Good morning, everyone. Welcome to FS KKR Capital Corp's Third Quarter 2022 Earnings Conference Call. Please be aware that this conference is being recorded. Now, Robert Paun, Head of Investor Relations, will start the introduction. Mr. Paun, please go ahead.

Thank you. Good morning, and welcome to FS KKR Capital Corp's Third Quarter 2022 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 on November 7, 2022. 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 September 30, 2022. A 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 third quarter earnings release that was filed with the SEC on November 7, 2022. 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, Chairman and Chief Executive Officer; 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.

Thank you, Robert, and good morning, everyone. Welcome to FS KKR Capital Corp's Third Quarter 2022 Earnings Conference Call. FSK again delivered strong earnings in line with our quarterly guidance. Our results were driven both by the positive impact of rising interest rates and consistent dividend and fee income. During the third quarter, we generated net investment income totaling $0.76 per share and adjusted net investment income totaling $0.73 per share. This compares to our public guidance of approximately $0.76 and $0.72 per share, respectively. Consistent with the overall private debt market, the value of our investment portfolio declined during the third quarter due primarily to spread widening and market multiple contraction. The 2.1% decline in the value of our investment portfolio equated to a 4.2% decline in our net asset value quarter-over-quarter. As Dan will discuss in more detail during his comments, the FS KKR adviser continues to maintain its high-quality credit standards and disciplined underwriting process. We originated approximately $900 million of investments during the third quarter, and we ended the quarter with ample liquidity totaling approximately $2.75 billion. Based on our third quarter financial results, our Board has declared a fourth quarter total distribution of $0.68 per share, which consists of our quarterly base distribution of $0.61 per share and a supplemental distribution of $0.07 per share. In terms of our forward-looking view, while we believe transaction flow for the next few months will continue to be below historical norms, we also believe our favorable liquidity position will enable us to take advantage of quality investment opportunities they present themselves during 2023 and beyond. Additionally, as Steven will discuss later in the call, our net investment income will continue to be positively impacted by the rise in base rates as almost all of our yielding debt investment portfolio is comprised of floating rate investments. And with that, I'll turn the call over to Dan and the team to provide additional color on the market and the quarter.

Thanks, Michael. From a market perspective, in the near term, we continue to expect above-average levels of volatility, given the Federal Reserve's primary focus on curbing inflation. We believe the Fed's actions and the resulting impact on the economy will continue to create compelling investment opportunities for large-scale private debt investors, such as KKR, over the next several quarters. Our belief is based on the view that before the Fed began increasing interest rates, the private debt market already had established itself as an attractive alternative to the syndicated debt markets. As a result, going forward, we believe sponsors are likely to continue to trust the execution capabilities of the largest platforms in the private debt industry. That being said, we do believe it will take some time for the Federal Reserve's actions over the last several months to be fully absorbed by the economy. And therefore, we believe M&A transaction volumes will remain below average until investors can gain confidence that inflation has stabilized and a greater consensus forms around what the broader economic landscape might look like going forward. Despite the current market backdrop, the vast majority of our portfolio companies continue to experience solid fundamental performance, which we attribute to our focus on larger companies at the upper end of the middle market. Companies with strong competitive positions, resilient cash flows, and businesses in noncyclical industries. These types of portfolio companies, due in large part to their size and market presence, are continuing to find ways to pass along price increases as evidenced by the weighted average year-over-year EBITDA growth of 12% across portfolio companies in which we have invested since the establishment of the FS/KKR Advisor in April of 2018. In addition to this EBITDA growth, by continuing to focus on larger companies, we have increased the weighted average EBITDA of our portfolio companies to $207 million as of the end of the third quarter, compared to just $78 million at the end of the second quarter of 2018. In terms of our quarterly results, Michael mentioned the decline in value associated with our investment portfolio. To us, it seemed natural that some level of decline is appropriate, simply from a mark-to-market perspective. More specifically, our independent valuation firms factored in spread widening in our valuations of approximately 25 to 100 basis points, depending on the seniority of the facility. This is in line with the wider pricing we are seeing in our more recent originations. Separately, an example of a mark-to-market move is highlighted in one of our largest attractors during the third quarter, athenahealth. The company continues to perform in line with our underwriting expectations, yet the value of the asset declined due to the movement in rates and spreads as opposed to underlying performance issues. Certain companies in our portfolio, though, have been meaningfully impacted by a combination of inflation, supply chain issues, and the increasing interest rate environment, which contributed to a portion of our portfolio depreciation during the quarter. Given the macroeconomic environment still includes many uncertainties, we are exercising caution with respect to new originations. Additionally, the human capital investments that we have made in our platform over the last several years enable us to proactively manage our remaining legacy portfolio from a position of strength. While assessing our sector exposure today, we take comfort in the fact that we have focused on more defensive industries over the past several years as our top industry exposures today include software services, healthcare services, and insurance services businesses, which represent approximately 37% of our portfolio. This compares to more cyclical and volatile sectors such as materials, capital goods, and energy, which represented approximately 34% of the total portfolio at the end of the second quarter of 2018 and today represent only 17% of our portfolio. Turning to our quarterly investment activity. During the third quarter, we originated $907 million of investments, which were primarily focused on fundings and add-on financings to existing portfolio companies. Approximately 81% of our originations came from opportunities and companies previously invested in by KKR. Our new investments, combined with $651 million of net sales and repayments, when factoring in sales to our joint venture, equated to a net portfolio increase of $256 million during the quarter. In terms of interest coverage, at the end of the third quarter, our portfolio companies had a median interest coverage ratio of 2.3x. Furthermore, most of our borrowers have access to revolving lines of credit, which provides them with additional committed liquidity should an economic downturn occur. With that, I'll turn the call over to Brian to discuss our portfolio in more detail.

Thanks, Dan. As of September 30, 2022, our investment portfolio had a fair value of $15.8 billion, consisting of 195 portfolio companies. This compares to a fair value of $16.2 billion and 192 portfolio companies as of June 30, 2022. At the end of the third 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 61.9% first lien loans and 70.5% senior secured debt as of September 30. In addition, our joint venture represented 9.3% of the fair value of the portfolio and asset-based finance investments represented 11.6%, equating to an additional 20.9%, which is comprised predominantly of first lien loans or secured asset-based finance investments. The weighted average yield on accruing debt investments was 10.4% as of September 30, 2022, compared to 9.2% as of June 30. As a reminder, the weighted average yield is adjusted to exclude the accretion associated with the merger with FSKR. The increase in our weighted average yield in the third quarter was primarily associated with the continued rise in base rates, a benefit, which will continue to accrue in our favor given the Fed's actions last week. During the third quarter, excluding the impact of merger accounting, we experienced net portfolio depreciation on investments of approximately $376 million. Approximately 75% of the portfolio depreciation we experienced during the quarter was tied primarily to market technicals such as spread widening and market multiple contraction, with the remaining 25% due to specific company performance issues related to the current economic environment. The largest negative movers in our portfolio, which were impacted by credit-related issues during the quarter, were by Rider Finance LLC and NBG Home. I would also point out that these names both were placed on nonaccrual during the third quarter, which means they are already factored into our third quarter reported earnings. Our new nonaccrual investments during the quarter had a combined fair market value of $56 million. In addition, there were 3 investments that were removed from nonaccrual status during the quarter with a fair market value of $13 million. Based on the third quarter's activity, as of September 30, 2022, nonaccruals totaled 5% of our portfolio on a cost basis and 2.5% on a fair value basis, compared to 4.9% on a cost basis and 2.9% on a fair value basis as of June 30, 2022. And we would note that none of the nonaccruals were related to assets originated by the FS/KKR Advisor since April of 2018. And with that, I'll turn the call over to Steven.

Thanks, Brian. The recent increases in interest rates have positively impacted our net investment income. As Brian mentioned, we are well positioned to continue to benefit from the Fed's most recent action as 89% of our debt investments are floating rate. From a starting point of September 30, a 100 basis point move and higher and short-term rates ultimately will increase our net investment income by approximately $0.25 per share per year, which equates to approximately $0.06 per share per quarter. As a reminder, there is a detailed breakout of how every 50 basis points of interest rate increases is expected to positively impact our investment income provided in our 10-Q filing. In terms of our financial results for the third quarter, total investment income increased by $32 million quarter-over-quarter, largely driven by increased interest income. The components of our total investment income during the quarter were as follows: Total interest income was $318 million during the third quarter, an increase of $31 million quarter-over-quarter. Dividend and fee income totaled $93 million during the third quarter, an increase of $1 million quarter-over-quarter. Our dividend and fee income during the third quarter is summarized as follows: $50 million of recurring dividend income from our joint venture, other dividends from various portfolio companies totaling approximately $17 million, and fee income totaling approximately $26 million. Our interest expense totaled $96 million, an increase of $13 million quarter-over-quarter, due to the fact that we were basically operating at target leverage throughout the quarter as well as the impact of rising base rates. Our weighted average cost of debt was 4.2% at September 30. Management fees were $61 million during the quarter, a decrease of $2 million quarter-over-quarter. Incentive fees totaled $25 million during the third quarter, which is net of the $15 million incentive fee waiver. As previously noted, as part of the FSK FSKR merger, which closed in June of 2021, the adviser agreed to waive $90 million of incentive fees spread evenly over 6 quarters, which began during the third quarter of 2021. As a reminder, the fourth quarter of 2022 will be the final quarter of the incentive fee waiver. And as we have discussed on prior earnings calls, the adviser does not earn an incentive fee on any of the merger-related accretion associated with FSK's acquisition of FSKR. The detailed bridge in our net asset value per share on a quarter-over-quarter basis is as follows: our ending 2Q 2022 net asset value per share of $26.41 was increased by GAAP net investment income of $0.76 per share and was decreased by $1.21 per share due to a decrease in the overall value of our investment portfolio. Our net asset value per share was reduced by our $0.67 per share dividend paid during the quarter and increased by $0.01 per share due to share repurchases. The sum of these activities results in our September 30, 2022 net asset value per share of $25.30. From a forward-looking guidance perspective, we expect fourth quarter 2022 GAAP net investment income to approximate $0.74 per share, and we expect our adjusted net investment income to approximate $0.75 per share. Detailed fourth quarter guidance is as follows: our recurring interest income on a GAAP basis is expected to approximate $347 million. We expect recurring dividend income associated with our joint venture to approximate $53 million. We expect other fee and dividend income to approximate $31 million during the fourth quarter. From an expense standpoint, we expect our management fees to approximate $61 million. We expect incentive fees net of the $15 million quarterly waiver to approximate $24 million. We expect our interest expense to approximate $110 million, and we expect other G&A expenses to approximate $11 million. During the fourth quarter, we expect our excise taxes to approximate $17 million. As many of you know, our spillback level currently approximates 2 quarters' worth of dividends, which we believe represents a healthy balance of having some spillback cushion, while at the same time not allowing our spillback balance to grow too large. We expect our excise taxes to be largely offset by the accretion of our investments due to merger accounting, which is why our projected fourth quarter GAAP net investment income is $0.01 per share below our projected adjusted net investment income. In terms of the right side of our balance sheet, our gross and net debt to equity levels were 128% and 119%, respectively, at September 30, 2022, this compares to gross and net debt to equity of 125% and 115%, respectively, at the end of the second quarter of 2022. At September 30, our available liquidity was $2.75 billion. At the end of the third quarter, approximately 52% of our drawn balance sheet and 42% of our committed balance sheet was comprised of unsecured debt and our overall effective average cost of debt was 4.2%. And with that, I'll turn the call back to Michael for a few closing remarks before we open the call for questions.

Thanks, Steven. As we begin focusing on 2023, I believe we are well positioned with respect to our investment and portfolio management team, strong capital structure, and committed liquidity position. Going forward, we believe the benefits of size and scale that we and a very few other debt providers offer will further separate us from the broader industry in terms of both transaction volume and asset quality. As we near the completion of our internal portfolio rotation, we believe the forward opportunity for our platform is extremely attractive. And as always, we thank you for your continued support. And with that, operator, we would like to open the call for questions.

And today's first question will come from John Hecht with Jefferies.

Dan, could you describe the current deal environment? How many deals are you evaluating? What are their characteristics? Would you say their quality is higher or lower compared to a few years ago?

Yes, John, it's Dan. I can start with a couple of different points. Total deal volumes are down, as this business is heavily influenced by M&A activity, which has slowed. However, we are also seeing some deals that would typically go to the syndicated market because the private debt market is currently the accessible option. This is a positive development, and we mentioned it in the script. There are significant advantages for private debt in this situation, as it's tied to long-term capital. I believe these advantages are still present and even intensified. The new lending environment is particularly attractive. For instance, the OID is about 1 point wider than it was last year, and spreads are approximately 100 basis points wider than a year ago, with better call protections. Ultimately, it's a lender-friendly environment that we are excited about, and I think this trend will continue for a while. While 2023 may start off bumpy, platforms that can operate in this market are likely to encounter very good investment opportunities.

And I think I'd just add, I think the quality of what we're seeing is good. Quite honestly, given the slowing in deal activity, sponsors are really selling their better companies because that's where they think they're going to get the best possible multiples given what's happened overall in the market. So I think you're seeing better companies and better structures overall.

Okay. That's very helpful. I believe you have achieved everything you aimed for as stated in your Analyst Day last year, so congratulations on that. Looking ahead to the coming year and quarters, how much of the legacy portfolio do you still need to rotate, and what do you anticipate the timing will be? Additionally, are there any significant maturities next year that we should consider regarding management and liability structure?

Yes. Regarding liabilities, the short answer is that we have none in terms of maturities. We feel quite confident about our position concerning unsecured debt. As we mentioned in our last call, we increased the revolver size and extended it through the last quarter. We take pride in our liability structure. In terms of the legacy book rotation, back in April 2018, it represented about 70% of our income-earning portfolio, but it's now down to approximately 10%. The entire legacy book, including non-income-producing assets, is likely around 15% of the portfolio. Upon closer examination, five names account for more than half of that portion. One of these is set to repay in the near term, and another is an amortizing position. We're actively engaged with three others—PRG, JWA, and Global Jet—aiming to maximize their value and consider selling those businesses. We expect to see significant activity over the next two years. Overall, we're satisfied with how we've managed that rotation. Additionally, we've seen meaningful increases in the average weighted EBITDA and a considerable shift in sector exposure from less cyclical industries. There's still some work to be done, but we see a clear path forward.

And one moment for our next question, that will come from the line of Casey Alexander with Compass Point Research and Trading.

I have 3 here. First of all, $300 million downstream to the credit opportunities portfolio. It feels like a lot this quarter. And what's the opportunity set there that has you driving that much capital down into COP?

I'll check on that. I don't think that $300 million is necessarily a large amount when I consider the last four to six quarters. That said, we are likely looking at that entity from a total return perspective and evaluating its ability to provide regular dividend income to FSK. The main focus is on determining our target leverage, which we're getting close to. Overall, we are pleased with the current status of that entity and its growth. As mentioned in Steven's prepared remarks, we have over $50 million in recurring dividend income, and we anticipate that will continue.

Secondly, Steven mentioned that the excise taxes could be $17 million in the fourth quarter. With a variable dividend structure like you have, which is an attractive dividend structure, you can really manage your distribution to your earnings stream. So is it really necessary to have that much spillback when you're managing your distribution stream against your earnings and to continue to have $17 million is a reasonably significant charge against your earnings?

And I'll let Steven sort of add to that. I think we've been thinking about it to ensure that we had kind of 1 to 2 sort of quarters of spillback income, we're kind of at the midpoint, a little bit closer to sort of 2 quarters there. But that's been I think our stated goal and stated objectives. But Steven, you might want to add to that?

Yes. Our target is, as Dan mentioned, on the low end one quarter and on the high end three quarters. This range is what many BDCs typically aim for. We appreciate your comments on the dividend and our payout, which we believe investors find appealing. Considering the excise tax, it is around 4% of our quarterly revenues on an annual basis, which aligns with others in the industry. We believe that our total spillback, being just over two quarters of dividends, puts us in a strong position. We might be a bit conservative, but it feels like a very comfortable position to maintain.

Yes. Well, I would just point out that these spillbacks grew when BDCs had really a fixed dividend level and their earnings would fluctuate, and they needed to make sure that they had a level that would protect them for periods where their earnings fell below the distribution rate. But the variable dividend structure tends to protect the BDCs better from that, and I'm not sure such a large spillback continues to be necessary for a lot of BDCs that have taken that structure. But that's my own soapbox. My last question is, in relation to looking at your portfolio, Dan, you can see where the pressure points are in the portfolio where they're coming because you get the numbers from each of your companies. How aggressively can you get in front of problems with portfolio companies by working with the portfolio company, by working with the private equity sponsor and creating amendments and modifications that allow this portfolio of companies the flexibility to get through this cycle and come out better competitors on the other side?

Yes. Thanks, Casey. I mean I'd put it in a couple of different buckets, right? I think one of the great advantages of the private debt market is allowing sort of lenders generally to do that, right? These documents are tighter, they have generally financial covenants. I think you want to be a good and responsible lender, but you want to sort of derisk your positions over time. And we haven't seen, I think, anything outside the norm of kind of amendment activity. And we will not be surprised if that does occur over the coming quarters. I think our expectation and our approach there is we will work with these companies and work with these sponsors to allow them to get to the other side of this. But that said, we're going to look to both reduce risk and where we can reprice our portfolio, albeit to be honest, I think we're going to be more focused on risk. And then I would point out, and I mentioned this in my prepared remarks, I think we've got the team to do that, right? We've talked about this on a handful of prior calls. We've built on our private credit business materially, we've built out our work out and governance team, we've built out our portfolio monitoring team. So that is a major focus for us, Casey. If you think about just we will continue to do kind of deals that we find very attractive as an environment, we will continue to see sort of payoffs in the portfolio. We will continue to look to reduce risk and/or sort of reprice the existing portfolio. So that's the focus for the handful of coming quarters.

And that will come from the line of Ryan Lynch with KBW.

First question I had was just, you talked about kind of looking forward fundings or new kind of portfolio growth will probably be focused more around funding commitments and adding on to existing portfolio companies. But then at the same time, you're talking about the environment being significantly better for deploying capital, spreads have widened and covenants have gotten better, leverage levels are down and just general stronger portfolio companies are getting funded today. But because your leverage level is where it is and kind of your focus just on mostly funding existing commitments and add-ons. Does it put you in a spot where you guys aren't going to be able to benefit as much from kind of the overall outside of your existing portfolio companies, kind of the new deals that are taking place in this marketplace today?

Yes. I don't think that's exactly the way I would look at it. I mean I'm just off the top of my head, one of the biggest realizations in Q3 was our joint venture with Home Partners of America that realized almost $300 million of cash proceeds. It was probably a 2x money multiple deal. I can think of 3 other names that have either repaid or announced to repay, and we're going to kind of recycle that money. One of those names, we actually did the financing for the new sponsor. So I think repayments are definitely slower. I don't expect that to change sort of meaningfully, but I think we will continue to see some, and we will continue to sort of see new deal opportunities and then we are kind of in the middle of our target leverage range. It is important that we kind of stay within that in our mind. So we'll be balanced. So maybe we're not going to be able to be as forward-leaning as we might necessarily like. But I do think we'll be able to capitalize on some of that. And going back to Casey's question, I do think some of the existing portfolio when you do either do an add-on or if there is an amendment request that comes on, you have a very good opportunity potentially to reprice or derisk the entire loan structure.

And that will come from the line of Kenneth Lee with RBC Capital Markets.

Just one follow-up on the previous question. You mentioned you don't see debt paydowns picking up anytime soon. One of the key factors that could drive a pickup. Is it going to really depend on M&A activity? Or would there be anything else that could potentially drive a pickup in debt pay down volumes over time?

Thanks, Kenneth. I believe M&A will be the most significant factor. We aren't particularly concerned about the immediate maturities of our asset portfolio, as most of those loans are structured as 5, 6, or 7-year loans. Historically, the weighted average life of our loan book is likely around 3 to 4 years, so it does refresh over time. I expect to see an increase in M&A activity, along with a slight uptick in broadly syndicated markets. These two factors are likely interconnected. For this quarter, we completed $900 million in new deals, and you can observe the repayment figures, which I mentioned for both Q3 and Q4 in relation to our portfolio's performance. You're correct; M&A is the primary driver.

One follow-up question. You mentioned that all the nonaccruals were outside of the FS/KKR Advisor origination investments. Could you provide more insight into the credit performance of some of the newer investments that were originated since 2018?

Yes. I would like to highlight a few points. We discussed earlier that the year-on-year EBITDA growth for our investments has been quite impressive, achieving a 12% increase. This gives us confidence moving forward. The newer investments have contributed significantly to EBITDA, and since April 2018, the weighted average EBITDA has nearly tripled as we focus on the higher end of the middle market. Regarding nonaccruals, while we saw a few new names that we're not pleased about, there were also some that exited. Overall, the nonaccrual movement was about 10 basis points. As mentioned, we've completed around $21 billion in deals since April 2018, none of which appear in the nonaccrual figures, which we consider important. Additionally, the income-generating assets attributed to the legacy adviser account for approximately 10%, yet they represent about 60% of the nonaccrual cost basis. We recognize there is work to be done, but we're proud of our progress in new origination and will continue to rotate the portfolio.

Thank you. And speakers, I'm showing no further questions in the queue at this time. I would now like to turn the call over to Mr. Dan Pietrzak for any closing remarks.

I wanted to thank everyone for their time and questions today. We're always available if you have any follow-up items, please do not hesitate to reach out. Thanks again, and have a good day.

This concludes today's conference call. Thank you for participating. You may now disconnect.