The group led by JPMorgan Chase controls credit

TO JPMorgan Chasebank-led group reduced its exposure to a private credit fund co-managed by kkr days before the asset manager announced it was spending $300 million to shore up the troubled vehicle.

The background, FS KKR Capital Corp., said in a statement Monday that KKR will inject $150 million into the fund as capital and spend another $150 million to buy shares from investors who want to exit.

Those moves, called “Strategic Value Enhancement Actions” by the fund, came after the JPMorgan-led group on Friday cut its credit facility by $648 million, or about 14%, to $4.05 billion. Some lenders may have exited entirely rather than extending their commitments, according to the document.

The fund, co-managed by KKR and alternative asset manager Future Standard and often referred to by its symbol, FSKIt has become one of the most visible failures in the history of private credit. Its shares have plummeted by almost half over the past year and trade at a deep discount to the fund's net asset value.

In March, Moody's downgraded FSK's ratings to junk amid growing strains on the portfolio. Since then, loans to software maker Medallia and dental services company Affordable Care have stopped paying interest, FSK executives said Monday.

FSK said it had losses of $2 per share in the first quarter, or about $560 million in total losses given its roughly 280 million share count, as the fund's net asset value fell about 10%.

“We are disappointed by our recent performance,” FSK President Daniel Pietrzak told analysts on Monday.

The firm's interpretation of the situation and KKR's actions to prop up the fund “support our view of a disconnect in FSK's trading price versus its intrinsic value,” Pietrzak added.

FSK loans no longer generating income rose to 8.1% at the end of the first quarter from 5.5% at the end of the year, the fund said.

In addition to trimming its credit line, the JPMorgan-led group also raised interest rates on the remaining credit line and gave the fund more room to absorb losses without triggering a default.

This latest move, which reduces the minimum equity floor from $5.05 billion to $3.75 billion, gives FSK more breathing room. But it also indicates that lenders believe the company's assets have to fall further.

During Monday's call, FSK executives warned that “individual names could deteriorate further” despite the company's efforts to stabilize troubled portfolio companies.

The FSK facility was funded by a syndicate of banks led by JPMorgan as administrative agent, a role that typically includes coordinating lender communications and amendment negotiations. ING Capital acted as collateral agent, while the other participating lenders were not named in the filing.

JPMorgan, the largest U.S. bank by assets, has taken broader steps to protect itself from the private credit turbulence, in part by writing down the value of private loans held as collateral on its own books, CNBC reported in March. Many of those discounted loans are going to software companies facing potential disruptions from artificial intelligence.

Executives also said Monday that FSK would sharply reduce new investments, focus on supporting existing portfolio companies and work toward a smaller, less leveraged balance sheet while buying back shares.

In addition to the $300 million KKR is spending to support FSK, the fund's board also authorized a separate $300 million share buyback program, and KKR agreed to waive half of its incentive fees for four quarters.

FSK, which makes loans to private, middle-market U.S. companies, became the second-largest publicly traded business development company, or BDC, when it was formed through the merger of two predecessor funds in 2018.

The fund's largest lending category is software and related services, which accounted for 16.4% of exposure at year-end.

FSK's problems have fueled debate over whether rapid growth in private credit poses systemic risks. Prominent investors, including DoubleLine Capital CEO Jeffrey Gundlach, have warned that private credit could cause the next financial crisis, drawing comparisons to the mortgage-backed securities market before the 2008 crash.

The private credit industry has rejected those comparisons, arguing that losses are dispersed among investors rather than concentrated within the banking system.

“Private credit industry regulators have consistently found that the industry is conservatively capitalized and structurally designed to mitigate, rather than transmit, risk to the financial system,” said Will Dunham, executive director of the American Investment Council, an industry trade group that represents private equity and private credit firms.

“The private credit system is working as designed,” Dunham said.