FS KKR Capital Corp. (NYSE:FSK) Q4 2023 Earnings Call Transcript February 27, 2024
FS KKR Capital Corp. isn't one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good morning, ladies and gentlemen. Welcome to FS KKR Capital Corporation's Fourth Quarter and Full-Year 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 you instructions on entering the queue. 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.
Robert Paun: Thank you. Good morning and welcome to FS KKR Capital Corp's fourth quarter and full-year 2023 earnings conference call. Please note that FS KKR 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. 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 December 31, 2023. The 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 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. For such measures, reconciliations to the most directly comparable GAAP measures can be found in FSK's fourth quarter earnings release that was filed with the SEC on February 26, 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 Steven 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 Michael.
Michael Forman: Thank you, Robert, and good morning, everyone. Thank you all for joining us for FSK's fourth quarter and full-year 2023 earnings conference call. During 2023, FSK accomplished many key objectives. First, our total investment income grew approximately 12% year-over-year. Second, our adjusted net investment income per share increased by approximately 6% year-over-year. Third, for the full-year, FSK generated an ROE of 10%. Fourth, we paid $2.95 per share in total distributions in 2023, representing an 11% increase over distributions paid in 2022, equating to a 12% yield on our average net asset value during the year. Fifth, we continued optimizing our capital structure by amending and upsizing our revolver in October and issuing $400 million of unsecured notes in early November.
In terms of our fourth quarter results, we generated net investment income totaling $0.71 per share and adjusted net investment income totaling $0.75 per share. During the fourth quarter, our investment team originated approximately $680 million of new investments, resulting in net portfolio growth of approximately $162 million. Our net asset value declined by 1.7% for the quarter, primarily due to specific challenges associated with a few credits, which we will discuss in more detail later in the call. From a liquidity perspective, we ended the quarter with approximately $3.9 billion of available liquidity. Based upon our overall operating results, our Board has declared a first 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.
Also, as we mentioned on our last earnings call in early November, our Board declared a special distribution totaling $0.10 per share. This special distribution will be paid in two equal installments of $0.05 per share in the first and second quarters of this year and will be paid in addition to our quarterly base and supplemental distributions. Based on the continued trajectory of the company's earnings power, coupled with our view that interest rate reductions will be more muted than some market participants expect, we are pleased to provide forward-looking dividend guidance for the full-year 2024 as we currently expect our base and supplemental distributions will total at least $0.70 per share per quarter throughout the year. Combining our $0.70 per share quarterly distributions for the full-year with our two $0.05 per share special distributions to be paid during February and May, investors should expect to receive a minimum of $2.90 per share of total distributions during 2024.
This equates to an 11.9% yield on our current net asset value and an annualized yield of approximately 14.3% based on our recent share price. While Dan will discuss the current market environment in greater detail, we continue to be optimistic about the significant growth trends within the private credit sector, which we believe will provide meaningful benefits for our industry for many years to come. And with that, I'll turn the call over to Dan and the team to provide additional color on the market and the quarter.
Daniel Pietrzak: Thanks, Michael. Looking back on 2023, I am pleased with the results for FSK as we produced an ROE of 10%, and we continue to take positive steps rotating our investment portfolio. Looking back on the last six years since the establishment of the FS/KKR Advisor, I take great pride in the team's accomplishments as well as the continued growth of the KKR Credit platform which has current assets under management of $219 billion. Within FSK, we have originated over $22 billion of new investments, and we have an annualized depreciation rate, which includes both realized and unrealized amounts of less than 50 basis points. In terms of the current economic and market environment, with U.S. inflation beginning to stabilize, combined with significant private equity dry powder, pent-up demand from an M&A perspective as well as the desire for private equity fund LPs to see a higher level of return of capital.
We expect to see a material increase in private market transaction activity during 2024, which we believe will be weighted towards the second half of the year. As Michael mentioned, private credit continues to be an exceptionally attractive asset class, due to its directly negotiated transactions, attractive total returns and significant issuer diversification. As a result, even if the syndicated debt markets become more active during 2024 which we expect they will, we believe private credit structures will continue to be one of the primary avenues for many sponsors as there is an increasing desire for sponsors to know their lenders. With that said, we are seeing spread compression in the upper end of the middle market with spreads back to January 2022 levels.
In addition, still elevated interest rates, supply chain disruptions due to the Middle East crisis and inventory destocking could potentially lead to a slowdown in economic growth. These market inputs will require borrowers and lenders to remain cautious during the coming quarters. In terms of our most recent results, this macro backdrop created challenges for a few of our portfolio companies during the fourth quarter. Specifically, Miami Beach Medical Group and Reliant Rehab, two names we have discussed on prior calls continue to be affected by higher wage pressures and a challenging Medicare reimbursement environment. And while we do not have any meaningful additional exposure to Medicare reimbursement dependent companies, both of these issuers were placed on non-accrual during the fourth quarter.
Additionally, late in the fourth quarter, we received an update from Kellermeyer Bergensons Services, another name we have discussed on prior earnings calls which showed a material deterioration in the company's forward earning projections. KBS is a labor-intensive facilities maintenance business and the impact of higher interest rates, wage inflation, and the loss of certain customers has resulted in restructuring discussions. The first step of the restructuring was completed during the fourth quarter, which resulted in a portion of our investment in KBS being placed on non-accrual. We expect the full restructuring to occur in the near-term. Our workout team has been active on these names for some time. And as Brian will discuss, they have achieved positive results, including significant principal paydowns at par and meaningful progress towards debt restructurings.
Turning to investment activity. During the fourth quarter, we originated $680 million of new investments. Approximately 58% of our new investments were focused on add-on financings to existing portfolio companies and long-term KKR relationships. Our new investments combined with $518 million of net sales and repayments, when factoring in sales to our joint venture equated to a net portfolio increase of $162 million. We are pleased with the quality of our new originations. During the fourth quarter, our direct lending investments had a weighted average EBITDA of approximately $250 million, 5.3x leverage through our security and a 60% equity contribution, all with a weighted average coupon of approximately SOFR plus 600. We also continue to see very attractive opportunities in asset-based finance with our investments this quarter having a weighted average projected IRR of approximately 14%.
One asset-based finance investment worth noting is vehicle secured funding trusts, which is an approximately $7 billion secured portfolio of super prime RV loans that we purchased from the Bank of Montreal. Given the scale of our asset-based finance business and the experience of the team, we were able to acquire this high-quality loan portfolio on attractive terms. While the macro backdrop suggests a continued uncertain economic environment in 2024, we continue to see portfolio company revenue and earnings growth. We remain focused on large, high quality borrowers with strong operating margins and significant equity cushions. The weighted average EBITDA of our portfolio companies was $236 million as of December 31, 2023. Additionally, our portfolio companies reported a weighted average year-over-year EBITDA growth rate of approximately 6% 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.
Brian Gerson: Thanks, Dan. As of December 31, 2023, our investment portfolio had a fair value of $14.6 billion, consisting of 204 portfolio companies. This compares to a fair value of $14.7 billion and 200 portfolio companies as of September 30, 2023. At the end of the fourth quarter, our 10 largest portfolio companies represented approximately 19% of the fair value of our portfolio which is consistent with prior quarters. We continue to focus on senior secured investments as our portfolio consisted of approximately 58% first lien loans and 66% senior secured debt as of December 31. In addition, our joint venture represented 9.5% 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 first lien loans totaled approximately 67% of our total portfolio and senior secured investments totaled approximately 75% of our portfolio as of December 31.
The weighted average yield on accruing debt investments was 12.2% as of December 31, 2023, which was flat compared to the yield as of September 30. As a reminder, the calculation of weighted average yield is adjusted to exclude the accretion associated with the merger with FSKR. Including the effects of our investment activity during the fourth quarter, as of December 31, 2023, approximately 87% of our total investment portfolio is comprised of investments originated either by KKR Credit or the FS/KKR Advisor. From a non-accrual perspective, as of the end of the fourth quarter, our non-accruals represented approximately 8.9% of our portfolio on a cost basis and 5.5% of our portfolio on a fair value basis. We believe it is also helpful to provide the market with information based on the assets originated by KKR Credit.
As of the end of the fourth quarter, non-accruals related to the 87% of our total portfolio, which has been originated by KKR Credit and the FS/KKR Advisor, were 5.1% on a cost basis and 2.6% on a fair value basis. During the fourth quarter, we placed five investments on non-accrual with a combined cost and fair value of $654 million and $422 million, respectively. The credit stress we have seen in these names primarily relates to the factors that Dan mentioned earlier. Specifically, Miami Beach Medical Group and Reliant Rehab, continue to be affected by higher wage pressures and a challenging Medicare reimbursement environment. Miami Beach is the second largest independent provider of capitated primary care services to Medicare Advantage plans in South Florida.
Reliant is hired by skilled nursing facilities to provide outsourced physical and occupational therapy and has also been impacted by a post-COVID environment or skilled nursing facilities or more reluctant to bring outside personnel into their facilities. During the fourth quarter, we restructured our Reliant $125 million first lien term loan into a cash pay $62.5 million first-out term loan and a $62.5 million second-out term loan, which was placed on non-accrual. Due to the proactive work of the KKR workout team, to date, we have received par paydowns of over $100 million in Reliant Rehab, and $75 million on Miami Beach. KBS is a labor-intensive facilities maintenance business and the impact of higher interest rates, wage inflation, and the loss of certain customers has resulted in restructuring discussions.
The first step of the restructuring was completed during the fourth quarter, which resulted in our $366 million first lien loan exposure being restructured into $166 million first-out and a $200 million second-out term loan with the second out investment in KBS being placed on non-accrual. We expect a full consensual restructuring to occur in the near term which will result in the lenders equitizing a portion of the second-out and taking control of the company. Our first lien position in Sweeping Corp of America, which is the largest outsourced provider of street and parking lot sweeping services in the U.S. was placed on non-accrual due to poor integration of add-on acquisitions and higher-than-expected customer churn following price increases.
We are actively negotiating the sponsor regarding restructuring, which will result in the sponsor investing a meaningful amount of equity into the company and the majority of the position going back on accrual. Additionally, our preferred stock position in JW Aluminum was placed on non-accrual based on the company's total enterprise value, contributing $215 million of cost and $149 million of fair value to our portfolio. JW Aluminum continues to perform well with strong EBITDA growth. However, given our preferred equity position, our current view of enterprise value does not support continuing to accrue on the name. In terms of one other portfolio update, Solera, a borrower who switched to PIK accrual from cash accrual two quarters ago, returned to cash accrual as expected during the fourth quarter.
This change accounted for the majority of the reduction in our PIK interest income recognized during the quarter. And with that, I'll turn the call over to Steven to go through our financial results.
Steven Lilly: Thanks, Brian. Our total investment income decreased by $18 million quarter-over-quarter to $447 million, primarily due to the specific portfolio company results, Dan and Brian mentioned as well as lower quarterly asset-based finance dividends. The primary components of our total investment income during the quarter were as follows: Total interest income was $368 million, a decrease of $6 million quarter-over-quarter. Dividend and fee income totaled $79 million, a decrease of $12 million quarter-over-quarter. Our total dividend and fee income during the quarter is summarized as follows: $51 million of recurring dividend income from our joint venture, other dividends from various portfolio companies totaling approximately $16 million during the quarter and fee income totaling approximately $12 million during the quarter.
Our interest expense totaled $118 million an increase of $1 million quarter-over-quarter, and our weighted average cost of debt was 5.4% as of December 31. Management fees totaled $56 million unchanged quarter-over-quarter and incentive fees totaled $41 million, a decrease of $6 million quarter-over-quarter. Other expenses totaled $10 million during the fourth quarter a decrease of $1 million. The detailed bridge in our net asset value per share on a quarter-over-quarter basis is as follows; our ending 3Q 2023 net asset value per share of $24.89 was increased by GAAP net investment income of $0.71 per share and was decreased by $0.39 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 quarterly distribution and the $0.05 per share special distribution.
So some of these activities results in our December 31, 2023, net asset value per share of $24.46. From a forward-looking guidance perspective, we expect first quarter 2024 GAAP net investment income to approximate $0.73 per share, and we expect our adjusted net investment income to approximate $0.71 per share. Detailed first quarter guidance is as follows: our recurring interest income on a GAAP basis is expected to approximate $348 million. We expect recurring dividend income associated with our joint venture to approximate $51 million. We expect other fee and dividend income to approximate $30 million during the first quarter. From an expense standpoint, we expect our management fees to approximate $55 million. We expect incentive fees to approximate $42 million.
We expect our interest expense to approximate $117 million and we expect other G&A expenses to approximate $10 million. And 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 during the first half of the year. Our gross and net debt-to-equity levels were 120% and 113%, respectively, at December 31, 2023, compared to 115% and 110% as of September 30, 2023. At December 31, our available liquidity was $3.9 billion and approximately 63% of our drawn balance sheet and 44% of our committed balance sheet was comprised of unsecured debt. Additionally, in November, we issued $400 million of 7.875% unsecured notes due 2029 further enhancing our balance sheet and liquidity position and extending our maturity ladder.
And with that, I'll turn the call back to Michael for a few closing remarks before we open the call for questions.
Michael Forman: Thanks, Steven. In 2023, FSK shareholders earned a total return of over 30%. And from a forward-looking perspective, giving our earnings prospect for the year, we believe we'll continue to provide shareholders with an attractive distribution and total return in 2024. And while we were disappointed with the challenged credits during the fourth quarter, the temporary loss in revenue associated with these companies does not alter the long-term view of our ability to continue to provide investors with an above-average dividend yield going forward. On behalf of our team, we thank you all for joining the call and for your continued support. And with that, operator, we'd like to open the call for questions.
Operator: [Operator Instructions] And our first question comes from the line of John Hecht from Jefferies. Your question please.
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