BDC Quarterly Analysis: FSK KKR Capital Corp. Reduces Distribution as Credit Deterioration Drives 9.9% NAV Decline, Enters Into $300M Equity Purchase Agreements With KKR Alternative Assets

Credit Research: Michael Soricillo

Relevant Documents:
Q1’26 10-Q
Q1’26 Results and Share Tender 8-K

Today, FS KKR Capital Corp., or FSK, reported first-quarter 2026 total investment income of $304 million, down from $400 million a year earlier. The decline was primarily driven by lower interest income, which fell $78 million year over year to $224 million, while dividend and fee income declined $18 million to $80 million. The weaker results reflected lower base rates, higher nonaccruals and a smaller portfolio, with total investments at fair value declining to approximately $12.3 billion from $14.1 billion a year earlier.

FSK reported a difficult quarter, with net asset value per share declining 9.9% to $18.83 from $20.89 sequentially. The decline in NAV reflected ongoing pressure from previously discussed portfolio companies, new nonaccrual investments and mark-to-market weakness across select areas of the portfolio. Credit deterioration was concentrated in several named investments. Legacy investments ATX and Production Resource Group accounted for approximately 15% of the total NAV decline, and more recent current-platform investments Medallia, Cubic Corp. and Affordable Care accounted for approximately 33%. Medallia was placed on nonaccrual during the quarter and marked down to 54 cents.

Nonaccruals increased to 8.1% of the portfolio at cost and 4.2% at fair value, up from 5.5% and 3.4%, respectively, at year-end. FSK paid a first-quarter 2026 distribution of 48 cents per share, consisting of a 45 cent base distribution and a 3 cent supplemental distribution. For the second quarter of 2026, the board declared a distribution of 42 cents per share.

FSK and KKR Alternative Assets LP, an affiliate of KKR & Co., Inc., announced a multi-part strategic support package intended to enhance shareholder value, improve liquidity, support net investment income and help the company transition toward a smaller and better-positioned balance sheet. KKR Alternative Assets agreed to invest $150 million in cumulative convertible perpetual preferred stock, carrying a 5.00% cash dividend or, at FSK’s option, a 7.00% PIK dividend, with an initial conversion price of $18.83 per share, equal to FSK’s March 31, 2026, NAV. In addition, a KKR Alternative Assets intends to launch a $150 million fixed-price tender offer for FSK common stock at $11 per share, which KKR Alternative Assets says it believes is below intrinsic value.

FSK also authorized a $300 million stock repurchase program which would expire on June 1, 2027, to be implemented after the tender offer and paced against investment repayments and leverage levels.

Finally, beginning in the second quarter of 2026, KKR will waive 100% of its portion of the subordinated income incentive fee for four quarters, representing 50% of the total subordinated income incentive fee, with the waiver intended to support net investment income and quarterly distributions.

FSK expects to use proceeds from the convertible preferred issuance to enhance liquidity and fund a portion of the $300 million share repurchase program. Management also intends to maintain a competitive quarterly distribution, supported in part by the income incentive fee waiver, while operating within the company’s target leverage range.

Management segmented the portfolio to highlight where it believes forward downside risk is most likely to reside. First lien investments marked at 90 or above, together with the asset-based finance portfolio and the joint venture, represented approximately 81% of the portfolio and were described as better positioned. The remaining approximately 19% of the portfolio includes first lien loans marked below 90, non-first lien and restructured names and all legacy investments regardless of current performance. Management noted that this higher-risk bucket includes performing names such as athenahealth, which represents 3.2% of the portfolio, as well as legacy investments such as JWA and Global Jet, which together represent 3.3% of the portfolio and have recently performed well.

Over the next 12 to 18 months, the advisor and KKR credit team intend to focus on reducing new investments, lowering leverage, maintaining liquidity for existing portfolio companies, supporting the share repurchase program, rotating larger or lower-yielding assets and pursuing strategic sales of certain minority private equity positions. The goal is to maximize value while rotating proceeds into income-producing investments. Overall, the call emphasized a shift away from growth and toward stabilization, with management prioritizing credit remediation, balance sheet flexibility, leverage management and shareholder support through the tender offer, preferred investment, fee waiver and buyback authorization.

Portfolio Yield and Income

FSK’s portfolio yield and income trends continued to soften in the first quarter of 2026. Reported yield on the portfolio declined to 10.7%, down from 11.2% in the fourth quarter of 2025 and 12.1% in the first quarter of 2025. Cash yield also declined to 9.8%, compared with 10.2% in the prior quarter and 10.6% a year earlier.

The cash-to-reported yield gap narrowed to 0.9% in the first quarter of 2026, down from 1.1% in the fourth quarter of 2025 and 1.5% in the prior-year period. This suggests noncash income became a smaller contributor to reported yield, with noncash income declining to $125 million, or 8.8% of reported investment income, from $144 million, or 9.5%, in the prior quarter.

Reported investment income declined to $1.423 billion on a last-12-months basis, down from $1.519 billion in the fourth quarter of 2025 and $1.687 billion in the first quarter of 2025. Cash investment income also declined to $1.298 billion, down from $1.375 billion in the fourth quarter of 2025 and $1.476 billion in the prior-year period. Noncash income decreased to $125 million, or 8.8% of reported investment income, indicating weaker overall portfolio income but a reduced reliance on noncash income.

Cost of Funds

Blended cost of funds declined to 7.7% in the first quarter of 2026, down from 8.2% in the fourth quarter of 2025 and 8.8% in the first quarter of 2025. Cash cost of debt also declined to 5.8%, compared with 6.1% sequentially and 6% in the prior-year period, while the implied cost of equity fell to 10.1% from 10.8% in the prior quarter. Total capital declined to $13.652 billion, reflecting a lower equity base and modestly lower average debt, while debt weight increased to 56%. Overall, the section points to a lower blended funding cost and improved true net spread of 2.1%, though conventional spread remained flat sequentially at 4% and continued to overstate economic spread by 1.9 percentage points.

Operating Cash Flow and Dividend Sustainability

Operating cash flow from investments declined to $481 million on a last-12-months basis, down from $511 million in the fourth quarter of 2025 and $613 million in the first quarter of 2025. Cash investment income fell to $1.298 billion, while net cash investment income declined to $857 million, reflecting weaker cash income despite lower cash interest expense. Cash operating costs and taxes also declined modestly to $376 million, but not enough to offset the reduction in cash investment income. Overall, the section points to continued pressure on recurring operating cash flow as portfolio cash income trends lower.

Dividend coverage remained pressured in the first quarter of 2026, with operating cash flow from investments of $481 million compared with dividends declared and paid of $784 million. The cash dividend coverage ratio declined to 0.6x, down from 0.7x in the fourth quarter of 2025 and 0.8x in the first quarter of 2025. Net cash flow after dividends was a deficit of $303 million, compared with a deficit of $273 million in the prior quarter and $185 million in the prior-year period. Overall, the section indicates that dividends continued to exceed cash operating generation, increasing reliance on portfolio repayments, asset sales or balance sheet capacity to fund distributions.

Fee Structure

Total fees declined to $324 million on a last-12-months basis, down from $342 million in the fourth quarter of 2025 and $376 million in the first quarter of 2025. Base management fees declined to $202 million, while incentive fees on net investment income fell to $122 million, reflecting the lower earnings base. Despite the decline in absolute fees, total fees increased to 53.5% of net investment income, up from 50.6% in the prior quarter and 46.4% in the prior-year period, as net investment income declined to $606 million.

Portfolio Activity and Capital Allocation

Net investing activity generated $1.082 billion of cash returned on a last-12-months basis, up from $236 million in the fourth quarter of 2025 and $241 million in the first quarter of 2025. Purchases declined to $3.908 billion, while repayments were $4.990 billion, resulting in a net deployment ratio of negative 0.3x. Cash flow before funding sources improved to $518 million, compared with a deficit of $167 million in the prior quarter and positive $277 million in the prior-year period.

Net funding was a use of $809 million in the first quarter of 2026, compared with a source of $105 million in the fourth quarter of 2025 and a source of $11 million in the first quarter of 2025. The change was entirely debt-driven, with net debt declining by $809 million and no change in common equity funding. Despite positive cash flow before funding sources, net cash flow was a deficit of $291 million, compared with a deficit of $62 million in the prior quarter and positive $288 million in the prior-year period. Overall, the section indicates that portfolio cash generation was used primarily to reduce debt, resulting in a lower cash balance despite meaningful cash returned from investment activity.

Per-share earnings declined in the first quarter of 2026, with reported net investment income per share falling to $2.16 on a last-12-months basis, down from $2.41 in the fourth quarter of 2025 and $2.90 in the first quarter of 2025. Cash net investment income per share also declined to $1.72, compared with $1.82 in the prior quarter and $2.19 in the prior-year period. The dividend per share remained at $2.80, while net asset value per share declined to $18.83 from $20.89 sequentially. Overall, the section points to weaker per-share earnings power, a lower net asset value and increased payout pressure.

Portfolio composition shifted modestly toward first lien exposure in the first quarter of 2026, with first lien investments increasing to 60% of the portfolio, up from 58% in both the fourth quarter of 2025 and the first quarter of 2025. Second lien exposure remained at 4%, while asset based finance increased to 14% and Credit Opportunities Partners decreased to 14% sequentially. The number of portfolio companies increased to 236, up from 232 in the prior quarter and 224 in the prior-year period.

Investment portfolio fair value declined to $12.269 billion in the first quarter of 2026, down from $13.009 billion in the fourth quarter of 2025 and $14.122 billion in the first quarter of 2025. Cash conversion improved to 91.2%, but cash dividend coverage declined to 0.6x, while true net spread compressed to 0.8% from 1.2% sequentially and 1.8% in the prior-year period. Debt-to-equity increased to 1.38x, and nonaccruals at fair value rose to 4.2%, up from 3.4% in the prior quarter and 2.1% a year earlier. Overall, the section points to a smaller portfolio, higher leverage, weaker spread economics and continued credit migration despite improved cash conversion.

Investment Portfolio Analysis

The breakout of the net portfolio activity and asset mix of the investment portfolio is shown in the chart below:

A breakout by sector is shown in the chart below:

Nonaccruals

Total nonaccruals as of March 31 were 8.1% at cost and 4.2% at fair value, up meaningfully from 5.5% and 3.4%, respectively. Nine investments, pictured below, were additions made to nonaccruals in the quarter, and two investments were taken off nonaccrual status.

Capital Structure and Liquidity

FSK ended the quarter with elevated gross leverage but solid liquidity. As of March 31, total debt outstanding was approximately $7.3 billion, with gross debt-to-equity of 1.38x, up from 1.31x at year-end. Approximately 51% of drawn debt was unsecured, and the weighted average cost of debt was 5.3%. Pro forma liquidity was approximately $2.3 billion. Subsequent to quarter-end, FSK amended its senior secured revolving credit facility, reducing commitments to approximately $4.1 billion, resetting certain covenants and increasing the borrowing spread by 12.5 basis points. Overall, liquidity remains meaningful, but elevated gross leverage reinforces management’s focus on portfolio rotation, reduced originations and deleveraging.