| Total investments at fair value | $15.277 billion | $15.377 billion at December 31, 2022 |
| Debt outstanding | $8.713 billion gross; $8.678 billion net | $8.731 billion gross at December 31, 2022 |
| Asset coverage | 180% | 180% at December 31, 2022 |
Net investment income represented approximately 50% of total investment income. Total investment income included approximately $399 million of cash income and $57 million of non-cash accretion and paid-in-kind interest. Net investment income increased despite higher financing costs, while the overall result declined because of net investment losses and weaker unrealized performance.
Material Changes Versus Prior Comparable Period
- Investment income increased 15% to $456 million, primarily due to higher interest income from the rising-rate environment and higher dividend income from Credit Opportunities Partners JV.
- Interest income increased to $327 million from $261 million; dividend income increased to $82 million from $63 million.
- Fee income declined to $5 million from $29 million, reflecting reduced structuring activity.
- Net operating expenses increased to $227 million from $191 million. Interest expense rose to $114 million from $77 million, and subordinated income incentive fees increased to $46 million from $40 million. The $15 million quarterly incentive-fee waiver applicable in Q1 2022 had expired.
- Net investment income increased modestly to $229 million from $220 million, but earnings per share declined to $0.71 from $0.79 because net realized and unrealized investment results deteriorated to a $30 million loss from a $5 million gain.
- Operating cash flow improved to $247 million from negative $520 million, primarily reflecting lower investment purchases and higher proceeds from sales and repayments.
- The Company purchased $270 million of investments and received $386 million from sales and repayments, resulting in net portfolio activity of negative $116 million.
- The Company repurchased 1,665,317 shares for $32 million at an average price of $18.89. The share repurchase program concluded after the authorized amount was expended.
Portfolio, Credit Quality and Liquidity
- The portfolio included 189 portfolio companies at March 31, 2023, compared with 197 at year-end 2022. First-lien loans represented 61.0% of fair value, second-lien loans 7.7%, asset-based finance 11.7%, Credit Opportunities Partners JV 9.1%, and equity/other investments 8.0%.
- Weighted average annual yield was 12.3% on accruing debt investments and 11.4% on all debt investments, compared with 12.0% and 11.2%, respectively, at year-end 2022.
- Investments on non-accrual represented 2.7% of portfolio fair value, up from 2.4%. Investment ratings also weakened: rating 4 investments increased to 4% of portfolio fair value from 3%, while rating 3 investments declined to 2% from 3%.
- Approximately 69.7% of portfolio fair value consisted of variable-rate debt investments and 8.3% of fixed-rate debt investments. The filing estimates that a 100-basis-point increase in rates would increase annual net interest income by approximately $70 million, assuming no defaults, prepayments or portfolio changes.
- The Company held $250 million of cash and foreign currency and had $2.577 billion of borrowing capacity available, subject to borrowing-base and other limitations. Unfunded commitments included $941.9 million of debt investments, $497.3 million of equity/other investments and $560.2 million to Credit Opportunities Partners JV.
- All financing covenants were reported as satisfied. The Company had no material legal proceedings and no outstanding guarantees for portfolio companies.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide formal earnings or distribution guidance. Management states that future results will depend on interest rates, portfolio company performance, investment activity, financing costs, credit losses, valuation changes, distributions from portfolio companies and broader economic conditions.
- Investment valuations are subject to significant judgment: $13.325 billion, or most of the investment portfolio, was classified as Level 3, using unobservable inputs such as discount rates and EBITDA multiples.
- Higher rates benefited floating-rate investment income but also increased borrowing costs and incentive fees. The Company had average borrowings of $8.842 billion during the quarter at a weighted average interest rate of 5.00%, compared with 3.07% in Q1 2022.
- The portfolio contained non-accrual and non-income-producing investments, including several deeply discounted positions. Credit deterioration, defaults, restructurings and recoveries could materially affect NAV and distributions.
- Russia’s invasion of Ukraine was identified as a material potential risk through market volatility, sanctions, commodity-price changes and economic uncertainty.
- The Company declared a regular $0.70-per-share distribution for Q1 2023. Subsequent to quarter-end, the board declared another $0.70-per-share regular distribution and special distributions totaling $0.15 per share for payment during 2023; future distributions remain subject to board discretion and legal restrictions.
- On April 27, 2023, the Darby Creek facility was amended to extend maturity to February 26, 2027, extend the revolving period to February 26, 2025 and increase total commitments to $750 million. Dunlap Funding was merged into Darby Creek, with outstanding borrowings assumed by the surviving facility.
Important Facts for Investors to Verify
- Reconcile net investment income, distributions and cash income, including the effect of paid-in-kind interest and non-cash accretion.
- Review changes in non-accrual investments, rating 4 exposures and the largest portfolio-company concentrations.
- Assess the sensitivity of NAV and earnings to Level 3 valuation assumptions, credit losses and foreign-exchange movements.
- Monitor debt maturities, floating-rate borrowing costs, asset coverage and the $2.577 billion of stated borrowing capacity.
- Confirm the source and sustainability of future distributions, including whether any portion becomes a return of capital.
- Track the post-quarter-end Darby Creek/Dunlap facility amendments and the ability to fund approximately $2.0 billion of aggregate unfunded commitments.