FS KKR Capital Q1 2024 Earnings Call Transcript

Quartr
Provided by Quartr
May 9, 2024

There are 15 speakers on the call.

Operator

Good morning, ladies and gentlemen. Welcome to FS KKR Capital Corp. First Quarter 2024 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 you instructions on entering the queue.

Operator

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

Speaker 1

Thank you. Good morning, and welcome to FS KKR Capital Corp. 1st Quarter 2024 Earnings Conference Call. Please note that FS KKR Capital Corp. May be referred to as FSK, the Fund or the Company throughout the call.

Speaker 1

Today's conference call is being recorded and an audio replay of the call will be available for 30 days. Replay information is included in a press release that FSK issued yesterday. 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, 2024. 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.

Speaker 1

Any unauthorized rebroadcast of this call in any form is strictly prohibited. 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.

Speaker 1

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 on May 8, 2024. Non GAAP information should be considered supplemental in nature and should not be considered in isolation or as a substitute for the related financial information prepared in accordance with GAAP. 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 Michael Forman, Chief Executive Officer and Chairman Dan Pietrzak, Chief Investment Officer and Co President Brian Gerson, Co President and Stephen Lilly, Chief Financial Officer.

Speaker 1

Also joining us on the call are Co Chief Operating Officers, Drew O'Toole and Ryan Wilson. I will now turn the call over to Michael.

Speaker 2

Thank you, Robert, and good morning, everyone. Thank you all for joining us today for FSK's Q1 2024 earnings conference call. FSK had a positive start to the year consisting of net investment income totaling $0.76 per share and adjusted net investment income totaling $0.73 per share. During the quarter, we also made significant progress with regard to 3 of the investments placed on non accrual during the Q4 of last year. We experienced increased origination volumes as our investment team originated approximately $1,400,000,000 Our net asset value as of the end of the Q1 was $24.32 From a liquidity perspective, we ended the quarter with approximately $4,200,000,000 of available liquidity.

Speaker 2

Finally, we delivered an annualized ROE of 10.1% for the quarter. Based on our positive operating results, our Board has declared a 2nd quarter distribution of $0.70 per share consisting of our base distribution of $0.64 per share and a supplemental distribution of $0.06 per share. As we mentioned on our Q3 2023 earnings call, our Board previously declared a special distribution totaling $0.10 per share. The first $0.05 per share installment was paid this February and the second $0.05 per share installment will be paid later this month. Accounting for the special distribution, our total second quarter distribution will be $0.75 per share.

Speaker 2

As a result of achieving our operating targets, we believe investors will be able to receive a minimum of $2.90 per share of total distributions in 2024, which equates to an 11.9% yield on our March 31, 2024 net asset value at an annualized yield of approximately 15% based on our recent share price. From a forward looking perspective, we remain confident in the long term earnings power of FSK, which enables us to continue paying an attractive distribution to our shareholders. We are encouraged by the increased level of origination activity and the quality of the deal volume during the Q1. The private credit markets continue to experience strong tailwinds and we believe we are well positioned to take advantage of these opportunities. And with that, I'll turn the call over to Dan and the team to provide additional color on the market and the quarter.

Speaker 3

Thanks, Michael. For the past year, it has been our view that inflation would remain elevated and the higher interest rate environment would last longer than some market observers expected. Our view has largely proven accurate. And should our views continue to play out, we believe floating rate asset structures, coupled with investment strategies focused on large defensive portfolio companies and asset based finance investments directly tied to financial and hard assets will remain attractive. Looking ahead, it is our expectation that the economy will experience thicker inflation in the near term, coupled with continued, albeit slowing, overall economic growth.

Speaker 3

As Michael highlighted earlier, there are strong tailwinds to our business as sponsors continue to utilize private credit solutions to finance transactions. Origination activity picked up meaningfully in the Q1 compared to the prior few quarters, and we expect a material increase in private market transaction activity during 2024, given significant private equity dry powder combined with pent up demand from an M and A perspective and the desire for private equity fund LPs to see a higher level of return of capital. As we mentioned on our last call, the macro backdrop created challenges for a few of our portfolio companies during the Q4 of last year. Our workout team has been active on these names. And as Brian will discuss, we are pleased to have achieved positive results quickly.

Speaker 3

And while there's still work to be done reducing our non income and non accrual investments, we clearly are pleased with the recent progress we have made. Turning to investment activity. During the Q1, we originated $1,400,000,000 of new investments. Approximately 75% of our new investments were focused on add on financings to existing portfolio companies and long term KKR relationships. Our new investments combined with $1,700,000,000 of net sales and repayments when factoring in sales to our joint venture equated to a net portfolio decrease of $221,000,000 New originations consisted of approximately 69% in 1st lien loans, 3% in 2nd lien loans, 3% in other senior secured debt, 1% in subordinated debt and 24% in asset based finance investments.

Speaker 3

As we mentioned on our last call, with regard to new investments, we are continuing to see tighter pricing in the upper end of the middle market. The trade off to the spread compression is still strong documentation and very solid credit profiles. We also continue to be pleased with the quality of the new deals. During the Q1, our new direct lending investments had a weighted average EBITDA of approximately $243,000,000 5.7x leverage through our security and a 47% equity contribution, all with a weighted average coupon of approximately SOFR plus 5.70 basis points. One example of a new deal in the quarter was our investment in Curia Global, a manufacturer of active pharmaceutical ingredients, who provides contract pharmaceutical development, manufacturing, packaging and analytical services.

Speaker 3

AKR was the sole lender as we provided $125,000,000 off balance sheet SPV structured trade receivables facility secured by Curia's U. S. Receivables. Pricing was 6.25 basis points with a 2% upfront fee. FSK committed $83,000,000 of the $125,000,000 facility.

Speaker 3

Additionally, in the Q1, KKR and its affiliates, along with other partners, purchased GreenSky, a point of sale finance company from Goldman Sachs, as part of its divestiture from consumer related businesses. GreenSky was founded in 2006 and focuses on offering home improvement financing alternatives for prime borrowers. FSK committed $80,000,000 to the transaction. I also want to highlight a sale of the Music IP investment in KKR Core IP Aggregator that occurred during the Q1. In connection with this sale, FSK received an $89,000,000 return of capital.

Speaker 3

FSK Cord IP Aggregator also received a well collateralized seller note that is expected to be repaid during 2024. And FSK's respective share of the seller note is approximately $30,000,000 The transaction resulted in a $20,000,000 gain to our net asset value, and we expect to realize an IRR of approximately 18% on our position. When we look at the aggregate trends across our portfolio of companies, we have continued to see high single digit EBITDA growth with modest margin pressure due to the continued inflationary environment. Over the coming quarters, while we expect continued revenue growth from our portfolio companies, we would expect growth to slow modestly as macro trends could potentially lead to a slowdown in economic growth. The weighted average EBITDA of our portfolio companies was $218,000,000 as of March 31, 2024.

Speaker 3

Additionally, our portfolio companies reported a weighted average year over year EBITDA growth rate of approximately 7% across companies in which we have invested in since April of 2018. And with that, I'll turn the call over to Brian to discuss our portfolio in more detail.

Speaker 4

Thanks, Dan. As of March 31, 2024, our investment portfolio had a fair value of $14,200,000,000 consisting of 205 portfolio companies. This compares to a fair value of $14,600,000,000 204 Portfolio Companies as of December 31, 2023. At the end of the Q1, our 10 largest portfolio companies represented approximately 20% of the fair value of our portfolio, which is in line with prior quarters. We continue to focus on senior secured investments as our portfolio consisted of approximately 57% first lien loans and 65% senior secured debt as of March 31.

Speaker 4

In addition, our joint venture represented 9.8% of the fair value of our portfolio. As a result, when investors consider our entire portfolio looking through to the investments in our joint venture, then 1st lien loans total approximately 66% of our total portfolio and senior secured investments total approximately 74% of our portfolio as of March 31. The weighted average yield on occurring debt investments was 12.1% as of March 31, a decrease of 10 basis points compared to 12.2% as of December 31, 2023. The decrease was largely driven by spread compression on new deals. As a reminder, the calculation of weighted average yield is adjusted to exclude the accretion associated with the merger with FSKR.

Speaker 4

From a non accrual perspective, as of the end of the Q1, our non accruals represented 6.5% of our portfolio on a cost basis and 4.2% of our portfolio on a fair value basis. This compares to 8.9% of our portfolio on a cost basis and 5.5 percent of our portfolio on a fair value basis as of December 31, 2023. We believe it will also be helpful to provide the market with information based on the assets originated by KKR Credit. As of the end of the Q1, non accruals relating to the 88% of our total portfolio, which has been originated by KKR Credit and the FS KKR Advisor were 2.3% on a cost basis and 1% on a fair value basis. During the Q1, we placed one small investment on non accrual with a cost and fair value of $21,000,000 $19,000,000 respectively.

Speaker 4

Additionally, we removed 3 investments from non accrual status with a combined cost and fair value of $395,000,000 $224,000,000 Witter was one of the names removed from non accrual during the quarter. As we've discussed on prior earnings calls, we placed our 2nd lien loan on non accrual during the Q1 of 2023 as it was facing persistent inflation headwinds as well as a slowdown in construction in China. The restructuring resulted in our 2nd lien loan being fully equitized and KKR taking control of the business. The 1st lien debt of the company was significantly reduced at the operating company and FSK's existing 1st lien loan was converted into a €52,200,000 other senior secured debt position. FSK and other funds managed by KKR provided new capital to the company to fund operations.

Speaker 4

This recapitalization resulted in $122,500,000 of cost and $31,000,000 of fair value being removed from non accrual status. Additionally, KBS completed its full consensual restructuring during the quarter, which resulted in an equitization of a portion of the non occurring second out loans and FSK and other lenders taking control of the company. FSK received $190,500,000 of a new first lien loan, dollars 82,800,000 of a new second out first lien loan, dollars 48,300,000 of preferred equity and KKR managed funds now own 46 percent of the company. This restructuring resulted in $197,600,000 of cost and $135,300,000 of fair value being removed from non accrual status. Lastly, our first lien position in sweeping Corp of America was restructured during the Q1 and the company received a $50,000,000 cash injection from the equity sponsor.

Speaker 4

The 1st lien debt facility was restructured into a $15,700,000 1st lien, first out cash paid term loan, a $28,100,000 1st lien, 1st out pick tranche, a $8,300,000 2nd lien, 1st out and a $24,000,000 second lien second out term loan. This restructuring resulted in $75,300,000 of cost and $57,200,000 of fair value being removed from non accrual status. The progress we've achieved with regard to these portfolio companies is an example of the benefits of KKR Credit's investment platform. Our fundamental de risking approach to these credits was evident in our resolution of non accruals this quarter. While we prefer sponsors to continue supporting their portfolio companies with additional equity, we have the resources and capabilities to support companies ourselves when necessary.

Speaker 4

By taking action quickly, we believe we will significantly improve our chances of receiving a meaningful or even full recovery of our investment capital over time. And with that, I'll turn the call over to Stephen to go through our financial results.

Speaker 5

Thanks, Brian. Our total investment income decreased by $13,000,000 quarter over quarter to $434,000,000 primarily due to repayments of higher yielding positions and the impact of investments placed on non accrual during the Q4 of last year. The primary components of our total investment income during the quarter were as follows: total interest income was $350,000,000 a decrease of $18,000,000 quarter over quarter. Dividend and fee income totaled $84,000,000 an increase of $5,000,000 quarter over quarter. Our total dividend and fee income during the quarter is summarized as follows: $53,000,000 of recurring dividend income from our joint venture other dividends from various portfolio companies totaling approximately $14,000,000 during the quarter and fee income totaling approximately $17,000,000 during the quarter.

Speaker 5

Our interest expense totaled $116,000,000 a decrease of $2,000,000 quarter over quarter and our weighted average cost of debt was 5.4% as of March 31. Management fees totaled $55,000,000 a decrease of $1,000,000 and incentive fees totaled $43,000,000 an increase of $2,000,000 quarter over quarter. Other expenses totaled $8,000,000 a decrease of $2,000,000 quarter over quarter. The detailed bridge in our net asset value per share on a quarter over quarter basis is as follows. Our ending 4Q 2023 net asset value per share of $24.46 was increased by GAAP net investment income of $0.76 per share and was decreased by $0.14 per share due to a decrease in the overall value of our investment portfolio.

Speaker 5

Our net asset value per share was reduced by our $0.70 per share quarterly distribution and the $0.05 per share special distribution. These activities result in our March 31, 2024 net asset value per share of $24.32 From a forward looking guidance perspective, we expect Q2 2024 GAAP net investment income to approximate $0.74 per share and we expect our adjusted net investment income to approximate $0.71 per share. Detailed second quarter guidance is as follows. Our recurring interest income on a GAAP basis is expected to approximate $341,000,000 We expect recurring dividend income associated with our joint venture to approximate $52,000,000 We expect other fee and dividend income to approximate $34,000,000 during the Q2. From an expense standpoint, we expect our management fees to approximate $55,000,000 We expect incentive fees to approximate $42,000,000 We expect our interest expense to approximate $114,000,000 and we expect other G and A expenses to approximate $10,000,000 As Michael indicated during his remarks, we currently expect our distributions during the year will total at least $2.90 per share comprised of $2.80 per share of quarterly distributions and $0.10 per share of special distributions.

Speaker 5

Our gross and net debt to equity levels were 117% and 109%, respectively, at March 31, 2024, compared to 120% 113% at December 31, 2023. As of March 31, our available liquidity was $4,200,000,000 and approximately 65% of our drawn balance sheet and 44% of our committed balance sheet was comprised of unsecured debt. And with that, I'll turn the call back to Michael for a few closing remarks before we open the call for questions.

Speaker 2

Thanks, Stephen. In closing, we're pleased with the positive start to 2024 as our origination activity picked up. We made significant progress on certain portfolio names and we continue to fully earn both our base and supplemental distributions on a per share basis. The long term earnings power of FSK continues to be strong and we have confidence in our ability to continue to award shareholders with these attractive distributions. And with that, operator, we would like to open the call for questions.

Operator

Thank you. At this time, we will conduct a question and answer session. Our first question comes from John Hecht with Jefferies. John, please go ahead with your question.

Speaker 6

Good morning, guys. Thanks for all the detail on the quarter and thanks for taking my questions. First one is you had a very active deployment quarter, but then also it was very active in repayments as well. Dan, I'm wondering kind of your outlook for both sides of that picture. I know you've talked about an increasing deal market over the course of this year because of private equity fund needs.

Speaker 6

And maybe give us an update on your perspective there? And then in addition, what kind of signals should we look for the repayment activity to either stabilize or start to drop? And is that a function of,

Speaker 4

call it, the liquid alone markets

Speaker 6

and different levels of competition in the space?

Speaker 3

Good morning, Maybe starting with your second question first. I think we probably are expecting, we'll call it some level of consistent repayments because the syndicated loan market is open. We think that's a good fact because that just speaks to overall market activity. And a lot of these companies have been held by their sponsors for some extended period of time, so they could very well be sold. All that said, I think the incumbency positions do have real value for us, and that you've seen that sort of quarter after quarter.

Speaker 3

I think we were happy to start to see some level of additional sort of pickup in the market. You can see that in our deployment numbers. Some of that is loan extensions, With some of those loan extensions came repricing, I think we touched on that during the call as well. We do remain pretty confident though that there are a we'll call it bunch of technicals out there that are going to push this M and A market to more fully reopen. There is pressure from the LPs.

Speaker 3

There is a lot of dry powder on the sidelines. And I do think that valuation mismatch that we saw for most of kind of the second half of twenty twenty two and twenty twenty three is definitely narrowed. So I think that should make for a productive kind of Q2 second half of the year.

Speaker 6

Okay. And then second question that's helpful by the way. And second question is that you mentioned spreads a little bit under pressure just because of the market dynamics. Where do you think those are going? And where are you finding opportunity in the market where maybe the spreads aren't getting quite as pressured?

Speaker 3

Yes. No, it's a very fair question considering, I think what everybody has been seeing out there. Spreads have definitely tightened. I would say they've tightened 75 odd basis points in maybe the last 6 months. I think we're there is a bit of that market technical out there in my mind, where while even though we're starting to see some level of activity, it's not that normalized level.

Speaker 3

And for some of the pools of capital, a decent amount of money has been raised that's looking to get deployed. My sense is that does change with the comments I made to your prior question, John. So if the market is kind of living in a probably $500,000,000 to $550,000,000 now, I think you're going to get back to probably where you were, we'll call it pre all the rate moves. I think the market was kind of a $550,000,000 to $600,000,000 market from a spread perspective. The one point I would make though is even with some of the repricings, we are getting the benefit of extending call protection.

Speaker 3

I would say we're extending that for 1 to 2 years on average. And we are getting the benefit probably more times than not of actually charging an upfront fee in conjunction with that. So there's some offsets to that, which is helpful. And then just your last point, I mean, we talked about some of the deals that we did in the quarter on the call. Some of the trade receivable stuff, some of the other asset based finance stuff is providing additional return to the portfolio, which we're happy to see.

Speaker 6

Great. Thanks very much.

Speaker 3

Have a good morning.

Operator

Standby for our next call. Our next call comes from Kenneth Lee with RBC Capital Markets. Kenneth, go ahead with your question.

Speaker 7

Hi, good morning. Thanks for taking my question. Just one on the asset based finance opportunities there. Wondering if you could just talk about the current outlook for such opportunities and perhaps talk a little bit more about the competitive landscape that you're seeing and whether you're seeing any kind of impact from new entrants into the space? Thanks.

Speaker 3

Sure. Good morning. Thanks for the question. It is a sector that we're pretty excited about and we feel like there's a lot of white space there. It is and kind of it goes a little bit to your comment, it is a very kind of large market.

Speaker 3

We estimate that market is north of $5,000,000,000,000 That makes it bigger than the direct lending market, the syndicated loan market and the high yield bond market combined. So I think that's a good fact. I think it's in the early days of kind of capital formation. So there's just not a lot of scale capital players out there. And then there have been some market thematics that have given some pretty good tailwinds to this business.

Speaker 3

Obviously, there's been certain challenges with the regional banks. There's been banks selling assets. There's been banks committing maybe less capital than they did to certain Fincos. Somebody needs to come there and fill that void. Pools of capital like ours that we are managing here with FSK or sort of otherwise we're able to sort of do that.

Speaker 3

So I think all that lines up, big market, not a lot of scale capital, some good sort of tailwinds. And I think we really like the up, down of the risk profile and the relative value. So I think we'll continue to be active there.

Speaker 7

Got you. Very helpful there. And then one follow-up, if I may. Really appreciate the details around the restructuring involving those 3 portfolio companies. Wondering if you could just talk a little bit more at a high level around the general approach that FSK has around potential de risking?

Speaker 7

What kind of options are available? And how do you choose the course of action for particular portfolio companies? Thanks.

Speaker 3

Sure. Happy to do that. I imagine we were pleased to see, we'll call it progress on these names. I think we are fortunate from human capital or a staffing perspective to have a very strong restructuring and workout team. It's a dedicated team.

Speaker 3

A woman, Lauren Kruger runs that team. In addition to running that she sits on the investment committee for the regular way business. So she's active across the board. I would say it's a very bottoms up approach in many ways, right. But and this is the comments that sort of Brian made.

Speaker 3

I mean, obviously, we would prefer the sponsor support the companies directly and we're obviously willing to work with the sponsors to do that. From time to time that won't be an option and we need to be prepared to take control. We're not afraid to do that. We got the resources of the entire firm, so they're behind us. But maybe just kind of one example of this is, while KBS was, I think, a difficult situation, that consensual deal, I think, will help kind of drive longer term value.

Speaker 3

We've brought other resources from the firm, including a handful of KKR Advisors to bear to that situation, which will be helpful. So I mean, in some ways, all the options are on the table. We're going to pick what we think is the best for that current situation. But I think it's just important to have the resources that are available. So I think we are happy to see these non accruals down quarter over quarter.

Speaker 3

I think we do still remain happy with the 88% of the portfolio is that KKR sort of originated piece and the non accruals were 2.3% 1%. So I think it's just an important factor to understand out there.

Speaker 4

Hey, Dan. The one thing I'd add to this, Ken, it's Brian, is that in situations like this, time is not always your friend. So I think our approach to sort of address things quickly and deliberately is really important, because sometimes we never believe in kicking the can down the road, because situations get worse, not better in those circumstances. So we want to drive to a resolution. Clearly, we do prefer the sponsor to support continue to support their portfolio companies and they often do.

Speaker 4

But when they don't, we just don't want to close our eyes and hope for the best. We need to be getting in there and preparing to maximize value for our investors.

Speaker 7

Got you. Very, very helpful there. Thanks again.

Operator

Our next question comes from Bryce Roe with B. Riley. Bryce, go ahead with your question.

Speaker 8

Thanks a bunch. Good morning. Appreciate you taking the question here. I want to kind of ditto some of the comments around the information around the restructurings resolutions, super helpful and certainly pleasantly surprised to see the pace at which you made those happen. Maybe shifting to the capital structure and might have talked about this in past calls, but Stephen, maybe you could speak to the opportunity to refinance or at least address some of the maturities you have coming up in 2024 and 2025, especially in light of how open the debt capital markets are today?

Speaker 8

Thanks.

Speaker 9

Bryce, thanks for the question. I think from our perspective, we took care of our July maturity last fall when we issued $400,000,000 of unsecured notes. And certainly agree with your point, the markets are open and appear to be active. So that's certainly a good thing. I think we'll evaluate things in the normal course as we've been a frequent issuer.

Speaker 9

I think we'll continue to be over time and certainly getting having a very nice start to the year like this quarter has been a very clean positive quarter for us. So I think we'll take all those things in consideration. But I think the way the capital structure, the way we have laddered it over the last several years really de risks us from that standpoint just in terms of being sort of methodical regular issuer on a year to year basis.

Speaker 8

That's helpful. And then maybe just one follow-up on the restructurings of the resolutions. Obviously, took care of some here in the Q1, but curious, I assume that workout group continues to kind of work hard on the other situations. Can you speak to maybe the pace of those potential resolutions and kind of maybe an update on Miami Beach since it was one of the larger non accruals that were added in the Q4? Thanks.

Speaker 3

Yes, Bryce, happy to. I mean, obviously, the team will remain busy there and kind of focus for the resolutions. And I thought the point that Brian made was a very good one. I think we continue to make progress on Miami Beach, probably a little bit more of a complicated situation, complicated sort of industry, probably more to talk about there in the coming quarters. There's a handful of other names that maybe are either on the non accrual or the non income producing list that we're kind of watching M and A markets closely.

Speaker 3

We are probably preparing for or thinking about kind of 2024 or early 2025 sort of exits there. And then maybe just one of the larger names that you have is Global Jet. That I think is roughly 44% of the non accrual balance. I think we've been very happy with what management has done of late. I think they've done a

Speaker 4

really nice job.

Speaker 3

That book is at the overall company level on the asset side is north of $2,000,000,000 sort of dollars. I don't believe there's one credit issue in that portfolio. They recently accessed the capital markets from a financing perspective, And we would have received roughly $130 odd 1,000,000 of distributions as that business continues to right size its equity base. So I think the team has done a really nice job there working with the management team, and the other sort of sponsors to push that business forward. But those are probably some highlights for you, Bryce.

Speaker 8

Excellent. Thanks, Dan. Appreciate it. Thanks for the time.

Speaker 3

Have a good day.

Speaker 10

Thank you.

Operator

Stand by for our next question. Our next question comes from Casey Alexander with Compass Point Research and Trading. Casey, go ahead with your question.

Speaker 2

Hi, good morning. A couple

Speaker 10

of questions, Stan. 1, in relation to the new underwriting environment, are we seeing repays with higher yields and the new spread compression? Should we be thinking about a drag on weighted average yields as the year goes along? And that's just I think a general question, but I'm curious how you feel about that. Good

Speaker 3

morning, Casey. I think it's rational to think that, right? I mean, I think this is not just an FSK point, but people's books will get rotated. Those rotations could go into lower yielding assets. But I think that lower yield will be driven obviously by the benchmark, but by the spreads as well.

Speaker 3

I do think though there'll be some offset to transaction fees that will sort of benefit kind of earnings and maybe sort of smooth that out a little bit. There's been extraordinary light amount of volume for probably the past 8 quarters. So I think you can probably go back and look kind of across the industry at that. So I think that's probably a bit of a balance. And then I think we come back to what price discussion was, we're working pretty hard on some of these non accrual or non income producing names that rotating that into income producing will be quite beneficial to the bottom line.

Speaker 3

And we're still a little bit we're within our target leverage range, we still got a little bit of room there, which

Speaker 10

help. Thank you for that. Secondly, on the ABL side, KKR has, I believe, set up a real effort to attack ABLs, not just withstanding the BDC. So that's clearly a focus at KKR. So what percentage of the portfolio would you be willing to take ABLs to in the BDC?

Speaker 10

And where do origination yields there sit relative to direct origination private credit? And is that also a way to potentially offset some drag on weighted average yields?

Speaker 3

No, thanks for that Casey. We do have a real effort there. We have north of 50 people dedicated to that space. We have north of $50,000,000,000 of total AUM in that space. I mean just a nomenclature point, we call it asset based finance, more focused on portfolios of financial and hard assets and the market historically used the ABLs as just receivables only.

Speaker 3

But it is a broad effort for us. We do, as I mentioned, like the downside protection, but specifically Casey to your point, we're probably seeing deals anywhere kind of 100 basis points to kind of 400 basis points wide of your regular way direct lending deal. I think we are kind of within the range that we've talked about historically for asset based finance inside of FSK. We obviously have the benefit of our joint venture to kind of help there. But I think you should continue to expect us to be active there, rotating into new deals as some of these other deals will continue to self liquidate or self amortize.

Speaker 8

Yes. Casey,

Speaker 4

The other constraint is just non EPC. ABS investments are usually non EPC and we have to stay within the 30% bucket and we also have the JV. So that's a bit of a constraint. But as Dan mentioned, we can also put ABF into the JV to basically increase our buying power in non EPC.

Speaker 10

Okay. Great color. Thank you for taking my question. Thanks, guys.

Operator

Standby for our next question. Our next question comes from Melissa Wedel of JPMorgan. Melissa, go ahead with your question.

Speaker 11

Thanks and good morning. I wanted to touch on I think it's really a follow-up to the first question about sort of investment activity levels. Obviously, with some elevated repayment activity in the first quarter, we saw leverage in the portfolio come down a bit. Given it's sort of middle of the target range right now, I'm curious how you feel about that level of sort of portfolio leverage, especially in the context of your comments about expecting portfolio company growth on the revenue side and I think on the EBITDA side as well to start to decelerate in the back half of the year?

Speaker 3

Yes. Thanks, Mohsen, and good morning. I think we're pretty comfortable with where we sit right now, right? We've historically given that kind of 1x to 1.25x range with probably the midpoint of or sort of the target of kind of the 1, 1, 5, so maybe slightly sort of below that. I think we like how much available liquidity we have.

Speaker 3

I think we like the maturity ladder we have on the liability side. I think we're prepared to kind of operate within that range, considering we have that level of dry powder. I think going to your other comment, I mean, I think like the overall market has taken the view maybe almost too aggressively that sort of the hard landing concept is removed from the equation and we're in this more kind of soft landing perspective. I think we are expecting some slowdown though. At the consumer side, more sort of broadly, which will impact some of the names here and maybe reduce that kind of year on year EBITDA growth.

Speaker 3

It is our job for these companies to be a little bit glass half empty. But we got a little bit of room to work on the leverage side and run a good liquidity position. So we feel good about that.

Speaker 11

Okay. Appreciate that. And then following up on the funding, there are a decent number of upcoming maturities and you guys have done have always approached your unsecured issuance as incredibly laddered and well diversified. But there are some maturities coming up in 2024 and 2025. Given the rate environment and the spread environment, how are you thinking about sort of funding those upcoming maturities?

Speaker 11

And are you what's the appetite for further diversification versus sort of using the available capacity on the revolver? Thank you.

Speaker 3

No worries. And I think Stephen may have touched on some of this. So Stephen, if there's something to add here, please do. But we did do that deal in November essentially prefunding the upcoming maturity in the summer. Obviously, we've got the $4,200,000,000 of available liquidity.

Speaker 3

We've got, I think, 65% of our balance sheet is funded today from unsecured. I think you should expect us to be a very active issuer there and do that with some level of consistency, but also do it in a bit on an opportunistic basis when markets are open. And then I think we'll also look at other tools like CLOs or sort of otherwise to make sure we're kind of fully diversified from a liability perspective. But Stephen, did I anything you want to add there?

Speaker 9

I think you covered it well.

Speaker 11

Okay. Thank you.

Operator

Standby for our next question. Our next question comes from Robert Dodd with Raymond James. Robert, please go ahead with your question.

Speaker 12

Good morning, guys. Jack, on the forward outlook in terms of economic risk and macro risk, how much of that concern stems from overall demand revenue versus margin? Right? But we're hearing mixed messages from some BDCs that well, generally BDCs with a lot of software are seeing margins go up because software companies are slashing sales expense. But on your companies, how much of the kind of the cost cutting or margin management tools have already been expended, so to speak, over the last several years?

Speaker 12

Because obviously, it's been a theme for a lot of companies for many years. And are they running out of tools on that front, do you think?

Speaker 3

Yes. Good morning, Robert. It's a fair question. I mean, our biggest sector exposure is sort of software, right. We've just focused on the larger sort of software names that were more EBITDA focused than recurring revenue sort of structures.

Speaker 3

I think we have seen out there that the ability to just blindly push through price is probably kind of abated and it will be more challenging just to do that. So I think that is one point and almost in line with I think what your thoughts are there. I think where we've seen probably the most challenge in certain situations is when a company when they're kind of expense line is heavily driven by wages, right? The wage inflation remains a real sort of point out there when you couple that with just the higher rate environment. And as we've talked about for multiple quarters now, we expect rates to remain higher for longer.

Speaker 3

So those are probably a little bit more of the things we do have our eye on. So I think we're mindful about that sort of revenue piece. I think that's partly why we're talking about expecting to see just kind of slower sort of EBITDA growth in the coming quarters.

Speaker 12

Got it. Thank you. And then just the other part, I mean, activity levels in the second half of the year, obviously, obviously, lots of expectation there to the point you outlined, right? I mean, LPs want the money back. How is in your is the bid ask between buyers and sellers on the PE side?

Speaker 12

Is that actually beginning to close? Or is because that's obviously been a factor of why activity levels have remained low. And do you think that's going to close sufficiently, say, this year for there to be a pickup, a material pickup in activity in the second half? Or people still playing chicken on that front?

Speaker 3

No, I think the short answer is yes. I think it has closed meaningfully or will kind of close enough to get the transaction levels up. I do think you had a bunch of what's called different factors in play. I think we even going back to last summer, we saw a little bit more activity, a little bit more books coming around or sort of chatter about deals than the events in Israel and the Middle East sort of happened in October that sort of we'll call put most things on hold. And then the market was forecasting these 6 rate cuts coming into the year.

Speaker 3

I think people wanted to hold assets with the view that in a lower rate environment, they would sort of get better prices. But I think there is a decent consensus out there that rates are going to be higher for longer. So that's kind of off the table. And I think there's also a decent consensus that while there might be certain bumps in the road or sort of challenges, This as I said in the conversation around hard landings off the table, it's all pretty muted in terms of sort of, I think, challenges in people's mind, albeit I think we're a little bit more cautious on that. So I think all that is coming together.

Speaker 3

And then Robert, you said it, I mean, people are looking for capital back on the LP side. And on the other side, there's a lot of dry powder.

Speaker 10

Got it. Thank you. Thanks.

Operator

Standby for our next question. Our next question is from Eric Zwick of Hovde Group. Eric, go ahead with your question.

Speaker 13

Thank you. Good morning, everyone. I wanted to start, first with a question regarding the pipeline. I'm curious if you could provide any commentary in terms of how that looks today in terms of the mix of new investments versus add on opportunities as well as if there are any particular industry segments that you're finding that are either kind of more active or more attractive from your perspective?

Speaker 3

I'd say it's almost in line with what you'd probably expect, right. We've been probably overweight the add on and the incumbency. So I think you're always going to see a large chunk of that considering the size of the platform, but some of that will be regular way, kind of new deals. So I think it's pretty balanced. I think the pipeline is decent right now.

Speaker 3

I think the level of deals that I see being screened, are making their way to investment committee is definitely up more quarter on quarter or up more than maybe what we saw last year. I still think it will take a little while to play out there, right, because some of the conversations here are just people gearing up for this. That means it's a multiple month process and a multiple month kind of close, but constructive.

Speaker 4

Yes. I mean the one thing I'd add, Eric, is that just because the company is being sold doesn't necessarily mean it's going to go out of our portfolio. We are always in active dialogue with sponsors looking to sell companies about providing financing to the new buyer. And because we have the incumbency position, that gives us a bit of an advantage over some of our competitors. So clearly, that's a focus for us.

Speaker 13

That's helpful. Thank you. And second question for me, it was just interesting to notice on Slide 10, meaning interest coverage for your companies has been pretty stable for about a year and actually ticked up a little bit in 1Q, which makes sense given that base rates have been pretty stable and given the fact that you said you've kind of seen high single digit EBITDA growth over the past year. So I guess if we assume that rates stay here or even potentially come down and you continue to see some EBITDA growth, is it a fair assumption that we've kind of seen, the bottom of kind of a trough for this particular metric for this cycle?

Speaker 3

Yes. That would be our view in terms of the trough. Now that view is a little bit driven off the fact of, well, we don't believe that rates are necessarily coming down anytime soon. I don't think they're going up either, right? So it's probably more leaning to over the next several years kind of these rate reductions.

Speaker 3

You did see that kind of uptick a bit. I think to be fair, it probably wasn't all or the entire sort of 0.1. I think some of it may have just been kind of the rounding there, but it definitely improved kind of quarter on quarter.

Operator

Our next question comes from Maxwell Pritchard of Truist Securities. Maxwell, go ahead with your question.

Speaker 14

Hi, good morning. I'm calling in for Mark Hughes. Just a broader question about the economy. But is there any sector in particular that you were seeing cracks in or staying away from? Or are there any credit issues?

Speaker 14

And this is industry wide, not just in your portfolio. Are these credit issues more idiosyncratic? Thanks.

Speaker 3

Yes. And I think we've talked about this on some of the prior calls. I mean, I think we have tried to build the portfolio staying away from the secular decliners, right. So that's been sort of positive out of the gate. But that has those I think in many ways would continue to be challenged.

Speaker 3

I think we have seen businesses in the healthcare space probably be a little bit more challenged. So I think some of that has had to do with and this is an industry point, not just anything with us. Some of it has to do with the revenue side and how people are getting reimbursed. We've seen some of the discretionary spend, names kind of struggle, some of these roll ups are sort of struggling. So healthcare, which historically has been viewed as a defensive asset class has probably been a little bit more mixed.

Speaker 3

And I think that probably continues for sort of some time. But Brian, anything else you want to add? I mean, look, I think you said it

Speaker 4

pretty well. I mean, we've been focusing on industries that we think are more defensive. We like software. We like consumer driven healthcare. We like consumer.

Speaker 4

We like professional services, business services. Those have all been pretty resilient. Energy, retail, consumer products, we've just tended to stay away from. Look, I think we're continuing to see pretty solid earnings growth across the book as evidenced by that 7% number that Dan focused, but that's clearly an average. So, I would tell you that there's nothing right now where we could say somatically beyond what Dan said, there are certain industries that are just in having real trouble.

Speaker 4

It's been somewhat specific situation specific with some of our non accruals and problem credits. And I think we just need to continue to be cautious about the overall economy and whether we have a soft landing or not.

Speaker 14

Got it. Thank you. And then switching gears to the 2nd lien investments. Are you still seeing good opportunities there? Obviously, lenders are focusing or emphasizing their 1st lien, which you do have that's the majority of your portfolio.

Speaker 14

So that's understandable. But any insight on the 2nd lease, what you're seeing there in terms of spread, yields, etcetera, and how you're looking at those?

Speaker 3

Yes. And I probably think about a little bit Maxwell, sorry, probably think about a little bit broader as kind of junior debt as a whole category, right, thinking about 2nd lien or things that might be more sort of mezz like. Obviously, activity has been muted there for several years because that is generally driven by more active M and A market. We have seen a handful of deals get done of late. They have been probably top decile businesses.

Speaker 3

So there has been 2nd lien in those structures. Those structures were actually pretty darn tight from a spread perspective. Our sense is as the M and A volumes do pick up, there's going to be more opportunity in that junior debt space. I think that will be an interesting opportunity as well. Considering that business, I think we view as a little bit more cyclical.

Speaker 3

So the time to kind of get in there is when the M and A picks backs up and the financing markets are going to need someone to kind of help fill that void. And those could be pretty attractive structures from a yield or a total return perspective. Now all that being said, I think we're quite mindful about portfolio construction here and making sure we've got a fair balance of kind of really leading with, which is the focus of this is that kind of 1st lien or unitranche senior secured risk.

Speaker 4

And then we have a pretty high bar for junior capital. We talk about the weighted average EBITDA of the portfolio being, call it, 2 20 give or take. If you look at our junior debt investments, on average EBITDA is probably twice that. So when we do go junior, they tend to be in much larger businesses. They tend to be businesses where sponsors have written $1,000,000,000 plus checks or multiple $1,000,000,000 checks.

Speaker 4

That's typically driven by new deal activities, as Dan mentioned.

Speaker 14

That's helpful. Thank you.

Operator

Showing no further questions. I would now like to turn it back over to Dan Pieterzak for our closing remarks.

Speaker 3

Thank you all for joining the call today. We're always available for any follow-up points that you might have. And we look forward to talking with you again next quarter. Have a good day.

Operator

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.

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Earnings Conference Call
FS KKR Capital Q1 2024
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