FS KKR Capital Corp. Q1 2023 Earnings Call
Good morning, ladies and gentlemen, welcome to the F. S. K K R capital Corp's first quarter 2023 earnings conference call.
Your lines will be in a listen only mode during remarks by.
S case 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. Please note. This conference is being recorded at this time Robert Pond head of Investor Relations will proceed with the introduction Mr. PON you may begin.
Thank you good morning, and welcome to Iff's KKR capital Corp's first quarter 2023 earnings conference call.
Please note that FX KKR capital Corp may be referred to as F. S. K.
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 the press release that <unk>.
Issued this morning.
In addition.
It's 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 todays 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 F. S K.
The authorized 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 <unk> or the economy generally.
We ask that you refer to FX cases, most recent filings with the SEC for important factors and risks that could cause actual results or outcomes to differ materially from these statements.
<unk> 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 <unk> first quarter earnings release that was filed with the SEC. This morning May five 2023.
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 <unk> website.
Speaking on today's call will be 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 Dan.
Thank you Robert and welcome everyone to FFS KK, Our capital Corp, 's first quarter 2023 earnings conference call.
Unfortunately, Michael Forman is not able to participate on today's call due to an unavoidable scheduling conflicts.
For the first quarter our team again delivered strong operating results <unk> generated net investment income totaling 81 per share and adjusted net investment income totaling 78 cents per share.
As compared to our public guidance of 77.
And 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 70 cents per share distribution and accretive share repurchases.
M&A activity remained muted during the first quarter as a result, our investment team originated approximately $270 million of new investments.
That said, we are seeing activity level in inquiries ramp up in recent weeks.
From a liquidity perspective, we ended the first quarter with approximately $3 billion of available liquidity.
With regard to our share repurchase program. During March we completed the remaining portion of our previously committed $100 million buyback program as we repurchased $32 million of shares.
Based on our continued strong financial results. Our board has declared a second quarter distribution of <unk> 70 per share.
Which consists of our base distribution of <unk> 64 per share and a supplemental distribution of <unk> <unk> per share.
As a reminder, based on the overall strength of the Companys earnings power, we expect our quarterly supplemental distribution to total a minimum of six cents per share throughout 2023, and possibly beyond equating to a minimum of 70 <unk> per share per quarter of quarterly.
<unk> during 2023.
Additionally, we are pleased to announce special distributions totaling <unk> 15 per share, which will be paid in three 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 spill back income.
Our special distributions equate to an additional five 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 based on our recent share price.
We further believe that our ability to provide shareholders of such and such an attractive distribution is based on the significant portfolio rotation work, we have accomplished over the last five years.
Turning to the current market and economic environment.
The volatility we experienced in the financial markets. During 2022 has continued during the first quarter 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 backed and asset based finance investments tied to collateral pools will remain attractive.
While we do expect M&A transaction volumes to remain below average for the next few quarters, the increased volatility and economic uncertainty does create compelling investment opportunities for 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 are 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 <unk>, we 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.
Our 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.
As I mentioned earlier during the first quarter, we originated $270 million 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 million of net sales and repayments when factoring in sales to our joint venture <unk>.
Equated to a net portfolio increase of $6 million.
In terms of interest coverage at the end of the first quarter our portfolio companies had a median interest coverage of one seven times.
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.
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 so at the end of the first quarter, we have not experienced a significant increase in amendment request, which we view as a positive.
With that I'll turn the call over to Brian to discuss our portfolio in more detail.
Thanks, Dan as of March 31, 2023, our investment portfolio had a fair value of $15 3 billion.
<unk> of 189 portfolio companies.
This compares to a fair value of $15 4 billion.
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 fair value of our portfolio.
We continue to focus on senior secured investments as our portfolio consisted of 61% first lien loans and 69, 4% senior secured debt as of March 31.
In addition, our joint venture represented nine 1% of the fair value of the portfolio and asset based finance investments represented 11, 7%, which are comprised predominantly of first 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 first quarter, our new originations consisted of approximately 82% in first lien loans, 11% in asset based finance investments, 3% in subordinated debt and.
<unk>, 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 exclude the accretion associated with the merger with Fs KR.
The increase in our weighted average yield during the first quarter 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 effects of the investment activity, we experienced during the first quarter 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 adviser. This compares.
The 84% at March 31, 2022.
During the first quarter, excluding the impact of merger accounting, we experience net portfolio depreciation on investments of approximately $17 million.
The largest negative movers in our portfolio, which were impacted by credit performance related issues during the quarter, where winter and reliant rehab.
Winter is the global leader in the outsourced elevator components segment with a focus on the production of elevator doors and the manufacturing of adjacent components for both new equipment markets and the aftermarket.
The company has been facing persistent inflation headwinds as well as a slowdown in construction in China, which has led to us, placing our second lien loan on non accrual this quarter.
Reliant rehab offers physical occupational and speech therapy services to skilled nursing facilities the.
The company has been affected by macroeconomic factors across the health care services industry, including a decline in labor productivity and increased and contract labor given the tight labor market in the U S and inflation driven wage increases.
I'd also like to comment on another investment Miami Beach Medical group.
Miami Beach Medical group provides primary care specialty care and house pharmacy in home visits primarily focusing on Medicare advantage members.
The company is recent recently experienced weaker performance due to lower membership growth elevated medical expenses and higher operating expenses related to wage inflation.
In the first quarter, we provided an amendment, which included a $15 million first lien debt paydown at par from the sponsor.
During the quarter, we placed two debt investments on non accrual with a combined fair market value of $72 million and a cost of $140 million and.
In addition, there were three debt investments fully removed from non accrual status with a combined fair market value of $7 million and a cost of $29 million.
Based on the first quarter's activity as of March 31, 2023, non accruals totaled five 5% of our portfolio on a cost basis, and two 7% on a fair value basis compared to four 9% on a cost basis and two 4% on a fair value base.
As of December 31, 2022.
We also thought it would be helpful to provide the market with information based on the assets originated by KKR credit.
As of the end of the quarter non accruals related to the relating to the 86% of our total portfolio, which has been originated by KKR credit and the F. S. K care advisor or two 8% on a cost basis and 0.8% on a fair value basis.
And with that I'll turn the call over to Steven.
Thanks, Brian .
As Dan mentioned earlier, we are pleased to reward shareholders with the declaration of a <unk> 15 per share special distributions.
Which will be paid in three equal installments in May August and November of this year.
Combining our quarterly base and supplemental distributions of <unk> 70 per share.
With the three five per share quarterly special distributions.
Total distributions 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 was $24 93 per share.
And a 16% yield on our current stock price both of which we view is quite attractive.
Turning to our financial results for the first quarter total investment income increased by $7 million quarter over quarter, driven by increased interest income.
The components of our total investment income during the quarter were as follows.
Interest income was $369 million, an increase of $9 million quarter over quarter.
Dividend and fee income totaled $87 million.
A decrease of $2 million quarter over quarter.
Our dividend and fee income during the first quarter is summarized as follows.
$55 million of recurring dividend income from our joint venture.
Other dividends from various portfolio companies totaling approximately $27 million and fee income totaling approximately $5 million.
Our interest expense totaled $114 million.
An increase of $5 million quarter over quarter.
Due to the impact of rising base rates on our secured debt facilities.
Our weighted average cost of debt was five 1% as of March 31.
Management fees totaled $58 million.
A decrease of $1 million quarter over quarter and incentive fees totaled $46 million during the first quarter.
A detailed bridge and our net asset value per share on a quarter over quarter basis is as follows.
Our ending <unk> 2022, net asset value per share of $24 89.
With increased by GAAP net investment income.
<unk> 81 per share and was decreased by <unk> 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 70 cents per share dividend.
Paid during the quarter and increased by <unk> <unk> per share due to share repurchases. So some 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 second quarter 2023, GAAP net investment income to approximate <unk> 78 per share.
And we expect our adjusted net investment income to approximate 75 per share.
Detailed second quarter guidance is as follows.
Recurring interest income on a GAAP basis.
<unk> to approximate $362 million.
We continue to expect the low average M&A activity during the quarter.
We expect recurring dividend income associated with our joint venture to approximate $55 million.
We expect other fee and dividend income to approximate $30 million.
From an expense standpoint, we expect our management fees to approximate $58 million.
We expect incentive fees to approximate $45 million.
We expect our interest expense to approximate $115 million.
And we expect other G&A expenses to approximate $10 million.
As a reminder, the <unk> per share difference between our GAAP net investment income.
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 fourth quarter levels.
At March 31, our available liquidity was $3 billion.
At the end of the first quarter, 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 five 1%.
And with that I'll turn the call back to Dan for a few closing remarks before we open the call for questions.
Thanks Steven.
In closing we are pleased that our portfolio rotation and achievement of operational goals have reached a 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 <unk> 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.
Thank you if you would like to ask a question at this time. Please press star one on your Touchtone telephone and wait for your name to be announced.
Your question. Please press star one again, one moment, while we compile our Q&A roster.
And our first question comes from the line of John Hecht with Jefferies. Your line is open. Please go ahead.
Good morning, guys. Thanks, very much for taking my questions Dan you said.
I think you said youre seeing activity pick up.
More recently in terms of deals.
Maybe can you talk about the source and characteristics of the pipeline.
Yes, no happy to Jonathan and good morning.
I do think it's a little bit early and sort of those processes, but.
I think we're just seeing more.
Either inbounds or inquiries.
From other sell side firms are companies themselves or quite frankly people, who we lend money to today.
Might be interested in us, indicating financing terms if that goes to the sale of the business.
I don't think Thats any guarantees of a big near term.
Set of M&A sort of plus but I think it was a bit of green shoots that we're seeing.
My sense is the overall M&A environment remains.
Lower or slow for the rest of this year, but we will start to pick up the very end of the year in the 'twenty four.
Okay, and then you mentioned I think you mentioned like a 100 basis points overall spread pickup.
Obviously theres dislocations in certain part of the markets you guys.
You guys have your ABS and then obviously the non ABS portfolios, maybe can you where is the where's the best opportunity in the wider spreads.
Yes.
Or is there any kind of arbitrage that you guys are focusing on in the market at this point.
Yes, I'm not sure if that arbitrage, but I'd probably split it in two pieces the direct lending market is extremely attractive today for.
Both new deals or even add onto this existing portfolio of 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.
Let's call it the start of 'twenty two.
Couple that with probably an extra point on average of upfront fees, probably better call Pro and then you add the overall.
Moving so for on top of that because obviously these are floating rate loans.
Youre 12 to probably 12, 5% on your regular way new direct lending deal today.
That's quite attractive.
I think especially when youre focused on the upper end of 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 and you mentioned the asset back side.
I think the overall available returns there probably didn't move as much as direct lending.
Still above it.
More I think the investing environment there for us is more Ben.
Pivoting to either different types of deals or different types different parts of really the capital structure to get the best risk adjusted reward we can get we've been busy there I think that will continue as well.
Okay, and then you mentioned I think one seven times coverage, maybe you could just give us a quick glimpse in the revenue and EBITDA trends at the portfolio level.
Yes, no happy to do that I mean, I think we talked about the one seven times I think we wanted to make it clear how we calculated that so that was not an LTM sort of interest number that was using kind of the 12 31 number for your benefit if we think about just where we are today or some of the top of that forward curve, you probably take that down to one six.
Not a big move from there.
We still have seen.
Year on year EBITDA growth.
We're happy to see that.
I think we're probably a little bit worried about margins. We've seen company has 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.
From a base case perspective, I think the portfolio is probably outperformed.
Thought it would've been a handful of seven quarters ago, and we just got to watch it going forward.
Alright, thanks, very much and congratulations on a good quarter.
Great.
Thank you.
Thank you one moment for our next question.
Our next question comes from the line of Ryan Lynch with <unk>. Your line is open. Please go ahead.
Hey, good morning.
First question has to do with you mentioned the potential for some pick up in activity.
The hope for that.
Other direct lenders talk about that as well.
Sure.
My question, though comes to you.
If that market does start to pick up at all and there is more activity in M&A and LBO going on I was just curious if you had any <unk> on that Emerson.
Emerson deal kind of switching from the direct lenders.
The broadly syndicated loan market.
Is that sort of a one off or do you think of deal activity picks up that will also potentially coincide with the broadly syndicated loan market.
Looking debt ticking back some share.
Hey, good morning, Ryan.
Probably no specific thoughts on the individual deal I think every deal in some ways is.
His unique either to the company or the situations.
If it's a sponsored deal the sponsor.
And I mentioned it on to John on the prior question 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 to.
Forward sort of a sale of that business. So I think thats a bit of sort of positive news I mean <unk>.
Clearly.
Private debt has filled the void for the syndicated loan market and the last.
Probably four or five quarters at that point.
The loan market comes back and functions that are as normal.
Eligible so to change a bit and I think we expect that the syndicated loan market is not going to go away I think what we feel good about though the tailwind on the other side as 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.
I think that trend continue so.
Clearly the syndicated loan market will refinance some of these companies over time, but I still think the tailwind this year for private debt.
Okay understood.
I wanted to ask when we hear about new non accruals in your portfolio or any BDC portfolios usually.
Socratic events that are happening.
The other business.
I would just love to hear though if you think about maybe the bottom quartile performers in your portfolio. So maybe not just the non accruals, which is just the somewhat underperformance of your portfolio have you been able to notice any sort of comments brands.
That youre seeing here why those those companies are struggling more than others in this particular environment.
I think we have seen.
Let's call it issues that have impacted companies.
Sort of broadly I think if you went back.
Four or six quarters, it was probably supply chain challenges.
I think today.
Most companies, who maybe are heavily reliant on the expense side on wages.
So to generally sort of struggling and I think the environment. We're in I do think if you look at that bottom 25% year example, it's outside of the idiosyncratic sort of points, it's probably companies who have struggled for whatever reason.
Pass through sort of price, Brian just with everything that sort of happened and that has sort of been impactful and I think that some of that has been.
Maybe maybe not in an environment or a sector, where they could do that maybe there is.
Maybe they are there.
And customers are sort of well stock, but I think wages I think where we sit today, it's probably wages and lack of ability to pass through.
Pass through price to keep the revenue setup.
Okay.
I just had one last one.
I think there's been a lot of disruption.
The banking sector with the central failure.
<unk> like and how that is going to be probably pull back in bank line.
Not sure how much that really effects.
Overall.
<unk>.
Private credit buyout business I'm not sure how much is competitor banks really arent holding those assets on our balance sheet, but it does seem that potentially could be.
So a competitor and maybe some of your ABL businesses. 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.
And banks that are lending.
Yes.
Yes.
That's a fair question considering what's happened this quarter.
Yes, I think youre right I mean, the impact on the regional banks.
Thanks.
Moves a lot on the regular way direct lending business.
Remember, what you were sort of mentioning ABL, we talked about ABL, we're probably talking more about receivables and inventory financing. That's clearly a product that we have that were out to companies. Those companies are probably ones, who were struggling who need to access an alternative form of capital and we're probably better providers of that.
Then that banks due to the shape of the corporate.
The broader sort of piece just not to confuse it too is our asset based finance effort, that's more consumer mortgage set of <unk>.
Funding, the real economy, but not really sort of corporate credit.
My sense is everything that is going on with the regional banks is probably.
A net positive to both of those pieces as there should be more deal flow and I think history will tell you that the private debt markets can comment Phil that that capital avoid that might be left.
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 Bob side, there from a volatility perspective or an impact on a recession.
I think we're mindful about all of those factors.
Okay understood.
Yes.
The negative impact of branches pulling back broadly understood.
I appreciate the time today.
Alright and have a good day.
Thank you and again, if you would like to ask a question at this time. Please press star one on your Touchtone telephone 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.
Thanks, So much I appreciate you taking my questions today.
Firstly I wanted 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.
Good morning.
I don't think I'd note a couple of things gentlemen, I think we are happy that we completed the $100 million.
I think we've been pretty consistent to the market that.
We intend to complete these when they.
When they get sort of put in place.
We have done more than most.
It would probably repurchased almost $500 million of shares over the last five years amongst the various bdcs that were public at one time or another so clearly this will be something that we.
On the top of our mind or are considering on a go forward basis in line with what we've done in the past.
No.
I think we are happy to also provide this special dividend dry which is kind of capital for the benefit of shareholders I think we've talked.
On the prior call about the <unk> between the 64 in the supplemental.
I think we continue to feel good about that that was $2 80 per share and then with this additional 15 year up to 295.
Yes.
11, 7% on sort of NAV. So we think the income potential is good but I think thats special.
It's something we were very happy we were able to do this quarter.
Yes, certainly.
Follow up question on funding.
A few unsecured maturities in 2024.
Kevin.
With the current funding split.
Queen revolvers and fixed rate debt and sort of your outlook for interest rates.
<unk> remained higher than perhaps implied by the forward curve. How are you thinking about your funding profile. Aaron how are you how should we expect you guys manage that going forward. Thanks.
Yes.
Ryan, it's Steve might want to add to this as well, but I think we're very happy with all of the unsecured as we did in advance at the beginning of <unk>.
22, I believe and did a deal and it was January February of 'twenty, two and sort of decent size. So I think we are quite happy about no near term maturities. Obviously, we have plenty of Undrawn capital on the revolver just to take those out if we needed to write that said I think we intend to continue to access this market will 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 access from the past as well whether they be sort of bilaterals, our CLO sort of etcetera. So I think we got a bunch of tools at our disposal and 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.
Thank you.
Thank you and I would now like to turn the conference back over to Dan Pietrzak for any further remarks.
Thank you everyone for your time today as always we're available for any follow up questions have a good weekend and speak next quarter.
This concludes today's conference call. Thank you for participating you may now disconnect.
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