INTRODUCTION

Most BDC earnings conference calls are – literally – repetitions of what has already been disclosed in the earnings press release – sometimes read word for word. However, there are often a few developments worthy of the spotlight which illuminate what’s going on at a particular BDC. FS-KKR Capital (FSK) held its IIQ 2023 earnings conference call on August 8, 2023, in which two items deserve mention:

LOAN SALE

In an unusual move for a BDC, FSK chose to undertake a bulk sale of a portion of its portfolio:

…During the second quarter, we completed the sale of approximately $500 million of lower-yielding investments. This sale to a third-party was proactive on our part as we sought to increase our go-forward investment capacity based on our view of the accelerating M&A environment.

Apparently, the assets were part of a “strip” (i.e. no picking and choosing by the buyer) of lower-yielding, performing assets held both at FSK and other funds managed by the external manager and sold at a slight discount to par.

The most immediate impact of this sale was to reduce FSK’s leverage at June 2023’s quarter’s end:

 …Our gross and net debt to equity levels were 118% and 113% respectively at June 30, 2023, compared to 125% and 118% at March 31, 2023″. 

FSK’s liquidity increased from $3.0bn to $3.5bn.

Reason Why

At least one analyst appeared surprised by why FSK would sell “good assets at a discount to par in order to reinvest them at par loans?” Management answered that the actual discount on the BDC’s real cost was modest. Moreover, FSK believes that the economics of new transactions that will be able to be booked with the capacity created by the sale should prove to be a plus.

…the market today is – let’s call it 50 basis points plus wide on a spread level. The upfront fees have kind of held it at probably three points with sort of better call protection. So it’s just a little bit of a portfolio rotation. I think, our fee income number has been sort of lower than usual. .. I think that number sort of picks up.

EARNINGS AND DIVIDEND GUIDANCE

Unlike most of its peers, FSK provides detailed guidance about both its future earnings and distributions. Here is what was revealed on the conference call:

From a forward-looking guidance perspective, we expect third quarter 2023 GAAP net investment income to approximate $0.79 per share, and we expect our adjusted net investment income to approximate $0.76 per share.

Detailed third quarter guidance is as follows: Our recurring interest income on a GAAP basis is expected to approximate $374 million. Interest income is expected to be relatively flat quarter-over-quarter, primarily due to the portfolio sale Dan mentioned earlier, as well as certain assets which were repaid during the month of July. We expect recurring dividend income associated with our joint venture to approximate $54 million. We expect other fee and dividend income to approximate $25 million as we expect normal course ABF dividends to be incrementally lower between now and the end of September.

From an expense standpoint, we expect our management fees to approximate $56 million. We expect incentive fees to approximate $45 million. We expect our interest expense to approximate $120 million and we expect other G&A expenses to approximate $10 million.

As a reminder, the $0.03 per share difference between our GAAP net investment income and our adjusted net investment income relates to the expected accretion of our investments during the quarter due to merger accounting. This difference affects our recurrent interest income, other categories of revenues and expenses are not affected.

Paying Out

Likewise, management was relatively specific about what shareholders should expect to receive in distributions this year:

In total, we estimate investors will be able to receive a minimum of $2.95 per share of total distributions in 2023,

VIEWS

Creative

This may be a “golden age of credit” for lenders thanks to the wider spreads and tighter structural terms available on new facilities.

The drop in syndicated loan activity and the accelerating pullback by regional banks from the new loan market has ensured this “lender-friendly” period has lasted much longer than in prior periods of financial stress.

However, FSK – trading at a discount to net book value per share and thus unable to raise new equity and close to fully invested by its own debt-to-equity standards – has had only a limited opportunity to get in on the current gold rush.

This half-a-billion-dollar asset sale will provide the BDC with an opportunity to book a material number of new loans at wide spreads and on attractive terms and speaks to the creativity of management at an important time.

Open Book

At this time, most BDCs are making money hand over fist, but most are being both mean with their distribution levels and with their transparency about their outlook and plans.

Rightly or wrongly, BDC managers like to maintain maximum optionality about their future moves and don’t like to offer much in the way of guidance.

In its earnings and dividend guidance, FSK – maybe because its stock price trades at a big discount to net book value – is taking a more “shareholder friendly” approach which we hope others will copy.