FS KKR Capital Corp quarterly report, Q2 FY2023

FS KKR Capital Corp. 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. It invests primarily in senior secured, second-lien, subordinated and asset-based financing of private middle-market companies, with a stated objective of generating current income and, to a lesser extent, long-term capital appreciation. This Form 10-Q covers the three and six months ended June 30, 2023; financial statements are unaudited.

Key Financial Metrics

Metric	Three Months Ended June 30, 2023	Six Months Ended June 30, 2023
Total investment income	$462 million	$918 million
Net investment income	$229 million; $0.82 per share	$458 million; $1.63 per share
Net realized and unrealized gain/(loss)	$(87) million	$(117) million
Net increase in net assets from operations	$142 million; $0.51 per share	$341 million; $1.22 per share
Stockholder distributions	$210 million; $0.75 per share	$406 million; $1.45 per share
Cash flow from operating activities	Not separately provided	$1,008 million

Total assets were $15.5 billion and total investments were $14.8 billion at June 30, 2023, compared with $16.1 billion and $15.4 billion, respectively, at December 31, 2022.
Net assets were $6.915 billion and NAV was $24.69 per share at June 30, 2023, versus $7.012 billion and $24.89 per share at year-end 2022.
Cash and foreign currency totaled $274 million. Borrowing capacity under financing arrangements was $3.091 billion, subject to borrowing-base and other limitations.
Debt outstanding was $8.190 billion gross under financing arrangements, or $8.158 billion net of deferred financing costs on the balance sheet. Asset coverage was 184%, above the statutory 150% requirement.
Weighted average annual yield was 12.7% on accruing debt investments and 11.8% on all debt investments. Approximately 68.9% of the portfolio at fair value consisted of variable-rate debt investments.
Investment portfolio fair value was distributed primarily among first-lien loans of $8.782 billion, asset-based finance of $1.779 billion, second-lien loans of $1.170 billion and equity/other investments of $1.235 billion.
Portfolio exposure was concentrated in Software & Services at 17.1%, Capital Goods at 15.2%, Health Care Equipment & Services at 12.3%, Commercial & Professional Services at 11.6% and Credit Opportunities Partners JV at 9.4% of fair value.

Material Changes Versus Comparable Periods

For the quarter, investment income increased 22% from $379 million to $462 million, while net investment income increased 13% from $203 million to $229 million. For the six-month period, investment income increased 18% and net investment income increased 8% from the prior-year period.
Interest income increased primarily because of higher benchmark interest rates. Fee income declined to $6 million for the quarter and $11 million for the six months, compared with $13 million and $42 million, respectively, in the prior-year periods, reflecting reduced structuring and repayment activity.
Interest expense increased to $118 million for the quarter and $232 million for the six months, versus $83 million and $160 million, respectively, driven by higher rates. The weighted average borrowing rate for the six months was 5.13%, compared with 3.18% in the prior-year period.
Net realized and unrealized results improved from a $(273) million loss in the second quarter of 2022 to an $(87) million loss in the second quarter of 2023. The six-month result was a $(117) million loss versus a $(268) million loss in the prior-year period.
Net investment activity was negative: purchases were $363 million and sales and repayments were $845 million in the quarter; for the six months, purchases were $633 million and sales and repayments were $1.231 billion.
Portfolio fair value declined $613 million from year-end 2022, while investment cost declined $771 million. The proportion of investments rated 1 decreased to 71% from 75%; ratings 2, 3 and 4 represented 23%, 2% and 4%, respectively, versus 19%, 3% and 3% at year-end.
Investments on non-accrual status represented 2.5% of portfolio fair value, compared with 2.4% at December 31, 2022.
During the six months, the company repurchased 1.665 million shares for $32 million. The authorized share repurchase program concluded after the approved amount was expended.

Guidance, Outlook, Risks and Unusual Items

The filing does not provide formal earnings guidance. Management states that future results depend on portfolio performance, interest rates, financing availability, distributions from portfolio companies, economic conditions and the Advisor’s ability to identify suitable investments.
The company declared regular distributions of $0.70 per share for the quarter ended March 31, 2023 and $0.75 per share for the quarter ended June 30, 2023. On August 3, 2023, the board declared a $0.70 per-share regular distribution payable in October 2023 and had previously declared $0.15 per share of special distributions payable in three installments through 2023.
The filing states that distributions paid during the six months were funded 100% from net investment income on a tax basis; no portion was classified as return of capital for the period. Future distributions remain subject to board discretion, legal restrictions and earnings.
Unfunded commitments totaled $976.1 million for debt investments, $623.7 million for equity/other commitments and $560.2 million to Credit Opportunities Partners JV. The company states that it has sufficient liquidity and available borrowings to fund these commitments, although commitments may be drawn in the future.
Key risks include rising interest rates, higher borrowing costs, possible defaults by portfolio companies, declines in fair value, credit-spread widening, inflation, foreign currency movements, LIBOR-to-SOFR transition risk and stress in the banking system.
The portfolio is heavily dependent on fair-value estimates: $12.839 billion of investments were classified as Level 3, using significant unobservable inputs. Changes in discount rates, EBITDA multiples, liquidity discounts or other valuation assumptions could materially affect NAV and reported earnings.
The company terminated the Burholme Prime Brokerage Facility, amended the Darby Creek facility, merged Dunlap Funding into Darby Creek, amended the Meadowbrook Run facility and amended CLO-1 documentation to replace LIBOR provisions with SOFR provisions.
The company reported no material legal proceedings, no defaults upon senior securities and no material changes to internal controls. Management’s disclosure controls were considered effective.

Important Facts for Investors to Verify

Reconcile distributions of $1.45 per share for the first six months with net investment income of $1.63 per share and assess the sustainability of the $0.70 quarterly distribution.
Review debt maturities, refinancing needs and floating-rate exposure, particularly the 2024–2027 unsecured notes and SOFR-linked facilities.
Examine the deterioration in portfolio ratings, non-accrual investments and investments designated as non-income producing.
Assess the valuation sensitivity of Level 3 assets and the effect of changes in discount rates and EBITDA multiples on NAV.
Evaluate the ability of portfolio companies and Credit Opportunities Partners JV to fund the company’s $2.160 billion of disclosed unfunded commitments.
Review concentration in Software & Services, Capital Goods, Health Care Equipment & Services and the Credit Opportunities Partners JV.
Confirm the company’s RIC qualification, tax treatment and annual distribution requirements, including the treatment of future distributions.