FS KKR Capital Q1 2023 Earnings Call Transcript

Quartr
Provided by Quartr
May 5, 2023

There are 8 speakers on the call.

Operator

Good morning, ladies and gentlemen. Welcome to the FSKKR Capital Corp. First Quarter 2023 Earnings Conference Call. Your lines will be in a listen only mode during remarks by FSK's management. At the conclusion of the company's remarks, we will begin the question and answer session, at which time I will give instructions on entering the queue.

Operator

Please note this conference is being recorded. At this time, Robert Pond, Head of Investor Relations will Proceed with the introduction. Mr. Pan, you may begin.

Speaker 1

Thank you. Good morning, and welcome to FS KKR Capital Corp's Q1 2023 Earnings Conference Call. Please note that FSKKR Capital Corp. May be referred to as FSK, the Fund or the Company throughout the call. Today's conference call is being recorded and an audio replay of the call will be available for 30 days.

Speaker 1

Replay information is included in the press release that FSK issued this morning. In addition, FSK has posted on its website A presentation containing supplemental financial information with respect to its portfolio and financial performance for the quarter ended March 31, 2023. A link to today's webcast and the presentation is available on the Investor Relations section of the company's website under Events and Presentations. Please note that this call is the property of FSK. Any unauthorized rebroadcast This call in any form is strictly prohibited.

Speaker 1

Today's conference call includes forward looking statements and are subject to risks and uncertainties that could affect FSK or the economy generally. We ask that you refer to FSK's most recent filings with the SEC for important factors and risks that could cause actual results or outcomes to differ materially from these statements. FSK does not undertake to update its Forward looking statements unless required to do so by law. In addition, this call will include certain non GAAP financial measures. For such measures, reconciliations to the most directly comparable GAAP measures can be found in FSK's Q1 earnings release that was filed with the SEC this morning, May 5, 2023.

Speaker 1

Non GAAP information should be considered supplemental in nature and should In addition, these non GAAP financial measures may not be the same as similarly named measures reported by other companies. To obtain copies of the company's latest SEC filings, please visit FSK's website. Speaking on today's call will be Dan Pieterzak, Chief Investment Officer and Co President Brian Gerson, Co President and Stephen Lilly, Chief Financial Officer. Also joining us in the room are Co Chief Operating Officers, Drew O'Toole and Ryan Wilson. I will now turn the call over to Dan.

Speaker 2

Thank you, Robert, and welcome everyone to FS KKR Capital Corp's Q1 2023 earnings conference call. Unfortunately, Michael Forman is not able to participate on today's call due to an unavoidable scheduling conflict. For the Q1, our team again delivered strong operating results as FSK generated net investment income totaling 0.81 dollars per share and adjusted net investment income totaling $0.78 per share as compared to our public guidance of $0.77 and $0.74 per share, respectively. Our net asset value increased modestly quarter over quarter as the slight decline in the value of our investment portfolio was offset by out earning our $0.70 per share distribution and accretive share repurchases. M and A activity remained muted during the Q1.

Speaker 2

As a result, Our investment team originated approximately $270,000,000 of new investments. That said, We are seeing activity level and inquiries ramp up in recent weeks. From a liquidity perspective, We ended the Q1 with approximately $3,000,000,000 of available liquidity. With regard to our share repurchase program, During March, we completed the remaining portion of our previously committed $100,000,000 buyback program as we repurchased $32,000,000 of shares. Based on our continued strong financial results, our Board has declared a 2nd quarter distribution of $0.70 per share, which consists of our base distribution of $0.64 per share and a supplemental distribution of $0.06 per share.

Speaker 2

As a reminder, based on the overall strength of the company's earnings power, we expect our quarterly supplemental distribution to total a minimum of $0.06 per share throughout 2023 and possibly beyond, equating to a minimum of $0.70 per share per quarter of quarterly distributions during 2023. Additionally, we are pleased to announce special distributions totaling $0.15 per share, which will be paid in 3 equal installments between now and the end of 2023. We are pleased to be in a position to share this additional income with investors as we have worked diligently over the last several quarters to achieve our targeted level of spillback income. Our special distributions equate to an additional $0.05 per share per quarter on top of our regularly quarterly and supplemental distributions over the next three quarters. As a result of achieving our operating targets, we believe investors will be able to receive a minimum of $2.95 per share of total distributions in 2023, which equates to 11.8% yield On our March 31, 2023 net asset value and an annualized yield of approximately 16% based on our recent share price.

Speaker 2

We further believe that our ability to provide shareholders with such an attractive distribution is based on the significant portfolio rotation work we have accomplished over the last 5 years. Turning to the current market and economic environment. The volatility we experienced in the financial markets during 2022 has continued during the Q1 of 2023, especially with the challenges in the banking space. We continue to expect inflation to remain elevated, and we believe the higher interest rate environment will last longer than some market observers are expecting. Should our views prove accurate, then we believe floating rate asset structures, Coupled with investment strategies, which contain a degree of inflation protection, such as large defensive portfolio companies and Asset Based Finance Investments tied to collateral pools will remain attractive.

Speaker 2

While we do expect M and A transaction volumes to remain below average for the next few quarters, the increased volatility and economic uncertainty does create compelling investment opportunities for FS KKR and other large scale players. We and other private debt investors are able to negotiate attractive pricing, enhanced call protection and lower overall leverage levels for extremely high quality companies. Spreads on new originations are approximately 100 basis points higher compared to a year ago. Additionally, large private debt platforms like FSK will continue to benefit from incumbency positions to support existing portfolio companies as well as protections in our loan documents, allowing us to reprice existing investments to current market rates, which we believe is quite important from a portfolio perspective. Our investment portfolio continues to perform well As our borrowers have adapted to the current operating environment and have successfully demonstrated an ability to pass through Price increases, which have helped maintain acceptable EBITDA margins.

Speaker 2

As I mentioned earlier, During the Q1, we originated $270,000,000 of investments. These investments were focused on funding and add ons to existing portfolio companies, resulting in approximately 87% of our originations coming from opportunities and companies previously invested in by KKR. Our new investments combined with $264,000,000 of net sales and repayments When factoring in sales to our joint venture, equated to a net portfolio increase of $6,000,000 In terms of interest coverage, at the end of the Q1, our portfolio companies had a median interest coverage of 1.7x. For clarity, this was calculated using base rates as of December 31, 2022, to align with portfolio company financials. As evidenced by our lower than average origination activity, We remain extremely selective in our underwriting and origination process.

Speaker 2

Also during periods of market stress, We benefit from our portfolio monitoring unit and our dedicated workout and governance teams. These dedicated internal teams are able to work seamlessly alongside our deal teams to navigate situations which potentially arise during more challenging operating environments. That being said, Through the end of the Q1, we have not experienced a significant increase in amendment requests, which we view as a positive. With that, I'll turn the call over to Brian to discuss our portfolio in more detail.

Speaker 3

Thanks, Dan. As of March 31, 2023, our investment portfolio had a fair value of $15,300,000,000 consisting of 189 portfolio companies. This compares to a fair value of $15,400,000,000 and 197 portfolio companies as of December 31, 2022. At the end of the first quarter, Our 10 largest portfolio companies represented approximately 19% of the share value of our portfolio. We continue to focus on senior secured investments as our portfolio consisted of 61% first lien loans and 69.4 percent senior secured debt as of March 31.

Speaker 3

In addition, our joint venture represented 9.1 The fair value of the portfolio and asset based finance investments represented 11.7%, which are comprised predominantly of 1st lien loans or secured asset based finance investments. Looking through To the investments in our joint venture, our total portfolio consisted of 77% senior secured debt as of March 31. During the Q1, our new originations consisted of approximately 82% in 1st lien loans, 11% in Asset Based Finance Investments, 3% in subordinated debt and 4% in equity and other investments. The weighted average yield on accruing debt investments was 11.7% as of March 31, 2023, compared to 11.4% as of December 31. As a reminder, the weighted average yield is adjusted to The accretion associated with the merger with FSKR.

Speaker 3

The increase in our weighted average yield during the Q1 was primarily associated with the continued rise in base rates as well as higher yields on new originations during the past few quarters. Including the effects of the investment activity we experienced during the Q1, as of March 31, 2023, Approximately 86% of our total investment portfolio is now comprised of investments originated either by KKR Credit or the FS KKR Advisor. This compares to 84% at March 31, 2022. During the Q1, excluding the impact of merger accounting, we experienced net portfolio Appreciation on investments of approximately $17,000,000 The largest negative movers in our portfolio, which were impacted by credit performance related issues during the quarter were Witter and Reliant Rehab. Witter is a global leader in the outsourced elevator component segment with a focus on the production of elevator doors and the manufacturing of adjacent components for both new equipment markets and the aftermarket.

Speaker 3

The company has been facing persistent inflation headwinds as well as the slowdown in construction in China, which has led to us placing our 2nd lien loan on non accrual this quarter. Reliant Rehab offers physical, occupational and speech therapy services to skilled nursing facilities. The company has been affected by macroeconomic factors across the healthcare services industry, including a decline in labor productivity, And increase in contract labor given a tight labor market in the U. S. And inflation driven wage increases.

Speaker 3

I'd also like to comment on another investment, Miami Beach Medical Group. Miami Beach Medical Group provides primary care, specialty care, In house pharmacy and home visits, primarily focusing on Medicare Advantage members. The company has recently experienced weaker performance due to lower membership growth, elevated medical expenses and higher operating expenses related to wage inflation. In the Q1, we provided an amendment, which included a $50,000,000 1st lien debt pay down at par from the sponsor. During the quarter, we placed 2 debt investments on nonaccrual with a combined Veramarket value of $72,000,000 at a cost of $140,000,000 In addition, there were 3 debt investments fully removed from nonaccrual status with a combined fair market value of $7,000,000 and a cost of $29,000,000 Based on the first As of March 31, 2023, non accruals totaled 5.5% of our portfolio on a cost basis and 2.7% on a fair value basis compared to 4.9% on a cost basis and 2.4% on a fair value basis as of December 31, 2022.

Speaker 3

We also thought it would be helpful to provide the market with information based on the assets originated by KCR Credit. As of the end of the quarter, non accruals relating to the 86% of our total portfolio, which has been originated by KKR Credit and the FS KKR Advisor were 2.8% on a cost basis and 0.8% on a fair value basis. And with that, I'll turn the call over to Stephen.

Speaker 4

Thanks, Brian. As Dan mentioned earlier, we are pleased to reward shareholders with the declaration of a $0.15 per share special distribution, which will be paid in 3 equal installments in May, in August November of this year. Combining our quarterly base and supplemental distributions of $0.70 per share With the $0.03 per share quarterly special distributions, our total distribution for 2023 should be a minimum of $2.95 per share. This represents an 11.8% yield On our March 31, 2023 net asset value of $24.93 per share and a 16% yield on our current stock price, both of which we view as quite attractive. Turning to our financial results for the Q1, total investment income increased by $7,000,000 quarter over quarter, driven by increased interest income.

Speaker 4

The components of our total investment income during the quarter were as follows: Total interest income was $369,000,000 an increase of $9,000,000 quarter over quarter. Dividend and fee income totaled $87,000,000 a decrease of $2,000,000 quarter over quarter. Our dividend and fee income during the Q1 is summarized as follows: $55,000,000 of recurring dividend income from our joint venture Other dividends from various portfolio companies totaling approximately $27,000,000 and fee income totaling approximately $5,000,000 Our interest expense totaled $114,000,000 an increase of $5,000,000 quarter over quarter due to the impact of rising base rates on our secured debt facilities. Our weighted average cost of debt was 5.1% as of March 31. Management fees totaled $58,000,000 a decrease of $1,000,000 quarter over quarter and incentive fees totaled $46,000,000 during the Q1.

Speaker 4

The detailed bridge in our net asset value per share on a quarter over quarter basis is as follows. Our ending 4Q 2022 net asset value per share of $24.89 was increased by GAAP net investment income of $0.81 per share and was decreased by $0.11 per share due to a decrease in the overall value of our investment portfolio. Our net asset value per share was reduced by our $0.70 per share dividend paid during the quarter and increased by $0.04 per share due to share repurchases. To sum of these activities results in our March 31, 2023 net asset value per share of $24.93 From a forward looking guidance perspective, we expect Q2 2023 GAAP net investment income to approximate $0.78 per share, And we expect our adjusted net investment income to approximate $0.75 per share. Detailed second quarter guidance is as follows.

Speaker 4

Our recurring interest income on a GAAP basis is expected to approximate $362,000,000 as we continue to expect below average M and A activity during the quarter. We expect recurring dividend income associated with our joint venture to approximate $55,000,000 We expect other fee and dividend income to approximate $30,000,000 From an expense standpoint, We expect our interest expense to approximate $115,000,000 and we expect other G and A expenses to approximate $10,000,000 As a reminder, the $0.03 per share difference between our GAAP net investment income and our adjusted net investment income relates to the expected accretion of our investments during the quarter due to merger accounting. This difference affects our recurring interest income. Other categories of our revenues and expenses are not affected. In terms of the right side of our balance sheet, our gross and net debt to equity levels were 125% and 118%, respectively, at March 31, 2023, both of which are unchanged from their 4th quarter levels.

Speaker 4

At March 31, our available liquidity was $3,000,000,000 At the end of the Q1, approximately 54% of our drawn balance sheet and 42% of our committed balance sheet was comprised of unsecured debt and the overall effective weighted average cost of debt was 5.1%. And with that, I'll turn the call back to Dan for a few closing remarks before we open the call for questions.

Speaker 2

Thanks, Stephen. In closing, we are pleased that our portfolio rotation and achievement of operational goals have reached the point where we can provide shareholders with such an attractive overall distribution rate for 2023 and possibly beyond. And while uncertainty in the overall economy remains, we believe FSK is well positioned from a portfolio construction standpoint to continue to deliver strong results for our shareholders. With that, operator, we'd like to open the call for questions.

Operator

Thank you. One moment while we compile our Q and A roster. And our first question comes from the line of John Hecht with Jefferies. Your line is open. Please go ahead.

Speaker 5

Good morning, guys. Thanks very much for taking my questions. Dan, you said I think you said you're seeing activity pick up More recently in terms of deals, maybe can you talk about the source and characteristics of the pipeline?

Speaker 2

Yes. Happy to, John, and good morning. I do think it's a little bit early in sort of those processes, but I think we're just seeing more either inbounds or inquiries from either sell side firms or companies themselves Or quite frankly, people who we lend money to today who might be interested in us indicating financing terms if they go sort of sell the business. I don't think that's any guarantees of a big near term sort of M and A sort of push, but I think it was a bit of green shoots that we are seeing. My sense is the overall M and A environment remains somewhat lower or slow for the rest This year, but we'll start to pick up very end of the year into 2024.

Speaker 5

Okay. And then you mentioned I think you mentioned like 100 basis points overall Spread pickup, obviously there's dislocations in certain part of the markets. You guys have your ABS And then obviously the non ABS portfolios, maybe can you where is the best opportunity in the widest spreads? Is there any kind of arbitrage that you guys are focusing on in the market at this point?

Speaker 2

Yes. I'm not sure it's an arbitrage, but I mean I'd probably split it in 2 pieces. The direct lending market is extremely attractive today for Both new deals or even add ons to these existing portfolio companies, the 100 basis points I mentioned is really where we see Credit spreads today on new loans versus where they may have been, let's call it the start of 'twenty I'd couple that with probably an extra point on average of upfront fees, probably better call pro. And then you add the overall Moving so far on top of that because obviously these are floating rate loans. You're 12% to probably 12.5 On your regular way new direct lending deal today.

Speaker 2

That's quite attractive. I think especially when you're focused on the upper end The middle market, so good in our mind defensive companies, companies that You feel quite frankly just well downside protected. So I think that direct lending market is very interesting and the move has been quite material. You mentioned the asset backed side. I think the overall available returns there probably didn't move as much as direct lending, Probably still above it.

Speaker 2

I think the investing environment there for us has more Pivoting to either different types of deals or different types or different parts of really the capital structure to get the best risk adjusted rewards we can get. We've been busy there. I think that will continue as well.

Speaker 5

Okay. And then you mentioned, I think, 1.7 times coverage. Maybe you could just give us a quick glimpse in the revenue and EBITDA trends at the portfolio level?

Speaker 2

Yes. Happy to do that. I mean, I think we talked about the 1.7 times. I think we want to make it clear how we calculated that. So that was not an LPM So the interest number that was using kind of the twelvethirty one number for your benefit if we think about just where we are today Or sort of the top of that forward curve, you probably take that down to 1.6%.

Speaker 2

So not a big move from there. I think we still have seen Year on year EBITDA growth, I think we're happy to see that. I think we're probably a little bit worried about margins. Yes, we've seen companies been able to pass through prices, but the inflation points are real, the wage inflation points are real. So we're quite mindful about the portfolio and managing the risk in it, but we probably From a base case perspective, I think the portfolio has probably outperformed where I thought it would have been a handful of sort of quarters ago, and we just got to watch it going forward.

Speaker 5

All right. Thanks very much and congratulations on a good quarter.

Speaker 6

Great. Thank you.

Operator

Thank you. One moment for our next question. Our next question comes from the line of Ryan Lynch with KBW. Your line is open. Please go ahead.

Speaker 6

Hey, good morning. First question has to do with, you mentioned the potential for some pickup in activity. Obviously, there's The hope for that, there's some other correct lenders talk about that as well. My question though Comes to, if that market does start to pick up at all and there's more activity and then M and A and LBOs going on, I was just curious if you had any take on that Emerson deal kind of switching from the direct Lenders to the broadly syndicated loan market, is that sort of a one off or do you think if deal activity picks up that will also Potentially coincides with the broadly syndicated loan market, looking to gain back some share.

Speaker 2

Yes. Good morning, Ryan. I mean, probably no specific thoughts on the individual deal. I think every deal in some ways It's unique either to the company or the situation or if it's a sponsor deal, the sponsor. And I mentioned it on to John on the prior question.

Speaker 2

I think we're just we're seeing a bit more inquiry. We're seeing a bit more of just existing companies or sponsors maybe to those that we lend to thinking about how we lend A forward sort of sale of that business. So I think that's a bit of sort of positive news. I mean clearly Private debt has filled the void for the syndicated loan market in the last probably 4 or 5 quarters at best point. Yes.

Speaker 2

When the loan market comes back and functions sort of as normal, that balance will sort of change a bit. I think we expect that the syndicated loan market is not going to go away. I think what we feel good about though the tailwinds on the other side is we've just seen more and more companies wanting to access a private debt solution. They want to know their lender. They want certainty of execution.

Speaker 2

And I think that trend continues. Clearly, the syndicated loan market will refinance some of these companies over time, but I still think the tailwind is here for private debt.

Speaker 6

Okay, understood. And then a lot of times when we hear about new non accruals in your portfolio or any BDC portfolio, it's usually idiosyncratic events that are happening in your business. I would just love to hear though, if you think about maybe the bottom quartile of performers in your portfolio, so maybe not just the non accruals, but just the somewhat underperformers of your portfolio. Have you been able to notice any sort of common threads that you're seeing bleed through of why those companies are struggling more than others in this

Speaker 2

I think we have seen, let's call it, Issues that have impacted companies, sort of broadly. I think if you went back 4 or 6 quarters, it was probably supply chain challenges. I think today, most companies who Maybe are heavily reliant on the expense side on wages are sort of generally sort of struggling. And I think the environment we're in, I do think if you look at that bottom 25% in your example, it's outside of the idiosyncratic sort of points. It's probably companies who Have struggled for whatever reason to pass through sort of price, right, just with everything that sort of happened.

Speaker 2

And that has Yes, so they've been impactful. And I think that some of that has been maybe not in an environment or a sector where they could do that. Maybe there's maybe their end customers are sort of well stocked, but I think wages I think where we sit today is probably wages and lack

Speaker 6

I just had one last one. Sure. There's been a lot of disruption in the banking sector with the several failures. It seems like there's going to be probably I'm not sure how much that really affects your overall LBO Private credit buyout business, so I'm not sure how much of a competitor banks really are in holding those assets on their balance sheet. But it does seem that banks Potentially could be a different competitor, maybe some of your ABL businesses.

Speaker 6

So I would just love to hear, have you seen any sort of pickup In your ABL business from the retreat or do you expect any sort of pickup in opportunities from a potential retreat In banks that they do lending in ABL?

Speaker 2

Yes. That's a fair question considering what's happened this quarter. Yes, I think you're right. I mean the impact on the regional banks, I don't think moves a lot on the regular way direct lending business. Remember what and you were sort of mentioning ABL.

Speaker 2

When we talk about ABL, we're probably talking more about receivables and inventory financing. That's clearly a product that we have that we're out to companies. Those companies are probably ones who are struggling, who need to access an alternative form of capital and Yes, we're probably better providers of that than banks due to the shape of the corporate. I think the broader So the piece just not to confuse it to is our asset based finance effort. That's more consumer mortgage sort of funding the real economy, but not really sort of corporate credit.

Speaker 2

My sense is everything that is going on with the regional banks is probably a net positive to both those pieces As there should be more deal flow and I think history will tell you that the private debt markets can come and fill that capital void that might be left. Yes, I think that said on the other side, I think we're a little bit mindful from a risk perspective that the regional banks taking a step back Or being forced to shrink their balance sheet could cause a credit contraction in the overall market and could provide some additional bumps either from a volatility perspective or an impact on a recession. So I think we're mindful about all those factors.

Speaker 6

Okay, understood. Yes, because the negative impact is anxious to point back broadly. So, understood. I appreciate the time today.

Speaker 2

All right. Have a good day.

Operator

Thank you. One moment for our next question. Our next question comes from the line of Melissa Wedel with JPMorgan, your line is open. Please go ahead.

Speaker 7

Thanks so much. Appreciate you taking my questions today. First, I want to touch on the share repurchase authorization, Which you completed this quarter with shares trading where they are relative to NAV, how are you guys thinking about future share repurchase activity and possibly pursuing another authorization.

Speaker 2

Good morning, Melissa. I would think you'd note a couple of things, I mean, I think we are happy that we completed the $100,000,000 I think we've been pretty consistent to the market that We intend to complete these when they get sort of put in place. I think we have done More than most, we probably repurchased almost $500,000,000 of shares over the last 5 years amongst the various BDCs that were public at one time or another. So clearly, this will be something that we have on the top of our mind or are considering on a go forward basis in line with what we've done in the past. I would note, I think we're happy to also provide this special dividend, right, which is kind of capital For the benefit of shareholders, I think we've talked on the prior call about the $0.70 between the $0.64 and the $6 supplemental.

Speaker 2

I think we continue to feel good about that. That was $2.80 per share. And then with this additional $15,000,000 you're up to 2.95 That's 11.7% on sort of NAV. So we think the income potential is good, but I think that special was Yes, it was something we were very happy

Operator

we were able to

Speaker 7

do this quarter. Yes, certainly. Follow-up question on Funding, you got a few unsecured maturities in 2024, given the current funding split Between revolvers and fixed rate debt and sort of your outlook for interest rates remaining higher than perhaps implied by the forward curve. How are you thinking about your funding profile? And how are you how should we expect You guys manage that going forward.

Speaker 7

Thanks.

Speaker 2

Yes. And Ryan or Steve might want to add to this as well. But I think we're very happy with all the unsecured we did in advance of the beginning of 2022. I mean, we even did a deal and And it was January, February of 'twenty two and sort of decent size. So I think we're quite happy about no near term maturities.

Speaker 2

Obviously, we have plenty of undrawn capital on the revolver Just to take those out if we needed to, right? That said, I think we intend to continue to access this market. We'll continue to talk to investors. We want to be a frequent issuer. But at the same time, I think we're going to be prudent and we're going to look at Other markets we've accessed in the past as well, whether they be sort of bilateral or CLOs sort of etcetera.

Speaker 2

So I think we've got a bunch of tools At our disposal, we got a lot of comfort for where we sit on the undrawn piece of the revolver, but our intention is to be active in that market.

Speaker 7

Thank

Operator

you. Thank you. And I would now like to turn the conference back Over to Dan Pietrzak for any further remarks.

Speaker 2

Well, thank you everyone for your time today. As always, we're available for any follow-up questions. Have a good weekend. I'll speak next quarter.

Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.

Powered by Quartr
Earnings Conference Call
FS KKR Capital Q1 2023
00:00 / 00:00