FS KKR Capital Corp. II
Q3 2020 Earnings Call Transcript

Published: 13 Nov 2020

[Operator:]

Good morning, ladies and gentlemen, and welcome to FS KKR Capital Corp II's Third Quarter 2020 Earnings Conference Call. Your lines will all be in a listen-only mode during the remarks from FS KKR's management. At the conclusion of the company's remarks, we will begin the question-and-answer session. Please note that this conference is being recorded. At this time, Robert Paun, Head of Investor Relations, will proceed with the introduction. Mr. Paun, please begin.

[Robert Paun:]

Thank you. Good morning, and welcome to FS KKR Capital Corp II's third quarter 2020 earnings conference call. Please note that FS KKR Capital Corp II may be referred to as FSKR the fund or the company throughout the call.

[Michael Forman:]

Thank you, Robert, and welcome, everyone to FS KKR Capital Corp II's third quarter 2020 earnings conference call. First, let me offer my continued well wishes to each of you, your loved ones and your co-workers as our country continues to adapt to a post-COVID world. The FS KKR team continues to function largely in a virtual work environment. Thanks to the ongoing dedication of our investment and operating teams, the day-to-day cadence of our business somehow has begun to seem almost normal. I continue to be extremely proud of the job our team is doing during these extraordinary times.

[Dan Pietrzak:]

Thanks, Michael. From a macro perspective, many of the trends we highlighted in our second quarter earnings calls have continued to develop, including a rebuilding of our investment pipeline alongside a re-emergence of M&A activity. And while the market is still not back to pre-COVID levels in terms of transaction volumes, we believe it has recovered to approximately 75% or 80% of those levels.

[Brian Gerson:]

Thanks, Dan. As of September 30, our investment portfolio had a fair value of $7.3 billion, consisting of 160 portfolio companies. This compares to a fair value of $7.3 billion and 154 portfolio companies as of June 30, 2020. At the end of the third quarter, our top 10 largest portfolio companies represented 26% of our portfolio, which remains in line with our results to the last several quarters. We continue to focus on senior secured investments as our portfolio consisted of 67% of first-lien loans and 77% senior secured debt as of September 30. The weighted average yield on occurring debt investments was 8.6% at September 30, 2020, as compared to 8.7% at June 30, 2020. The decline in our weighted average portfolio yield was primarily due to the change in certain investment spreads and maturity coupled with LIBOR contracts which reset at lower levels during the quarter. From a non-accrual perspective, as of the end of the third quarter, our non-accruals represented approximately 9.2% of our portfolio on a cost basis , and 4.2% of our portfolio on a fair value basis, compared to 11% and 5.4% as of June 30. During the quarter, we placed two investments on nonaccrual. Belk, a mall based retailer for the cost basis and fair value of $42 million and $19.2 million, respectively, as well as Intelsat Jackson, the communications satellite provider, with a cost basis and fair value of $3.5 million and $2.4 million respectively. From an overall valuation perspective, our investment portfolio increased by approximately 1% or $59 million during the quarter. The details associated with our quarterly valuation results are as follows. The total amount of realized and unrealized appreciation we experienced across the portfolio during the quarter was $336 million. A quarterly appreciation includes the reversal of $207 million of unrealized appreciation associated with certain portfolio company restructurings, including Borden Dairy, FourPoint, Mood Media and Arena.

[Steven Lilly:]

Thanks Brian. My comments will be less focused on the reporting financial metrics already contained in our earnings press release in 10-Q, but rather focus more on the color behind our results. Hopefully linking them in a more transparent and informative way to the broader comments on which Michael, Dan and Brian have touched. First, the $4 million increase in our investment income this quarter was related to an increase of $12 million in dividend income from both our joint venture and asset based finance investments, which was partially offset by a decrease of $2 million and fee income and $6 million of interest income. As a reminder, 98% of our floating rate investment portfolio has floors which average 91 basis points, our recurring dividend income from our JV totaled $21.9 million during the quarter. As many of you know we typically expect this recurring dividend to approximate between $17 million and $22 million on a quarter-to-quarter basis. Our interesting expense declined by $9 million during the quarter as we've benefited from the reduction in LIBOR as approximately 86% of our drawn balance sheet is floating rate. Management fees decreased by $1 million during the quarter due to the lower amount of average gross assets during the quarter compared to the prior quarter. The detailed bridge in our net asset value per share on a quarter-over-quarter basis is as follows. Our starting 3Q 2020 net asset value per share of $24.22 was increased by net investment income of $0.52 per share and was further increased by $0.35 per share due to an increase in the overall value of our investment portfolio. Additionally, our net asset value per share was positively impacted by share repurchases of $0.12 per share during the quarter. And our net asset value per share was reduced by our $0.55 per share dividend. The sum of these activities results in our September 30 net asset value per share of $24.66. From a forward-looking perspective, the bridge from our third quarter net investment income per share of $0.52 to our fourth quarter recurring net investment income per share guidance of $0.52 to $0.55 is as follows. Our recurring interest income is expected to be $5 million higher due to overall growth in our investment portfolio. We expect recurring dividend income associated with our JV to approximate $21 million. We expect other fee and dividend income to approximate $14 million during the quarter which flat quarter-over-quarter. From an expense standpoint, we expect our interest expense will increase by approximately $2 million during the fourth quarter due to an increase in origination activity. We expect management fee and other general and administrative expenses will remain relatively flat during the quarter. As a reminder, over the long-term we expect our dividends per share will equate to a 9% yield on our net asset value per share. Though, we acknowledge there will be certain quarters where our annualized yield maybe great or less than this range due to quarter-to-quarter fluctuations in the business from an operational standpoint. That being said, we are pleased that during the first three quarters of 2020, despite the far-reaching effects of COVID and the resultant investment portfolios, we have been able to exceed our 9% target dividend yield. Obviously, our dividend policy of achieving a 9% target dividend yield on our net asset value means that, overtime, it would be normal for our quarterly dividend to fluctuate somewhat in concert with the quarter-to-quarter change in our net asset value. In terms of the right side of our balance sheet, our gross and net debt to equity levels are 78% and 73%, respectively. These leverage levels represent a modest decline from our leverage levels during the first and second quarter of this year. Our available liquidity of $1.8 billion equates to approximately 25% of the value of our investment portfolio, which continues to be a very comfortable percentage. Our capital structure is approximately 90% secured with an overall weighted average cost of debt of 3.1% Finally, from an unfunded commitments perspective, as of September 30, 2020, we had approximately $465 million of unfunded debt commitments, of which $128 million represented revolver facilities and $210 million of unfunded equity commitments, primarily associated with commitments related to our asset-based finance portfolio. As we said during both our first and second quarter earnings calls, the majority of our unfunded debt and equity commitments are generally used for capital expenditures for acquisitions and therefore subject to performance or other threshold tests including, in certain situations, our specific consent. As a result, while these commitments are disclosed in our 10-Q for informational purposes, we do not believe they will be drawn in any meaningful capacity on a quarter-to-quarter basis. And with that, I'll turn the call back to Michael for a few closing comments before we open the call for questions.

[Michael Forman:]

Thanks, Steven. As we have mentioned throughout this call, there is no shortage of issues our world currently faces. And we believe the federal government will continue to play an active role in the economy for the foreseeable future. That said, we continue to believe the long-term benefits that we believe would accrue to investors from the establishment of the FS KKR platform are beginning to materialize in tangible ways. From deep sponsor relationships to the rigor of investment committee decision-making, to proactive portfolio management, to broad-based dedicated workout teams, to seasoned BDC industry operators, the best of what we structured and planned for as we establish the FS KKR Advisor seems to be coming to fruition at a very opportune time. We will look forward to continuing to update you on future progress. And with that, operator, we would like to open the call for questions.

[Operator:]

And our first question comes from the line of Rick Shane with JP Morgan. Your line is open. Please go ahead.

[Rick Shane:]

In terms of the sales nonaccrual, that had been on nonaccrual at FSK previously, and I believe it's two different securities. Can you just talk about the decision to move to security at FSKR on to nonaccrual as well, please?

[Michael Forman:]

Thanks, Rick. And you're correct, it is a different security. I think there's nothing a scholar specific about the name other than being kind of a mall based retailer. Obviously impacted by COVID. We actually don't have any knowledge of them, not expecting to pay in the near term, they've actually made all of their recent payments up and down the capital structure both first and secondly, including amortization payments. So we thought the prudent thing to do is have this on nonaccrual.

[Rick Shane:]

That's helpful color especially the continued payments. And then obviously, the other big move during the quarter was the restructuring or production resource from a loan to an equity investment. When we look at the history of that nonaccrual that seems to be given the timing of going on nonaccrual in the first quarter, a COVID related challenge, is that correct? And when you look forward on the path given the equity investment and potentially the COVID sensitivity. How do you think that plays out? Is this a recoverable investment?

[Michael Forman:]

It's very much a COVID impacted name, I mean, just to level set, it is sort of, and industry leader, the industry leader in providing in production services lighting sort of volume et cetera. Broadway's in a big focus for them. Obviously, with the status of large scale events and Broadway in particular, the business has been challenged. I think we're quite happy with where we've gotten to on this. It's been a lot of hard work, I think we're quite happy with the team there. And what their footprint is. I think their road to recovery will be -- we'll call dictated by what happens with the pandemic, and when things start to open up, but we think -- we think a lot of hard work still in front of them. But I think, we're satisfied with where we sit today being cognizant of the meaningful impact that COVID has had on this thing.

[Operator:]

Thank you. And our next question comes from Finian O’Shea with Wells Fargo Securities. Your line is open. Please go ahead.

[Finian O’Shea:]

Just a question on the CLP's credit facility that was amended to a higher interest rate, Alpha Street 30. Which is a little bit against the trend. Obviously, by July 30 a lot better by understanding, those processes can be in place for some time. So any color you can provide on why those -- yes, I guess lending conditions may have gotten more tight on the joint venture?

[Michael Forman:]

Yes, Finian it's a fair question. I think a lot of it is timing related. I think we've used -- we've seen a euphoria in the market as it relates to financing spreads on deals like this. But that's probably even more, post-August of the middle of August. The terms here, here were agreed in what's called a bit of a harsher environment and in the middle of the summer. That said, I think it was it's a one year extension, I think we continue to optimize, and in some ways kind of clean up the overall liability structure of FSKR. So it's a one year extension. But I think your point is right, with where we sit today versus when that would have been specifically negotiated.

[Finian O’Shea:]

And I guess just a follow up on a higher level? I think it's IPO about six months ago, maybe less. But on any, obviously, you have a history of some merging the BDC vehicles together, understanding so expensive thing to talk about. But any, like higher level direction on how you view these vehicles being separated. Is it still a medium to long term desire to have them come together? And anything, any sort of color on the journey that, that you need to go through before that would happen?

[Michael Forman:]

Now, it's a good question. And we've obviously got that question a bunch of times on this call last quarter, or sort of along the way. I mean, we've obviously been focused on kind of performance and getting FSKR deployed. I think we're very happy. This is, the first kind of full public quarter as a public entity, so it's clearly something that remains in our minds. And I think the color we've gotten for many years it's something that can make a lot of sense. I think we've just been focused on this sort of quarter now. But it's a very fair question to ask.

[Operator:]

Thank you. And I'm showing no further questions at this time and I would like to turn the conference over to Mr. Dan Pietrzak for any further remarks.

[Dan Pietrzak:]

Thank you. We want to thank everyone again for your time today. We do hope that you and your families remain safe and healthy. And we do look forward to talking with you again soon. Thank you.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day.