Fitch Ratings has affirmed FS KKR Capital Corp.'s (FSK) Long-Term Issuer Default Rating (IDR), secured debt rating and unsecured debt rating at 'BBB-'.

The Rating Outlook is Stable.

The Long-Term IDR of 'A' and the Stable Outlook assigned to KKR & Co. Inc. (KKR) are unaffected by these actions. KKR is the parent company of KKR Credit Advisors (U.S.), LLC, which alongside Franklin Square Holdings, L.P. serve as FSK's external manager.

Today's rating actions have been taken as part of a broader review of business development companies (BDCs) which included 18 publicly rated firms. For more information on the peer review, please refer to 'Fitch Ratings Completes 2023 BDC Peer Review,' available at www.fitchratings.com.

Key Rating Drivers

IDR AND SENIOR DEBT

The rating affirmation reflects FSK's appropriate asset coverage cushion, solid funding flexibility and demonstrated access to the unsecured debt markets over time, sound liquidity, experienced management team and affiliations with KKR Credit Advisors (U.S.), LLC and Franklin Square Holdings, L.P., which provide the BDC with access to investment resources and risk management capabilities.

Rating constraints include FSK's weaker than peer asset quality metrics, above-average exposure to paid-in-kind (PIK) income, higher relative exposure to nonqualifying assets and an above-average level of non-debt investments, which could experience more valuation volatility in times of stress. FSK's significant size, relative to other BDCs, also poses some constraints on its operational flexibility. For example, at certain points in the cycle, FSK may be more challenged to identify sufficient investment opportunities to invest proceeds from repayments, which could pressure dividend coverage. FSK's size may limit capital markets' capacity to provide it with sufficient unsecured financing.

Rating constraints for the BDC sector more broadly include the market impact on leverage, given the need to fair-value the portfolio each quarter, dependence on access to the capital markets to fund portfolio growth and a limited ability to retain capital due to dividend distribution requirements. Additionally, Fitch believes BDCs will experience weaker asset quality metrics in 2023 amid macroeconomic headwinds and higher debt service burdens and slower growth prospects at portfolio companies.

At Dec. 31, 2022, FSK had $16.1 billion of total assets, making it one of the largest BDCs. Non-accrual investments accounted for 3.3% of the debt portfolio at value and 6.7% at cost at YE 2022; above the peer average and up from 2.6% and 5.3%, respectively, at YE 2021. FSK recognized net realized gains from portfolio company exits totaling $182 million in 2022, up from $161 million in 2021. Still, cumulative net realized losses totaled $444 million since inception through 2022, which compares unfavorably with peers.

FSK's portfolio remains largely focused on senior secured loans, with first lien loans representing 60.3% of its portfolio at YE 2022, which is relatively flat with the prior year. Still, senior exposure is below-average, due to the firm's above-average exposure to non-debt investments, namely asset-based finance investments and an off-balance sheet joint venture (Credit Opportunities Partners JV, LLC [COPJV]), which represented 12.4% and 9.3% of the portfolio at YE 2022, respectively.

FSK's core operating performance improved in 2022, with net investment income (NII) up 50% yoy, driven by an increase in assets resulting from the 2021 merger with FS KKR Capital Corp. II (FSKR), higher interest rates, greater dividend income received on its investment in COPJV and a continued rotation away from non-yielding investments. The weighted average yield on income-producing investments was 12.0% at YE 2022, up from 9.2% at YE 2021. NII yield, adjusted for certain non-recurring items, was 5.0% of the average portfolio at cost in 2022, which was in line with the rated peer average and up from 4.6% in 2021.

FSK's leverage (debt/equity) was 1.25x at Dec. 31, 2022, up modestly from 1.19x at YE 2021, resulting from unrealized losses. Adjusting for cash, foreign currency and net receivables for unsettled transactions, net leverage was 1.18x at YE 2022, up from 1.07x at YE 2021. The gross leverage ratio implied an asset coverage cushion of 16.8% at Dec. 31, 2022, which is within Fitch's 'bbb' category leverage benchmark range of 11%-33%, but below the peer average. Fitch expects FSK to manage leverage with an appropriate cushion to account for potential credit issues and valuation volatility.

FSK's NII coverage of dividends was solid in 2022, amounting to 118.8%, but considerably weaker when adjusted for non-cash income and expenses, at 86.3%. FSK's exposure to PIK income, which amounted to 10.0% of investment income in 2022, is above average compared to rated BDC peers, which can increase its exposure to realized losses should portfolio companies ultimately default. Fitch will monitor FSK's ability to ultimately collect PIK in cash over time.

The Stable Outlook reflects Fitch's expectation that FSK will maintain satisfactory asset quality, operating consistency, and solid liquidity and dividend coverage. The Outlook also reflects Fitch's expectation that FSK will manage leverage within the targeted range and that there will be no material change to the risk profile of the portfolio.

Rating Sensitivities

Factors that could, individually or collectively, lead to negative rating action/downgrade:

A sustained increase in leverage above the targeted range, a sustained increase in non-accrual levels, meaningful realized losses, a sustained decline in unsecured debt below 35% of total debt outstanding, an inability to improve cash-based NII coverage of the dividend, and/or a material change in the firm's risk profile without a commensurate decline in leverage could yield negative rating action.

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Strong and differentiated credit performance of recent vintages, evaluated in combination with the consistency of FSK's investment valuations and underlying portfolio metrics would be positive for ratings.

Positive rating momentum would also be conditioned upon an improvement in cash NII coverage of the dividend, the maintenance of sufficient liquidity, leverage levels commensurate with the risk profile of the portfolio, continued demonstrated access to the unsecured debt markets and the maintenance of unsecured debt above 40% of total debt outstanding.

DEBT AND OTHER INSTRUMENT RATINGS: KEY RATING DRIVERS

The alignment of the unsecured debt rating and secured debt rating with that of the Long-Term IDR reflects solid collateral coverage for all classes of debt given that FSK is subject to a 150% regulatory asset coverage limitation and has a meaningful unsecured funding component.

DEBT AND OTHER INSTRUMENT RATINGS: RATING SENSITIVITIES

The secured and unsecured debt ratings are primarily linked to the Long-Term IDR and are expected to move in tandem. However, a material reduction in unsecured debt as a proportion of total debt could result in the unsecured debt rating being notched down from the IDR.

Best/Worst Case Rating Scenario

International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

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