FS KKR Capital Corp Q4 FY2025 Earnings Call

Good morning, ladies and gentlemen. Welcome to FS KKR Capital Corp.'s Fourth Quarter and Full Year 2025 Earnings Conference Call. Please note that the conference is being recorded. At this time, Anna Kleinhenn, Head of Investor Relations, will proceed with the introduction. Ms. Kleinhenn, you may begin.

Thank you. Good morning, and welcome to FS KKR Capital Corp.'s Fourth Quarter and Full Year 2025 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 yesterday. 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 December 31, 2025. A link to today's webcast and the presentation is available on the For Investors 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 fourth quarter earnings release that was filed with the SEC on February 25, 2026. 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, Chief Executive Officer and Chairman; Dan Pietrzak, Chief Investment Officer and President; and Steven Lilly, Chief Financial Officer. Also joining us on the call today are Co-Chief Operating Officers, Drew O'Toole and Ryan Wilson. I'll now turn the call over to Michael.

Thank you, Anna, and good morning, everyone. Thank you all for joining FSK's Fourth Quarter and Full Year 2025 Earnings Conference Call. I'd like to start today's call by reviewing the goals we set for 2025 and discussing how we performed against those priorities. Our first goal was to originate attractive, well-structured investments, which would be accretive to the quality of our investment portfolio. During 2025, we achieved this goal as our investment team leveraged its deep sponsor relationships to originate $5.6 billion of predominantly first lien and asset-based finance investments. Second, we set out to provide shareholders with $2.80 per share of total distributions through a combination of our quarterly base and supplemental distributions. Our spillover income, which purposely was increased during the high interest rate environment, allowed us to achieve the objective even against the backdrop of a declining interest rate environment. Our third goal was to continue proactively laddering the right side of our balance sheet. During 2025, we continued to optimize our capital structure by issuing $400 million of new unsecured notes, closing on a new $400 million bilateral lending facility, diversifying our funding sources through two new middle market CLOs and further enhancing our liquidity profile through an amendment to our senior secured revolving credit facility that increased our total commitment, extended the maturity and reduced pricing. Despite the achievement of these goals, during the second quarter and fourth quarter of 2025, we experienced downward pressure on a few specific investments across our portfolio, which resulted in a decline in our net asset value. We acknowledge that non-investment-grade private debt investing necessarily will result in underperforming assets from time to time. However, we are disappointed by these markdowns. Dan, of course, will discuss these topics in more detail later in the call. Looking ahead to 2026, our goals are as follows: First, we expect to address underperforming assets through restructurings, exits and continued proactive portfolio monitoring to reduce the number of non-accruals and non-income-producing investments in the portfolio. Second, we will continue our strategy of focusing on first lien senior secured originations with the goal of continuing to increase the overall quality and diversification of our investment portfolio while simultaneously continuing to focus on rotating a portion of our legacy investments. Third, we remain focused on preserving our strong liquidity and balance sheet flexibility by keeping net leverage within our target range and maintaining ample revolver capacity to manage volatility and selectively deploy capital. Turning to our fourth quarter results. FSK generated net investment income totaling $0.48 per share and adjusted net investment income of $0.52 per share as compared to our public guidance of $0.51 and $0.56 per share, respectively. Our net asset value share declined by 5% to $20.89 compared to $21.99 as of the end of the third quarter. The two primary components of the quarterly change in net asset value are a $0.22 per share decline as a result of our $0.70 per share distribution compared to our GAAP NII of $0.48 per share and an $0.87 per share decline as a result of downward pressure on certain investments. From a liquidity standpoint, we ended the quarter with approximately $3.8 billion of available liquidity. Based on our updated dividend framework and expected operating results, our Board declared a total first quarter distribution of $0.48 per share, consisting of our base distribution of $0.45 per share and a supplemental distribution of $0.03 per share. This represents a 100% payout of our GAAP net investment income and a 9.2% yield on our ending fourth quarter net asset value. With that, I'll turn the call over to Dan to provide additional color on the market and the quarter.

Thanks, Michael. I'd like to start by focusing on FSK's recent performance. As Michael noted, our recent underperformance reflects challenges in certain legacy investments, including Production Resource Group, as well as challenges in certain current adviser-originated investments such as Medallia, Cubic Corp, KBS, and 48forty. We are actively engaged in each of these situations and are pursuing company-specific solutions to stabilize performance and maximize recoveries, although we acknowledge each company faces challenges unique to a specific business. We also acknowledge that our non-accrual assets are higher than we would like, which tempers our near- to intermediate-term view from an NII standpoint. Specifically, this means that our 2026 dividend, which we originally believed would equate to approximately 10% of net asset value, may now be more in the range of 9% of net asset value. Stepping back a bit, focusing on the current adviser's long-term performance. Since the formation of the FS/KKR Advisor 8 years ago, we have originated $34 billion of investments in FSK, generating an unlevered IRR of 9.1% since inception. And while recent non-accruals have emerged from this body of work, we do believe some level of defaults is inevitable in a sub-investment-grade portfolio, particularly across various market cycles. Nevertheless, we are focused on the work ahead of us during 2026 and beyond, not only to establish more stability in our investment portfolio but also to regain the market's confidence in our ability to deliver more consistent results on a quarter-to-quarter basis. And with that, I'll turn to a few specific comments about the quarter. During the fourth quarter, approximately 50% of net realized and unrealized losses were attributable to four investments: Production Resource Group, Medallia, Peraton, and Cubic Corp. We have spoken about most of these investments in detail in the past. However, I'll give a quick update on each name. PRG, a legacy investment, is a leading provider of integrated entertainment and live event production solutions. PRG continues to be impacted by softer operating performance due to headwinds in their TV, film, and music segments. During the quarter, we incurred approximately $47 million of net losses. Medallia, an enterprise software as-a-service experience management platform, has faced competitive pressures, which have resulted in the company's recent financial underperformance. This investment contributed $29 million of unrealized losses during the quarter. Peraton, a provider of technology-focused services and solutions to U.S. government agencies, contributed $23 million of unrealized losses during the quarter. Cubic Corp, an existing non-accrual investment, is a diversified technology provider to defense and civil-related agencies across governments throughout the world. Over recent periods, the company has experienced order and implementation delays, resulting in the current period valuation. Cubic Corp contributed $21 million of unrealized depreciation during the quarter. Turning to the investing environment. During 2025, we experienced a 13% increase in the number of investment opportunities we evaluated, though I would highlight we are remaining extremely selective. We are focused on continuing to diversify our portfolio by taking smaller position sizes in a greater number of borrowers. Additionally, based on the opportunities we are seeing in the market today, we continue to believe the best risk-adjusted returns are in first lien loans and asset-based finance investments. During the fourth quarter, we originated approximately $1.1 billion of new investments. Approximately 80% of our new investments were focused on add-on financings to existing portfolio companies and long-term KKR relationships. Our new investments, combined with $806 million of net sales and repayments when factoring in sales to our joint venture, equated to a net portfolio increase of $292 million. New originations consisted of approximately 65% in first lien loans, 15% in asset-based finance investments, 18% in capital calls to the joint venture, and 2% in equity and other investments. Our new direct lending investment commitments had a weighted average EBITDA of approximately $352 million, 6.2x leverage through our security and a weighted average coupon of approximately SOFR plus 475 basis points. We continue to focus on upper middle market companies with EBITDA in the $50 million to $150 million range across a diverse set of industries and sectors. As of December 31, the weighted average EBITDA of our portfolio companies was $236 million, and the median EBITDA was $132 million. Our portfolio companies reported a weighted average year-over-year EBITDA growth rate of approximately 4% across companies in which we have invested since April of 2018. Median interest coverage increased to 1.9x compared to 1.8x at the end of the third quarter. Software and services currently represent 16% of our investment portfolio, diversified across 50 issuers with an average position size of 33 basis points of our total investment portfolio. Average and median EBITDA of approximately $162 million and $110 million, and a median LTV of approximately 39%. This segment of our portfolio historically has been one of our best performers and has been underwritten with a particular focus on primary customer relationships and the durability of revenue and cash flow streams attached to those relationships. We will continue to assess potential future AI risks with each investment we analyze as our current belief is that widespread AI adoption may result in an overall expansion of the addressable market, even though it likely will negatively impact certain companies that either have not yet achieved meaningful positive cash flows or are less well positioned from a customer retention standpoint. During the fourth quarter, five investments were added to non-accrual status and one was removed. New non-accrual assets include Alacrity Solutions, Amerivet Partners, Dental Care Alliance, Gracent, and Lionbridge Technologies. Together, these investments totaled $255 million of cost and $214 million of fair value across our investment portfolio. As previously disclosed, Production Resource Group was removed from non-accrual status. As of December 31, non-accruals represented 5.5% of our portfolio on a cost basis and 3.4% of our portfolio on a fair value basis. This compares to 5% of our portfolio on a cost basis and 2.9% on a fair value basis as of September 30. Non-accruals relating to the 90% of our portfolio which has been originated by KKR Credit were 5.1% on a cost basis and 3.1% on a fair value basis as of the end of the fourth quarter. This compares to 3.4% on a cost basis and 1.8% on a fair value basis as of the end of the third quarter. While we acknowledge that this non-accrual rate is above the long-term BDC industry average cost basis non-accrual rate of approximately 3.8%, we also recognize that this measure is a point-in-time data point. KKR's long-term average cost basis non-accrual rate since April 2018 is 1.2%. In summary, regarding our investment portfolio, we recognize there's work to be done, which may result in an above-average level of portfolio volatility during certain periods, coupled with lower levels of net investment income compared to prior estimates. Portfolio metrics do move over time, and we believe our investment and workout team are well equipped to successfully navigate this period of elevated portfolio volatility. Lastly, subsequent to quarter-end, we announced that the aggregate capital commitment to our joint venture with South Carolina Retirement Systems Group Trust increased from $2.8 billion to approximately $2.975 billion, reflecting an additional net $175 million contribution from our partner. Following this transaction, our partner's ownership percentage climbed from 12.5% to 21.1%, and our ownership percentage changed from 87.5% to 78.9%. We and our partner have been very pleased with the performance of the JV to date, and this incremental capital positions the joint venture to continue scaling while fully leveraging the breadth and depth of the KKR credit investment platform. With that, I'll turn the call over to Steven to go through our financial results.

Thanks, Dan. As of December 31, 2025, FSK's investment portfolio had a fair value of $13 billion, consisting of 232 portfolio companies. At the end of the fourth quarter, our ten largest portfolio companies represented approximately 19% of the fair value of our portfolio compared to 20% as of the end of the third quarter. We remain focused on senior secured investments as our portfolio consisted of approximately 58% first lien loans and 62% senior secured debt as of December 31. In addition, our joint venture represented approximately 15% of the fair value of our portfolio as of the end of the fourth quarter. As a result, when investors consider our entire portfolio, looking through to the investments in our joint venture, then first lien loans total approximately 68% of our total portfolio and senior secured investments total approximately 72% of our portfolio as of December 31. The weighted average yield on accruing debt investments was 10% as of December 31, a decrease of 50 basis points compared to 10.5% as of September 30. As a reminder, the calculation of weighted average yield is adjusted to exclude the accretion associated with the merger of FSKR. Turning to our quarterly operating results. Our total investment income was $348 million for the fourth quarter, a decrease of $25 million compared to the third quarter. The primary components of our total quarterly investment income were as follows: Total interest income was $256 million, representing a decrease of $29 million quarter-over-quarter. The decline in interest income was driven by investments placed on non-accrual during the quarter, lower base rates, and the repayment of higher-yielding investments. Dividend and fee income totaled $92 million, an increase of $4 million quarter-over-quarter. Our total dividend and fee income is summarized as follows: $58 million of dividend income from our joint venture, other dividends from various portfolio companies totaling approximately $28 million during the quarter, and fee income totaling approximately $6 million during the quarter. Our total expenses were $213 million during the fourth quarter, a decrease of $1 million compared to the third quarter. The primary components of our total expenses were as follows: Our interest expense totaled $110 million, a decrease of $6 million quarter-over-quarter, and our weighted average cost of debt was 5.1% as of December 31. Management fees totaled $50 million, a decrease of $1 million quarter-over-quarter. Incentive fees totaled $28 million, a decrease of $5 million from the third quarter. Other expenses totaled $7 million, a decrease of $3 million quarter-over-quarter. Lastly, excise tax totaled $18 million during the quarter. The detailed bridge in our net asset value per share on a quarter-over-quarter basis is as follows: Our ending third quarter 2025 net asset value per share of $21.99 was increased by GAAP net investment income of $0.48 per share and was decreased by $0.87 per share due to a decrease in the overall value of our investment portfolio. We experienced a $0.01 per share reduction in net asset value from realized loss on extinguishment of debt and a $0.70 per share reduction as a result of the total quarterly distribution paid during the quarter. The sum of these activities results in our December 31, 2025, net asset value per share of $20.89. From a forward-looking guidance perspective, we expect first quarter 2026 GAAP net investment income to approximate $0.45 per share, and we expect our adjusted net investment income to approximate $0.44 per share. The detailed components of our first-quarter guidance are as follows: Our recurring interest income on a GAAP basis is expected to approximate $226 million. We expect recurring dividend income associated with our joint venture to approximate $60 million. We expect fee and other dividend income to approximate $29 million. From an expense standpoint, we expect our management fees to approximate $48 million. We expect incentive fees to approximate $26 million. We expect interest expense to approximate $104 million, and we expect other G&A expenses to approximate $9 million. Capital Structure. In December, we closed our third middle market CLO, raising $363 million of low-cost secured debt priced at a weighted average rate of SOFR plus 157 basis points. We are pleased with this financing given it is match-funded with no mark-to-market at an attractive rate. As of December 31, our gross and net debt-to-equity levels were 130% and 122%, respectively, compared to 120% and 116% at September 30. Our leverage remains within our target range of 1 to 1.25x net debt to equity. At the end of the fourth quarter, our available liquidity was $3.8 billion, and approximately 62% of our drawn balance sheet and 43% of our committed balance sheet was comprised of unsecured debt. Pro forma for the $1 billion unsecured bonds that matured on January 15, 2026, 49% of our drawn balance sheet and 38% of our committed balance sheet was comprised of unsecured debt, and our next balance sheet maturity is a $400 million bond in January of 2027. And with that, I'll turn the call back to Michael for a few closing remarks before we open the call for questions.

Thank you, Steven. As we enter 2026, we actively are focused on working through the portfolio-related items Dan discussed in detail. Our new and recent originations are performing well, and the vast majority of our portfolio continues to perform in line with our original expectations. As a result, we believe our scale, experience, and proactive portfolio management will enable us to maximize recoveries and to continue providing shareholders with an attractive level of current income relative to the risk-free rate. As always, we appreciate you joining us today. With that, operator, please open the line for questions.

Your first question comes from Finian O'Shea with Wells Fargo Securities.

So just to start, like big picture, FSK is shrinking, which makes it worse, and likely stuck below book. So do you ever think about like a grand bargain where, say, the FS side allows for a lower fee, and then the KKR side puts in some balance sheet money to inject life into the BDC and ultimately show that the partnership model can work?

I mean that's probably a bit of a complicated question. But I think if you take a step back, I think we have been, I think, both sides quite happy with just the partnership. I mean, clearly, this has been a harder quarter. But if you do think about, we have originated $34 billion of investments into FSK in the last eight years. The last quarters have felt bumpy, but we're sort of 9.1% sort of IRR sort of against those. I think we've got some work to do clearly on the portfolio. I think we've got some work to do, to your point about how to either grow this thing or create some levers as it relates to income growth. The short or the low-hanging fruit there is we do have too many non-income-producing assets, right? We're roughly 9.5% there. I think we've been stuck with that for a while because that really started with some of the older assets that were here. But I think us as a team have gone through, I'd say, a laundry list of things as I would think about kind of a forward operating plan as we evolve this thing for '26 and '27. I don't think this is a quarterly sort of discussion as we work on that evolution.

Okay. Sorry about that. A follow-on on the performance fee. So one of your peers yesterday, Blackstone, they had a few write-downs. They got a little bit less of an incentive fee. The stock was fine. Do you think that makes sense to revisit again? The look back that is?

Yes, we are very aware of fee structures and are continually assessing our position in relation to the market and other competitors. We are also considering our dividend numbers. Currently, at around $0.48, we are approximately at 9.2%. As a team, we are consistently evaluating this, and it is something we will discuss further. We are primarily focused on the total earnings reflected in that 9.2%, which is likely lower than our desired target today, but still above our historical average.

Your next question comes from the line of Ethan Kaye with Lucid Capital Markets.

Wondering if there's anything you can kind of point to any common thread or common denominator here across the positions that drove the underperformance this quarter?

Yes, Ethan, thank you for your question. Let me break it down into a couple of categories. Among the five names added to non-accruals, two are in the medical or healthcare roll-up sector, which is an area we're monitoring closely. We've seen many companies perform well in this space, but wage inflation and employee retention have had an impact, particularly in dental and veterinary fields. This is a common theme we've observed regarding non-accruals. Additionally, four names accounted for about 50% of the marks we discussed earlier, one being PRG, which has faced challenges for some time. We have dedicated significant resources to it, but the issues are specific to that company. The other cases can likely be categorized as operational underperformance, with some risk associated with government contracts involved, especially with companies like Peraton and Cubic. So, we have some recurring themes in the medical roll-ups, as well as in government-related areas, along with general operational performance issues.

Got it. I believe the three non-legacy companies you mentioned, along with at least one of the new non-accrual companies, are either focused on software or have a close relationship with software. I am curious if there is any pressure from the emergence of AI and the risks it presents to software companies.

Yes. No, it's a very fair question considering what's going on news-wise. I mean, the overall portfolio from software for us is about 16%. I think we have been evaluating what I would call AI risk in that portfolio for some time, not just on the back of the recent news flow. We do have the benefit of working with our private equity colleagues and have come up with this sort of what I'll call framework looking at 20 different data points to assess what might be high risk or not. I think from an investing perspective, we have focused on what I would call mission-critical products, those that are sort of hard to rip out or have focused on those businesses that, in our opinion, truly have proprietary data. I think we have not been active in the ARR space, right? We do have one ARR loan left, which is Medallia, which we sort of talked about. I think when you put all that together, when we look at our portfolio, we got sort of roughly 2% of the names that we think have a high AI risk attached to them. Of the names you kind of referred to, you look at the ones that were talked about as it relates to driving the mark. I don't think that they actually had anything to do with AI as it relates to underperformance. It's really more in that operational camp. The one that did would be Lionbridge, right? That business is a language translation business and sort of a gaming business. The language business has, in our opinion, had some headwinds from that. We think the gaming business is quite attractive. I think for a long time, and I think we still might believe we could be covered from that gaming business. But really not AI-driven is the summary point.

Your next question comes from the line of Arren Cyganovich with Truist Securities.

The 2026 goal of kind of dealing with the problem credits, maximizing value can often take a while to unfold. How are you kind of approaching this to try to both quickly address these, but also maximize the value that you're going to get from potential restructuring?

Yes. The line isn't great, but I believe the question was about maximizing value. If my response isn't complete, feel free to expand on it. We did discuss our goals for 2026, and clearly, addressing these underperforming assets is a top priority. Another focus is increasing diversification in the portfolio, which is essential and should continue. Additionally, we need to consider liquidity. We have a strong investment team, particularly those working on workouts, with around 25 people dedicated to portfolio monitoring. It's a bit situational; some issues are going to take multiple years to resolve, and some matters have already been ongoing. We anticipate that certain cases may allow for a quicker sale process, either because they would add value or for risk management reasons. In several instances, we have revamped management teams, introduced new senior leadership, and utilized our senior advisor network. Each case will be handled individually, but I want to stress that this is not something that will happen overnight. We expect it to take some time, which is why we're discussing things over a longer timeframe, specifically looking at 2026 and 2027.

Got it. And maybe you could just provide a little more details on the JV equity changes there and what drove that? And how much of a drag will that be from the dividend income associated with that?

Yes. Fair question. We've been happy with the joint venture. I think that's the starting point, right? We've talked about a lot on prior calls about getting that towards its target number of roughly 10% to 15%. It's been at the upper end of that range. We do want to see it continue to grow over time, which that was really the driver here. South Carolina has been a great partner for us. Then putting additional capital in, I think you can just equate to FSK kind of selling a portfolio or an asset sort of that kind of the mark and then you can use those proceeds to reinvest into other places. So there's some offset to that to your question around any sort of dividend reduction. But the point and the purpose of it was to allow the entity to grow. My guess is, over time, you will see our percentage potentially kind of tick back up as we continue to put additional sort of capital in there. That's not necessarily automatically will happen, but it's something that sort of could happen. But it's about trying to continue to grow. I think it will have a certain amount of an impact out of the gate. I think we're mindful about that, but I think we were pretty happy to continue this good partnership with South Carolina.

Your next question comes from the line of Casey Alexander with Compass Point Research & Trading.

I have one question and a follow-up. First, it seems like the stock is currently trading at 55% of book value, which suggests that instead of investing in new loans, it might be wise to focus on taking repayments and buying back stock. Can you share your thoughts on when you might consider starting meaningful stock repurchases? I understand that employees and advisers have bought the stock, but currently, the best way to increase NAV is through accretive share repurchases at such a significant discount to book value.

Yes. Casey, thanks for the question. I think we understand the point there. I think as the entity, these numbers might not be perfect, but I think we have historically bought back $350 million of stock. That's probably more than sort of most out there. It is something that we do have to consider. I think the only thing on the other side of that, that I just need to be mindful about is the market noise and/or volatility. And I do believe some of that is overdone out there broadly, but that's kind of top of mind and then where we're at vis-a-vis sort of leverage and target leverage. But it is, yes, something that we will be talking about.

Yes. And the fact that maybe some of the movement in the stock is related to broader market noise would argue even more, I would think, to buying it here because some of that will then be relieved by the absence of the market noise, and this would be the most accretive level. My second question is there have been multiple reports of pretty material dislocation in the fix and flip market. And FSK has a significant investment in Toorak. And so I was wondering if you could remind us what the structure of the Toorak investment is and how it's performing?

The investment in Toorak was made in 2016, initially viewed almost as a trade since there was no institutional presence at the time. We aimed to take advantage of that situation. Back then, I would have been satisfied with $1 billion to $2 billion in loans. However, today we've provided $12.5 billion in loans. Over the ten years, cumulative losses have been around $100 million, which is quite manageable. While there have been some challenges, particularly with a direct origination business that generated nearly $800 million last year and a solid operation in the U.K., we have noticed an increase in delinquencies in the U.S., around 10%, although this is beginning to stabilize. Returns on equity have faced pressures, largely due to delinquency rates and the discrepancy between loan rates and financing costs. This has impacted our dividends from Toorak, which have historically been about 10% annually. Despite some fluctuations, the overall narrative over the last decade has been positive. Toorak acts as both a direct originator and a buyer of loans in both the U.S. and U.K., allowing us to benefit from its cash flows or partner with its management for future monetization opportunities. While there has been some risk associated with smaller loan origins, Toorak has had minimal exposure to these issues, with returns on equity being the more significant concern.

Your next question comes to the line of Rick Shane with JPMorgan.

Casey really addressed what I believe is the most significant structural issue regarding share repurchases. You had over $5 billion inflow last year and $5 billion the year before. It's reasonable to assume that the repayment run rate will be similar this year, providing substantial liquidity for repurchases. In listening to all the BDC calls, I haven't encountered any strong arguments suggesting there's a remarkable dislocation or an attractive opportunity to invest in new loans. What options are actually more beneficial to both earnings and NAV than repurchasing shares at this time?

Yes, thanks for the question, Rick. The investing environment has been quite interesting over the past few years. There have been various market events affecting the market. On the direct lending side, it has felt relatively tight, with noticeable spread compression, largely due to high inflows from the wealth channel, coupled with lower-than-normal M&A volume. This creates some market technicals. However, the quality of the companies accessing the market has been strong, and we prefer to lend to larger companies. We've focused on enhancing diversification in our portfolio, which included growing our joint venture to meet our target number. We've identified some compelling opportunities in asset-based finance, as we've discussed on previous calls, such as with Harley-Davidson or PayPal. As we look ahead, I anticipate a more lender-friendly environment throughout 2026, influenced by the openness of the capital markets, which are quite accessible at the moment. However, we may see a slight tempering of the flows, and the movement of capital markets will likely be a primary driver of that. Our attention remains on these factors.

Your next question comes from the line of Robert Dodd with Raymond James.

Excuse me. Sorry, I'm following up on Rick's comments because I agree with him. I have a couple of questions regarding credit. Specifically, about the main markdowns this quarter, PRG, Medallia, and Peraton. Cubic is already on non-accrual. These three, I mean, PRG just came off non-accrual, it is marked down. Looking at the severity of the markdowns, I wonder if there is a high probability that those businesses will also end up on non-accrual or if large segments of them will. Will they need to go through aggressive restructurings where, even if they don't go on non-accrual, a significant portion of the debt must be equitized? Also, is there an additional risk, apart from the five new ones this quarter, concerned specifically with those three, particularly PRG, which has been undergoing a multi-year process, with the first restructuring not being successful? Is there a significant risk of further earnings loss from those assets?

Yes. Thanks, Rob. For each of those companies, there is an ongoing dialogue or some level of active monitoring. Peraton has evolved over time to be more of a Level 2 asset than a Level 3. We're making significant changes on the PRG side. There is a substantial amount of equity-like risk in the non-income-producing category. The lenders have been doing a lot of work on the Cubic side, but there are still challenges from the government. Peraton had some positive news in Q4 regarding a major contract win. We'll spend time with the other lenders and engage in discussions with the sponsor on Medallia. There is considerable capital involved with Medallia, but its performance has been more challenging, primarily operational but not related to AI. All these situations are currently active.

Got it. You mentioned the health care and roll-up issue in response to another question. A few years ago, there were physician office rollups. I’m not referring to your portfolio at this moment, and then it shifted to dental. You have DCA, but many others in DCA and two other dental businesses went back on non-accrual this quarter. This has clearly been an ongoing theme. The roll-up issue in health care does not appear to be improving across the industry. Is this continuing to spiral? There are still many dental businesses not currently facing those pressures, both in your portfolio and elsewhere. The same goes for veterinarians. What is the next challenge for the roll-up strategy as it begins to face difficulties in your portfolio?

Yes, I think that's a valid question, and you're right. For a while, it was among the favorites in both private equity and direct lending. This has been an emerging theme for us over the last several quarters. Initially, we noticed it with consumer discretionary sectors, which were facing challenges. As I mentioned earlier, wage inflation continues to be an issue. We've observed a significant variance in performance within the dental sector, which can be attributed to the structure of the business or how employees are compensated, whether they have ownership in their practice or share in a larger pool. Each situation is somewhat unique. Currently, 5.7% of our portfolio is invested in these medical roll-ups, with 3.3% specifically in dental. DCA went into non-accrual and was marked down this quarter. However, we are optimistic about that business and its team. We're engaged in active discussions with the junior debt holders and sponsors involved, and it appears that a first-lien led solution is likely. Overall, that business is performing reasonably well, aligning with our expectations, although being a 2021 investment in a different interest rate environment has led to it being over-leveraged. We've also seen some other names in the dental space struggle more this quarter. One of those is in affordable care. This area is currently a focal point for us as it faces challenges.

Your next question comes from the line of Dillon Heins with B. Riley Securities.

I know we've discussed this quite a bit, but what was the turning point from last quarter’s expectations of a decrease in non-accruals? There was the pro forma guidance of 3.6% on cost and 1.9% on fair value after the PRG restructuring. So, what led us from that situation to where we currently stand?

Yes, that’s a good question. Just to clarify, the 3.6% was really more of a theoretical estimate given the circumstances with PRG. It wasn’t meant to serve as guidance, but if that was the impression, we will improve our communication. Regarding non-accruals, three of the names are quite small in terms of market value. The main factors driving the situation are DCA and Lionbridge. I mentioned DCA in the previous call, and we had an ongoing discussion with our subordinated units, which is evolving in a way we didn’t anticipate. For Lionbridge, we are in an active sales process, and we believe some parts of that business still hold potential. This was the one area in our portfolio where I noticed a direct impact from AI, affecting not just performance but also the overall sentiment around the business, which has made the sales process challenging. Therefore, the developments regarding DCA and Lionbridge were the key factors influencing our current position.

Your next question comes from the line of Finian O'Shea with Wells Fargo Securities.

I'll be less abstract this time. I wanted to get an update on the dividend. You mentioned it briefly, but part of what led up to this conclusion was the spillover item. Can you provide an update on that? Did you reach your target range? Should we expect any special items in addition to the supplemental program?

Yes. And I'll let Steven kind of go through that. I think just for everybody's benefit on the call, just as a reminder, right, we did change the dividend effect of the dividend policy in the last call to be more sort of base and supplemental, the 45 base and supplemental sort of thereafter. But Steven, do you want to add?

Yes. We concluded the year with an estimated spillover of about $464 million, as indicated in the 10-K report. This aligns with approximately 3.5 quarters based on the current dividend. Looking ahead to late 2024 and 2025, as the ABF portfolio continues to grow alongside international structured investments and partnerships, we are making early estimates regarding potential tax impacts. In some cases, especially where cash hasn't been received, there may be quarter paper profits that will affect our tax allocations, contributing to spillover. Thus, we may encounter some timing differences. We expect to have more clarity around August and September. We maintain our previous stance that if a payment is necessary later this year, we will ensure it is made. However, it's still early to determine if any reversals might occur or what the final partnership tax returns will entail over the summer. So, we are in a wait-and-see mode. Rest assured, we will announce any developments when they arise.

Yes. No, I appreciate it. So it's not like last year where it's overpaying like the 45% is your true like NOI target?

Yes. I think what we've said in terms of the dividend is as GAAP net investment income moves quarter-to-quarter, then the dividend will move as well. And then if we need to make an additional payment later in the year to satisfy something from a spillover-related basis, we will do that, which is, as I think you're pointing out, different than the concept last year of effectively guaranteeing the market that we're going to pay $0.70 for all four quarters of 2025 because for other reasons, more over-earning reasons in the higher interest rate period, the spillover balance had grown.

This concludes the question-and-answer session. And I would now like to turn it back to Dan Pietrzak for closing remarks.

Thank you, everyone, for your time on the call today. We very much appreciate it. We are available for any follow-up questions as needed. And if not, we look forward to speaking with you on our Q1 call. Thank you.

Thank you for your participation in today's conference. This does conclude the program, and you may now disconnect.