FS KKR Capital Corp. 2023 Form 10-K Summary
Business context and reporting period
FS KKR Capital Corp. (NYSE: FSK) is an externally managed, non-diversified business development company and regulated investment company. Its objective is to generate current income and, to a lesser extent, long-term capital appreciation through primarily senior secured and second-lien loans to private middle-market U.S. companies, along with asset-based finance, subordinated debt, equity and related investments. The filing covers the fiscal year ended December 31, 2023; it is an annual filing rather than a standalone fourth-quarter filing. The filing was signed February 26, 2024.
At year-end, FSK had approximately $15.5 billion of total assets, $14.6 billion of investments at fair value, 204 portfolio companies and $6.8 billion of stockholders’ equity. The portfolio was managed by FS/KKR Advisor, LLC, a partnership between FS Investments and KKR Credit.
Key financial metrics
| Metric | 2023 | 2022 | Change |
|---|---|---|---|
| Total investment income | $1,830 million | $1,635 million | +12% |
| Net investment income | $892 million; $3.18/share | $865 million; $3.05/share | +3%; +4%/share |
| Net increase in net assets from operations | $696 million; $2.48/share | $92 million; $0.32/share | Improved materially |
| Net realized gain/(loss) | $(323) million | $182 million | Shifted to loss |
| Net unrealized appreciation/(depreciation) | $130 million | $(950) million | Improved materially |
| Net asset value per share | $24.46 | $24.89 | Down 1.7% |
| Cash distributions declared | $2.95/share; $827 million | $2.66/share; $754 million | +11%/share |
| Cash flow from operating activities | $1,384 million | $1,107 million | +25% |
| Debt outstanding | $8,223 million gross; $8,187 million net | $8,731 million gross | Down $508 million gross |
Investment income increased primarily because of higher benchmark interest rates. Interest income was $1,295 million, paid-in-kind interest was $192 million, dividend income was $308 million and fee income declined to $35 million from $80 million. Cash income represented $1,584 million of total investment income, while non-cash discount accretion and PIK income represented $246 million.
Total net expenses, including excise taxes, were $938 million, up from $770 million. Interest expense increased to $467 million from $365 million, and subordinated income incentive fees increased to $181 million from $159 million. The ratio of net investment income to average net assets was 12.67%, compared with 11.42% in 2022; the ratio of net operating expenses to average net assets was 13.32%, compared with 10.17% after the prior-year incentive fee waiver.
Portfolio, liquidity and leverage
- Portfolio fair value declined to $14.649 billion from $15.377 billion. First-lien loans represented 58.2% of fair value, second-lien loans 7.5%, asset-based finance 14.2%, COPJV 9.5% and equity/other investments 7.7%.
- Purchases totaled $1.817 billion and sales and repayments totaled $2.570 billion, producing net portfolio activity of negative $753 million. This compares with negative $99 million in 2022.
- Weighted average annual yield on accruing debt investments increased to 12.7% from 12.0%; the yield on all debt investments was 11.2% in both years.
- Investments on non-accrual increased to 5.5% of portfolio fair value from 2.4%. Investments rated 1 declined to 71% of the portfolio from 75%, while ratings 2 and 3 increased to 22% and 4%, respectively. Rating 4 investments remained 3%.
- FSK held $231 million of cash and foreign currency and reported $3.409 billion of available borrowing capacity, subject to borrowing-base and other limitations.
- Asset coverage was 183%, versus the statutory minimum of 150%. The company stated that it was in compliance with all financing covenants at December 31, 2023.
- Unfunded commitments included $995.1 million of debt commitments, $616.4 million of equity/other commitments and $560.2 million to COPJV. Management stated that it had sufficient liquidity to fund these commitments, although not all commitments are expected to be drawn.
- The company’s average borrowings were $8.528 billion at a weighted average interest rate of 5.29%, versus $9.449 billion and 3.72% in 2022. The year-end weighted average effective borrowing rate was 5.42%.
Material changes versus the prior comparable period
- Higher rates increased investment income and net investment income, but also increased borrowing costs and incentive fees.
- Realized investment results deteriorated from a $149 million realized investment gain to a $343 million realized investment loss. Management attributed the 2023 unrealized result primarily to the conversion of unrealized depreciation into realized losses on several specific assets.
- Portfolio fair value decreased by $728 million, while the number of portfolio companies increased from 197 to 204. Direct originations represented 96.8% of total investment fair value in both years.
- Non-accrual investments more than doubled as a percentage of fair value, from 2.4% to 5.5%, and the proportion of investments rated 1 declined.
- Debt outstanding declined by $508 million. The company terminated the Burholme Prime Brokerage Facility, merged Dunlap Funding into Darby Creek, and consolidated financing arrangements under the Darby Creek facility.
- In November 2023, FSK issued $400 million of 7.875% unsecured notes due January 2029. Several nearer-term maturities remain, including $900 million of notes due in 2024 and $1.595 billion of notes due in 2025.
- The company repurchased 1,665,317 shares for $32 million at an average price of $18.89. The share repurchase program subsequently concluded after the authorized amount was expended.
Guidance, outlook, risks and unusual items
The filing does not provide formal earnings or distribution guidance. The board intends to declare regular quarterly cash distributions, subject to legal restrictions, earnings, liquidity, RIC status, asset coverage and board discretion. On February 20, 2024, the board declared a $0.70 per-share regular distribution and $0.10 per share of special distributions payable in 2024. The filing states that all 2023 distributions were sourced from net investment income on a tax basis and that no portion represented a return of capital.
- Management characterizes the operating environment as involving capital-market disruption and economic uncertainty, including inflation, elevated interest rates, geopolitical conflict, financial-sector instability and possible recessionary conditions.
- Interest-rate sensitivity is significant. Assuming no defaults or prepayments, a 100-basis-point increase was estimated to increase annual interest income by $98 million, interest expense by $31 million and net interest income by $67 million, or 7.0%. A 100-basis-point decrease was estimated to reduce net interest income by $67 million.
- Most investments are privately negotiated and valued using Level 3 inputs. Level 3 investments totaled $13.073 billion, or approximately 89% of investment fair value excluding investments measured using the net asset value practical expedient. Valuation changes could materially affect NAV and earnings.
- PIK and other non-cash income totaled $246 million. Such income can increase taxable income without corresponding cash receipts, potentially requiring asset sales, additional borrowings or other financing to fund distributions and maintain RIC status.
- Leverage magnifies both gains and losses. Debt agreements contain asset coverage, minimum equity, borrowing-base and other covenants; a breach could restrict distributions, accelerate debt repayment or force asset sales.
- The company faces credit, non-accrual, recovery, liquidity, prepayment, foreign-currency, derivative, cybersecurity, regulatory, tax, competition and conflicts-of-interest risks. The Adviser receives base management and incentive fees, and manages other affiliated investment vehicles.
- No material legal proceedings were reported. Management stated that internal control over financial reporting was effective, and Deloitte & Touche issued unqualified opinions on the financial statements and internal controls.
Most important facts for an investor to verify
- Whether the elevated 5.5% non-accrual ratio and the 3% rating-4 portfolio exposure continue to increase or stabilize after year-end.
- The identity, collateral coverage, repayment prospects and recovery assumptions for the largest non-accrual and materially marked-down positions.
- Whether recurring cash income is sufficient to cover the $2.95 per-share 2023 distribution, particularly given $192 million of PIK income and other non-cash income.
- Refinancing plans and pricing for the $900 million of 2024 note maturities and $1.595 billion of 2025 note maturities.
- Compliance with the 150% asset-coverage requirement and all borrowing-base, minimum-equity and other debt covenants under stressed portfolio valuations.
- The sensitivity of NAV and net investment income to benchmark-rate changes, credit-spread widening, defaults, prepayments and foreign-currency movements.
- The assumptions supporting Level 3 valuations, including discount rates, EBITDA multiples, projected cash flows and collateral values.
- The terms, funding requirements and performance of COPJV and other controlled or affiliated investments, including potential conflicts arising from the Adviser’s related-party relationships.