FS KKR Capital Corp (FSK) 2016 Q2 法說會逐字稿

Good morning and welcome to FS Investment Corp second-quarter earnings conference call. Please note that FS Investment Corporation maybe referred to FSIC, the fund or the company throughout the call. This call is being recorded and an audio replay of the call will be available for 30 days.

(Operator Instructions)

FSIC has posted on its website a supplemental financial information with respect to its portfolio and financial performance for the quarter that ended June 30, 2016. A link to today's webcast and a presentation is available on the Investor Relation section of the Company's website at www.fsinvestmentcorp.com under presentations and reports. Please note that this call is property of FSIC. Any unauthorized rebroadcast of this in any form is strictly prohibited.

I would also like to call your attention to the customary disclosure and 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 factors that could cause actual results or outcomes to differ materially from these statements. FSIC does not undertake to 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, a reconciliation to the most directly comparable GAAP measures can be found and FSIC's second-quarter earnings release that was filed with the SEC on August 9, 2016. NonGAAP financial measures 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 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, Kayla, and welcome, everyone, to FS Investment Corp's second-quarter 2016 earnings conference call. We appreciate your interest in FSIC. On today's call, I'll 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.

Despite a spike in financial market volatility at quarter end following Britain's decision to exit the European Union, Investor appetite for corporate credit improved in the second quarter 2016, and made generally positive US economic data and rising commodity prices. As evidenced by the performance in the weeks following the Brexit vote, leverage credit markets and, more specifically, US middle market companies, tend to be more insulated from broad macroeconomic events relative to larger peers and multi-national public companies.

As market sentiment and asset prices improved during the quarter, our primary focus was on leveraging the capital base of Franklin Square's BDC platform and the resources and credit expertise of GSO/Blackstone to improve the liquidity and operating efficiencies of our portfolio companies.

Net investment income for the second quarter of 2016 was $0.23 per share compared to $0.21 per share for the first quarter of 2016, and $0.39 per share for the quarter ended June 30, 2015. The quarter-over-quarter increase was largely attributable to higher fee income driven primarily by refinancing of investment AP Plasman, and to a lesser extent, prepayments and upside direct origination financings to existing portfolio companies.

The fee income totaled $16 million in the second quarter of 2016, compared to $1.6 million in the prior quarter. Adjusted net investment income for the second quarter of 2016 was $0.24 per share, compared to $0.21 per share for the first quarter of 2016, and $0.35 per share for the quarter ended June 30, 2015. As a result, distributions of approximately $0.22 per share were fully covered by net investment income and adjustment net investment income during the second quarter.

Following payment of its regularly scheduled distribution, FSIC's total accumulated undistributed net investment income on a tax basis was approximately $0.63 per share as of June 30, 2016. FSIC's net asset value as of June 30, 2016 was $9.18 per share, compared to $8.82 per share as of March 31, 2016 and $9.10 per share as of June 31, 2015. NAB growth was driven primarily by unrealized appreciation and direct originations in opportunistic investment.

It is important to note that we, along with our Board of Directors, work with independent third-party valuation service providers to mark 100% of the investment portfolio to market each quarter. At June 30, 2016, approximately 97% of the fair value of the total investment portfolio was allocated to our core investment strategies, which include direct origination opportunistic investments, and which generally offer the potential for higher yields and stronger covenant protections that may be found in the broadly syndicated markets.

This level has remained relatively unchanged for the past several quarters and approximates our target allocation. We have also maintained a focus on investing in senior secured debt, which at the end of the second quarter represented approximately 73% of the portfolio based on fair value.

With that, I will now turn it over to Brad to discuss our investment activity during the quarter. Brad?

Thank you, Michael. During the second quarter, our primary focus was on providing additional capital and operational support to our existing portfolio companies. Total purchases for the quarter was $389.8 million, the majority of which was committed to existing portfolio companies including AP Plasman, Allen Systems, FourPoint Energy and Greystone.

We exited approximately $413 million of investments during the quarter, which included the previously anticipated repayments of Flanders and Pittsburgh Glass Works. Looking forward, given the overall strength in the credit markets, we expect similar levels of activity in the third and possibly fourth quarters of 2016. Given our healthy investment pipeline, we will look to actively match the flow of potential prepayments with the deployment of capital into new investments.

We continue to use the size and scale of GSO's direct lending platform and FSIC's capital base to identify source and structure investments with attractive return profiles. As of June 30, 2016, the gross portfolio yield prior to leverage and excluding non-income-producing assets was 10.2%, down slightly from 10.4% in the prior quarter, due to repayments during the quarter of some of our higher-yielding assets.

The average leverage for our direct originations through the respective tranche in which we invested excluding equity and collateralized securities was 5.4 times compared to 5 times as of March 31, 2016. The increase in average leverage was driven primarily by single challenge company that experienced a large uptick in leverage during the quarter. This position in Swiss Watch International represents 0.6% of FSIC's portfolio on a fair value basis.

If this company's leverage had been held constant quarter-over-quarter, average leverage would have effectively been unchanged. All of our directly originated portfolio companies have access to Blackstone's group purchasing organization 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 in turn, stronger performance for FSIC. As of July 11, 2016, FSIC portfolio companies that participated in the program had an average savings on addressed spend of 20%, increasing EBITDA for those companies by an average of 3.6%.

While we do not typically invest in stressed or distressed credit, when our credits under perform, we welcome the opportunity to employ our significant operating and restructuring expertise, which enables us to partner with portfolio companies in an effort to create additional operational efficiencies in an effort to mitigate losses, create above-average recovery rates and maximize returns.

As of June 30, 2016, we had three investments on nonaccrual, which in aggregate represents only 0.3% of the portfolio based on fair value, and 0.7% of the portfolio based on amortized cost. In addition, these investments represent approximately $2.5 million or approximately $0.01 per share in annual income.

Since quarter end, we placed our investment in Lightstream Resources, a nonaccrual. This position represents less than 0.1% of the portfolio based on fair value, and 0.1% based on amortized cost. We are working with all of these companies to maximize our recoveries.

This week, Logan's Roadhouse filed for Chapter 11 bankruptcy protection as result of the restructuring and turnaround plan, we believe that Logan's can achieve meaningful savings through our rent expense reduction, working capital optimization and operational improvements. Moreover, Logan's will exit bankruptcy in an improved liquidity position with a cleaner balance sheet and reduced interest expense.

Although we expect to convert an undetermined portion of our debt position into equity, which will result in a loss of income, we believe doing so provides the best opportunity to effectuate Logan's turnaround and realize increased value on our investment.

Since FSIC's inception, where FSIC's portfolio companies have defaulted on their debt, the fund recoveries have been in excess of the par value of our exposure, which means we have made money in aggregate when a company has defaulted. We work hard as an equity owner and as GSO is part of Blackstone, many tools are at our disposal in order to maximize our recoveries in the event of default.

Let me now turn to our energy portfolio. Energy-related investments as of June 30, 2016 represented approximately 12% of FSIC's investment portfolio based on fair value, compared to 10% as of March 31, 2016. The increase is due to the fact that our directly originated energy investments experienced meaningful appreciation as energy credit prices rallied during the quarter.

For FourPoint, the company acquired certain assets from Chesapeake Energy for approximately $385 million in the second quarter. This transaction, which FourPoint has funded entirely with equity, provides further cash flow and asset protection to our debt positions, and positions the company as one of the largest in the Western Anadarko Basin. Our investment of FourPoint appreciated significantly as the result of the acquisition.

Similarly during the quarter, we experienced appreciation in our largest energy exposure, Ascent Resources, Utica. The company, which owns what we believe to be an attractive acreage in the Utica basin considerably improved its capital structure in the first quarter of 2016 by raising approximately $700 million in equity. Our senior secured debt sits at the top of this improved capital structure and we remain confident in our position.

The recent improvements at FourPoint and Ascent exemplify our approach to direct originations in energy, investing in strong companies, generally at the top of the capital structure, with strong assets and sponsors that provide support throughout commodity price cycles.

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

Thank you, Brad. Net investment income for the second quarter of 2016 was $0.23 per share, compared to $0.39 per share for the second quarter of 2015. Adjusted net investment income for the second quarter of 2016 was $0.24 per share, compared to $0.35 per share for the quarter ended June 30, 2015.

As Michael noted, fee income during the second quarter was higher than more recent quarters driven primarily by the refinancing for AP Plasman, and prepayments at Flanders and Pittsburgh Glass. Interest income declined approximately 6.9% in the second quarter of 2016, as compared to the first quarter, primarily due to reduced fund leverage, prepayments of higher-yielding assets and increased equity holdings as a result of restructurings.

In the second quarter of 2016, we declared our regular quarterly distribution of approximately $0.22 per share, which was paid on July 5, 2016. That distribution was fully covered by net investment income of $0.23 per share in the second quarter. For the third quarter of 2016, we declared a regular quarterly distribution of approximately $0.22 per share to be paid on or about October 4, 2016 to stockholders of record on September 21, 2016.

Given the decline in interest income in the second quarter of 2016, and barring significant fee income in the third quarter, we currently expect to use a portion of the accumulated undistributed net investment income to help fund our third-quarter distributions. NAV was $9.18 per share as of June 30, 2016, compared to $8.82 per share as of March 31, and $9.10 as of December 31, 2015, resulting in a second-quarter NAV return of approximately 6.6%, and a year-to-date NAV return of approximately 5.8%.

Net change in unrealized appreciation on investments during the second quarter of 2016 totaled approximately $89.5 million or $0.37 per share, which was primarily attributable to appreciation in our investments in FourPoint Energy. Net realized losses of $7.6 million or $0.03 per share during the second quarter were largely driven by the sale is our investment in Noviya. We've now fully exited our holdings in Noviya.

At quarter end, FSIC debt to equity ratio was 76%, compared to 82% as of March 31, 2016. The reduction in leverage was intentional and driven by both rising asset values as well as a meaningful reduction in borrowings from $1.8 billion as of March 31, 2016, to $1.7 billion as of June 30, 2016.

During the first six months, we reduced borrowings under the JPMorgan facility from $800 million to $650 million. In connection with the reduction, we incurred $938,000 in breakage fees, $469,000 of which was incurred during the second quarter. Approximately 97% of the funds total borrowings were fixed rate as of June 30, 2016, with a weighted average effective interest rate of 3.9%.

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 are the largest manager of BDCs with more than $16.5 billion in assets under management and we believe our investment at FSIC serves to further align our interests with our stockholders.

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

(Operator Instructions)

Jonathan Bock, Wells Fargo Securities.

Good morning and thank you for taking my questions. Michael, I want to ask the question just because I see two statements and I want to understand if they conflict. Because I do believe we heard that Brad mentioned there would be similar levels of prepayment activity in the third and fourth quarter, which is certainly great, but then also Jerry outlined that you're going to expect a decline in third quarter to where you are going to effectively pull from undistributed net investment income on the balance sheet or spillover to effectively fill the dividend gap. I am under the impression that prepayments likely bring outsized fee income, so am I wrong in making that assumption?

Right. John, this is Jerry. I think it really depends on the timing of the prepayments and the redeployment of that capital. If you note, during the second quarter, we had $0.18 to $0.19 per share of income purely from interest income and then the balance of $0.03 to $0.04 was covered through roughly $16 million of gross fee income.

Without that $16 million of fee income, we would have used $0.03 to $0.04 of undistributed income to cover the second-quarter distribution and we were just highlighting the fact that in the third quarter, if the timing of any prepayments and redeployment of capital slips for any reason, then we would need to cover that shortfall with the undistributed income that we have got on the books that's about $0.63 per share.

Jonathan, it's Brad. I would just add to that, because I know this kind of comes up and I think it came up last quarter on the fee income. If you go back to 2013, so over the past 3.5 years, on average, we are about $45 million, $44 million a year in fee income. So it's been a fairly steady stream of contribution to our overall earnings and I think that's just important to point out because it is often part of how we structure and price deals.

So it may not always be in rate but it may be taking a little less rate, but adding a lot of extra back-end or front-end fees. Just want to kind of highlight that and use the historical averages as a decent proxy for going forward. And Jerry's right, quarter-over-quarter, each quarter, it may not be perfect as this year has kind of exemplified between the first quarter and second quarter, but on a whole, on a annual basis, that's what it should look like.

Okay. Great. Thank you, Brad. It's the $64,000 question that often gets asked, certainly this quarter, for BDCs that some have reduced dividends or are at least talking about dividend policy and, Brad, we appreciate your comments on equitizing part of Logan's, et cetera, and the upside that comes to it and that can effectively be the correct credit decision.

And so as we look at the dividend, clearly with some prepayments for the remainder of this year and some expectations, how would you describe the current dividend policy with respect to NII when we find that, if fees don't necessarily come in exactly as modeled, or perhaps a little light and/or we have a credit blip for whatever reason, which is normal, that we are a bit at the line as it relates to the dividend.

How would you foreshadow the cost to capital that that dividend produces? Something we refer to as the math. In your, and importantly, GSO's ability to source what we consider to be attractive risk-adjusted returns, because if we look at the current dividend today at NAV, I think it's about a 10% yield. You throw on some credit loss assumptions and run through the cost structure, you certainly need to originate in excess of that. So walk us through how the dividend policy is playing out here in terms of sustainability and in terms of the new investments that you're looking at originating and the risk adjustment returns in those.

Okay. A lot in there, but I'll try and tick through them. I think we do get the math. We look every quarter, and I'll answer this generally, then more specifically, but every quarter, we try and look out two quarters ahead. We look at what the prepayment schedule looks like, so we try and map out what the fee income will ultimately look like and what the pipeline looks like and what the market environment is like and we plug that into the model and we determine whether our dividend rate is appropriate.

That's kind of what we have done historically and if we need to increase it, the dividend, or decrease the dividend, those are conversations that FS has alongside GSO. Historically, we have actually increased the dividend, but on a look-forward basis, we will continue to have those discussions.

As it stands now, we feel comfortable with the dividend rate. If we feel like the environment is such that we can't replenish the portfolio, we don't reach for risk and we'll look to [stack] the dividend rate appropriately. But right now, it seems well covered.

So specifically, just look at the last quarter. I think the average yield on the investment, the income producing assets that we generated was 10% and I think 80% of the portfolio origination was in first lien so we haven't reached for risk at the top of the capital structure. I mentioned the fee income, historically, what it looks like. We expect that to continue to produce similar levels of fee income.

And then if you look at the actual, the non-income-producing assets, it's 10% of the portfolio that is in equity and we would continue to see those equity positions get realized and migrate to yield or into investments. So all of that goes into the model and we continue to look at that on an ongoing basis.

And then to your other question about what we are seeing in the market and how we're differentiating ourselves, it's a longer question, or a longer answer, but I think, briefly, the market is more competitive than it was the first quarter. I think the first quarter was a very good environment for us for put capital to work and the second quarter got a little bit more competitive, but that is just how our market moves.

I think our capital, we have always tried to differentiate it. We're partnership minded. We try and provide solutions, so when the banks back off, we try and step in. That's not the case today. We try and offer operating services and cost savings for our portfolio companies. There could be something unique about the credit. We have a long history with many of these companies that we can think about the asset a little differently than others. And then I think there's just a comfort level with the FS and GSO platform.

So I think those would the ways that we will differentiate. We see a lot of different types of deal flow and we will continue to be core to our strategy, which is senior secured debt and I think that's, the environment is still very good for us, especially relative to others that may not see the same opportunity set, or have as many differentiated tools that we have.

I would agree that the bells and whistles that can be offered to sponsors certainly in this environment are with the pricing premium and appreciate that, Brad. And two more questions, if I may. One additional lever and I'm curious. This is normally a question you ask as the funds effectively just increase in significant scale and, Michael, understand that there's been quite a bit of capital raised under the FS banner, I think $18 billion and counting and continually growing.

And so while that 175 base, I'm curious, do you ever believe there'd be an opportunity to lower that just in light of the general size of the platform now relative to others. I think we have seen some at similar sizes at 150. How does that calculus enter into your thinking today? Particularly regarding cost to capital discussions.

Thank you, Jon, for the question. Right now, our funds are spread across a number of different vehicles. Some of them at 2% management fee, some of them at a 1.75% management fee. When we listed, we thought we'd put in a very investor-friendly management fee structure including the three-year look back that you know well. We always look at everything in the market, whether it's the return to capital, the performance we are delivering to our investors, the management fees and the like and it's something that we will think about as we move forward.

At this point, we think that we have delivered very good performance. We think that we have a very, a reasonable management fee in light of the performance that we've delivered since the listing. And if you look at the totality of the management fee and incentive fee, we believe that we are where we should be. I would also note that we have a very low administrative expense cost because we can spread our cost over a very large platform. So we think we are investor friendly, but we are always open-minded to the views of our investors and always have to have that conversation, John.

Totally, and Michael, to your point, the 34 basis points of G&A, I mean, clearly on a TTM basis, that's better than anyone else. So I appreciate that. Last question, as it relates to equity capital. Some might say being above book is a luxury and happy to see FS certainly above it.

And given just the general size of the platform in terms of capital dollars raised, sometimes an incremental $75 million raise at a BDC might seem nice and it might appease a few folks, but it might not necessarily be the right economic decision even though you are effectively above book. Give us a sense of how you are looking at future equity capital at FSIC only and whether or not today is the day that your, well, today, or this market environment is really an appropriate one to be raising additional equity capital? Thank you.

It's certainly an issue, Jon, we think about all the time. We do believe we have built a very good model for capital raising and we can see that in that kind of performance that we have delivered to our investors this year across all the FSICs, both FSIC and the [non-trade] in two, three, and four, and feel very good about that and we've been able to build scale without having to do any kind of serial issuances or dilutive issuances.

We do think as we continue to mature as a franchise, FSIC does, assuming we continue to trade at a premium over book, it's something we will consider if we believe it will be accretive to our investors. So if there's the right opportunities in the marketplace and the timing is right and we are trading at a significant enough premium to NAV, it might make some sense and we think about it all the time as we look at how to grow FSIC and how to deliver good results for our investors.

Great. Thank you for taking my questions.

Ryan Lynch, KBW.

Good morning. Following-up on some of Jon's questions about your size and scale of your platform. FSIC II, your private fund, that has been closed for quite a bit of time now. You guys are out there optimizing the portfolio at that private fund. We have talked about this in the past, but just given your current stock price, I thought it might be appropriate to bring this up again. What are the potential options at FSIC II and is one of those options potentially considering a merger with FSIC and how would that work?

Thanks for the question. When we launch our funds, we talk about an exit being either a sale of the portfolio or liquidation in the ordinary course or merger into one of our vehicles. That decision will be made at the Board level and FSIC I, FSIC II, and all of our funds have separate Boards that need to make those determinations.

We have told our non-traded clients that we are pleased with the recent performance in FSIC II. It was one of the issues that we really needed to solve for was increasing the NAV at FSIC II and with the market performance, with very good credit selection, we have had a very good run over the last several months in FSIC II and we've told folks that we're in effect thinking about an exit for FSIC II in 2017 and that one of the routes for that liquidity event would be a merger with FSIC.

So we have started to talk to our boards about it. We are starting to think about it. We did list FSIC favorably, probably more favorably than most expected. And we would use the same play book for the merger of two into one if that's where the boards want to take it. We do think growing scale in the public market makes a lot of sense. We think one of the challenges we have for our institutional investors is they're not being enough liquidity and as they grow scale, either through what Jon talked, some smaller offerings if it makes sense or the larger merger, we think overall will be beneficial to the markets.

What we learned in FSIC from the listing is that our investors are, independent broker dealer and RI investors, aren't really looking for an exit. They like the liquidity, but they continue to be our largest shareholder base in FSIC. They like what we doing in FSIC and I think the same will be the case in FSIC II. So a longer answer, but it is something on our radar screen for 2017, it is something that we are thinking about and certainly a merger of two into one is a potential, if not likely, outcome.

Okay, great. That's a good update on that. Jerry, maybe this is a question for you. Your [JPM] facility, about $650 million outstanding on it that is due in a little under a year's time. What are your thoughts around replacing that facility? And even over the next few months, are you guys going to continually pay that down as you did in this quarter? And ultimately, where does that $650 million, what is that going to be replaced with?

It's something we're constantly looking at and we're always looking to optimize that side of the balance sheet. We are in ongoing discussions and looking at various options for ultimately refinancing and/or replacing that facility, either in whole or in part, through a couple of different options and that's something that I think you will see play out over the next 12 months, if not sooner.

We are focused always on the cost of capital. We are focused on fixed versus variable and we're focused on diversifying our sources of funding. That's something that Brad and I spend a lot of time talking about. Talk actively with a number of counter parties and I think we will have ample options in terms of how to select to deal with that.

Okay. Great. And then just one last one, maybe for you, Brad. You talked about Advanced Lighting. I know that that's in the process employ of exploring some sort of balance sheet restructure potentially. If you could just give any update on that business to the extent that there is any, that would be great.

Yes there is no update on Advanced Lighting. We continue to explore options on what the right capital structure is, what the business plan is going forward, but no real update at this point.

Okay. Thanks for answering my questions.

Terry Ma, Barclays.

Good morning. I just wanted to touch on your equity positions for a second. You guys talked last quarter about how rotating out of your equity positions was a lever for driving earnings growth, but yet the holdings actually continue to grow each quarter. So can you just give us some more color on how you expect to reduce that and how we should think about that percentage going forward?

Sure. I'm happy to address that. Some of our equity positions, our control LBOs, or positions that we have become the minority shareholder in where we don't necessarily drive the exact timing. So I think we are directionally headed in a number of positions to migrate out of those positions, but at the most optimal time.

It's just hard to pinpoint the exact timing of those and then, in some cases, when we're going through a restructuring, we are converting some of our debt to equity. But, I would say over the next period of time, you will see those equity levels come down, but again, we are always trying to optimize those positions and we will do that at the right time.

And Terry, just to put a finer point on that, the increases have been primarily, as part of the FourPoint transaction, where they raised the equity capital to make the acquisition, we increased our equity exposure there and then, as Brad noted, we've had a couple of restructures where we converted the debt to equity. But there are a few names that we think are moving towards a liquidity event, as Brad mentioned, looking to time it to maximize the value and that will play out over the coming months.

Okay. Got it. But I would imagine, in terms of the exits, it's partially or mostly dependent on market conditions. So is it possible to realize the fair value marks you have on your equity? I think [Pisa], for example, a charter IPO this quarter and then it was pulled.

Yes, I think the marks accurately reflect where we think we could sell our equity positions.

Okay. Got it. And you guys gave some guidance last quarter that you expect to fully cover your dividend for the full year with NII. Is it still the case or has anything changed?

It's all based on our quarter-over-quarter basis. It's based on the timing of events in fee income, but for the full-year, yes, we still expect to be able to cover through a combination of interest income and fee income and, as Brad talked about earlier in the answer to Jonathan's question, it's something that we evaluate all the time and look at expected repayments, expected new investments and the timing of those and run that through the model and one of the other factors is the redeployment of the non-income-producing equity into a yielding debt position.

That's something we look at all the time and we feel good overall. I'd also point out that we have got, as we said, $0.63 per share of undistributed net investment income, some of which we will end up having to distribute to meet our [RIC] obligations in any event, so we have a bit of a safety net there even if there's a timing difference in terms of when certain events occur relative to the normal distribution schedule.

Okay. Got it. That's it for me. Thanks.

Arren Cyganovich, D.A. Davidson.

Thank you. The investment activity in the quarter was only in existing securities versus new investments and you mentioned competition picking up a bit in the second quarter. Are new investment opportunities not hitting the hurdle rate of return for relative to the existing portfolio? What's been driving that decision to invest in your existing portfolio versus into new opportunities?

Yes. Thanks, Arren. Our first and primary focus is always our existing portfolio companies. When we do deals with them, we sell our partnership and our commitment to grow with them as they build out their platforms. So we used all our available capital during the quarter to support those commitments to those portfolio companies.

In terms of your second question, as we look forward, do new investments meet the deals that are exiting and, by and large, I would say yes. I would say the market's a little tighter than it was three or four months ago, but by and large, we are trying to find unique situations where we can price at a little bit of a premium to the market, that's always been the case. And that's no different for this past quarter and this existing quarter.

Thanks. I guess it kind of plays into the prior questions as well about capital. The first quarter clearly had better dynamics for middle market investing, but at the same time, you guys have been somewhat capital constrained at FSIC. Would it have made a difference if you had additional capital available on that flexibility to take advantage of that or was it just a function of that the markets were kind of just shut down while there was so much volatility earlier in the year?

In the first quarter?

Well, yes. I'm just trying to think of where we stand today and it all kind of works together. If you find enough opportunities to invest, at least at or above, you are trading above book value, if you raised additional equity to take advantage of these other opportunities besides your existing portfolio.

It sounds like if you had more capital available, that you would be able to raise equity at a premium to book and then invest that at least similar metrics, which I think generally, would be a net positive and share the value of your franchise. I feel like your franchise is somewhat constrained right now, despite you can raise it outside of FSIC, but with this particular BDC, I feel like you are not fully unleashing the power of the platform.

I think we agree. And it's certainly something we're going to think about. The BDC market, as we all know on this call, has seen a fair amount of volatility over the last several months. It's traded better recently and we have traded consistently at a premium and I think if we continue to trade at a premium and I think if we think there's opportunities in the marketplace, we will access the public markets because I think it's a way to provide some more liquidity.

But we have to really focus on where we are trading and how we can deploy the capital. I think that's where we are going to focus. We don't need to raise money in the public markets to build a platform. We have built a great platform with GSO and have scale. So we can be in a position to go out and raise capital only when it's accretive and when we see the opportunities in the marketplace. After this call, we will see how things trade over the next couple weeks and maybe something to think about.

Sounds good. Thank you.

Rich Shane, JPMorgan.

Thanks for taking my question this morning. I just want to circle back about the comments on third quarter and dividend coverage. When I think about it, there are basically four ways that you would cover dividends: spread, fee, spillover, and then ultimately, return of capital.

Frankly, I think the market tends to lump spread and fee together and you guys made the observation that you need to think about fee income sort of over time and that there are going to be quarterly fluctuations and that you have the spillover to basically act as a cushion on any fluctuations there.

What I didn't understand in your response to John's question at the beginning is do you think there is something idiosyncratic in the third quarter that may cause you to dig into that spillover cushion a little bit more or was it just a more general observation, A, we are partially through the quarter and this might be the quarter where we fall a little bit short. I'm just try to understand what the message is specific to the third quarter.

No, I think it's the latter of the two. It's just a general observation on timing of events and realization of fees and other things, nothing idiosyncratic for the quarter, per se.

Got it. And then the second question, tying together two things that we know about you. One is that you guys have observed that in distressed situations, you have always been fully paid off. Also, and again, this cuts both ways, you have a higher concentration of oil and gas exposure than many of your peers. But at the same time, that suggests you have some greater expertise as well.

We have heard some discussions in the market about opportunistic investments in the oil and gas sector. Given your experience with distressed companies and your experience in oil and gas, is this going to be a place where we should sort of counter [two] expectations, actually anticipate a little bit more activity on your side?

Yes, I can tackle that one. I think we are comfortable with our energy exposure right now being around 12% and any capital that will go into the sector will be more dedicated supporting those companies versus trying to find distressed situations in the market.

I would also not that (multiple speakers).

And I know that here are people out there cringing when I raise the specter of actually increasing oil and gas exposure, but sometimes you really do have to go against the grain.

Yes, I think we have always taken the view that is good to have a well diversified portfolio and not take concentrated bets by asset or by industry. And so I think in or around 12% feels like the right level for us.

Got it. And then last question. I mean, look, we have always sort of assumed that the capital raises would come through the non-traded BDCs as opposed to through the public BDC and the tenor, at least in my years, has changed a little bit of late. Is this just really a reflection of there is a Mendoza line in the BDC space in terms of book value and you are one of the few that's on the right side of that right now so there's a huge competitive advantage in accessing public markets for you?

I think the answer is yes to that, Rick. I think we have tried to be consistent in that we are in the unique and, we believe, fortunate position that we don't have to look to the public equity markets to grow our platform and to access deals.

But, now that we have been trading for over two years and trading very, very well for a BDC of our size and scale, if we can continue to trade at a premium NAV and we can access deals that we believe are accretive to our investors, we would be open to an equity offering. We have talked about it from time to time. We wanted to see how things in the market kind of shook out over a while, but it is something that we will look to, but only opportunistically.

Okay. Got it. Thank you, guys, for taking my questions.

Christopher Testa, National Securities.

Good morning, guys. Thanks for taking my questions. Just looking at the leverage on the portfolio, we saw it was up, I mean, it's still at five turns even, excluding the one distressed investment you cited. I just wanted to know if you were comfortable with this or you would foresee this going down with the structure that you are seeing as well as the first lien focus of the portfolio.

Yes, we are definitely comfortable with the leverage level. I would say the market is maybe up a bit of a quarter turn generally, but I think our investments have been in line with where we have attached historically.

And from the sponsor side of things, are you seeing sponsors sort of push more leverage into structures when they went a deal or do you think that they have kind of come to terms with the declining M&A volume and tighter structures at this point in the cycle?

Very, very sponsor specific. We had some sponsors that we transact with that do not want to take the last turn of leverage or they are looking at more cyclical type businesses that they are mindful of how they are setting up the capital structure. I think the one exception, generally, is technology. I think there are seeing some fairly full leverage levels and M&A multiples paid in the technology space and that's pushing the debt levels higher.

Okay. And how much of the unrealized appreciation during in quarter was technical in nature?

I would say, generally, it's probably 50/50, not too dissimilar to the first quarter. Half the movement was technical, half of it was fundamental, both in the upside and downside.

Okay. Great. And just with regards to what are you seeing in terms of the differential between first and second lien yields? I know for a while, especially after Brexit, we were saying first lien [that bid much more is a slide to safety]. Is that something that you have seen continue through this quarter and foresee continuing for the remainder of the year?

I would say that the second lien, first lien spread had tightened. Where at the start of the year, it was probably 600 basis points, it's probably closer to 450. And if the deal has certain size and scale, we are seeing banks become more active syndicating first lien debt to CLOs. It's tightened quite a bit as well. Both second lien spreads have come in as well as first lien spreads have come in, but second liens have come in more than first liens.

Okay. And last one for me. The average EBITDA on the portfolio has come down, obviously, as you guys have shunned the syndicated market in favor of the direct originations. Is this kind of a run rate at about $113 million we should expect or is there a chance of that picking up, doing larger deals co-investment across the [prongs]?

I think you'd expect that to come down over time.

Okay. Great. That's all for me. Thanks for taking my questions.

Troy Ward, Ares Management.

Thank you, Michael. I just wanted to follow-up on the message change on the additional equity. Arren touched on it. One of the rationale that you gave for it was higher liquidity. For us, as we look at this, with $2.2 billion of market capital over 750,000 shares average daily over the last 30 days, it seems like to us, the liquidity would be fine. What type of liquidity do you think is necessary to raise additional equity from an institutional standpoint?

Right. Again, I don't think the message has changed. I think that we're looking to be opportunistic and accretive here. But, I would say the liquidity comment is something we've talk about a fair amount, is that it's hard for the larger institutions to build a position in FSIC based upon where we trade. And the market typically moves up on enhanced when there are bigger purchases. That's the liquidity issue we were addressing.

So if there was a way to get larger chunks of stock into some of the institutions' hands at what they saw as attractive value that was not dilutive to our existing investors and we thought we could deploy that capital in deals that were accretive for the portfolio, we would have to think about and I think that's been our message all along since the road show in 2014.

Okay. Thanks.

This concludes today's conference call. Thank you for joining and have a great day.

Thank you.

You are welcome.