FS KKR Capital Corp. II
Q1 2021 Earnings Call Transcript

Published: 11 May 2021

[Operator:]

Good morning, ladies and gentlemen. Welcome to FS KKR Capital Corp. II’s First Quarter 2021 Earnings Conference Call. 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. II’s first quarter 2021 earnings conference call. Please note that FS KKR Capital Corp. II maybe referred to as FSKR, 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 FSKR issued on May 10, 2021.

[Michael Forman:]

Thank you, Robert and welcome everyone to FS KKR Capital Corp. II’s first quarter 2021 earnings conference call. The first quarter represented another positive stable quarter for FSKR. During the quarter, our investment team originated $719 million of new investments, we experienced an increase in our net asset value and we again outearned our $0.55 per share quarterly dividend. Again, I congratulate our team for achieving these solid results, especially during such a volatile period. During the first quarter, our net investment income was $0.57 per share, which was $0.02 per share above our quarterly dividend of $0.55 per share and also $0.01 per share above our public guidance at the end of the fourth quarter. From a liquidity perspective, we ended the quarter with approximately $2.2 billion of available liquidity with no meaningful near-term debt maturities. Looking forward to the second quarter, assuming the proposed merger between FSK and FSKR closes before the end of the second quarter, we plan to file a single combined 10-Q for the quarter for the surviving entity, FSK. From an FSKR dividend perspective, our Board has declared a distribution of $0.55 per share for the second quarter, which equates to an annualized yield of 8.7% on a net asset value per share of $25.33 as of March 31, 2021.

[Dan Pietrzak:]

Thanks, Michael. In early November of last year, on our third quarter 2020 conference call, we shared our belief that the fed’s primary focus was reducing unemployment with a secondary goal of targeting inflation at around 2% per year. At that time, unemployment was 6.9%. Today, just 2 quarters later, unemployment is 6.1%, an impressive decline in its own right but even more so when one accounts for the number of eligible workers still choosing not to work due to lingering pandemic-related concerns as well as the extra financial support provided by the most recent stimulus package. Going forward, we believe fed policymakers will continue to lead with the primary focus on the labor market and then hiring in certain – that hiring in sectors such as travel, hospitality and leisure, infrastructure and homebuilding will lead to a continued near-term drop in unemployment with wage growth perhaps occurring sooner than many observers may expect. In our conversations with financial sponsors and portfolio companies, we have been encouraged by their operating and financial performance, which has included meaningful increases in both revenues and EBITDA on a quarterly basis for the last three to four quarters. Going forward, we believe the coming quarters will be marked by continued improvement in free cash flow growth across many sectors, offset only partially by the effects of expected higher near-term inflation. Over the intermediate term, while we continue to believe that modest inflation is healthy for the overall economy, we believe inherent structural forces, including technology and demographic trends, will help balance longer-term inflationary pressures.

[Brian Gerson:]

Thanks, Dan. As of March 31, our investment portfolio had a fair value of $7.6 billion, consisting of 153 portfolio companies. This compares to a fair value of $8 billion and 155 portfolio companies as of December 31, 2020. At the end of the quarter, our top 10 largest portfolio companies represented approximately 23% of our portfolio, which remains in line with our results for the last several quarters. We continue to focus on senior secured investments as our portfolio consisted of 65.5% of first lien loans and 75.8% senior secured debt as of March 31. In addition, our joint venture represented 8.4% of the portfolio, and our asset-based finance investments represented 11% equating to an additional 19.4% of the portfolio, which is comprised predominantly of first lien loans or asset-based finance investments, which we believe have meaningful principal protection. The weighted average yield on accruing debt investments was 8.4% as of March 31, 2021 as compared to 8.5% at December 31, 2020. The modest decline in our weighted average yield during the quarter was primarily associated with the repayment of higher yielding assets during the quarter and new lower yielding investments which closed during the quarter.

[Steven Lilly:]

Thanks, Brian. In terms of color behind our financial results, the $9 million decline in our total investment income quarter-over-quarter was impacted by the following

[Michael Forman:]

Thanks, Steven. The first quarter of 2021 represent a strong start to what we believe will be an active year from an investment standpoint. In addition, our team has been preparing for our proposed merger with FSK and we continue to be excited by the strategic opportunities a single BDC platform will provide our shareholders. The last few years has represented a time of change across our platform from the establishment of what has proved to be an excellent partnership with KKR to repositioning our investment portfolio to a broadening and deepening our team to fortifying our balance sheet, we are well positioned for the future. On behalf of our entire team of more than 200 professionals, we look forward to keeping you informed of our progress, and we appreciate your interest and support. And with that, operator, we would like to open the call for questions.

[Operator:]

Our first question comes from Gary Mandell with LPL Financial. Your line is open.

[Gary Mandell:]

Hi. Good morning. Thank you very much for the call. You mentioned that investment income, if you will, declined a little bit. You’re maintaining the dividend. I imagine there is still a lot of legacy assets at a high interest rate that are going to be repaid in the near future, which would further decrease the investment income, but you’re maintaining your dividend. And after the merger, you’re anticipating a higher dividend yield at 9%. So I’m just curious how, with all of these higher-paying assets coming off of the books, you’re being able to maintain or even increase the dividend after the merger.

[Dan Pietrzak:]

Thanks, Gary, for the question. I think a couple of things. I mean, your points are fair in terms of where we’re seeing some of those repayments and where we’re seeing us putting on new risk in terms of a yield perspective. I think the one thing that we feel quite good about, while sort of repayments, we’re sort of mindful about. But if you look at where we are net leverage for this vehicle, or even net leverage when you think about sort of the pro forma side, that does give us a fair amount of runway to be able to deploy capital, which we’re happy about in this market, right? We haven’t been sort of chasing deals here but a $1.1 billion origination quarter. If you heard the prior call, I think we’ve been pretty happy how we’ve invested in our origination team. So I think that, that runway will provide us some pretty good cover. And then we have been focused on rotating out of non-income-producing assets. I think we’ve got a bunch of line items done over the last several quarters. I think we’re going to continue sort of that focus, but that will also provide some tailwinds.

[Gary Mandell:]

Is there a way to quantify given, for lack of a better term, the legacy assets that are still on there. Is there a way to quantify the negative effect of those ongoing repayments will have on investment income over the next several quarters.

[Dan Pietrzak:]

It’s probably a little bit hard to quantify. I mean, I think you can see where overall yields did move this quarter. If you look at the prepared remarks, I think it was roughly sort of 10 basis points portfolio wise. And then you have to remember, there is a little bit of a mix here, right? Because when we are getting repaid on certain assets that generally could be accretive to fee income. If you looked at our fee income, specifically in FSKR over the last couple of quarters, we had a fairly large origination number Q4, quite strong origination number sort of here for Q1. So I think there is a fee income on the other side of that to offset.

[Gary Mandell:]

Alright. Thank you very much. I appreciate it.

[Dan Pietrzak:]

Thank you.

[Operator:]

Our next question comes from Finian O'Shea with Wells Fargo Securities. Your line is open.

[Finian O'Shea:]

Hi everyone. Good morning. Just first small question. I think, Brian, you mentioned was 76% originated by KKR and then I think also on my notes here, you also give the percent originated by the FS/KKR adviser as well. Can you refresh us on both those numbers?

[Brian Gerson:]

Yes. 76% is a good number. I think the FSKR joint venture is – I don’t have the number in front of me. I think it’s close to 80%.

[Dan Pietrzak:]

I was going to say, just to put that in context, I mean, the numbers are different by sort of vehicle. Obviously, the entities that came together that form this entity, that number would have been much closer to almost entirely non-KKR in April 2018.

[Finian O'Shea:]

Right. The CCT is the difference? I thought…

[Dan Pietrzak:]

Yes.

[Finian O'Shea:]

Okay. And on the dividend at 9% target yield is that – I know there is going to be a little bit of a spillover payout maybe other credit facility changes, I’m not sure, but what do you in terms of the FSKR $0.55 level translated to FSK shares and so forth? Do you see this dividend holding up? Is that – is it – is this $0.55 reflects 9% of what will perform post-merger assuming that plays out?

[Dan Pietrzak:]

Yes. And Fin, I think you had a couple of points in there and let me try to answer those and then Steven Lilly, feel free to sort of add to this. I mean I think we’ve been happy with the response that we’ve gotten on the overall sort of dividend policy and going back to the sort of prior question here, I think we do feel good about being sort of under sort of target leverage I think this is the market where we actually feel pretty good being sort of under target leverage. I think – I think the point you were getting at is you are correct, FSKR would have to sort of pay out sort of any and all spillovers as part of the merger being completed. I think our estimate is that, that $0.55 sort of payout that’s been declared should really cover most, if not all, of that.

[Finian O'Shea:]

So the $0.55 this quarter will be – okay. That’s helpful. I guess, a final question on the Global Atlantic merger, correct me if I’m – apologies if it’s – that’s not the arrangement. I’ve only casually looked at that. But it does say that’s a significant amount of private credit inflow to the platform – presumably your part of the platform. Can you tell us how – or what kind of impact you expect? How much of this will be investing alongside of you versus elsewhere? And anything else that do you think we should consider?

[Dan Pietrzak:]

Yes. No, sure, happy, Fin. And just for context, obviously, that was – Global Atlantic is now a subsidiary of KKR, and you can look at the all the various kind of public statements out there, we own roughly just north of 60% of that. As with most insurance companies, their main focus is not middle market lending, right? Their main focus is mainly investment-grade sort of corporate and other forms of secured transactions from a capital perspective, kind of IG is the focus. So we do believe it’s quite accretive to the whole sort of platform when thinking about our ability to have size and scale and grow sort of staffing. But again, just the focus of that entity is really not in that middle-market sort of lending bucket. There can be some deals that they might participate in, but it will be on the smaller side.

[Finian O'Shea:]

Okay. Thanks helpful. Thank you.

[Dan Pietrzak:]

Thank you, Fin.

[Operator:]

Our next question comes from Casey Alexander with Compass Point. Your line is open.

[Casey Alexander:]

Yes. Good morning. I’m just kind of wondering, I’ve always been kind of struck by the disparity of the liability structure of the two BDCs. As you consider the merger of the two BDCs noting that FSKR has a much more secured credit facility oriented liability structure and FSK, more unsecured debt. How do you look at the balance between the two of those, once you have the entities merged? And what type of opportunities are there to continue to drive down your cost of capital?

[Dan Pietrzak:]

Yes. And Casey, very good question. I think we’ve acknowledged that in the past out of FSKR, they haven’t had the same necessarily runway as others to issue right, harder to do when you’re sort of non-traded. They were obviously smaller until sort of merged together and then the rating agencies who cover FSKR, just not as broad of a set of sort of agencies. So I would think about on a pro forma go-forward basis, us targeting a capital structure that looks more like FSKR – I’m sorry, FSK. I think we’ve been very happy with the long-dated and flexible nature of the revolver, I think we will continue to be interested in tapping that unsecured market. I think we’ve been happy that we’re able to sort of access the CLO market. So I think we like kind of our mix, but I think you should assume it’s trending more towards what FSK looks like today.

[Casey Alexander:]

Okay, thank you.

[Operator:]

There are no further questions. I’d like to turn the call back over to Dan Pietrzak for the closing remarks.

[Dan Pietrzak:]

Well, thank you to everyone for taking the time for the call this morning. We look forward to talking with you again in the coming months. Have a good day.

[Operator:]

Ladies and gentlemen, this does conclude the program. You may now disconnect. Everyone, have a great day.