FS KKR Capital Corp.

Good morning, ladies and gentlemen. Welcome to FSKKR Capital Corp's third quarter 2024 earnings conference call. Your lines will be in a listen-only mode during remarks by FSK's management. At the conclusion of the company's remarks, we will begin the question-and-answer session, at which time I will give you instructions on entering DOCU. Please note that this conference is being recorded. At this time, Anna Kawahai, Head of Investor Relations will proceed with the introduction. You may now begin.

Thank you. Good morning and welcome to FSKPR Capital Corp's third quarter 2024 earnings conference call. Please note that FSKPR 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 yesterday. 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, 2024. 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 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, reconciliation to the most directly comparable GAAP measures can be found in FSK's third quarter earning release that was filed with the SEC on November 6, 2024. 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 FST's website. Speaking on today's call will be Michael Foreman, Chief Executive Officer and Chairman, Dan Pietrzak, Chief Investment Officer and Co-President, Brian Gerson, Co-President, and Steven Lilly, Chief Financial Officer. Also joining us on the call today are Co-Chief Operating Officers Drew O'Toole and Ryan Wilson. I will now turn the call over to Michael.

Thank you, Anna, and good morning, everyone. Thank you all for joining us today for FSK's third quarter 2024 earnings call. FSK's financial and operating results showed continued strength during the third quarter as we again exceeded our earnings guidance and over-earned our quarterly base and supplemental distribution. During the third quarter, FSK generated net investment income of 77 cents per share, and adjusted net investment income of 74 cents per share as compared to our public guidance of approximately 72 and 70 cents per share respectively. Our net asset value per share at the end of the third quarter was 23.82. On October 8th, 2024, we announced that our board declared a total fourth quarter distribution of 70 cents per share consisting of our base distribution of 64 cents per share and a supplemental distribution of $0.06 per share. This results in $2.90 per share of total distributions in 2024, which equates to a 12.2 percent yield on our September 30, 2024 net asset value of $0.2382 per share and a yield of approximately 14 percent based on our recent share price. As Dan will discuss in more detail during his comments, the FSK Care Advisor continues to maintain its high bar on credit quality and disciplined underwriting process. During the third quarter, we originated approximately $1.1 billion of investments, and we ended the quarter with ample liquidity totaling approximately $4.4 billion. As we begin focusing on 2025, FSK is well positioned to capitalize on expected market conditions. First, Given the recent reduction in interest rates and assuming some level of additional rate cuts over the next 12 months, our portfolio companies should experience improved credit metrics such as interest and fixed charge coverage ratios. Next, based on our expectation for continued improvement in the M&A environment, there should be additional opportunities to rotate out of certain legacy portfolio companies which have positioned themselves favorably over the last several years. Lastly, we're optimistic about the outlook for new investment opportunities and continue to believe that the KKR credit platform is well positioned to generate differentiated deal flow across private debt and asset-based finance investments. And with that, I'll turn the call over to Dan and the team to provide additional color on the market and the quarter.

Thank you, Michael, and good morning, everyone. Despite the recent noise surrounding the presidential election, the U.S. economy has continues to remain on solid footing. Since the Fed began raising rates in early 2022, the US economy has experienced a 6.8% growth rate in real terms. Recent economic data released through September illustrates that the labor market has remained resilient, boosting income levels for workers, which continues to support consumer spending. At the same time, inflation has declined from 9.1% in June of 2022 to approximately 2.4% today. Both of these inputs create a favorable backdrop for a sustained economic expansion. As Michael alluded in his comments, we believe that M&A activity will increase meaningfully in 2025, as the market has seen interest rates peak and economic sentiment improve. In line with this, We have seen greater momentum in middle market deal volumes and our pipeline of new investment opportunities continues to grow. The bar remains high when looking for new opportunities to deploy capital. The market continues to be competitive, which has resulted in tighter credit spreads and more borrower-friendly terms. Nevertheless, we remain prudent and disciplined in our underwriting and have continued to pass on opportunities that do not meet our credit standards. We continue to see compelling opportunities in asset-based finance, as banks strategically reposition their portfolios, largely due to regulatory requirements. As we have discussed previously, our ABF investments are often structured as fixed rate, which helps offset the impact of declining rates in the direct lending portion of our investment portfolio. During the third quarter, FSK originated $1.1 billion of new investments. Approximately 57% of our new investments were focused on add-on financings to existing portfolio companies and long-term KKR relationships. Our new investments, combined with $1 billion of net sales and repayments when factoring in sales to our joint venture, equated to a net portfolio increase of $185 million. New originations consisted of approximately 84% in first lien loans and 16% in asset-based finance investments. Our new direct lending investments had a weighted average EBITDA of approximately $211 million, 6.3 times leverage through our security, and a weighted average coupon of approximately SOFR plus 505 basis points. Through our ABF team and the broader KKR network, we have developed deep relationships which allows us to access niche sectors that we find attractive within the ABF market and to structure deals that many market participants are unable to execute on due to transaction size, complexity, or platform capabilities. One example of an asset-based finance deal that we originated during the quarter was the purchase of an approximately $10 billion pool of seasoned private student loans from Discover Financial Services. This portfolio is focused on prime borrowers or co-signers and has an average FICO score above 750. KKR Credit and another large manager jointly led and structured the multi-billion dollar deal, with FSK committing $94 million. The trend of well-performing portfolio companies proactively seeking repricings continued during the third quarter. We have also experienced instances of companies seeking overly aggressive price reductions or structural amendments, which don't align with our return or risk thresholds. In those situations, we have proactively chose to be repaid. When we look at aggregate trends across our portfolio companies, we observed a 13% year-over-year EBITDA growth rate. at portfolio companies in which we have invested in since April of 2018. Additionally, the weighted average and median EBITDA of our portfolio companies was $237 million and $121 million, respectively, as of September 30th, 2024. As of the end of the third quarter, non-accruals represented 3.8% of our portfolio on a cost basis. and 1.7% of our portfolio on a fair value basis. This compares to 4.3% of our portfolio on a cost basis and 1.8% of our portfolio on a fair value basis as of June 30th, 2024. Brian will provide further details on this during his comments. We also believe it is helpful to provide the market with information based on the FSK assets originated by KKR Credit. Non-accruals relating to the 88% of our total portfolio, which has been originated by KKR Credit and the FF KKR Advisor, were 2.2% on a cost basis and 50 basis points on a fair value basis as of the end of the third quarter. This compares to 2.4% on a cost basis and 60 basis points on a fair value basis as of June 30th, 2024. And with that, I'll turn the call over to Brian to discuss our portfolio in more detail.

Thanks, Dan. At the end of the third quarter, our investment portfolio had a fair value of $13.9 billion, consisting of 217 portfolio companies. This compares to a fair value of $14.1 billion in 208 portfolio companies as of June 30th, 2024. Our net leverage remained flat quarter over quarter, and the decline in our investment portfolio's fair value was primarily driven by unrealized depreciation relating to three investments, Production Resource Group, Miami Beach Medical Group, and WorldWise. PRG continues to be impacted by the lingering effects of the writer's strike and its corresponding impact on TV and film, as well as softness in its live performance business due to the delay a certain artist tours. Miami Beach recently filed for Chapter 11 as part of its anticipated sale to Humana. Over the coming months, should this transaction close, we will exit our position in Seoul. WorldWise has experienced headwinds in its core pet-fed business due to increased competition from low-cost foreign suppliers. We are actively engaged with the sponsor of WorldWise to negotiate a potential restructuring, and we will provide additional updates as we learn more. At the end of the third quarter, our 10 largest portfolio companies represented approximately 20% of the fair value of our portfolio, which is in line with prior quarters. We continue to focus on senior secured investments as our portfolio consisted of approximately 60% first lien loans and 67% senior secured debt as of September 30th. In addition, our joint venture represented 9.9% of the fair value of our portfolio, As a result, when investors consider our entire portfolio, looking through to the investments in our joint venture, then first lien loans total approximately 69% of our portfolio and senior secured investments total approximately 76% of our portfolio as of September 30th. The weighted average yield on accruing debt investments was 11.5% as of September 30th, a decrease of 50 basis points compared to 12% at the end of the second quarter. The decrease is primarily attributable to lower spreads on new investments, the repayment of certain higher yielding investments during the quarter, and portfolio company repricings. As a reminder, the calculation of weighted average yield is adjusted to exclude the accretion associated with the merger with FSKR. During the third quarter, GlobalJet returned $76 million of capital to SSK, which is used to further reduce our position. This distribution brings our total capital received to $205 million over the last two and a half years, and we continue to be pleased with the performance of the company. During the quarter, one investment was added to non-accrual status and three investments were removed. Our subordinated delay draw position in Miami Beach Medical was added to non-accrual status contributing $17 million of cost and $8 million of fair value. Five-arch income fund, a legacy investment, which has been on non-accrual since 2020, was fully exited, removing $54 million of cost and $2 million of fair value. Lastly, a recapitalization of Belk resulted in the removal of $36 million of cost and $13 million of fair value across two investments. And with that, I'll turn the call over to Stephen to go through our financial results.

Thanks, Brian. Our total investment income increased by $2 million during the third quarter to $441 million. The primary components of our total investment income during the quarter were as follows. Total interest income was $356 million, representing an increase of $3 million quarter over quarter. A component of interest income, PIC interest, was $66 million as three portfolio companies, ATX, ERG, and KBS, paid their interest in the form of PIC. Dividend and fee income totaled $85 million, a decrease of $1 million quarter over quarter. Our total dividend and fee income during the quarter is summarized as follows. $46 million of recurring dividend income from our joint venture other dividends from various portfolio companies totaling approximately $18 million during the quarter, and fee income totaling approximately $21 million during the quarter. Our interest expense totaled $118 million, an increase of $3 million quarter over quarter, and our weighted average cost of debt was 5.5% as of September 30th. Management fees totaled $54 million, unchanged quarter over quarter. and incentive fees totaled $44 million, a decrease of $1 million quarter over quarter. Other expenses totaled $10 million, unchanged quarter over quarter. The detailed bridge in our net asset value per share on a quarter over quarter basis is as follows. Our ending 2Q 2024 net asset value per share of $23.95 was increased by GAAP net investment income of 77 cents per share and was decreased by 20 cents per share due to a decrease in the overall value of our investment portfolio. Our net asset value per share was reduced by our 70 cents per share total quarterly distribution paid during the quarter. The sum of these activities results in our September 30, 2024 net asset value per share of $23.82. From a forward-looking guidance perspective, we expect fourth quarter 2024 GAAP net investment income to approximate 63 cents per share, and we expect our adjusted net investment income to approximate 68 cents per share. Detailed fourth quarter guidance is as follows. Our recurring interest income on a GAAP basis is expected to approximate $332 million. We expect recurring dividend income associated with our joint venture to approximate $52 million, an increase of approximately $6 million quarter over quarter. The expected increase is a result of the recent sale of $370 million of assets to the joint venture from FSK's balance sheet. We expect other fee and dividend income to approximate $31 million due to lower non-recurring fee income within our investment portfolio. From an expense standpoint, we expect our management fees to approximate $53 million. We expect incentive fees to approximate $36 million. We expect our interest expense to approximate $117 million. And we expect other G&A expenses to approximate $10 million. During the fourth quarter, we expect our excise taxes will approximate $24 million. we expect the net effect of excise taxes to be partially offset by the accretion of our investments due to merger accounting. The primary drivers of the change from FSK's third quarter adjusted net investment income of 74 cents per share to our expected fourth quarter adjusted net investment income guidance of 68 cents per share are the reduction in interest rates by the Federal Reserve in September and lower fee income in the fourth quarter as compared to the third quarter. Turning to our capital structure, our gross and net debt to equity levels were 121% and 109% respectively at September 30, 2024, as compared to 119% and 109% at June 30, 2024. As of the end of the third quarter, our available liquidity was $4.4 billion, and approximately 66% of our drawn balance sheet and 46% of our committed balance sheet was comprised of unsecured debt. As a team, we are very focused on managing the right side of our balance sheet and optimizing our capital structure through multiple funding sources. Like certain other BDCs, which took advantage of the lower rate environment in 2019 and 2020, FSK has some lower-cost debt maturing next year. In 2025, FSK has approximately $1.2 billion of unsecured notes maturing, representing approximately 10% of our total debt commitments and carrying a weighted average cost of 5.1%. FSK has been a frequent issuer in the unsecured market with a focus on well-laddered maturities. We will continue to opportunistically assess the unsecured market, and we have over $3.5 billion of undrawn capacity under our Senior Secured Revolving Credit Facility to utilize should we desire to aid with timing differences. And with that, I'll turn the call back to Michael for a few closing remarks before we open the call for questions.

Thank you, Stephen. In closing, we are pleased with FSK's third quarter performance as we have further reduced our non-accrual investments and are continuing to see significant new investment opportunities. As we look towards 2025, we believe the next several quarters could yield meaningful opportunities for FSK as the M&A market continues to improve. As we actively pursue well-structured new investments and focus on rotating legacy investments, we believe that 2025 has the potential to be a very active year for FSK. And with that, operator, we'd like to open the call for questions.

Now opening the floor for question and answer session. If you'd like to ask a question, please press star followed by number one on your telephone keypad. Your first question comes from Bryce Rowe from B Riley Securities. Your line is now open.

Thanks a lot. Good morning to everyone. Wanted to maybe start on just on yields and what you're seeing there in the market. Obviously, you called out yield compression within the portfolio in the quarter of 50 basis points. Just wanted to try to understand the impact from lower rates and spread compression within that 50 basis points. And then the guide that you're giving here for the fourth quarter of you know, I guess lower interest income from rates. Is that all lower rates or is there some spread compression kind of baked into that assumption too?

Yeah, good morning, Bryce. Good morning. I think the simple summary is it's a little bit of both, right? Clearly there was the initial Fed move of the 50 basis points. You know, we have seen from a new deal perspective, you know, your regular way, You know, direct lending deal is probably, you know, 500 basis points to 550 basis points. That's before kind of fees and OID. You know, we have seen some repricings across the book. I think we called that out in our prepared comments. I think for names that we're comfortable with and we like the risk, you know, we could be supportive of those. You know, we have used a couple of those opportunities to just get repaid. You know, it is... I think a little bit of a harder market these days. The M&A volumes that everybody's been forecasting, including ourselves, have been a little bit slow to return. I think we've been happy with our deployment numbers, but there's a bit of an imbalance in terms of available capital and kind of deal flow, which I think is driving some of that. All that being said, I think what you are earning on these loans in totality is still north of 10%, and considering I think the quality of the company that we are seeing, considering the LTV or the equity checks below us, that is one comforting fact in terms of total return on these deals. Okay.

All right. That's helpful. And then one more for me, and I'll jump back in queue. But when we think about kind of the guide, and obviously we're getting to a point where most BDCs are seeing earnings compression and putting themselves into a position where you've got dividend coverage starts to fall below 100%, especially when we're thinking about the supplemental plus the base. You guys have plenty of spillover income. So I think you all have communicated in the past that spillover income is certainly sufficient to bridge any gaps. Kind of curious where you've Where you'd like, you know, the spillover to kind of base out, so to speak, where do you want to try to reserve or keep two quarters of spillover versus what you have right now in roughly three?

No, that's a fair question. I think your estimates there are, you know, pretty much on point. You know, I do think that, you know, the spillback income is, you know, quite beneficial in, you know, in the environment that we're in. I would kind of note, I mean, our starting point from an earnings perspective is strong. I think 12.2% on NAV from a yield perspective is attractive. I think we are, as Stephen talked about, forecasting lower fee income in Q4. I think the one thing that we'll watch play out is we do believe increased activity in 25 will occur. That should be beneficial to that fee income line. and provide some offset, but yes, the nearly three-quarters of spillback is available as it relates to the 70 cents.

Okay. Thank you, guys. Thank you.

Your next question comes from Casey Alexander from Compass Point. Your line is now up.

Yeah, hi, good morning. You know, the income generation in the quarter was, you know, I think better, actually, than most of us expected. But there was a meaningful, especially over the last two quarters, increase in PIC income. Can you give us some sense of how you expect that to develop next quarter and in some of the succeeding quarters?

Yeah, good morning, Casey. I think in terms of the PIC, I kind of frame it in one way, and then maybe Brian will talk about some of the specific deals. While it's a smaller part of our portfolio, we have been active in certain junior debt deals. Athena Health would be an example of that. So of the PIC income, roughly half of that – is what I'll call regular way kind of new business. A lot of those companies end up being kind of a larger size, which we like from a risk perspective. I think when we did the Athena deal as an example, it was like a billion dollars of EBITDA. The rest of it, as Stephen called out, was related to a handful of names. And those names were using that as they were reinvesting dollars into kind of growth activities, which I think were you know, supportive of them doing. You know, but I think in terms of the forward outlook, you know, I think we were roughly 15% this quarter. You know, you're probably in and around that range, you know, my guess would be for the next couple of quarters. But, Brian, you might want to add to that.

Yeah, look, I think when you step back, you know, as it relates to these three names, when we restructure businesses, we always size the debt capacity to the current and projecting earnings part of the business. But these businesses are being restructured because they've been underperforming. They've lacked strategic guidance. They often need management upgrades. They may have been underinvested in SG&A or CapEx. And we structure these loans, this new debt, with a pick option, which gives us in management flexibility to address these underperformance issues and gives us But we do have sign-off on all the budgeting since we're on the board. So, you know, I do think these picks, they're not surprising. They were intentionally structured. And, you know, I think currently the deals that do have that option are utilizing it. You know, that may address your question about future. But, again, there's a lot of thought that goes into how we structure these deals and really focusing on the ultimate outcome of that deal.

Okay, thanks.

My next question is, you know, last year around this time, you gave kind of pretty clear indications of, you know, how you sort of intended to manage the dividend for 2024, and it ended up getting broken into kind of three components. I'm curious if you have any view of of how you think the board expects to handle it, especially against, you know, A, rate compression, B, declining base rates. I mean, would it be your expectation that in 2025 investors should think more in terms of the base dividend and then see how things develop through 2025?

You know, and thanks for that, Casey. I think we We've tried to be pretty transparent the way we've thought about dividend policy, and you are correct. We broke it into kind of three pieces, right? We wanted to reward shareholders for what's called outperformance on the income side. That was the $0.05 that was the additional that I think we paid for five straight quarters. We have broken it down into the $0.64 and the $0.06 to get to the $0.70. I think what we do talk about with this with the board, You know, we do think about it over a longer term, at a longer term horizon, right? That's why we did set the base at 64. You know, I think we'll continue to evaluate that with the board. You know, I think you had an interesting piece out yesterday, you know, as it relates to the potential impact of the presidential election. I think our initial gut is while rates will continue to trend down, it probably will be a little bit slower than maybe we would have guessed 30 or 60 days ago. So I think we have to kind of watch that play out. I think we have to watch the deal volume sort of play out, see what that does to kind of fee income. But I would go back to Bryce's question. We're at the upper end of the range on the spillback, and that's available to support that $0.70 number we've been paying out.

And just to be clear and put a fine point on it, the $0.05 was the spillover that we were paying out for five quarters, and the $0.06 was what reflected the higher rate environment that we've been operating in.

Right.

Right. All right, great. Thank you for taking my questions. Thank you, Casey.

Your next question comes from John Hecht from Jefferies. Your line is now open.

Thanks very much for taking my questions. Actually, a couple just were asked. I'm wondering, on the investment pipeline, Dan, it sounded like there's more activity, but maybe the pipeline of activity growth isn't quite as much as you would have expected. I guess my question is... As you look into 2025, given the forward curve and some anticipated maybe deregulation, do you think that the M&A pipeline and the investment pipeline will grow over the course of the next few quarters or is kind of where we are where we are?

Yeah, thanks, John. You know, I think we do believe that it will grow, right? You have the continued fact out there that You know, the holding period for a bunch of these deals that are sponsor-owned has been probably longer than intended. You do have, I think, a continued focus from LPs to get capital back out of these funds. So I think there is, you know, a certain amount of pressure to sell some of these companies. There's a lot of dry powder on the private equity side that's, you know, arguably getting kind of further down the road inside of fund life. So you have the capital there to, you know, be involved or acquire these companies. So I think that setup kind of remains. You know, it probably has been, well, it's just called slower to start than I think we would have guessed maybe at the start of 24. You know, I think we did have a view that, you know, to make the bid-ask kind of difference narrow, you needed kind of market participants to get their arms around inflation being under control, rates being, let's call it, more stable, and, you know, kind of the hard landing being removed from people's kind of minds. You know, I think that all happened, but I think we have seen more and more people anticipating these rate reductions, so it has been kind of slower. You know, now, all that said, when I do look at, you know, the pipeline and I do look at activity of the deal teams, You know, it's been the highest it's been, you know, since the start of 22. You know, so I think that's positive. So I think we do expect that to play out as we get into 2025. Okay.

That's helpful context. And then maybe just from a credit outlook perspective, is there anything to talk about or maybe call out in terms of EBITDA or revenue trends within the portfolio at the company level?

I think two things. Number one, we've still seen revenue and EBITDA growth. I think that's positive. I would say that revenue and EBITDA growth has been slower than we would have seen maybe in the years prior, so I think we are kind of watching that. I think all market participants would probably say this, but we are in an environment where rates have been that most companies' interest coverage ratios are just tighter than we'd probably like it to be. So I think that does provide a backdrop. If there is a challenge, if somebody does lose a customer, they had done a bad M&A deal or what it might be, these kind of issues bubble to the surface more because there's not a lot of room to maneuver anymore. I think that obviously can change a little bit. The one benefit of a falling rate environment is kind of more cash flow at these kind of companies. But I think in totality, it's generally been positive. I think some of the issues that we have seen either in the portfolio or in the market have been more idiosyncratic to the particular name than anything that's more widespread.

And really, the Kabbalist sectors that we've been seen underperforming over the course of the year, sort of continue to be, you know, anything that's sort of touching old retail, which we have very little exposure to. But, you know, consumer product companies are being, you know, far down because the retail is just carrying much lower levels of inventory. People keep talking about de-stocking. I don't know how you de-stock for two years, but I think you're talking about just a lower inventory model And then with industrial, there's certain pockets of weakness given, I think, this year there was more of a conservative outlook on capital spend in a lower rate environment. That should be positive.

Great. Thanks very much. Thanks, John.

Your next question comes from Mark Hughes from Truist. Your line is now open.

Yeah, thanks. Good morning. The repricing activity you've seen, portfolio companies looking for better terms, how has that trended over the last few months? Is that kind of a step function when you see the rates change, or is that just flow with the day-to-day interest rates and the spreads?

I think it's probably maybe a little bit more nuanced than that. I think I think it's based upon what I would call new deal activities. You have data points out there that someone can sort of comp to. I think companies can only really make those tasks because they've had steady performance over a period of time. So the one, let's call it, positive thing of the repricings would be a high correlation to well-performing businesses. I think we would have a thesis, Mark, that As rates do fall, I think that will put a little bit of pressure on spreads to widen. I don't think that will be basis point for basis point in any scenario. But I think general kind of fixed income markets, as the benchmarks sort of change, there will be some impact on credit spreads. Obviously, the benchmark moved almost 500 basis points yesterday. and you've seen some spread reduction since January 22. So I think it is sort of case by case, but I think we would expect, as rates fall, a bit of movement wider on spreads.

Okay. And then have you seen any change in the trajectory on that activity in the recent months, or has it been reasonably steady?

Yeah, I would say it's probably been a little bit slower, right, or at least kind of spreads have settled at a level I think there's a level of where spreads are that on particular deals wouldn't make sense for pools of capital like this. So I think there's a little bit of a floor there. But I think you've seen, let's call it a bit of slowdown or kind of finding kind of that sort of bottom point.

Yeah. And then you talked about passing on more deals based on the a pricing issue, you're maintaining your discipline. When you think about kind of when you do pass credit versus competition, what's the usual dynamic there? And, you know, maybe you can't separate those because they're interrelated, but how significant is that when you get the little tighter mark, how much harder is it to see the origination activity in your usual ratios?

Yeah, I'll probably answer it a little bit differently, but tell me if it makes sense. I think we have, as I mentioned, been happy to see what's called an uptick of activity. I think the larger lenders like us do benefit from these existing portfolios. You can maintain that incumbency position. We can pass on deals for a multitude of reasons. I mean, sometimes it's just the sector or the credit. We're not going to do it. Those deals probably don't even make it to a screening or an investment committee. It's more of a death skill. There are deals we won't play in because of where it's priced versus where we think it should be priced. That said, I think our primary focus is on credit. Then there are structural pieces. There are certain asks on certain deals that we think is a step too far for private debt or liquid credit. And, you know, we've walked away from certain deals, you know, after having done a lot of work on it because it was not comfortable with the structure.

Look, and I think the other thing to note is that our leverage is currently in the middle of our target range. So, you know, there's no, you know, pressure to deploy. I mean, we do, you know, benefit as Dan said from those incumbency provisions. And, you know, when repricings occur, we like to credit, we maintain them. Yeah.

And maybe one last point, Mark, because I think it is important. I think we're very focused on maintaining kind of that broad origination funnel. We've always talked about being active in the upper end of the middle market. We probably classify that as $50 to $150 million of EBITDA. Obviously, when the syndicated loan markets were shut in 22 and 23, we had the opportunity to participate in some larger deals. I think those were kind of very, very good risk-reward opportunities. We are prepared to go down to a lower number than that 50. The floor is probably 25, but there's a very high bar for that. It would be an industry or a sector that we really like. We're probably lending to one of their competitors, so we've got a real view in it that it's going to grow. But we do think it's important to have a broad kind of funnel there. We've got a very active non-sponsor business. We have people dedicated to that. We think that's helpful. You know, we've been active in some of the ABL activity, let's call that receivables and inventory, right? We find those deals quite interesting from a risk-adjusted return perspective. And then our asset-based finance business remains active. We talked about Discover, you know, in our prepared remarks, but, you know, those deals are generally returning, you know, several hundred basis points wide of what we're seeing in direct lending. So I think that broad funnel is an advantage to us and the ability to deploy, you across different companies, sponsor, non-sponsor, and things like asset-based finance is quite important.

Yeah, yeah. Thanks for that perspective.

Appreciate it. Have a good day. Thank you.

Your next question comes from Kenneth Lee from RBC. Your line is now open.

Hey, good morning. Thanks for taking my question. Just one follow-up on that last comment around the asset-based finance opportunities there. I'm wondering which benchmark rates are they typically keyed off, given that they're fixed rates? And it sounds like the spreads are pretty wide right now. Just, you know, any kind of additional color there around that? Thanks.

Yeah, no, happy to give. You know, it is... It is a different, let's call it, return profile in a lot of ways than what you're seeing in direct lending. I think you could either have loan portfolios that you're buying that the underlying loans themselves are fixed rate. We're usually using the bank market or the capital markets to finance those loan portfolios so you can generate kind of that, what I'll call, fixed rate return. even though if it's floating rate loans, if we are financing with floating rate debts, you're effectively creating that more kind of stable or almost fixed rate return profile. In that part of the market, I don't think we think about it entirely like spreads. You're acquiring these asset portfolios, thinking about making a kind of targeted return on it, That's generally in kind of the mid-teens type context. We remain quite bullish on the market opportunity there. We think that market is approaching $7 trillion of market size. That doesn't mean everything's for us, but that does mean there's a lot of white space because there has not necessarily been a lot of scaled capital raised. We're fortunate to have 50 people dedicated to that space. There's some pretty good tailwinds there that we expect to continue to be quite active in.

Gotcha. Very helpful there. And just one follow-up on the comments around the PIC income and the earlier comments you made there. Just wanted to clarify, how much of the PIC income was originally underwritten as PIC versus electing? Thanks.

Roughly half.

Okay. Gotcha. That's all I had. Thanks again. Thank you.

Your next question comes from Melissa Weddle from JP Morgan. Your line is now open. Good morning.

Thanks for taking my questions. Just to follow up on the theme of PIC, definitely take your points that those deals were structured to give some flexibility during perhaps a return around. I'm curious you know, how PIC versus cash paying income will impact sort of if it impacts and to what extent it impacts your fair value marks over time, particularly if you see in certain deals PIC persisting longer than you would have originally expected.

Yeah, good morning, Melissa. You know, I would say, and Brian, you might want to add to this, it's probably, you know, it's going to be very much on a case-by-case basis. I think you could probably make a correlation that if a company is forced to pick for an extended period of time, the company could be underperforming. But on the other side of that, you could have, because these companies are in turnaround, either the seeds being planted or some meaningful let's call it upside kind of on the revenue side. So, you know, I think you are independently valuing this, these businesses based upon, you know, what their financial performance is and all the other inputs that would go into the valuation model. So, you know, there's probably not kind of the perfect answer, but, you know, it's, and Brian, feel free to add to that.

Yeah. I mean, look, when you, Owning a business, you're always making capital decisions and trying to figure out what dollars can be invested at the highest return on capital. So, I mean, that sort of goes to the commentary of flexibility because we are very much focused on the long-term exit in all of these. And, look, it's going to be performance-related in terms of and capital decision-making-related decisions as we go forward in terms of whether the companies continue to pick or not.

Okay.

And then to your comments about rates likely to trend lower, but the initial thought is maybe they won't go as low or as quickly as we would have thought a few months ago. You know, does that impact how you're thinking about sort of credit trends across the industry broadly? We think if there's, you know, a slower pace of rate decline that a natural trade-off on that would be a bit more distressed or default activity.

Thanks. It's a fair question, and I think our thoughts on this are probably evolving. Obviously, there were some pretty big market moves in the last couple of days. I think we've always expected the Fed to be disciplined as they bring down rates. I think the Fed's done a a nice job of getting inflation under control. I think there are certain things that could happen in this Republican administration that could be viewed as inflationary. That said, I think the big focus of the election was to make sure inflation is under control, so I think it will be balanced there. I don't think that slower pace, though, Melissa, is kind of that long to have a real impact to kind of credit. I just, you know, if you were thinking that there was going to be you know, three or four rate cuts in the next, let's call it, you know, 12, 18 months. You know, maybe you're just kind of one slower than that or one less than that. But it's, I think it'll be interesting to watch how that kind of plays out in the coming months and the coming quarters.

Yeah, look, I'd add is, you know, where it's less constructive is to the equity in these deals. You know, higher rates have extended the hold periods for companies because we've had less cash to spend on debt, which is how an LDO works. So if the extent rates stay higher, it could extend, but that's offset by the pressure that LPs are putting on GPs to sell assets and return capital.

So there's certainly a balance there. Got it. Thank you. Thank you.

That concludes our question and answer session. I'd now like to hand back over to Dan Pietrzak for a purger remark.

Well, thank you, everyone, for your time today. We're always available for any follow-up points as needed. We do wish everyone a great holiday season, and we'll talk with you next quarter. Thank you.

Thank you for attending today's call. You may now disconnect. Have a wonderful day.