FS KKR Capital Corp quarterly report, Q3 FY2022

FS KKR Capital Corp. — Form 10-Q Summary

Business context and reporting period

FS KKR Capital Corp. is an externally managed, non-diversified business development company and regulated investment company focused primarily on current income from senior secured, second-lien, subordinated and asset-based investments in private middle-market companies. This filing covers the quarter and nine months ended September 30, 2022. The financial statements are unaudited and presented in millions, except per-share and share data.

Key financial metrics

Metric	Three months ended September 30, 2022	Nine months ended September 30, 2022	Comparable period
Total investment income	$411	$1,186	$360 and $717, respectively
Net investment income	$216; $0.76 per share	$639; $2.25 per share	$201 and $395, respectively
Net realized gains	$70	$235	$196 and $119, respectively
Net unrealized gain/(loss)	$(413)	$(846)	$(127) and $820, respectively
Net increase/(decrease) in net assets from operations	$(127); $(0.45) per share	$25; $0.09 per share	$270 and $1,334, respectively
Stockholder distributions	$190; $0.67 per share declared for the quarter	$562; $1.98 per share declared year-to-date	$186 and $335, respectively

Net investment income increased primarily because of higher interest income in the rising-rate environment and the larger asset base following the 2021 FSKR merger.
Investment income included $180 of non-cash accretion and paid-in-kind interest for the nine-month period. Management reported that 84.8% of gross investment income was cash income, 4.9% was non-cash accretion and 10.3% was PIK interest.
Net unrealized investment depreciation of $930 million for the nine months was driven primarily by widening credit spreads.
Net assets were $7.16 billion at September 30, 2022, down from $7.73 billion at December 31, 2021. NAV per share declined to $25.30 from $27.17.
Cash and foreign currency totaled $266 million. Borrowing capacity was $2.114 billion, subject to borrowing-base and other limitations.
Debt outstanding was approximately $9.176 billion; asset coverage was 178%, compared with the statutory minimum applicable to the company of 150%.
Average borrowings for the nine months were $9.553 billion at a weighted average interest rate of 3.43%; the weighted average effective borrowing rate at September 30 was 4.21%.
Operating cash flow was $411 million for the nine months, compared with $(306) million in the prior-year period. Financing cash flow was $(522) million, including $548 million of distributions and $33 million of share repurchases.

Portfolio, liquidity and credit quality

Investments at fair value totaled $15.792 billion, versus $16.102 billion at December 31, 2021. The portfolio comprised 195 portfolio companies.
Portfolio mix by fair value included first-lien senior secured loans of $9.781 billion, or 61.9%; second-lien loans of $1.245 billion, or 7.9%; asset-based finance of $1.826 billion, or 11.6%; COPJV of $1.466 billion, or 9.3%; and equity/other investments of $1.109 billion, or 7.0%.
Variable-rate debt investments represented 70.9% of portfolio fair value, while fixed-rate debt investments represented 8.7%. The weighted average annual yield was 11.1% on accruing debt investments and 10.3% on all debt investments.
Investments on non-accrual status increased to 2.5% of portfolio fair value from 1.9% at year-end. Investments rated 1 declined to 75% of portfolio fair value from 78%; ratings 2, 3 and 4 represented 21%, 1% and 3%, respectively.
Unfunded commitments included $1.042 billion of debt investments, $363 million of equity/other commitments and $560 million to Credit Opportunities Partners JV. The company stated that it had sufficient cash, available borrowings and liquid securities to fund these commitments.

Material changes versus prior comparable periods

Quarterly investment income rose 14% to $411 million, while nine-month investment income rose 65% to $1.186 billion, reflecting higher benchmark rates and, for the nine-month comparison, the larger post-merger asset base.
Net investment income increased 7% for the quarter and 62% for the nine-month period. However, higher interest expense, incentive fees and market-related valuation losses materially reduced net asset growth.
Net unrealized investment losses were $451 million for the quarter and $930 million year-to-date, compared with losses of $142 million and gains of $784 million in the respective 2021 periods.
Interest expense increased to $96 million for the quarter and $256 million year-to-date, from $70 million and $158 million, respectively, due to higher borrowings, the 2021 merger and rising rates.
First-lien loan fair value increased modestly as a percentage of the portfolio, while second-lien and asset-based finance exposure declined. Subordinated debt and equity/other investments increased.
On May 17, 2022, the senior secured revolving credit facility was amended to increase commitments, extend the revolving and maturity periods to May 2026 and May 2027, respectively, and transition benchmark provisions from LIBOR to SOFR. The facility was subsequently increased to $4.655 billion on June 29, 2022.
The company redeemed its 4.750% notes due 2022 on April 15, 2022 and issued $500 million of 3.250% notes due 2027.

Guidance, outlook, commentary, risks and unusual items

The filing does not provide formal earnings or distribution guidance. On November 4, 2022, the board declared a $0.68-per-share quarterly distribution payable on or about January 3, 2023.
Management emphasized a defensive investment approach, rigorous portfolio monitoring and a focus on principal protection, but noted that results depend on interest rates, credit performance, investment activity, financing costs and market conditions.
Rising rates benefit the predominantly floating-rate portfolio but also increase the cost of the company’s floating-rate debt and may increase incentive fees. Management estimated that a 100-basis-point increase in rates would increase annual net interest income by approximately $72 million, assuming no portfolio or financing changes.
Level 3 investments represented $13.711 billion, or most of the investment portfolio. Their valuations depend on subjective assumptions, including discount rates and EBITDA multiples; changes in these assumptions could materially affect NAV and earnings.
The Russia-Ukraine conflict, sanctions, geopolitical developments, inflation, market volatility, credit-spread widening and economic weakness may adversely affect the company and its portfolio companies.
Distributions may be funded from net investment income, capital gains, asset sales, borrowings or other legally available sources. Although no portion of the first nine months’ distributions was classified as return of capital, future distributions may exceed earnings.
The company reported no material legal proceedings and no material changes to previously disclosed risk factors other than the Russia-Ukraine risk. It also reported no recent developments in the MD&A section.
On November 1, 2022, Todd C. Builione resigned from the board, and Daniel Pietrzak was appointed effective November 4, 2022. The filing states the resignation was not due to a disagreement with the company.

Most important facts for an investor to verify

Whether the elevated non-accrual rate, investment rating migration and distressed holdings lead to further fair-value depreciation or realized losses.
The sustainability of the $0.68-per-share distribution relative to recurring cash net investment income, PIK income and required debt service.
Actual borrowing-base availability, covenant compliance and refinancing needs for debt maturities beginning in 2024 and 2025.
The sensitivity of NAV to credit spreads, discount rates, EBITDA multiples, foreign exchange and further interest-rate changes.
The funding requirements and performance of the $560 million COPJV commitment and other unfunded portfolio commitments.
The effect of the 2021 merger, incentive-fee waiver expiration and changes in financing costs on future net investment income.