FS Credit Opportunities Corp.

Good morning, and welcome to FS Credit Opportunity Corp's second quarter 2023 earnings conference call. Please note that FS Credit Opportunities Corp may be referred to as FSEO, 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 FSTO issued on July 25th, 2023. In addition, FSTO has posted on its website a presentation containing supplemental financial information with respect to its portfolio and financial performance for the quarter ended June 30th, 2023. A link to today's webcast and the presentation is available on the company's webpage at www.fsinvestments.com under the FSCO tab. Please note that this call is the property of FSCO. Any unauthorized rebroadcast of this call in any form is strictly prohibited. Today's conference call includes forward-looking statements with regard to future events, performance, or operations of FSCO. These forward-looking statements are subject to the inherent uncertainties in predicting future results and conditions. Certain factors could cause actual results to differ materially from those projected in these forward-looking statements. We ask that you refer to FSEO's most recent filings with the SEC for important factors and risks that could cause actual results or outcomes to differ materially from these statements. FSEO does not undertake to update its forward-looking statements unless required to do so by law. Additionally, information related to past performance, while helpful as an evaluative tool, is not necessarily indicative of future results, the achievement of which cannot be assured. Investors should not view the past performance of FSEO or information about the market as indicative of FSEO's future results. In addition, this call will include certain financial measures that have not been prepared in accordance with generally accepted accounting principles in the US or GAAP. FSEO uses these non-GAAP financial measures internally in analyzing financial results and believes that the use of these non-GAAP financial measures is useful to investors as an additional tool to evaluate ongoing results and trends, and in comparing FSEO's financial results with other closed-end funds. For such non-GAAP measures, reconciliations to the most directly comparable GAAP measures can be found in FSEO's Form N-1 CSRS that was filed with the SEC on August 22, 2023. 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 FSTO's website. Speaking on today's call will be Andrew Beckman, Head Portfolio Manager for FSTO, and Nick Hellebitt, Director of Research and Portfolio Manager for FSTO. Also joining us on the phone is Jason Zeleznik, Chief Operating Officer of the Fund. Just a reminder, we will not be taking live Q&A during today's webinar. However, you can submit your questions using the Q&A function on the left side of your screen, and we will strive to answer as many questions as possible throughout the webinar and at the Q&A session at the end. In addition, I'd like to point out the resources that we have listed at the bottom of the screen, which you can access throughout the webinar. And with that, I will now turn the call over to Andrew.

Thank you, Robert, and thank you all for joining us today. We are pleased to report solid results for the second quarter as the fund returns 7.5% driven by strong earnings as net income fully covered distributions of 15 cents per share and NAV appreciation of 33 cents per share. Performance was broad-based across the portfolio with contributors far outnumbering detractors. Since quarter end, the fund's NAV increased by approximately 3.9%, driven by company-specific events for a select number of the fund's larger positions, bringing year-to-date NAV-based returns to 14.9% as of August 18, 2023. We are pleased to announce a 15% increase in the annualized distribution effective with the July monthly payment, bringing the annualized distribution rate to approximately 9.9% based on NAV as of August 18th. This marks the second increase since the fund's common shares were listed on the NYSE in November of last year. As many participants are aware, we implemented a phased approach to listing FSTO's common shares through which one-third of common shares were available for trading in November of last year. An additional one-third of shares were made available for trading 90 days after the listing on February 13th. And the final one-third of shares were made available for trading on May 15th. While the stock was largely range-bound during the quarter, the discount at which it has traded compared to net asset value narrowed following quarter end. We believe this is reflective of the fund's recent positive performance and broader market strength, but also the reduced selling pressure on the stock now that all the phases of the listing are complete. In our view, the current discount at which the stock is trading compared to the net asset value is not indicative of the health of the portfolio or the forward return potential of our diversified credit strategy. We believe FFCO offers a differentiated value proposition in the market for several key reasons. First, FSEO is one of the largest credit-focused closed-end funds in the market. Size and scale matter in credit investing, especially when it comes to maximizing deal flow, mitigating risks, and achieving economies of scale. Our dynamic strategy provides the flexibility to invest across public and private credit based on what we believe are the best risk-adjusted return opportunities. As of June 30th, 2023, the split between public and private investments was 55% and 45% respectively. We tend to have a differentiated focus than traditional credit funds. We are not constrained by a specific asset class mandate. We can invest across loans, bonds, structured credit or highly structured equity investments, and across fixed and floating rate assets. We look for situations where return premiums exist due to complexity, illiquidity, or as a result of corporate events. These opportunities often require significant expertise and resources to source and analyze due to the complexity of company balance sheets, a lack of publicly available information, or the illiquidity of the asset. Our private investment portfolio includes highly bespoke investments originated through our firm-wide sourcing network. Our intensive due diligence process benefits from the sharing of collective insights on markets and individual credits. We believe our origination capabilities within the private market and focus on providing specialized financing solutions differentiates us from our closed-end fund peer group. The fund offers a highly attractive annualized distribution yield of approximately 9.9% based on NAV and a current yield of approximately 13% based on stock price, which we believe is attractive on an absolute and relative basis compared to our peers. The distribution has been fully covered through net income since I joined FS Investments, and the current investment team assume management of the fund. in January of 2018. Over that time, net investment income has represented 116% of distributions paid to shareholders. The portfolio is weighted to senior secured debt with a focus on first lien debt, which has helped preserve capital over time. Senior secured debt represented 77% of the portfolio's fair value as of June 30th, 2023. Floating rate assets comprise approximately 58 percent of the portfolio as of June 30th. We're seeing the benefit of higher base rates pass through to shareholders as evidenced by our ability to increase the annualized distribution by a total of 34 percent through two distribution increases since December of last year. Finally, the fund uses a modest level of leverage to help enhance shareholder returns. Our diversified capital structure provides us with the flexibility to invest across asset types and maturities through a mix of revolving, term loan, and preferred financings. I'll now turn the call over to Nick to provide our perspective on the markets and discuss our investment activity during the quarter.

Thanks, Andrew. Markets have displayed notable strength throughout much of 2023 against a backdrop of slowing U.S. inflation, a strong labor market, and steady consumer demand. Year-to-date, high-yield bonds and loans have returned 5.9% and 8.4%, respectively, with lower-rated credits materially outperforming higher-rated credits. Interest rates and uncertain economic outlook continue to weigh on M&A activity, which has reduced private equity demand for LBO financings and limited the supply of new issuance. In addition, just $142 billion, or 4.5% of loans and high-yield bonds outstanding, is scheduled to mature by the end of 2024. With new issuance and refinancing activity down significantly from the 2021 peak, demand has outstripped supply year-to-date despite net outflows for both high-yield and loan retail funds. Demand has remained strong from investors reinvesting interest income and proceeds from paydowns, along with continued demand from CLOs. As a result, the size of the public credit market is on pace to shrink for the second consecutive year. The technical supply-demand imbalance has supported credit prices through the first half of the year. Despite the positive technical backdrop, we still see reasons for caution. Default rates have slowly risen across bond and loan markets and now sit at two-year highs. High-yield defaults, including distressed exchanges, increased to 2.71%, while loan defaults and distressed exchanges increased to 2.94%. However, default rates remain below the long-term average of 3.2% for high-yield bonds and 3.1% for loans. In addition, the rapid rise in interest rates has pressured coverage ratios, margins, and the liquidity profile of many companies across various sectors. We believe the current environment requires a deep, bottoms-up understanding of fundamental credit risks. In our experience, inflection points in a market cycle or periods of volatility often present attractive investment opportunities. As Andrew will discuss further, you're focused on businesses with strong cash flows, moderate leverage profiles, and management teams and or private equity sponsors with deep operational experience managing through market cycles. Turning to the portfolio, Sales and repayments of $216 million outpaced purchases of $144 million during the second quarter. The majority of investment purchases during the quarter were to existing portfolio companies. Our incumbency position provides a natural source of deal flow with companies and capital structures that we know well. Senior secured debt investments represented the majority of purchases during the quarter, and 77% of the portfolio fair value a year at quarter end with senior secured debt. As Andrew mentioned, the mix of public and private assets was approximately 55% and 45% as of quarter end. As of June 30th, the largest sector rating was healthcare equipment services, followed by consumer services and commercial and professional services. We believe these investments offer the potential to drive strong risk-adjusted returns and operate in areas of the economy that may be more insulated in the event of a broader economic slowdown. Turning to the liability side of our balance sheet, we believe our cost structure gives us a competitive edge with 58% of drawn leverage comprised of preferred debt financings, which provide favorable regulatory treatment versus traditional term or revolving debt facilities. Approximately 52% of drawn leverage is multi-year fixed rate preferred debt and provides flexibility in the types of assets we can borrow against. On August 1st, the fund paid down $100 million of preferred debt maturing during the month. As a result, all the fund's remaining preferred debt matures in 2024 or beyond. On a pro forma basis, following the pay down, the fund's cash balance was approximately $39 million. Despite a modest cash balance, we have ample availability in our credit facilities should a liquidity need arise. I'll now turn it back to Andrew to discuss our forward outlook.