Executive Summary / Key Takeaways

• FSK delivered a strong start to 2025, exceeding adjusted net investment income guidance while maintaining its $0.70 quarterly distribution, supported by significant spillover income and a strategic focus on income stability.
• The company is actively managing portfolio risks, including potential tariff and Department of Government Efficiency (DOGE) impacts, leveraging its large, diversified portfolio companies and proactive engagement with borrowers.
• Origination activity remains robust, driven by FSK's expansive deal funnel and incumbency advantage, with a strategic emphasis on upper middle market direct lending and growing its asset-based finance (ABF) portfolio.
• Credit quality shows signs of improvement, with non-accruals decreasing, although certain legacy and idiosyncratic positions continue to require active management and restructuring efforts.
• FSK maintains a strong balance sheet and ample liquidity, positioning it to capitalize on expected increases in M&A activity and navigate competitive pressures and potential market volatility in 2025.

Setting the Scene: A BDC Adapting to a Complex Landscape

FS KKR Capital Corp. stands as a significant player in the U.S. middle-market lending landscape, operating as an externally managed business development company (BDC) under the guidance of FSKKR Advisor, LLC, an affiliate of global investment giant KKR (KKR). Since commencing investment operations in 2009, FSK's core mandate has been to generate current income and, secondarily, long-term capital appreciation for its shareholders, primarily through investments in the senior secured debt of private U.S. companies. The company's history includes the notable 2021 merger with FS KKR Capital Corp. II, which further solidified its scale and market presence.

The competitive terrain for middle-market debt financing is dynamic and populated by a range of participants, including large BDCs like Ares Capital Corporation (ARCC), Main Street Capital Corporation (MAIN), Hercules Capital, Inc. (HTGC), and Golub Capital BDC, Inc. (GBDC), as well as banks, private credit funds, and fintech lenders. FSK positions itself by focusing on directly originated transactions in the upper middle market, targeting companies with EBITDA generally between $50 million and $150 million at the time of investment. This segment is perceived to offer a balance of scale and resilience compared to smaller borrowers.

While some peers are noted for leveraging digital lending tools and AI-driven risk assessment for potential efficiency gains, FSK's competitive differentiation is primarily rooted in the extensive reach, deep relationships, and broad expertise provided by the KKR Credit platform. This integrated platform facilitates a robust and diversified deal funnel, offering access to opportunities across various sectors and structures, including traditional direct lending and the increasingly strategic area of asset-based finance (ABF). This platform-driven approach, rather than proprietary lending technology, forms the basis of FSK's operational capability and competitive standing.

The broader economic backdrop presents a complex picture. While the U.S. economy has demonstrated resilience with real growth and declining inflation since 2022, recent market volatility, geopolitical risks, and domestic policy uncertainties, including potential tariffs and the impact of the Department of Government Efficiency (DOGE), have tempered the outlook. These factors contribute to a slower-than-anticipated pickup in M&A activity, intensifying competition for available deals and leading to tighter credit spreads and more borrower-friendly terms in the direct lending market. Despite these headwinds, FSK believes tailwinds persist for private credit, driven by companies' increasing willingness to utilize private debt for certainty of execution and a desire to know their lenders.

Strategic Focus and Operational Execution

FSK's strategy is centered on disciplined capital deployment, proactive portfolio management, and maintaining a robust balance sheet to navigate the current environment and capitalize on future opportunities. The company emphasizes investing in high-quality companies with strong defensive positions, particularly crucial in an environment where elevated interest rates have tightened interest coverage ratios for many borrowers, reducing their flexibility when facing operational challenges.

A key strategic area is the growth of the Asset Based Finance (ABF) portfolio. FSK views ABF as a compelling opportunity, especially as banks reposition their portfolios due to regulatory requirements. These investments, often anchored in tangible collateral and structured with attractive upfront and exit fees, provide diversification benefits and offer risk-adjusted returns that management believes are currently wider than those in traditional direct lending. FSK leverages KKR's significant ABF expertise and dedicated team to access niche sectors and structure complex deals that smaller market participants may struggle with.

The company also utilizes its joint venture, Credit Opportunities Partners JV, LLC (COPJV), as a vehicle for co-investing across various credit opportunities. This partnership allows FSK to participate in a broader range of deals and is seen as a focus area for future growth.

Portfolio management involves rigorous monitoring and proactive engagement with borrowers. FSK employs an internal investment rating system to track expected returns and identify potential issues early. A significant focus has been placed on resolving non-accrual investments and rotating out of legacy positions, particularly those in more cyclical industries. Since Q2 2018, over $3 billion has been rotated into more defensive sectors. Recent quarters have shown progress in reducing non-accruals, although certain idiosyncratic situations continue to require attention.

Financial Performance and Credit Quality

FSK's financial performance in the first quarter of 2025 reflected the prevailing market dynamics. Net investment income totaled $0.67 per share, with adjusted net investment income at $0.65 per share, exceeding guidance. Total investment income decreased compared to the prior year quarter, primarily due to lower base rates and spread compression on new investments. However, dividend income saw an increase, notably from asset-based finance investments. Operating expenses decreased, mainly driven by lower subordinated income incentive fees tied to investment income.

The weighted average yield on accruing debt investments saw a slight decrease, reflecting market trends. Despite tighter interest coverage ratios across the broader portfolio due to past rate hikes, the median first quarter coverage remained steady at 1.7 times.

Credit quality, as measured by non-accruals, showed improvement, decreasing slightly to 3.5% of the portfolio on a cost basis and 2.1% on a fair value basis as of March 31, 2025. Non-accruals specifically within the KKR Credit originated portion of the portfolio (approximately 90% of the total) were lower at 2% cost and 1% fair value. While some investments were added to non-accrual status during the quarter, others were successfully restructured or saw progress towards resolution, such as the refinancing at JW Aluminum and restructurings at Alacrity Solutions and Accuride. The sale of legacy position Maverick Natural Resources also contributed positively.

The net change in unrealized appreciation/depreciation in Q1 2025 was negative, primarily due to reduced valuations in specific portfolio companies like Production Resources Group and 48Forty Solutions, highlighting the impact of company-specific performance and market conditions on portfolio valuation.

Liquidity, Capital Structure, and Outlook

FSK maintains a strong liquidity position, ending Q1 2025 with $472 million in cash and $2.635 billion available under its financing arrangements.

The company actively manages its capital structure, utilizing unsecured notes and collateralized loan obligations (CLOs) to ladder maturities and enhance financial flexibility. In March 2025, FSK closed its second middle market CLO, raising $380 million of secured debt at an attractive rate, and amended its Morgan Stanley (MS) facility to reduce costs and extend maturity.

As of March 31, 2025, the company's gross and net debt to equity stood at 122% and 114%, respectively, within its stated target range of 1x to 1.25x. The asset coverage ratio was a healthy 182%, well above the regulatory requirement.

Looking ahead, FSK's management is optimistic about the potential for increased M&A activity in 2025, which is expected to drive new origination opportunities. The company's significant available liquidity and diversified origination channels position it well to be selective and pursue attractive deals. Management expects rates to continue a downward trend, albeit potentially slower than previously anticipated, which could provide some relief to borrower interest burdens.

FSK's 2025 distribution guidance remains firm at $2.80 per share ($2.56 base, $0.24 supplemental), supported by a healthy balance of spillover income accumulated during periods of higher rates. This strategy aims to provide shareholders with income stability despite potential quarter-to-quarter variances in net investment income driven by rate changes and market conditions. Second quarter 2025 guidance anticipates GAAP NII of approximately $0.64 per share and adjusted NII of $0.62 per share, reflecting expected recurring interest income of $302 million, JV dividend income of $56 million, and other fee/dividend income of $43 million, offset by anticipated expenses.

Risks and Challenges

Despite the positive outlook on certain fronts, FSK faces several pertinent risks. The worsening global economic outlook, continued market volatility, and geopolitical uncertainties could negatively impact portfolio company performance and valuations. Specific concerns include the potential direct and indirect impacts of tariff policies (estimated 8% direct exposure) and Department of Government Efficiency (DOGE) initiatives (estimated low to mid-single-digit exposure) on certain industries within the portfolio (consumer durables, discretionary, staples, capital goods, software/services, healthcare, aerospace/defense). While FSK's larger, diversified portfolio companies may have more pricing power, the full second and third-order effects remain uncertain.

Elevated wage inflation and challenges in securing adequate labor could also pressure portfolio company margins. Furthermore, while non-accruals have decreased, the remaining underperforming assets pose risks to income and principal recovery. The competitive market environment continues to pressure yields and terms on new investments, potentially impacting future income generation. Interest rate risk remains relevant, particularly for fixed-rate investments and floating-rate borrowings, although FSK employs hedging strategies. Valuation of illiquid private investments inherently involves subjective judgments and estimates, which could be impacted by changing market perceptions or company performance.

Conclusion

FS KKR Capital Corp. enters the second quarter of 2025 from a position of strategic strength, marked by a robust balance sheet, ample liquidity, and a diversified origination platform powered by the KKR network. While navigating a volatile macroeconomic and competitive landscape, FSK has demonstrated progress in improving credit quality and actively managing its portfolio. The commitment to a stable $0.70 quarterly distribution, backed by accumulated spillover income, provides a clear signal of confidence to investors amidst earnings variability driven by interest rate fluctuations and market dynamics. The strategic focus on upper middle market direct lending and the growth of the ABF portfolio offer avenues for differentiated deal flow and risk-adjusted returns. However, investors should remain mindful of potential impacts from policy changes, market volatility, and the performance of specific portfolio positions. FSK's ability to leverage its platform for disciplined deployment and continue its proactive portfolio management will be key determinants of its performance and the realization of its investment objectives in the coming quarters.