FS KKR Capital Corp.

Good morning, ladies and gentlemen, and welcome to FSKKR Capital Corp's third quarter 2020 earnings conference call. Your lines will be in a listen-only mode during remarks by FKS's management. At the conclusion of the company's remarks, we'll begin the question and answer session, at which time I will give you instructions on entering the queue. Please note that this conference is being recorded. At this time, Robert Pond, head of investor relations, will proceed with the introduction. Mr. Pond, you may begin.

Thank you. Good morning and welcome to FSKKR Capital Corp's third quarter 2020 earnings conference call. Please note that FSKKR Capital Corp may be referred to as FSK, 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 FSK issued on November 9th, 2020. In addition, FSK has posted on its website a presentation containing supplemental financial information with respect to its portfolio and financial performance for the quarter ended September 30th, 2020. A link to today's webcast and the presentation is available on the investor relations section of the company's website under events and presentations. Please note that this call is the property of FSK. Any unauthorized rebroadcast of this call in any form is strictly prohibited. Today's conference call includes forward-looking statements and are subject to risks and uncertainties, including risks associated with the possible impact of COVID-19 that could affect FSK or the economy generally. We ask that you refer to FSK'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. FSK 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, reconciliations to the most directly comparable GAAP measures can be found in FSK's third quarter earnings release that was filed with the SEC on November 9th, 2020. 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 FSK's website. Speaking on today's call will be Michael Forman, Chairman and Chief Executive Officer, Dan Pietrzak, Chief Investment Officer and Co-President, Brian Gerson, Co-President, and Stephen Lilly, Chief Financial Officer. Also joining us on the phone are Co-Chief Operating Officers Drew O'Toole and Ryan Wilson. I will now turn the call over to Michael.

Thank you, Robert, and welcome everyone to FSKKR Capital Corp's third quarter 2020 earnings conference call. First, let me offer my continued well wishes to each of you, your loved ones, and your coworkers as our country continues to adapt to a post-COVID world. The FSKKR team continues to function largely in a virtual work environment. Thanks to the ongoing dedication of our investment and operating teams, the day-to-day cadence of our business somehow has begun to seem almost normal. I continue to be extremely proud of the job our team is doing during these extraordinary times. In recent weeks, our country has been almost entirely consumed by events leading up to the presidential election. The uncertainties associated with the election, combined with the effects of the pandemic and social unrest, seem to have permeated every aspect of our society. Our hope is that as we move toward the Thanksgiving holiday season in just a few weeks, that our country will begin the process of healing by recognizing we are stronger together than we are divided. Across our investment portfolio, we have seen management teams and sponsors continue to make well-informed business decisions focused on positioning their companies for long-term value creation. These decisions have included such things as building cash reserves, streamlining operations, communicating proactively with customers, and realigning supply chains to maximizing time to market for products. These decisions are manifesting themselves in tangible ways as the value of our investment portfolio appreciated during the third quarter, resulting in an increase in our net asset value per share of 4.7% as of quarter end. The FSK Care Investment Team has done an exceptional job working closely with these companies. From an operating perspective, our net investment income was 63 cents per share during the quarter, which was 3 cents above our third quarter dividend of 60 cents per share, and also 3 percent per share above our public guidance. From a liquidity perspective, we ended the quarter with approximately $1.5 billion of available liquidity, with no meaningful near-term debt maturities. Looking forward, consistent with our dividend strategy of targeting a long-term yield to investors of 9% of our net asset value, we currently expect our fourth quarter adjusted net investment income to approximate $0.64 per share. As such, our board has declared a distribution of $0.60 per share for the fourth quarter, which equates to an annualized yield of 9.8% on our NAV per share of $24.46 as of September 30, 2020. And with that, I'll turn the call over to Dan and the team to provide additional color on the market and the quarter.

Thanks, Michael. From a macro perspective, many of the trends we highlighted in our second quarter earnings calls have continued to develop, including a rebuilding of our investment pipeline alongside a reemergence of M&A activity. And while the market is still not back to pre-COVID levels in terms of transaction volumes, We believe it has recovered to approximately 75% or 80% of those levels. Another topic we discussed in detail in our second quarter call, the disconnect between the markets and the general U.S. economy, continues to raise meaningful questions and still concerns us with regard to near-term economic performance and ongoing economic recovery. The high-yield market continues to experience record monthly issuance levels as illustrated by year-to-date 2020 cumulative issuances of $338 billion through September 30th, which is only $7 billion below the full-year annual issuance record of $345 billion the market set during 2012. The high-yield market continues to be fueled by a record level of refinancings not seen since the Great Recession. In the leveraged loan market, the record level of monthly issuances in January and February evaporated in March and remained depressed through July. However, in both August and September, the leveraged loan market has returned to record levels of issuances as borrowers have accessed the market with a healthy balance of LBO, M&A, and refinancing activity. Pricing for these leveraged loans has been aggressive in many instances, driven in part by the low overall yield environment and a desire by many managers to put money to work in an effort to generate current yields. From a KKR perspective, we continue to believe the Federal Reserve's stated goal of reducing unemployment from the current level of 6.9% to the Fed's long-term target of 4.1%, while simultaneously targeting inflation of around 2% per year. clearly illustrates the Fed's focus on recovery of jobs first, with inflation targeting a distant second. As a result, we believe significant levels of government stimulus will continue well into 2021 and possibly beyond. Across the FSKKR platform, we are participating in a number of active processes relating to new investments. Thank you very much. In some cases, we are seeing pricing and structural terms return to pre-COVID levels. Across the FSKTR platform, we benefit significantly from our incumbency positions with existing borrowers, as well as our deep relationships with key sponsors. These positions and relationships have allowed us to see our fair share of new opportunities while still maintaining a selective bias which hinges on protection of principal first, and yield second. As a result of these fundamental drivers, during the third quarter, we originated $174 million in new investments, which is still below our capabilities from a processing or capacity standpoint. Our $174 million of total investments, combined with $231 million of net sales and repayments when factoring in sales to our joint ventured, equated to a net portfolio reduction of approximately $57 million during the quarter. I should mention that during the period from October 1st to November 4th, FSK closed on an additional $300 million in investments. As a result, even though we believe we have remained disciplined from an origination perspective, we think we are well positioned from an overall portfolio standpoint as we move into the last few months of the year. Last quarter, we began providing detailed investment performance metrics for the FSK CARE Advisor. This information is detailed on slide 12 of our investor presentation on our website. The updated information is summarized as follows. Since the FSK CARE Advisor was formed through December 31, 2019, we made approximately $3.2 billion in new investments, and we experienced 42 basis points of cumulative appreciations. From the same starting point through September 30, 2020, we have originated approximately $4.2 billion of new investments and have experienced 1.17% of cumulative depreciation, which includes the effects of COVID. We continue to be satisfied with the investor performance our team has been able to deliver over this time period, and we believe these data points illustrate the manner in which we are turning the investment portfolio forward toward what we believe to be more conservative investment structures in companies with more defensible operating positions. Lastly on this point, as of the end of the third quarter, approximately 51% of our portfolio has been originated by the FSKKR Advisor, and 81% has been originated by KKR. From a forward-looking perspective, we believe the federal government will continue to find ways to support the economy until either an effective COVID vaccine is developed or herd immunity is achieved. We believe the broader market, which has been in receipt of stimulus dollars and government support, will continue to function somewhat in line with where we are today. That is, liquidity will continue to exist for both borrowers and lenders, some level of corporate M&A activity will continue, and the public markets will continue to function within a ban of relative normalcy. Of course, these assumptions in large part depend on investors' and operators' collective trust in the future actions of the federal government. We also believe government intervention in the economy will be increasingly difficult to unwind in a non-disruptive manner the longer the monetary support is required. As a result, we are pleased with the performance of our investment portfolio this quarter, and while we are confident that the investment decision's we currently are making are based on thorough analysis and diligence, we have to acknowledge that the operating world we find ourselves in is still far from normal. These observations lead us to conclude that the road back to full recovery may at times be volatile, if for no other reason than the significant dependence the capital markets has placed on our federal government for the foreseeable future. Nevertheless, we are pleased with the quarter and believe we are well positioned as we begin to look forward to 2021. And with that, I'll turn the call over to Brian to discuss some investment portfolio specifics.

Thanks, Dan. As of September 30th, our investment portfolio had a fair value of $6.6 billion, consisting of 172 portfolio companies. This compares to a fair value of $6.6 billion and 173 portfolio companies as of June 30, 2020. At the end of the third quarter, our top ten largest portfolio companies represented approximately 23% of our portfolio, which remains in line with our results for the last several quarters. We continue to focus on senior secured investments as our portfolio consisted of 54% of first lien loans and 68% senior secured debt as of September 30th. The weighted average yield on occurring debt investments was 8.6% at September 30th, 2020, as compared to 8.7% at June 30th, 2020. The decline in our weighted average portfolio yield was primarily due to exits of certain higher-yielding assets throughout the quarter. From a non-accrual perspective, as of the end of the third quarter, our non-accruals represented approximately 8% of our portfolio on a cost basis and 2.8% of our portfolio on a fair value basis, compared to 9.9% and 3.8% as of June 30th. We did not place any new investments on non-accrual in the third quarter, and four previous non-accrual debt positions were restructured. From an overall valuation perspective, our investment portfolio increased by approximately 2% or $132 million during the quarter. The details associated with our quarterly valuation results are as follows. The total amount of realized and unrealized depreciation we experienced across the portfolio during the quarter was $356 million. Our quarterly appreciation includes the reversal of $180 million of unrealized depreciation associated with certain portfolio company restructurings, including Borden Dairy, 4Point, and Mood Media. Our remaining $176 million of portfolio appreciation primarily was driven by a combination of positive operating results and improved valuation inputs during the quarter for specific investments initially impacted by spread widening and general market conditions during the first and second quarters, but which continue to recover. Our realized and unrealized depreciation totaled $224 million during the quarter. Over 90% of our unrealized depreciation was related to certain legacy investments, many continuing to be impacted by the effects of COVID-19. In addition, approximately $182 million of depreciation related to realized losses, primarily from the previously mentioned restructurings. While we discussed many of the specifics of these investments on our second quarter earnings call, having a series of completed restructurings across the legacy portion of our portfolio represents a meaningful step for us from both an operating and valuation perspective. KKR's dedicated work group was instrumental during these complicated and time-consuming processes, which we believe demonstrates the value of having a dedicated internal team of investment professionals able to work seamlessly alongside our investment teams to navigate these challenging situations. And with that, I'll turn the call over to Stephen to discuss our financial results in more detail.

Thanks, Brian. My comments will be less focused on reporting financial metrics already contained in our earnings press release and 10Q, but rather focused more on the color behind our results, hopefully linking them in a more transparent and informative way to the broader comments on which Michael, Dan, and Brian have touched. First, the $3 million decline in our total investment income quarter over quarter was impacted by the following. We experienced a decline of $12 million in our interest income, primarily due to repayments of higher yielding assets across our investment portfolio, coupled to a lesser extent with continued declines in LIBOR. Given that 98 percent of our floating rate investment portfolio has floors which average 88 basis points, we believe the vast majority of LIBOR-based interest rate compression has now worked its way through the portfolio. Our fee and dividend income increased by $9 million during the third quarter as compared to the second quarter. The largest components of our fee and dividend income included $17.5 million of dividend income from our joint venture during the quarter. As many of you know, we typically expect this recurring dividend income to approximate between $15 and $20 million on a quarter-to-quarter basis. Other dividends, primarily from our asset-based finance investments, totaled approximately $12 million during the quarter, and fee income totaled $3 million during the quarter. Our interest expense declined by $2 million during the quarter as we benefited from the reduction in LIBOR as approximately 54 percent of our drawn balance sheet is floating rate. Management fees decreased by $2 million during the quarter due to the lower amount of average gross assets during the quarter compared to the prior quarter. The detailed bridge in our net asset value per share on a quarter-over-quarter basis is as follows. Our starting 3Q 2020 net asset value per share of $23.37 was increased by net investment income of 63 cents per share and was further increased by $1.06 per share due to an increase in the overall value of our investment portfolio. our net asset value per share was reduced by our $0.60 per share dividend. The sum of these activities results in our September 30 net asset value per share of $24.46. From a forward-looking guidance perspective, we expect our fourth quarter recurring net investment income per share to approximate $0.64, and we expect our GAAP net investment income per share to approximate $0.57. The bridge from our 63 cents per share of net investment income during the third quarter to our fourth quarter guidance is as follows. Our recurring interest income is expected to be relatively flat quarter over quarter as new investments and repayments somewhat offset each other, coupled with more static yields associated with our floating rate portfolio, given that most of our LIBOR floors have now been achieved. We expect dividend income associated with our JV to approximate $20 million. We expect other fee and dividend income to approximate $15 million during the fourth quarter. From an expense standpoint, we expect our interest expense will remain relatively flat quarter over quarter. We expect our quarterly management fee will increase by approximately $2 million during the fourth quarter based on the higher average value of our investment portfolio during the quarter. and we expect other general and administrative expenses will remain flat quarter over quarter. Finally, during the fourth quarter, we expect to pay excise taxes totaling approximately $9 million. To reflect more accurately the ongoing operational nature of the business, we add back excise taxes to calculate our recurring net investment income and net investment income per share. Nevertheless, we believe it is important to provide the market a bridge for both calculations. As a reminder, over the long term, we expect our dividends per share will equate to a 9% yield on our net asset value per share, though we acknowledge there will be certain quarters where our annualized yield may be greater or less than this range due to quarter-to-quarter fluctuations in the business from an operational standpoint. That being said, we are pleased that during the first three quarters of of 2020, despite the far-reaching effects of COVID and the resultant volatility on most companies' investment portfolios, we have been able to exceed our 9% target dividend yield to investors. Obviously, our dividend policy of achieving a 9% target dividend yield on our net asset value means that over time, it would be normal for our quarterly dividend to fluctuate somewhat in concert with the quarter-to-quarter change in our net asset value. In terms of the right side of our balance sheet, our gross and net debt to equity levels are 131% and 120%, respectively. These leverage levels represent a decline from our leverage levels during the first and second quarter of this year. Our available liquidity of $1.5 billion equates to approximately 22% of the value of our investment portfolio, which is a very comfortable percentage. And as we said on our second quarter earnings call, we continue to be pleased with our liability structure, which is 36% unsecured and 64% secured, with an overall weighted average cost of debt of 3.7%. In terms of debt maturities, we have no maturities until the middle of 2022. Our largest year of maturities is 2024, when approximately 50% of our capital structure will roll forward. Finally, from an unfunded commitments perspective, as of September 30, 2020, we had approximately $311 million of unfunded debt commitments, of which approximately $46 million represented revolver facilities and $212 million of unfunded equity commitments primarily associated with commitments related to our asset-based finance portfolio. As we said during both our first and second quarter earnings calls, the majority of our unfunded debt and equity commitments are generally used for capital expenditures or acquisitions and therefore subject to performance or other threshold tests, including in certain situations our specific consent. As a result, while these commitments are disclosed in our 10-Q for informational purposes, we do not believe they will be drawn in any meaningful capacity on a quarter-to-quarter basis. And with that, I'll turn the call back to Michael for a few closing comments before we open the call for questions.

Thanks, Stephen. As we have mentioned throughout this call, there is no shortage of issues our world currently faces, as we believe the federal government will continue to play an active role in the economy for the foreseeable future. That said, we continue to believe the long-term benefits that we believed would accrue to investors from the establishment of the FS KKR platform are beginning to materialize in tangible ways. From deep sponsor relationships, to the rigor of investment committee decision-making, to proactive portfolio management, to broad-based dedicated work teams, to seasoned BDC industry operators, the best of what we structured and planned for as we established the FSKKR Advisor seems to be coming to fruition at a very opportune time. We will look forward to continuing to update you on future progress. And with that, operator, we would like to open the call for questions.

Thank you. And as a reminder, ladies and gentlemen, to ask a question, you will need to press star one on your telephone. To withdraw your question, please press the pound key. Please stand by while we compile the Q&A roster. And our first question comes from the line of Casey Alexander with Compass Point. Your line is now open.

Hi. Good morning. Can you put a pencil around, you know, kind of a run rate, for dividends being generated by the portfolio. There's been a fair amount of fluctuation that came in at a higher than normal number, and I'm just trying to get to the right run rate going forward.

Yeah, Casey, it's Dan. Good morning. I think you've seen the dividend growth out of the joint venture over the last several quarters. I think we have started to get that to steady state. Maybe there's a little bit more growth there. We did have... some strong performance out of the asset-based finance portfolio this quarter. You know, some of those, you know, mainly due to sort of COVID reasons had been sort of turned off, but they, you know, returned to sort of paying. Those numbers are probably, in some ways, you know, maybe a little bit higher because there was some sort of catch-up in there. And then the only other thing I'd note is if you look at our fee income, you know, for the quarter, it was, you know, $3 million. I think the range in the four quarters prior was $6 to $16 million. But that's probably the ranges and the bounds for, you know, sort of what you're seeing in dividend and fee income.

Okay. Well, you stole my next question, which was about fee income. So you discussed that pricing and structured terms in some cases have returned to pre-COVID levels. From a logical standpoint, it seems to me that the deals that got into the pipeline first were kind of the no-brainers that performed exceedingly well through COVID and would have been done under any circumstances. Is there a point in time where we start to see some somewhat COVID – dinged companies that are going to come to market for money because they have to for refinancing reasons, where, you know, spreads may be a little bit better, terms may be a little bit stronger because of their financial condition at the point in time that they're coming to market?

Yeah, no, it's a good question. I'd probably break it down in a couple ways, though, right? I think a lot of the COVID-impacted names could have already come sort of seeking – capital. Maybe those things weren't done by us, but just done by either other market participants or different forms of the market. I think where we see things today, pipeline is definitely built back up, but we quoted the 75% to 80% number. The teams are very busy. I think for transactions that are more center of the fairway, the ones that you want to be invested in for sure from a credit perspective. We are seeing them at, we'll call it, those pre-COVID levels. I do think there's more scrutiny on documentation. I do think there's more scrutiny on ad backs, but at least from a pricing perspective. I think some of that is just a supply-demand point. We're still catching up on the pipeline activity. There are people who want to deploy money in this market. I do think if you have a credit which maybe is not even COVID-impacted but just has a story to it, you're a little bit harder, a little bit more work. That is still wide of what we would have seen in, say, January or February by maybe 50 to 75 basis points. So I think that's the way we're seeing things sort of today in the market.

Okay. All right. Thank you. I'll step back in the queue and let some other folks ask some questions. Thank you. All right. Thank you, Peter.

Thank you. And our next question comes from the line of Rich Shane with J.P. Morgan. Your line is open.

Good morning, everybody, and thank you for taking my questions. I hope everybody's well. You know, first of all, I really appreciate the effort to provide so much guidance. It's helpful as we look forward. When we think about the overall mix of the portfolio and the combination of repayments and you highlighted the fact that there are higher yielding loans repaid disproportionately in the third quarter. When we think about where spreads are now and the opportunities particularly that you're considering, do we think that spreads are going to stabilize, drift higher, drift lower? And again, I realize given the size of the portfolio, it's very marginal, but where do you see the marginal investment at this point?

Yeah, no, and good morning, Rick, and hope you're well as well. I think spreads are, you know, let's call that, you know, fairly sort of stable now, right? I think we would have talked about in April or May a scenario where we would have thought, you know, every deal would have been 100 to 200 basis points wide. That didn't last very long, and there wasn't necessarily a lot of deals that had done there. You know, I think for that regular way, you know, we'll call it Unitron's type loan, you know, I think we're seeing, you know, a fairly, let's call it stable sort of spread environment. I think there are things that on an opportunistic basis that we can do, whether it be second lien or maybe back to Casey's question, something that maybe had a little bit more of a COVID impact, but we're comfortable on the recovery that we can, you know, out earn kind of that normal type investment. You know, so I think those opportunities exist. I think the way we've constructed the portfolio to date is a way that we will continue in terms of portfolio construction. I think the comment you made about repayments in the quarter being sort of higher-yielding investments, I mean, there wasn't that many repayments in the quarter, so that was skewed really to sort of one or two names. But obviously, we're looking to build the portfolio on a very diversified basis with you know, principal protection first, kind of yield second, but knowing, you know, we've got dividend sort of goals and sort of targets to meet.

Got it. And then I'll ask the same question basically in the context of covenants and protections in terms of have you regained any power in the market in terms of structure?

Yeah, I think we have. While pricing for that center of the fairway deal has sort of come back to what we'll call pre-COVID levels, I do think there's just a bit more discipline out there as it relates to ad backs and structure and sort of covenants. I think you've heard us say this before. We're a big believer that the first lean Unitron product is supposed to have a covenant. You're not getting paid enough to sort of not, and I think you will continue to see us, you know, employ that strategy on a go-forward basis. But I think a little bit more, you know, weighted to the lender side to the now.

Great. Hey, Dan, thank you very much.

Thanks, Rick.

Thank you. And our next question comes from the line of John with Jeffrey. Your line is open.

Good morning, guys. Thanks very much. First question, it's a little bit of a tag on to the last question. Characteristics of the recent pipeline and the recent kind of post-end of Q3 investment activity, but maybe not terms, but any industry or geographical characteristics we should be thinking about.

Yeah, good morning, John. I don't think any, you know, geographical per se. I think you should assume that, you know, with the higher risk bar, underwriting bar that we have today, We are focused on non-cyclical, in many ways, not names that we would be worried about being impacted by a, we'll call it second wave of COVID. Hopefully the news yesterday sort of changes that dynamic a bit. But I think we're playing defense when we think about sort of underwriting today. And those would be the kind of industries that you should expect we're sort of playing in. Obviously, a lot of the deals that closed in that first month of this quarter were things that were committed to sort of last quarter, but I think that's the way we'd expect the pipeline to come together over the next sort of quarter or two for sure.

Okay. And then within the last quarter of your net deployments, asset-based finance was a pretty big portion. Was that one particular deal, or was that just sort of an opportunity that presented itself in that quarter, or is that something more of a long-term deal? call it? There might be a bigger mix of that. How do we just think about that component of the originations in the quarter?

Yeah, no, it's a good question. I'd start on the portfolio construction sort of piece. I think we've talked about asset-based finance being, let's call it, somewhere between 10% and 15% of the portfolio. We're kind of there now, so I think we're happy about that. Because I think the total numbers inside of Q3 are you know, on the origination side were, you know, fairly small versus kind of normal quarters. I think that's probably skewing it a little bit. There was one, you know, more opportunistic transaction that does come to mind that we sort of did, but I wouldn't read too much into that. I focus on the 10 to 15% guidance from the portfolio construction.

Okay. And then last question, Dan, you talked about, you know, in a lot of parts of the markets kind of terms getting back to norm or even pre COVID levels. Um, But you also kind of refer to, I guess, other activities like LBO and maybe acquisition kind of financings creeping up. Just as you look into 2021, assuming more of the same, where we have a, call it a slow recovery that might not be straight-lined, but more or less a recovery, some levels of stimulus, Do you guys have an opinion on how the kind of deal market shapes up next year in terms of the drivers of the flow?

You know, it's a good question. I think we've seen a lot of add-ons in recent sort of months. That's companies just effectively going on the offensive as their businesses have stabilized. I think it's probably been easier to buy a competitor today than arguably do sort of a new deal. So I think for us, percentage-wise, that has probably been higher. I think we're starting to see more regular way M&A processes happen and occur and advisors are hired. I mean, people are not traveling regularly. as much as they used to or as much as maybe what the historical norms would be, but I think people are finding ways to get deals done. I think if we're in and around the environment we are today, so let's call that no sort of large second wave lockdowns, maybe sort of an understanding of the economy can be a bit bumpy and volatile, but people have some comfort around it. I think you'll just continue to see that more traditional pipeline sort of pick up on the M&A side.

Great. Thanks very much, guys.

Thank you. Thank you. And our next question comes from the line of Finian O'Shea with Wells Fargo Securities. Your line is now open.

Hey, good morning. Thank you. Just a first question on the dividend again, appreciating the target levels you all laid out. Is there a certain point where you'll go back to a fixed dividend, perhaps when you feel NAV is stabilized? Just like should we think of this variable policy as a more transitory or permanent concept?

Yeah, Finn, maybe I'll start and Steven can add to this. I think we've gotten a lot of feedback from the market. I think it's probably a bit of a combination of creating a sense of stability but also I think understanding what this product is and what the BDC is, I think that variable component does make some real sense to us. But Stephen, why don't you kind of add to that?

Yes. So I think Dan's right. We think of this more as a permanent shift rather than a transitory shift. And we think, frankly, the industry would benefit itself in the same way, not just our platform. There are so many variables every quarter that BDCs deal with in terms of changing interest rate environments, changing deal environments. We've talked a lot about pricing a pipeline, credit quality. There are just lots of inputs that you handle every quarter as an operator. And to have a fixed dividend over time becomes very difficult for all BDCs. So we think having more of a of a floating-type policy that matches NAV and creates a target yield for investors over a long, sustained period of time is, we think, a more enlightened, better way to go for the industry as the industry continues to mature, frankly.

That's helpful. What would you think of, similarly, the concept of a floating hurdle rate?

Yeah. It's an interesting question, Finn. You could argue it does align with what the general investments of these types of vehicles are, which are floating rate loans. The other side of that, it probably puts a little bit of complexity in there as you think about how to manage your asset liability side. And I think there's also some complexity because most of the deals do sort of come with LIBOR floors. So, I mean, I think the concept is probably interesting. I think the complexities could be a challenge, though, to be honest.

I understand. That's all for me. Thank you, guys.

Thanks, man.

Thank you. And our next question comes from the line of Robert Dodd with Raymond James. Your line is now open.

Hi, guys. Good morning. Back to kind of a pricing question, but not just about spreads. Obviously, I mean, with your comments, Dan, I mean, talking about, you know, better structures, maybe lower leverage, etc. I mean, the spread might have been given back, so to speak, in a very competitive market after the COVID spike. But what about, if you can, kind of talking about what's the forward risk-adjusted total return yield or however you want to word it, given, you know, if ad backs are reduced, if docs are better, it's not, you know, if OIDs are higher, right? The spread might have been competed away, but those other components don't seem to have been. So what impact – do those have right now in kind of the implied total return pricing rather than just spread pricing?

Yeah, it's an interesting question. I mean, I think, you know, I'm not entirely sure those other pieces are, you know, so far away from, you know, pre-COVID items that you would give them a ton of value in a pricing sort of standpoint. So, I mean, documents are better, but documents are not what they would have been in an April or May deal. You know, covenants, I think, are holding. I think the focus on ad backs are sort of better for sure. And I think the market saw, you know, certain, you know, challenges on deals where ad backs were done. Obviously, that was inflating EBITDA. Maybe that cash sort of didn't come through. So, I think it's an impact. I would say this for your benefit. I think from our view that regular way, Unitron's deal is probably LIBOR plus 625. It's probably two points of OID. You probably get an assumption of some level of call fees or call pro when you think about your overall portfolio. That's putting you maybe 80% on an unlevered basis. You know, we've been pretty selective in the second lien space, but, you know, we're prepared to do those. A lot of times those second lien credits will be locked. I mean, I think all the time they'll be larger companies, but in our mind they could be some of the better credits in the portfolio. You know, they're probably 400 basis points back of, you know, the first lien syndicated markets, and now you're talking probably 200 basis points back of what we just said on the Unitron. So, you know, I think there's ways to build, you know, an overall pretty attractive yield here, especially considering where, you know, overall sort of rates are. But I think that's the way we've been thinking about it.

Got it. I appreciate that. On the asset-backed, I mean, obviously, Turok paid a dividend this quarter, so you're seeing a rebound in those areas. But still kind of maintaining the 10% to 15% target for that mix in the portfolio, even, you know, obviously asset-backed security has something going for it versus other areas of the market. But what would it take – for lack of a better term, for you to be interested in shifting that 10% to 15%, either higher or lower?

Yeah. It is a sector that we are very fond of, and you've heard us talk about it on calls prior. We like the sort of collateral backing of those deals. They're generally paying sort of a higher sort of overall margin I think there probably is a governor to why we would not take that higher. Obviously, the strategic purpose of our platform here is to focus on directly originated corporate loans, focused on that upper end of the middle market. I think you've got one sort of natural governor, and obviously a lot of this stuff can be non-EPC, so that's another sort of piece of that. But again, I think we really like what we see there as real downside protection and very attractive return. So I think we're comfortable with that balance today. I think we could have some flex to take it down if we saw other lending situations, spreads just widen, and maybe we didn't see the spreads widen in the asset-based finance space. And we are dynamic as we think about portfolio allocation, albeit we're cognizant it isn't a liquid asset book, right? So you just can't sort of move it sort of that quickly. But I would probably stay in that 10% to 15% range.

Thank you. Thank you. Our next question comes from Bryce Rowe with the National Securities.

Thanks. Good morning, and I appreciate you taking the questions here. I wanted to ask a little bit about the restructurings, Dan and or Brian. You mentioned the reversal, the $180 million of reversals associated with realized losses. I'm curious what the mark might have been on those assets and what kind of loss was associated with those exits?

Brian, so we had $180 million of reversal of unrealized depreciation and $182 million of realized losses associated with those same assets. So it's pretty much on top of each other.

Great. That's encouraging. And then, again, on the restructuring, you noted the four restructurings here in the third quarter Maybe, Dan, you can talk a little bit about, you know, your thoughts on the outcome there, the process, you know, within the organization from a restructuring perspective. And then if we look at, you know, the current pipeline, if you will, of restructurings, what's your, you know, you guys provided some good detail around, you know, around that last quarter. So just curious how you think about, you know, the current, you know, portfolio of potential restructurings here. over the next three to six months? Thanks.

Yeah, no, thanks for that. And I'll take the first part and Brian will sort of add to it. I mean, maybe just start off with the team, right? I think we've, you know, kind of, really dating back to the end of 2017, sort of leaned into the idea of wanting to have a dedicated restructuring team. We've added that over time. We actually added someone there, sort of April-ish sort of timeframe. I think we're very happy that we have that. I think we've been The team has worked tremendously hard. They've been, in our minds, very effective. I think it adds us not just value for these names when they get to the spot, but adds us a lot of value when just a company is on the watch list. We can be thoughtful with what amendments we might make. We're not in the business of trying to take over sort of all these companies, but we need to be prepared to do that. People need to know we're prepared to do that. So we think that team adds us a lot of value sort of generally. I think Borden was sort of one example inside the quarter. We think that we put ourselves in a good position there. We took some take-back paper. We got an equity stake. That equity stake is marked effectively at zero. We partnered with what I would call a best-in-class sort of management team to do that. That was a lot of, I think, hard work and brain damage to get to that point. But I think we're happy with where we sit. We're going to work hard and support that team to try to maximize our recovery versus our initial investment.

Yeah, and Brian, four points, probably another name worth mentioning. We were investors in a second lean tranche, and we had some equity as well in that business. The company was certainly impacted by COVID and the decline in commodity prices. It's a gas-weighted E&P business. Back in the summer, July, we basically were part of a restructuring where we converted The second lien notes to equity took control of the business, significantly delivered the balance sheet, took it from, you know, close to six times to under one times leverage, and, you know, also, you know, redid some of their hedges, so they're 80 to 90 percent hedged. You know, we think control of that business is important. It allows us to focus on some SG&A opportunities as well as potentially M&A down the road.

Okay, that's helpful. And just any forward guidance on how to think about the current portfolio of non-accruals? Are you closer to getting some more restructured here over the near term?

I'm not sure there's things in the guidance perspective. I mean, I think we're pretty happy and pleased with how we've rotated the portfolio forward. sort of where we sit today, and clearly there's some names that we're focused on, but I don't think we see, you know, anywhere near the, we'll call it, you know, restructuring pipeline, I think was your words, on sort of a forward basis.

Okay. All right. Thank you, guys. Appreciate the time.

Thank you.

Thank you. And our next question comes from the line of Ryan Lynch with KBW. Your line is now open.

Hey, good morning. Thanks for taking my questions. You know, really, credit performance has been the focus for FSK investors over the past several quarters, and in fact, in the last several years. Q2 versus Q3's credit performance was dramatically different despite, you know, I think a pretty similar, you know, background for liquid loan prices and credit spreads. And I think that was due to some specific credit issues and some markdowns in Q2 that caused a pretty big decline in NAV. And then in Q3, you saw the opposite of that, a big uptick in NAV. So, what do you think changed between Q2 and Q3's performance in your portfolio? And do you think that the portfolio has really turned the corner from a credit perspective with the restructuring and the current markdowns of those stressed investments, or is there still just too much certainty out there to make that call?

Ryan, thank you for that. I mean, there's a couple maybe sort of different pieces in there. I don't think the quote unquote credit performance has sort of changed over Q2 to Q3. I would go with kind of your point. It was much more certain specific names that we continued to kind of work through. And I think if we take a step back here, we've been very focused on rotating the portfolio. you saw in our earlier comments, we've got 50 plus percent originated from the FS KKR Advisor, 81 percent plus from KKR overall. I think we've had some legitimate challenges on some of these older names and I think we've been forced to dig deep on the restructuring side, and quite frankly, the recovery rates on some of those names have not been great. So I think that's been a driver. Now, what I would, what we do want to make sure the market understands, and this was page 12 of our slide deck that's up on the website, we've originated since the start of this advisor, so 10 quarters now, over $4.5 billion of assets you know, total cumulative depreciation sort of $49 million, right? So I think if you put that in context, you know, almost $4.5 billion of investments, you know, $49 million over 10 quarters, you know, that's well within a range that we talk about as, you know, probably a target of sort of 1% annual losses. So I think I think we've made some really good progress. I think we're quite proud of what the team has done both on the origination side but also on the portfolio side. I think we've still got some work to do. as it relates to some names in there, but I think we do believe the portfolio has sort of turned the corner and we look forward to continuing with what we believe are strong originations to good and defensive companies and continue to build this portfolio in a creative manner for our investors.

Okay, that's a good call. I just had one other one. I know there's been a lot of discussion on terms and pricing in the market as well as your current pipeline. You know, just as I look at your guys' leverage levels today, and I understand where you guys' leverage targets are set at, is it the expectation, you know, going forward that at this point, you know, you guys are just going to match repayments with originations, or what's the thought from leverage levels going forward from here?

Yeah, I'm not too sure that's the wrong assumption. I mean, we were happy to see the leverage come down this quarter. I mean, you know, we've, at that 1.2 times net, you know, it's within inside our sort of target range. Our target range of, you know, one to one and a quarter times hasn't changed. So I think you should suspect us to operate within there. I think we feel very good where we are from a liquidity perspective. both from, you know, available liquidity, but also sort of near-term debt maturities. You know, and then the only time I think that we would probably take it above there would be to capitalize on what we see as a market opportunity and volatility, which is, you know, obviously not there today the way it may have been in kind of end of Q1, you know, beginning of Q2.

Okay. Understood. That's all from me. I appreciate the time today and congrats on the next quarter.

Thank you.

Thank you. And our last question and follow-up question comes from a line of Casey Alexander with Compass Point. Your line is now open.

Yeah, real quick for Steve, because this is just math that I want to check. You know, if you level set your earnings stream going forward, do you know how many quarters of additional incentive fee waivers we have in front of us before they're absorbed through the look-back?

Casey, we gave guidance, I guess, probably two quarters ago now, you know, that we said we expected it to be kind of in the five to six quarter range from that period of time. Clearly, in our guidance for the fourth quarter, there's not an incentive fee. You know, clearly the books moved in a positive direction, too. So, Forgive me for not having the exact math, but hopefully that's maybe a bit of a bookend for you, and we can also follow up offline.

Yeah, if you want to follow up offline, that would be great. Thank you.

Great. Thanks so much.

Awesome. Thanks for taking my question. Thanks, Jason.

Thank you. And this does conclude today's question and answer session. I would now like to turn the conference call back to Dan for closing remarks.

Thank you. We want to thank everyone again for taking the time today. We do hope that you and your family remain safe and healthy, and we do look forward to talking to you again soon. Thanks again.

Ladies and gentlemen, this concludes today's conference call. Thank you for standing by.