FSK

FS KKR Capital Corp. 2018 Annual Report (10-K) Summary

Business Context and Reporting Period

Company: FS KKR Capital Corp. (NYSE: FSK)
Reporting Period: Fiscal year ended December 31, 2018
Business Model: Externally managed, non-diversified, closed-end management investment company regulated as a Business Development Company (BDC) and taxed as a Regulated Investment Company (RIC).
Strategy: Focuses on generating current income and long-term capital appreciation by investing primarily in senior secured and second lien secured loans of private U.S. middle-market companies. The company employs leverage to enhance returns.

Key Financial Metrics

Material Changes vs. Prior Period

• Corporate Capital Trust (CCT) Merger: The most significant event was the acquisition of Corporate Capital Trust, Inc. on December 19, 2018. This transaction resulted in the issuance of approximately 292 million shares of common stock and the addition of approximately $4.2 billion in investments at fair value. This merger drove the doubling of total assets and net assets compared to 2017.
• Portfolio Growth: Total portfolio investments increased from $3.9 billion in 2017 to $7.4 billion in 2018. The number of portfolio companies grew from 100 to 204.
• Operating Results: While Net Investment Income remained relatively flat ($205M vs $204M), the Net Increase in Net Assets from Operations surged to $569 million from $182 million. This increase was primarily due to a $717 million non-cash "change in unrealized appreciation from merger accounting" related to the CCT acquisition.
• Expense Reduction: Total operating expenses decreased to $185 million in 2018 from $213 million in 2017, driven by lower management and incentive fees relative to the asset base prior to the merger's full impact.
• NAV Decline: Despite the merger, NAV per share declined from $9.30 to $7.84, reflecting the market discount at which the merger was executed and unrealized depreciation on certain equity and other investments.

Guidance, Outlook, and Risks

• Management Commentary: Management emphasizes a defensive investment approach focused on long-term credit performance and principal protection. The merger with CCT is expected to provide scale and diversification. The company maintains a stock repurchase program authorized in December 2018 to repurchase up to $200 million of shares below NAV.
• Outlook: The company anticipates continued opportunities in the senior secured and second lien loan asset classes, particularly in the underserved middle market. They expect to maintain their RIC status by distributing at least 90% of investment company taxable income.
• Risks and Contingencies:
  • Leverage Risk: The company utilizes significant leverage (debt-to-equity ratio approx. 81% based on outstanding debt vs. net assets). Rising interest rates could increase borrowing costs and reduce net investment income.
  • Asset Quality: As of December 31, 2018, 1.0% of the portfolio was on non-accrual status. The company holds investments in private companies which are illiquid and subject to valuation uncertainty.
  • Regulatory: As a BDC, the company is subject to asset coverage requirements (minimum 200% generally, or 150% with stockholder approval) which limit the ability to pay distributions or issue additional debt if asset values decline.
  • Interest Rate Risk: Approximately 67.6% of the portfolio consists of variable-rate debt. While this provides some protection against rising rates, it also exposes the company to higher borrowing costs if rates rise significantly.

Key Facts for Investor Verification

• Merger Accounting Impact: Verify the $717 million unrealized appreciation gain from the CCT merger, as this significantly inflated the 2018 net increase in net assets and may not reflect ongoing operational performance.
• NAV vs. Market Price: Confirm the current trading price of FSK relative to the $7.84 NAV per share to assess the discount or premium at which the stock is trading.
• Debt Maturities: Review the schedule of debt maturities, noting that $400 million in 4.000% Notes are due in July 2019 and $405 million in 4.250% Notes are due in January 2020.
• Non-Accrual Assets: Monitor the 1.0% of the portfolio on non-accrual status and the specific portfolio companies involved (e.g., Advanced Lighting Technologies, AltEn, Aspect Software) for potential credit deterioration.
• Distribution Coverage: Assess whether the $205 million in Net Investment Income is sufficient to cover the $205 million in distributions declared, noting that distributions may include return of capital if taxable income exceeds cash flow.