FS Credit Opportunities Corp.

Good morning, and thank you all for joining us for FS Credit Opportunity Corps' second quarter 2025 earnings conference call. Please note that FS Credit Opportunities Corps 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 FSEO issued on August 6, 2025. In addition, FSEO 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, 2025. A link to today's call and the presentation is available on the company's webpage at www.futurestandard.com under events and presentations. 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 predicating 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 filing 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. Information relating to past performance, while helpful as an evaluative tool, is not necessarily indicative of future results, the achievements 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. Speaking on today's call will be Andrew Beckman, Head of FS Global Credit and Portfolio Manager for FSEO, and Nick Halbutt, Director of Research of FS Global Credit and Portfolio Manager for FSEO. Also joining us on the call is James Beach, Chief Operating Officer of the fund. Following our prepared remarks, we will conduct a Q&A session. I will now turn the call over to Andrew.

Thank you, Josh, and good morning, everyone. We're pleased with the results we delivered for our shareholders during the second quarter of 2025 across several key fronts. First, FSEO delivered a net return of 4.01% based on the fund's net asset value, outperforming high-yield bonds by 44 basis points and loans by 169 basis points. It's worth noting that the portfolio remained highly weighted to first lien senior secured loans throughout the year, representing close to 80% of the portfolio's fair value as of June 30, 2025. Results were driven by 20% share in distributions and NAV growth of $0.09 per share. The largest contributor was our investment in Blackstone products and manufacture of outdoor cooking appliances, specializing in griddles, accessories, and consumables. FSEO held the company's first lien loans and convertible bonds, which we underwrote at $65 million of EBITDA in late 2022. EBITDA subsequently grew to approximately $180 million in 2024. On May 5, 2025, the company was acquired by Weber, an iconic global barbecue brand. The fund realized a 2.75x MOIC and a net IRR of 55.3% on our positions. Second, the fund increased its monthly distribution in June representing a 5% increase from May and nearly 60% higher than at the time of FSEO's listing on the New York Stock Exchange in November of 2022. As has been the case since our team assumed management of FSEO in January of 2018, distributions paid during the quarter were fully funded through net income on a tax basis. As of September 2, 2025, the annualized distribution yield was 11% based on NAV and 10.91% based on market price. Third, the fund deployed $122 million in the second quarter, bringing year-to-date investment activity to $274 million. While M&A activity was muted, we continue to benefit from our robust deal sourcing engine, which includes our team and firm wide origination network and our private sourcing partnership with JP Morgan to finance directly originated investments. Finally, The stock returned 5.8% in the quarter, with meaningful progress narrowing its discount to NAV. Since quarter end, the fund has traded at 98% or more of NAV on 90% of trading days, based on its closing price. We are encouraged by the progress, which we believe reflects the fund's continued strong performance the multiple increases in the monthly distribution rate since its listing, and the flexibility of our strategy. Since assuming full management of the fund in January of 2018 and through July 31st, 2025, FSEO has outperformed the high yield and loan indexes by over 340 basis, and 270 basis points per year, respectively. 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. Persistent macro uncertainty and shifting policy expectations shape financial market performance in the second quarter. Elevated tariffs and ongoing trade disputes continued to weigh on global growth sentiment, while resilient U.S. consumer spending and services activity helped offset weakness in manufacturing. Inflation continued to moderate but remained above the Fed's long-term target, keeping interest rates higher and contributing to volatility in rates and credit spreads. Despite these headwinds, market liquidity remained generally healthy, creating a constructive environment. Syndicated loan market activity rebounded after April's volatility, with spreads tightening to multi-year lows and secondary prices recovering. However, excluding repricings, new-issue loan volume declined 45 percent quarter-over-quarter to $79.7 billion. The average debt-to-EBITDA leverage ratio of new-issue LBO deals was 5.1 times, slightly lower than at year-end, while the interest coverage ratio was 2.7 times up from 2023 and 2024 levels. U.S. high yield issuance surged to 71.6 billion, fueled by a sharp rebound in prices and spreads, which narrowed from 409 basis points in April to 268 basis points by mid-June. Credit quality trended higher, with BB-rated bonds accounting for 41% of issuance and CCC-rated deals falling to just 2%. Refinancing remained the primary driver, though M&A and dividend recaps gained momentum. Private credit activity slowed in the second quarter of 2025 after a strong start to the year. Overall volume declined 20% from the first quarter and 30% year over year. Sponsors increasingly relied on add-on M&A to sustain activity, while refinancing and dividend recap volume declined. Despite tariff and trade uncertainty, spreads stayed competitive as lenders focused on higher quality credits and yields moved modestly lower in line with steadier base rates. Clear differences emerged across the market by company size. While the following figures are based solely on sponsor-backed investments, they highlight broader private credit trends. In the large cap segment, spreads compressed steadily through the quarter, ending below S plus 500 in June, with leverage ratios for Unitronch deals around 5.5 times, a reflection of high competition among the largest private credit lenders. By contrast, spreads in the lower and core middle market ended June in the S plus 530 to 540 range, with leverage holding near 3.6 to 3.7 times. This bifurcation shows that while larger borrowers continue to benefit from abundant liquidity, the middle market remains differentiated by tighter structures and more attractive spread premiums. Turning to our investment activity, we maintained a cautious stance in the first half of the year amid volatility from geopolitical, fiscal, and trade risks. We continue to favor private credit, where we see more compelling value relative to the public markets. Approximately 98% of new investment activity was in privately originated investments, 100% of which were in first lien senior secured loans. Despite muted M&A market activity, originations were strong in the second quarter, driven by our expansive sourcing network and diversified deal flow. A broad investment funnel is essential to generating strong risk-adjusted returns. The more opportunities we evaluate, the more selective we can be in building the fund's portfolio. Our base of incumbent borrowers across our credit platform also remains a consistent source of repeat opportunities. In addition, our sourcing agreement with JPMorgan has become a highly accretive source of deal flows across our platform. Last year, FSCO and other funds managed by our team were among a select group of alternative lenders that partnered with J.P. Morgan to fund mid-market private credit opportunities sourced through its commercial and investment banking channels. The bank initially committed $10 billion to this sourcing partnership and has upsized that commitment to $50 billion this year. We made five new private credit investments in the second quarter with a weighted average EBITDA of $72 million, underscoring our focus on the lower and core middle market, which we believe represents a competitive sweet spot. These businesses are meaningful scale and domestically focused, yet often overlooked by larger credit managers due to their size and balance sheet profile. Because these companies often fall outside the standardized criteria of traditional bank lenders, we can negotiate favorable terms and structure investments that mitigate downside risk. Approximately 70% of investments during the quarter were in sponsor-backed businesses with the remaining 30% in non-sponsored companies. Within sponsored lending, we do not compete against the large direct lending funds and instead lend to smaller or emerging sponsors where there's typically less competition and greater potential to capture a yield premium. Non-sponsored lending opportunities comprise a wide range of borrowers that in many cases have never accepted outside capital. This includes multi-generational family owned businesses, sole proprietors, or other tightly held businesses. We favor these types of investments because there's often a strong ability to control deal terms and create highly structured investments to protect our downside. Year to date through June, we've made nine new private credit investments in the fund with a weighted average spread of SOFR plus 693 basis points. Approximately 89% of these investments included one or more maintenance covenants. By contrast, roughly 86% of the broadly syndicated loan issuance last year and similar thus far this year were cove-like, meaning loans that typically lack maintenance covenants. When considering the excess spread, we earn over those markets plus the covenants and other negotiated protections we've discussed. We believe the fund is well positioned to deliver strong risk-adjusted returns for our clients. Sales, exits, and repayments totaled $235 million during the second quarter. compared with $122 million of purchases, excluding portfolio hedges, as we repositioned the portfolio towards higher yielding investments. The weighted average yield on new purchases was 12.1% versus 10.5% on portfolio exits. We've actively deployed excess liquidity from these sales and repayments into an attractive investment pipeline of private credit deals in the third quarter. As of June 30th, private credit investments represented approximately 72% of the portfolio unchanged from the prior quarter. Approximately 86% of the portfolio consisted of senior secured debt, up from 84% the previous quarter. The funds allocation to unsecured debt was 4% compared to 3% as of March 31st, 2025. Asset-based finance represented 2% of the portfolio, while equity and other investments represented 80%. Turning to the liability side of our balance sheet, we believe our cost structure gives us a competitive edge with 58% of drawn leverage as of the end of the quarter comprised of preferred shares which provide favorable regulatory treatment versus traditional term and revolving debt facilities and flexibility in the types of assets we can borrow against. I'll now turn it back to Andrew to discuss our forward outlook.

Thanks, Nick. Shortly after quarter end, FSEO commenced selling shares under its at-the-market offering, which was the first of its kind for the fund. The capital raised through the ATM program may enhance the investment team's ability to capitalize on a robust pipeline of attractive investment opportunities. Our portfolio is built for long-term durability. We believe active management combined with disciplined fundamental credit underwriting remain essential for generating returns while managing risk. As we originate new investments, we carefully evaluate each opportunity for potential risks related to tariffs or broader geopolitical and economic uncertainty. We believe FSEO offers a differentiated value proposition designed to deliver strong risk-adjusted returns across diverse market and economic environments supported by several factors. First, we target businesses with strong cash flows, modest leverage, and seasoned management teams with deep operational experience navigating market cycles. We invest in credits with appropriate loan-to-value ratios to help ensure repayment, even in a more pronounced economic slowdown. Our sector allocations are guided by our bottoms-up fundamental research, and we generally avoid highly cyclical segments of the economy. Second, we remain focused on senior debt investments that offer strong structural protections and attractive yields or expected total returns. We generally avoid lending to private equity-owned companies that contain heightened risk of asset leakage or potential lender disputes. We're also cautious of credits with aggressive EBITDA add-backs that may not materialize and instead view free cash flow as a more reliable indicator of credit quality. Third, we compete primarily in the core middle market, where we believe the risk return profile is most attractive, typically offering higher spreads, lower leverage, and stronger documentation than large cap private transactions. Unlike many smaller managers in this space, we bring the resources, infrastructure, and discipline of a large platform, which allows us to originate, underwrite, and manage investments with greater scale and rigor. By focusing our private allocations in this segment, We seek to capitalize on inefficiencies and deliver superior risk-adjusted returns. Finally, our ability to invest across private and public markets differentiates us from traditional credit funds and allows us to adjust allocations based on where we see the most compelling risk-adjusted return opportunities. Our goal is to dynamically allocate capital to the most attractive opportunities across the credit and business cycle, and we think this leads to enhanced stockholder returns relative to a more confined strategy. Importantly, we are not constrained by a specific asset class mandate. In summary, we believe FSEO, supported by the resources and insights of our broader credit platform, is well positioned to deliver strong, risk-adjusted returns across a wide range of economic and financial market conditions. The fund's performance during the second quarter reinforced that view. Once again, thank you all for joining us today. With that, we'll take a brief pause before answering questions.

Thanks, Andrew. First question is FFCO delivered an NAV-based return of 4.01% and a stock price return of 5.9% in Q2. Can you walk us through the key drivers of this outperformance relative to high yield and senior secured loan benchmarks?

So our returns were driven approximately by 100 basis points of price appreciation and fees. So positions in the portfolio increasing generally kind of in price based on events. And then about 300 basis points. of yield on the portfolio. So the outperformance really was driven by a combination of a higher yielding portfolio to that of those indices as well as those capital gains.

Thanks, Andrew. And with the June distribution increase of 5.1% and a current yield of 11.2%, how confident are you in maintaining or growing the distribution going forwards?

Well, we think the distribution level is appropriate right now, but we'll obviously monitor how earnings evolve. I'd make a couple of points. Our distributions are currently fully covered by investment income. And two, we have a strong spillover income balance that we can use to cover the distribution in the future. Additionally, we believe just discipline underwriting and strong origination capabilities will keep the portfolio kind of yielding appropriate levels.

And private credit represented 96% of new investment activity in Q2, with 100% in first lien senior secured loans. What's driving this continued preference, and how do you see this mix evolving?

So we constantly look at what the opportunity set is in private credit versus public credit and are constantly adjusting and readjusting our focus. When we look at the market today, we still think that private credit is more attractive than public credit. And we think it just offers better risk return. We think the spreads, I think everyone knows the spreads are kind of better in private credit. There continues to be a decent premium to the public markets. But on the other side, we think on average, leverage and loan to value levels are lower in private credit than public credit. And the documents are better. So there's better structural protection. So not only is kind of the yield going into the investments kind of more attractive, but as we look through cycle and think about loss adjusted returns, we think those will also kind of enhance the current return.

Thanks. And how has competition for deal flow evolved in Q2, especially in the lower middle market? Are you seeing any easing in pricing pressure or covenant terms?

So the market is competitive. It's always been competitive, but our deal flow remains kind of very robust. We have, our firm has, you know, fairly significant scale and we use that scale to not compete up market, but to compete in the middle market. So we really think we have a sourcing advantage compared to our peers and our sourcing engines produce tremendous amount of deal flow. Additionally, we do have a focus on less crowded segments like the non-sponsor segment as well as transitional lending. And what I will say is those parts of the market do tend to be less cyclical. So when we saw a slowdown in LBO activity earlier this year, those segments were a lot less affected by that slowdown.

And this next question is for Nick. Sales exits and repayments totaled $253 million versus $136 million in purchases. Was this net selling posture deliberate and how do you expect that to shift in Q3?

You know, in the beginning of the quarter, when we were experiencing elevated levels of macro uncertainty, you know, we tried to reduce things that we felt, you know, were at the lower end of the sort of risk-adjusted return spectrum. And so that took down... risk a little bit in the beginning of the quarter and then throughout the quarter we sort of rebuilt risk in the portfolio. I think when you sort of summarize the activity it is more or less fair to say that this was just a normal course of the business playing out and you know we've had a fairly robust start to Q3 in terms of new deployment. So you know at the margin we were able to build additional yield in the portfolio through rotating. And I think we're really confident with the current sort of level of investment in the book.

And how are you managing duration and reinvestment risk given the mixed signals from treasury yields and potential Fed rate cuts?

This is today and has always been a short duration portfolio. Obviously, we do have exposure to floating rate assets. We also have some floating rate liabilities, which helps offset that. The front end of the yield curve ends up coming in as we sort of expect and as interest rate curves suggest they will. There will be a little bit of deterioration in yield that's partially offset by changes in portfolio mix and the liability side of the balance sheet kind of going forward. But generally speaking, given the duration of the fund, we think that this is a very manageable phenomenon over the next year or two.

And for the final question, FFCO's NAV has grown nearly 13% since listing and shares are trading close to NAV as of quarter end and currently trading above book value. How do you view this premium in the context of future capital raising and shareholder value?

You know, I think if we look back at the performance of FSCO over the past eight years that we've managed this vehicle, we've seen consistent value creation for our shareholders. Obviously, we went through a listing process several years ago and there was some shareholder turnover when that happened and the shares were trading at a large discount to NAV. I think hopefully today people understand the value proposition that our team brings to the market and they see our performance and that's reflected in the current trading price of NAV. of the shares relative to net asset value. Hopefully, we'll be able to continue delivering good risk-adjusted performance. We expect that we'll be able to do that, but it's what we come into work every day focused on.

This concludes our call. Thank you for joining us and for your continued support. If you have any questions, please feel free to reach out. Thanks again, and see you next quarter.