FS KKR Capital Corp (FSK) 2015 Q3 法說會逐字稿

Good morning ladies and gentlemen, to the FS Investment Corporation's third-quarter 2015 earnings conference call.

(Operator Instructions)

Please note that this conference call is being recorded. And at this time Jim Ballan, Senior Vice President of Investor Relations and Capital Markets will proceed with the introduction. Mr. Ballan you may begin.

Thanks Brandon. Good morning, and welcome to the FS Investment Corporation's third-quarter 2015 earnings conference call. Please note that FS Investment Corporation may be referred to as FSIC, 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 FSIC issued on November 9, 2015. In addition, FSIC has posted on its website, a presentation containing supplemental financial information with respect to its portfolio and financial performance for the quarter ended September 30, 2015. A link to today's webcast and the presentation is available on the Investor Relations section of the Company's website at, www.FSInvestmentCorp.com under presentations and reports.

Please note, that this call is the property of FSIC. Any unauthorized rebroadcast of this call in any form is strictly prohibited. I would also like to call your attention to the customary disclosure in FSIC's filings with the SEC regarding forward-looking statements. Today's conference call includes forward-looking statements and we ask that you refer to FSIC's most recent filings with the SEC, for important factors that could cause the actual results or outcomes to differ materially from these statements.

FSIC does not undertake or 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 FSIC's third-quarter earnings release, that was filed with the SEC on November 9, 2015.

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 FSIC's website.

Speaking on today's call will be Michael Forman, Chairman and Chief Executive Officer of FSIC; Brad Marshall, Senior Portfolio Manager of FSIC, and the Senior Managing Director at GSO Blackstone, FSIC's investment sub advisor. And Jerry Stahlecker, President of FSIC. We will then open the call for questions.

I will now turn the call over to Michael.

Thank you, Jim. And welcome everyone, to the FS Investment Corporation third-quarter 2015 earnings conference call.

We appreciate your interest in FSIC. On today's call, I will provide a summary of FSIC's key highlights and strategies. After which Brad will provide an overview of our investment activity. Then, Jerry will discuss our financial results in greater detail.

Our third quarter results reflect our high-quality portfolio, differentiated model, strong partnership with GSO Blackstone, and the scale of our platform. Net investment income for the third quarter of 2015 was $0.26 per share, compared to $0.39 per share for the second quarter of 2015. And $0.25 per share for the third quarter of 2014. Adjusted net income for the third quarter of 2015, was $0.21 per share. Compared to $0.35 share for the second quarter 2015, and $0.25 per share in the third quarter of 2014.

Adjusted NII was lower than expected. Primarily due to lower fee income, as a number of closings and direct originations expected during the third quarter were pushed into the fourth quarter. Looking at to the fourth quarter of 2015, we foresee a stronger quarter for direct originations and fee income.

Increased financial market volatility in the third quarter contributed to weaker secondary prices and wider clearing yields across the corporate credit markets. This impacted FSIC's net asset value which, as of September 30, 2015, was $9.64 per share, down from $9.89 per share as of June 30, 2015. The majority of the decline in NAV was driven by unrealized appreciation as a result of mark-to-market volatility in the investment portfolio.

Our core investment strategies include direct originations and opportunistic investments. Which, at September 30, 2015, made up approximately 95% of the fair value of our total investment portfolio. As of quarter end, direct originations represented more than three quarters of the fair value of the portfolio.

We believe directly originated investments typically provide a potential for higher risk adjusted returns, than those available in the broadly syndicated markets. Due to higher yields, and the ability to generate fee income such as origination and prepayment fees.

Our opportunistic investments, typically our anchor orders and event-driven opportunities. With anchor order investments, we seek to use FSIC's scale, strong capital base, and reputation to take an anchor position in broadly-syndicated deals in return for better (technical difficulty) economics or allocations, than those offered to other market participants.

During the third quarter, FSIC continued to grow its investments in specialty finance operating companies. Including investments in NewStar Financial, and Global Jet Capital. As of the end of the third quarter, FSIC and other BDCs managed by affiliates of Franklin Square, in collaboration with NewStar have provided $1.5 billion in unitranche financing to nine portfolio companies. We believe these types of customized credit solutions are an effective way to provide value for FSIC stock holders, by enhancing the risk-adjusted returns on our investments.

Subsequent to the end of the third quarter, Global Jet Capital agreed to purchase -- subject to customary regulatory and other approvals, approximately $2.5 billion in net assets from GE Capital's Corporate Aircraft portfolio in the Americas. Where a portion of the committed financing provided by FSIC, and other BDCs managed by affiliates of Franklin Square. We view this transaction as a significant step forward in our specialty finance platform strategy and we're pleased that the scale of our BDC platform enabled us to support the acquisition of this size.

Finally, alignment of management interests with those of FSIC stockholders is of critical importance to us. In the third quarter, Franklin Square Directors and Officers of FSIC purchased approximately 1.9 million of the Company shares. Since the close of the quarter, Franklin Square and Directors and Officers of FSIC [approached] an additional $650,000 in shares bringing the total purchase since the beginning of 2015 to $5.3 million.

In addition, Franklin Square members of FSIC's management continue to have 10b5-1 trading plans in place. I will now turn the call over to Brad Marshall. Brad?

Thank you Michael. In the third quarter, we continued to leverage the capital base of Franklin Square BDC platform. The sourcing and credit expertise of GSO's direct lending platform, and the broad and deep knowledge and resources of Blackstone to identify structure and fund investments with attractive return profiles.

During the third quarter, we invested $284 million. The sequential quarter decline was largely due to timing issues as several expected closings were pushed into the fourth quarter. The time of the direct originations contributed to the income below our typical range in the third quarter of 2015 but is expected to contribute to a stronger fee income level in the fourth quarter.

Our investment pipeline continues to be the deepest we have seen in a number of years. We believe the strong pipeline, in combination with the widening spreads in the market, should enable us to obtain increasingly attractive investment terms. While maintaining our focus on investing in senior secured debt which at the end of the third quarter, represented approximately 77% of the fair value of our total portfolio.

We believe that recent financial market volatility has presented a number of unique investment opportunities to improve FSIC's overall credit profile. While maintaining or improving the overall yield of its investment portfolio. The dislocation of liquid credit markets is grading more anchor orders [needing] event driven opportunistic investment options, then we have seen in several years. In fact, on a risk adjusted basis, we believe some of our most potentially lucrative investments are opportunistic investments.

The gross portfolio yield prior to leverage, of all funded direct originations in the portfolio as of September 30, 2015, was 10.1%. Based on amortized costs and excluding non-income producing assets, unchanged from the end of the second quarter. The gross portfolio yield, prior to leverage of all income producing assets was 10.4%, based on amortized cost as of September 30, 2015. It was also unchanged from the end of the second quarter.

As of September 30, 2015, the average leverage for our direct originations through the respective tranche in which we invested, excluding equity and collateralized securities was 4.7 times down slightly from 4.8 times at June 30, 2015. We believe the size and scale of FSIC platform allows it to add value to its portfolio companies beyond just initial capital. Our scale enables us to provide incremental capital to fund the growth of our portfolio company businesses whether it is through organic means or acquisitions.

A great example of this is Sequential Brands. Sequential has made multiple acquisitions, including the Joe's Jeans Brand and a majority interest in Jessica Simpson Brand which have significantly grown the business, and enhanced our credit. During the fourth quarter, we expect to close on our fourth financing with the company.

In addition, as we have stated before, all of our direct originations have access to Blackstone's GPO program. Which leverages the collective buying power of Blackstone's portfolio companies to reduce operating expenses. This potentially leads to improved EBITDA margins for the participants, and ultimately, better credit metrics for our portfolio companies, and performance for FSIC.

As of late October, FSIC portfolio companies that participated in the program, had an average savings on address spend of 18.6%. Increasing EBITDA for those companies by an average of 4.7%. GSO also has significant operating expertise which we have been able to utilize in restructurings, where we partner with portfolio companies to help them achieve their financial goals. In this way, we can be a catalyst for positive change in value creation to enhance returns for FSIC stockholders.

Examples include ALAN Systems, Sorenson Communications, and Kodak. Which have all seen significant improvements in earnings since we took a more active role in management. What we tend to avoid stress or distressed investment when credits under perform we welcome the opportunity to use our broad operating resources to improve performance of our companies.

I want to provide an update on the energy-related investments in FSIC's portfolio. Energy-related investments at the end of third quarter comprised approximately 10% of FSIC's investment portfolio, based on fair value, down from 12% the previous quarter. 90% of our energy investments, based on fair value, were direct originations.

In these direct originations, we were generally at the top of the capital structure and benefit from strong asset coverage. To be more specific, there are three direct originations that constitute approximately 86% of our total energy exposure as of September 30, 2015, based on fair value. Those are FourPoint, Plains Offshore and Ascent Resources.

For FourPoint, the company had a strong asset base in the mid-continent region. What we believe to be an excellent management team, and has reduced capital spending to protect its liquidity position. Our exposure is primarily in the senior debt of the company and there's only a small amount of debt above us in the capital structure.

FourPoint's debt to invested capital was approximately 50% as of September 30, 2015 which we believe provides strong asset coverage. For Plains Offshore, the company's required CapEx going forward is expected to be minimal. We believe the company is profitable, down to $20 per barrel of oil and there is significant common equity in the business below us which we believe gives FSIC strong asset coverage in our preferred equity position.

Finally, for Ascent, we believe our principle is well protected as our loan-to-invested capital is approximately 35%, as of September 30, 2015. While the company remains challenged from a liquidity standpoint, we believe the equity sponsor remains supportive of the company. We continue to work closely with the company in this investment.

We are highly confident in the credit worthiness of our energy-related direct origination investments. We continue to view certain areas of the energy market as interesting. Given GSO's experience and expertise in this sector, we remain confident that FSIC is well-positioned to capitalize on these opportunities.

As Michael mentioned, we made significant progress in the expansion of the breadth of our investment in specialty finance operating companies in the third quarter. FSIC and other BDCs managed by affiliates of Franklin Square originate $440 million in unitranche investments in partnership with NewStar in the quarter. Bringing the total since the origination of our relationship with NewStar 12 months ago, to $1.5 billion in nine deals.

Subsequent to the end of the third quarter, we announced that our portfolio company Global Jet Capital, had signed an agreement to purchase approximately $2.5 billion in net assets from GE's Corporate Aircraft portfolio in the Americas. The transaction is expected to close in stages over the next several months, subject to customary regulatory and other approvals. We believe this transaction demonstrates how the scale of our platform and the sourcing skills in investment expertise of GSO, creates potential for FSIC shareholders to obtain strong risk adjusted returns.

I will now turn the call over to Jerry to provide additional details on our results.

Thanks Brad.

Net investment income for the third quarter 2015 was $0.26 per share, compared to $0.39 per share in the second quarter 2015 and $0.25 per share for the third quarter of 2014. Adjusted net investment income for the third quarter was $0.21 per share, compared to $0.35 per share in the second quarter of 2015 and $0.25 per share in the third quarter of 2014. Adjusted NII was lower than expected, primarily due to lower fee income as the closings of a number of directly originated investments expected in the third quarter slipped into the fourth quarter.

In addition, our entry along with other first lien bank lenders, into a restructuring support agreement with Caesars Entertainment Operating Company Inc. resulted in the reversal of $0.01 per share in interest income accrued in prior quarters, due to our agreement to accept lower interest payments pursuant to their restructuring support agreement. Because fee income is generally driven by investment in prepayment activity, it can be less predictable quarter-over-quarter and therefore should be evaluated on a multi quarter basis. Looking ahead to the fourth quarter of 2015, we foresee a pickup in fee income.

As we have previously stated, we expect full year fee and dividend income to be similar to or slightly above the 2014 level. Net realized losses on investments were approximately $21 million in the third quarter of 2015. The majority of this was a result of our complete exit of our position in Samson Resources.

The portfolio had a change in unrealized depreciation totaling $48 million during the third quarter. Largely, due to changes in the value of FSIC's investments in Avaya Technology's bonds and Amaya Gaming [lines] and mark-to-market volatility in our energy portfolio. Partially offset by unrealized appreciation in our equity position in Allen Systems. As a result, FSIC experienced a net decrease in net assets, resulting from operations of $0.02 per share in the quarter ended September 30, 2015.

In the third quarter 2015, we declared a regular quarterly distribution of $0.22275 per share, which was paid on October 2. Taking that distribution into account, FSIC's total accumulated undistributed net investment income on a tax basis, was approximately $0.64 per share as of September 30, 2015. For the fourth quarter, we declared our regular quarterly distribution of approximately $0.22275 per share. To be paid on or about January 5, 2016 to stockholders of record on December 22, 2015.

Adjusted net investment income in the third quarter was slightly below our quarterly distribution, however adjusted NII for the nine months of 2015 exceeded distributions for that time period by $0.12 per share and we are expecting stronger fee income in the fourth quarter. With regard to the use of undistributed taxable income, we believe that in the current environment, excess capital is most productively deployed by investing in income producing assets. As has been our policy, we continue to evaluate the best use of our capital to maximize value for our stockholders and, as we have in the past, may pay special distributions when we deem it most prudent.

As of September 30, 2015 we had approximately $1.8 billion in total debt outstanding. Which was the same as the balance at June 30, with a weighted average effective interest rate of 3.96%. At quarter end, FSIC's debt-to-equity ratio was 78.4%, up slightly from 76.7% as of June 30, 2015. Primarily due to unrealized appreciation in the portfolio.

We believe FSIC is well positioned for a rising interest rate environment. As approximately 90% of our debt outstanding is at a fixed rate while more than two-thirds of our debt assets pay variable rates. We believe that rising rates, FSIC should experience net-investment income growth as our interest income grows, while our interest expense remains largely unaffected.

As we've said in the past, we do not need to rely on serial public equity issuances to achieve scale. While we have no immediate intention to issue new equity in FSIC, we would note that we may opportunistically raise new equity to the extent we have visibility into investment opportunities that we believe would be accretive to our existing stockholders.

I will now turn the call back to Michael.

Thanks Jerry.

We at Franklin Square believe our experience, scale and partnership with GSO Blackstone will continue to benefit FSIC investors. We're the largest manager of BDCs, with more than $15 billion BDC assets under management. And we believe FSIC is well positioned to provide customized credit solutions to many of the middle market companies that are driving the growth of the American economy and to generate reliable and sustainable income for our stockholders.

I would like to thank you all for joining us today. With that we will now open the call for questions. Operator?

(Operator Instructions)

Jonathan Bock, Wells Fargo Securities.

Perhaps a note of congratulations to you, Michael. I know yourself and Mike Gerber, and your legislative team did a Herculean task and getting the BDC bill out of committee. So a big congratulations to you. That wouldn't have happened without you a part of the process.

Real quick question that comes from more energy centric. You outlined in Ascent Resources, that there were some challenges from a liquidity perspective. And what I'm trying to understand is, how can there be challenges from a liquidity perspective given the fact you just had asset sales and a recap of fresh equity?

Jonathan, it is Brad Marshall I can take that question. The liquidity, I think in the markets generally, is fairly light. I think we're seeing this especially in high yield market. And we don't see that changing in the near term. I think there is a general rotation of risk going into the end of the year.

So, we're seeing high quality BB type names trade very well. But a migration away from risk at the bottom of the credit ratings. So we're seeing some of the more CCC type names trade off quite a bit. Not really on fundamentals, but more on technical. So as you look across the portfolio and see where our markets have taken a negative turn, it is mostly in those types of securities.

We mark our portfolio 100% every quarter. So, we have to take those marks. I would expect those to eventually reverse themselves to reflect more fundamentals in those companies, in those credits. But that takes time. And we are long-term investors, and in the meantime we're going to take those marks and live with them.

An additional question on a mark down. Avaya, just because we saw it written down from $41 million to $23 million, and I think that the bonds in 4Q 2015, also had a bit of volatility. Would you also be willing to just give us an update on that name and specific? And then we can turn to some aircraft questions.

I think Avaya is a perfect example of what I just said. It is a credit that competes in a competitive space. It's got near-term earning pressures, but there hasn't been any real fundamental changes in the business. In fact, their latest earnings came in line with where we thought they would be. And yet the bonds traded off as much as they did, largely on the back of dealers aren't taking inventory.

There is some price discovery in some of these securities. So I think that is a good example of the lack of liquidity in the market. And I think over time, it will eventually trade to where the fundamentals will support higher levels. But right now that is not the case.

Maybe taking a stab at structured products, or unique financings. Either NewStar, which was obviously a very attractive financing et cetera, to GE's aviation business. Brad, Michael, at times business [of the companies] -- that over own structure product securities, have had historically lower valuations. On top of the fact that some of those folks are very bad credit managers, but also because of the fact that what is owned in the BDC is a bit opaque. Whether it's a structured product aircraft securitization, or lending to a specialty [thinco].

Just your view, given that GSO is so large. And FS is so large. That it would make sense to migrate towards this area. But how do you balance what you might perceive to be a good return with the downside of additional complexity, that comes in as you start to make these financings and improve shareholder ROE?

John this is Jerry. Just to step back for a second. Global Jet isn't a structured credit. It is an operating business that finances and leases corporate jet aircraft. Principally, in the US and Europe. But, really globally.

They brought the US corporate jet financing business out of General Electric. Including personnel, who are involved in doing those financings and leasing those aircraft to corporate customers. It really is an operating company.

We, Franklin Square Funds, together with Carlisle and Aeroequity, are the other investors, help provide the financing for the purchase of that business from General Electric. So, it is not really a structured securitized investment.

I would just add to that North NewStar, [needs] their loan to operating companies, Jonathan. The type of investments that you are referring to are more on the collateral loan obligations, and those type of structure products. Which, we have a fairly low exposure to, and I think will always be a smaller part of the portfolio, 1%, 2% 3%.

So, the point is taken in the sense that some of those structure products don't have a lot of good visibility into the underlying assets, or what investors are buying. But our loans to these businesses like NewStar and Global Jet are really operating loans, likely due to our other portfolio companies.

Lastly, as it relates to NewStar and their Unitranche product offering, as well as their focus on the lower end of the middle market. Interested in any of the consolidation waves or trends that you have seen? I found that there are three folks, in addition to yourselves that sit atop the Unitranche product ladder. Whether it is Golub, Aires, [Enteris] or yourself.

Interested in where NewStar is fitting in that competitive dynamic? As they have benefited from your capital, and are continuing to focus on that lower end of the middle market. Boosting your visibility and deal flow there and elsewhere.

NewStar is a great partner. They are like-minded underwriters. And we will typically partner with them on a Unitranche, where they are looking at a small portion as the first out, and [we] are looking at taking the vast majority of the Unitranche in the last out. And that is the nature of our relationship. We show them opportunities, and vice versa they show us opportunities.

Okay great.

Some of the other partnerships John, where it has gone through a joint venture entity. These are all one-off situations where we will look at a transaction, show it to them, and they will decide whether they want to do a small first-out participation. And, I think, as Brad talked about in the past, in situations where we control the outcome and control the entirety of that capital structure, as opposed to being a small last-out piece. Where we are at the mercy of a larger first-out lender.

Great. Thanks guys.

Greg Mason, KBW.

This is Ryan Lynch filling in for Greg. I just had a question. The Wall Street Journal had an article out this morning talking about a trend of some banks originating loans, and then not being able to sell off these loans. And being forced to hold them on their balance sheet, or causing these banks to have to sell these loans at really big discounts.

FSIC, and the broader Franklin Square platform is one of the biggest BDCs and a player with the ability to take down some of these loans from these banks. Are these some of the trends that you guys are seeing in the market? And is this a strategy that you guys would consider pursuing? Buying some of these large loans off banks at big discounts?

This is Brad, yes absolutely. I think there is times in the market where you can get better risk adjusted returns by buying the bigger end of the market, because banks are holding these loans and need to sell these loans for a variety of reasons. The market may not be there to digest it, and we can go in with size and be a meaningful player, and helping them achieve their goals.

That market has presented itself in the third quarter. The end of the third quarter. And has continued into the fourth quarter. And we will take advantage of those situations to the extent that credit is worthwhile, and the pricing is a good return for investors.

One other broad-based question. It look like the SNC review came out. And they were pretty critical of energy loans, but also critical of loans on banks. Saying they were fairly highly levered, and were very criticized. So are you guys seeing any more additional pull-back from banks due to that SNC review? Or can you comment in what potential future impacts that may have on your space?

What I would say is the SNC review, and other regulatory pressures on banks continue to present good opportunities for investors, in FSIC and other credit investors.

That's all for me. Thanks guys.

[Aaron Semyonovich], DA Davidson.

You mentioned your investment pipeline is the deepest in years. Is that mainly from the direct origination side? Or is that also at the opportunistic investments that you are highlighting?

Aaron, it is Brad. I would say both.

Is it more direct? Or how would you describe the breakdown there?

What I would say, is we have more opportunities in our direct origination pipeline than we have capital. And we brought in some other co-investors to invest in alongside some of our opportunities to address that. In addition, we see an overflow of opportunities in the liquid market that we're balancing against our direct origination pipeline.

I think we have talked about this in the past, but the issue I have with the opportunistic is that they are generally liquid loans. Then you are subject to the volatility of technical pressures that you are seeing in the market et cetera. So, how do you balance that when you see the opportunities out there? But also thinking about it in terms of a mark- to-market exposure on the balance sheet each quarter? How do you balance that risk when you are making that decision?

It is a good point. Which is, why that part of our portfolio is only going to be part of our overall strategy, managing through volatility can sometimes be challenging. But, typically the type of investment we are making is the first lien senior secured investment that won't have more than five or six points of volatility. But it is an opportunity to come in at attractive entry point relative to the rest of the market.

So you're going to see some volatility, but not a ton of volatility in those types of names. It will be a smaller portion of the overall portfolio as it relates to our originated pipeline.

Lastly, on the right side of the balance sheet, you have one of your smaller undrawn facilities that will be maturing in the fourth quarter. What are your plans there? And I guess longer term, you have the large JPMorgan facility, it doesn't mature until April 2017. But what are your thoughts about looking to replace that very low cost facility?

Aaron there is no borrowings under that facility right now. So to the extent it is not expensive to keep in place we will. But we have a lot of undrawn capacity right now in FSIC. And we only want to have that capacity for leverage that we can draw on. So, we will evaluate that. But the bank has already suggested they will extend that to the extent we would like to.

Melissa Wedel, JPMorgan.

Melissa Waddell on for Rick Shane. You indicated a willingness to increase your energy exposure in the portfolio. And I know it was down a little bit quarter-over-quarter. Could you comment on how high you might be willing to take that in the current environment?

We are 10% now. I think we are comfortable in that plus or minus 10%. While we're seeing a lot of great opportunities, we don't want to take outsized risk in the sector. But to the extent we see the first lien secured return for our investors then we will evaluate that but I think it is in and around where it should be.

As a follow up can you comment on the incremental return available by increasing exposure through additional energy investments?

Is going to be on a case-by-case basis, Melissa. We are looking at, just historically, our energy exposure is a range between 10% and 15%. It is at 10% now, which is on the low end of that range. For every opportunity that comes along, we're looking at the risk-adjusted return in each of those opportunities, compared to the other opportunities that present themselves. And then making adjustment as a manager as to the best place to deploy the capital and earn the best risk-adjusted return.

Certainly, the bar is set a little bit higher right now, in the energy sector. Just given the volatility in the commodity price environment and other things. But I think there will be opportunities to earn outsized returns. And you can be a liquidity provider and a solution provider for these companies. But we are setting the bar pretty high on evaluating those opportunities.

Terry Ma, Barclays.

Just wanted to follow up on the energy for a second. You guys have said in the past that $45 oil is not sustainable over the long term. It is just a price pass. It is uncertain.

So, if we just assume that $45 is the new to normal over the next 2 to 3 years, can you talk about how you think about your energy investments in that context? And whether or not there's anything you can do with your existing investments to protect them? And shareholder losses?

I will try and take that one Terry. So, claims offshore, as we mentioned has a breakeven price of $20 a barrel. So they will continue to be profitable on a $45 oil environment. Four Points, the company that has both oil and gas production, as does Ascent Resources. So, we need to bring gas into the analysis there.

I think both of those companies, we'll take Four Points. Four Points will continue to operate fewer rigs in that environment, to preserve liquidity. But, at those levels, we continue to feel good about our investment. And in Ascent Resources, it is more natural gas heavy. So we will have to look at natural gas prices.

There from an asset coverage standpoint, we still feel very well protected from a liquidity standpoint. Longer for lower or lower for longer gas price. We put pressure on their liquidity, and the sponsor would have to continue to put capital in, in order to prove up their reserves.

Having said all that, we have recently done an asset sale that suggests that at levels that exceed our quantum of debt. So we still feel good about our coverage on those three assets.

Just to add to that, Terry. the value of the proved reserves -- when we made the initial investment, the company just had undeveloped acreage. The value of their proved reserves, even at these pricing levels, is in excess of the first lien debt.

Then their undeveloped acreage is a multiple of that as well. Based on a discount for the prices they received in the most recent asset sale. So, those asset value support the initial setup structure, which was one third senior secured debt and two thirds subordinating capital, so we still feel strong about the asset coverage in that position.

That's helpful. On the specialty finance investments, can you talk about how big those can get as a percentage of the portfolio? Maybe just remind us what returns you are targeting for those?

NewStar in total across the FSIC Funds was a $300 million commitment. Really spread across FSIC One, FSIC Two, and FSIC Three. So, from an individual funds standpoint, the position isn't a meaningful percentage of the portfolio overall. And we are targeting 10% plus returns on a current basis.

We have got warrant coverage that increases the value that we expect to receive on that. Because we have got warrants across the front to acquire about 20% of the company. So we expect to see some value creation there. Global Jet, again is across all of our BDCs. So, it is a fairly significant investment across the BDCs.

North of $400 million across the BDCs. But again, not overly significant in any single fund. And I think, as those companies growth there will be other opportunities for them to fuel their growth beyond simply us increasing our exposure. But, where it makes sense to do so, we would do that on a prudent basis.

Terry what I would add to that, is like all of our strategies, were never going to take an outsized exposure in any particular strategy. So, operating in and around -- depending on what you classify as the specialty thinco investments, but in the 5% to 10% zip code, I think is probably a good ballpark. And again, some of these we just view as operating loans to companies like NewStar. But I think that is probably is a good benchmark.

Okay great. That's helpful. That's it for me. Thank you.

Christopher Testa, National Securities.

On the senior secured bonds, which experienced the most fair value marks. Just wondering how much of that was particular to energy? And how much of that was the spreads widening and the loan prices being marked down significantly during the quarter?

The three biggest movers in terms of the unrealized appreciation. One was Avaya. Which are liquid bonds. That, the value of the Amaya gaming warrants, those warrants -- the stock price of Amaya went down significantly at quarter end. And then rebounded subsequent to quarter end because the company had good news in terms of getting approved for online gaming in New Jersey.

That decline in the Amaya warrants was reversed after quarter end. And then the third mover, it was all roughly equal parts, was in aggregate across the energy positions and the bulk of our energy exposure. 90% plus of our energy exposure, is in direct originations. But because we mark the entirety of our portfolio to market every single quarter, when spreads widen in the overall markets, then the spreads that are used in the third-party evaluations on those direct originations widen out based on the market comps.

Even though there may be no fundamental change to the company's business such as the way fair value works. It was equally spread across those three. Two specific names and then broadly in energy.

Just to put some specifics to that, Chris. The high yield market spreads widened150 basis points during the quarter.

Right.

So invariably, that is a benchmark. And Four Points is a good example. The company's credit profile improved during the quarter. Yet, we had to take a mark down on those because spread relative to the public energy market on our 8% bond, would suggest that you had to widen those spreads.

It is definitely a product of the volatility we saw in the third quarter. In the third quarter, versus any credit issues with any of the portfolio companies.

Just in terms of your internal rankings, they were largely positive. Much more moving into the 1% bucket. Moving out of the 5%. Excuse me moving out of the 4% further. Were there a particular few investments that were really driving that?

Yes, I think ALAN Systems came out, Sampson came out because we sold it. Those would be the big movers out of that category.

Okay. Given the closings that were pulled into the fourth quarter, were they mostly second liens to take advantage of the higher spreads? And also, should we expect, given the spread widening that your funded originations minus the exited should be positive going into the fourth quarter?

What I would say, is that as we move into the fourth quarter, we have several second liens that are paying down. And we are taking that capital and moving it further up the capital structure.

Okay.

So we are moving those investments into, as I suggested at the start, using this opportunity to try and maintain yield but further up the capital structure.

Okay. Just last one for me. How to think about your capital goods energy exposure given the bellwethers of the industry, caterpillars really global have been struggling a lot lately. What is the emerging market exposure for the capital goods portfolio? And do you expect that to experience any mark downs on a fair value basis? Given what has been going on in the industry?

It is a good question. Our exposure to emerging markets is very low. Something that we are focused on at FSIC and Blackstone more generally. But, where we have that type of exposure and how we think about it. So we've gone through this analysis recently and the exposure is fairly light.

We have some exposure to China in some of our portfolio companies. But really nothing that amounts to more than 5% or 10%. So, we view it more as an equity issues than a credit issue. We feel good about our exposure.

Okay. That's all for me. Thank you for taking my questions.

Henry Coffey, Sterne Agee, CRT.

I think you focused on a lot of the key issues, especially around energy. A big open issue for me is: A, how important is size? And as the world changes, is that going to change? And B, are there any other obvious industry concentrations that might become next quarter's obsession?

In terms of industry, I think we are spending a lot more time on metals and mining as well as our retail. Metals and mining clearly has had a similar show off in commodity prices. So we are trying to understand where we have high levels of exposure. And it doesn't seem like we have much of any.

We have a repackager of aluminum that isn't directly exposed to commodity prices. But has some working capital issues we are working through. I think that will be a net positive for that company. And then in terms of retail, we are seeing a higher rotation out of fiscal retail to online. And it's been a theme that is been going on for many years, but one that we have seen a pickup in activity.

So, we're pretty focused on that exposure and how to mitigate it. Then, in terms of your first question on how important is size. Was that in relation to how important is it for us to have scale as we focus on portfolio companies that are looking to grow?

It is really both. Your ability to have a very large hold size. And while we were all talking about the SNC review, they will create complexities in your life as you get bigger. They being our friends, the regulators. So, they are ultimately are always going to be administrative overhead et cetera that complicates the equation. So it is really both. Hold size, and having the size to be efficient.

I think certainly scale helps in both of those regards, Henry. Scale to provide financing solutions gives us pricing power in the marketplace, and helps us to get better yields overall. Without having outsized hold sizes. Because we want our positions to be generally less than 5% of the portfolio overall.

In terms of dealing with complexities. Having the right platform certainly gives us the scale to better deal with those in the smaller players. So I think it is only helpful overall.

Great thank you.

(Operator Instructions)

Ryan, KBW.

Going to throw you another curveball. This is Troy Ward. Filling both in for Greg and filling in for Ryan. Michael, in the prepared commentary, it was mentioned that you have no real immediate intentions to raise equity. And of course, we know you haven't raised equity in this vehicle. And would only do so in a circumstance where it's an outsized opportunity, that would be beneficial.

I just want to comment, there are two basic issues that we have seen with the BDC sector, with regard to equity issuance. And the first is, equity that is raise below book value which we believe is a non-starter. The second, is equity aright raised about book value, but really does not provide any economic benefit to shareholders.

It seems we have just seen far too many equity deals that are basically an economic push to shareholders. And they're being justified, we're bigger, we're more diversified,. Things like that. Can you speak to the minimum level of economic value? I.e. higher earnings and dividends that you believe any new equity should deliver before you would undertake raising new equity?

Thank you Troy. Certainly, we agree that we have a bit of a differentiated model based upon our ability to raise capital and build scale in the non-traded space. We are not subject to some of the same pressures that the other managers may be subject to. Or some of the same analysis that they could be subject to.

We want to keep the door open, that, if we see a significant and accretive opportunity in the markets, and we want FSIC, which is not currently raising capital now, to have exposure, we would entertain that strategy. And we recognize that will be held to a fairly high standard. We recognize that the transaction has to be accretive to our investor base overall. And not be done for other extraneous reasons. We haven't seen that yet.

As we continue to grow our franchise, there may be times when there is a great risk adjusted opportunity in the marketplace that would be accretive to our investors. And then we could, very opportunistically look to raise equity in the public markets.

When you say accretive do you differentiate between accretive to book value and accretive to earnings?

I think you've got to look at both of them. I think you look at the analysis of how it would drive future performance. And I think there are two components to performance. Book value and income. And we would look with a fairly high standard of both of those. And what impact the capital rates would have. We recognize the distaste that this market has for below book value issuances. Which is something we would certainly be very mindful of.

Okay. Great. Thanks.

Thank you. I just want to thank everybody for their time this morning, and look forward to next call with you all.

Ladies and gentlemen, this concludes today's conference, thank you for joining. You may now disconnect.