FS KKR Capital Corp. (NYSE:FSK) Q3 2023 Earnings Call Transcript

FS KKR Capital Corp. (NYSE:FSK) Q3 2023 Earnings Call Transcript November 7, 2023

Operator: Good morning, ladies and gentlemen. Welcome to FS KKR Capital Corp’s Third Quarter 2023 Earnings Conference Call. [Operator Instructions] Please note that this conference is being recorded. At this time, Robert Paun, Head of Investor Relations, will proceed with the introduction. Mr. Paun, you may begin.

Robert Paun: Thank you. Good morning and welcome to FS KKR Capital Corp.’s third quarter 2023 earnings conference call. Please note that FS KKR 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 30, 2023. The 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, 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 6, 2023.

Non-GAAP information should be considered supplemental in nature and should not be considered in isolation or as a substitute for the related financial information prepared in accordance with GAAP. In addition, these non-GAAP financial measures may not be the same as similarly named measures reported by other companies. To obtain copies of the company’s latest SEC filings, please visit FSK’s website. Speaking on today’s call will be Michael Forman, 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 in the room are Co-Chief Operating Officers, Drew O’Toole and Ryan Wilson. I will now turn the call over to Michael.

Michael Forman: Thank you, Robert and good morning, everyone. I’d like to start by acknowledging the tragedy in the Middle East and the loss of innocent lives. Like so many of you, I was shocked by the invasion of Israel. To the many people who have had family, friends and loved ones impacted by these devastating and tragic events, our hearts go out to you. And now, turning to FSK’s results for the third quarter. Our financial and operating results showed continued strength as we exceed our earnings guidance and outearned our quarterly base and supplemental distribution. During the third quarter, we generated net investment income totaling $0.84 per share and adjusted net investment income totaling $0.80 per share as compared to our public guidance of approximately $0.79 and $0.76 per share, respectively.

Our net asset value per share at the end of the third quarter was $24.89 which is equal to our net asset value per share at the start of the year. During the third quarter, our net asset value per share increased by approximately 1%. Based on our positive operating results, our Board has declared a fourth quarter regular quarterly distribution of $0.70 per share. consisting of our base distribution of $0.64 per share and a supplemental distribution of $0.06 per share. As many of you will recall, in May of this year, we declared a series of 3 special distribution payments totaling $0.15 per share. The third $0.05 per share installment will be paid at the end of this month. Based on our continued strong performance, coupled with our positive earnings outlook, I’m pleased to announce that our special distribution will continue for the next 2 quarters and amount totaling $0.10 per share.

Consistent with our corporate view of sharing additional earnings with our investors on a real-time basis, this special distribution will be paid in 2 equal installments of $0.05 per share in the first and second quarters of 2024 and will be on top of our quarterly base and supplemental distributions which currently total $0.70 per share. From a solid-looking perspective, we continue to be optimistic about the growth in the private credit sector which provide significant tailwinds for our industry. In general, our portfolio companies have been adjusting well to the higher interest rate environment as we have not seen significant increases in credit stress or defaults. FSK continues to generate strong earnings and has ample liquidity to take advantage of new, high-quality investments as well as to support our existing portfolio companies through add-on 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.

Dan Pietrzak: Thank you, Michael. In the wake of continued inflationary pressure and higher for longer interest rates, private credit continues to be an attractive asset class due to its directly negotiated transactions, predominantly floating rate infrastructures and significant issuer diversification. As a result of these and other positive attributes, private credit is continuing to become an increasing allocation for institutional investors. As we mentioned on last quarter’s call, we have seen an increase in deal flow as M&A activity continues to ramp. In addition, there are recent signs that the syndicated markets are beginning to stabilize, with activity picking up in that part of the market as well. At the same time, we are seeing some pressure on spreads in the upper end of the middle market as spreads have tightened by 25 to 50 basis points during the quarter.

With private equity funds holding more than $2 trillion of dry powder, we continue to believe sponsors will utilize private credit solutions to finance transactions. Turning to investment activity; during the third quarter, we originated $504 million of new investments. Over 65% of our investments were focused on add-on financings to existing portfolio companies and long-term KKR relationships. Our new investments combined with $386 million of net sales and repayments, when factoring in sales to our joint venture equated to a net portfolio increase of $118 million. In terms of recent deployment opportunities, 1 new investment of note is a partnership with PayPal. KKR Credit has agreed to purchase approximately €40 billion of PayPal’s consumer receivables originated in Europe.

FSK has committed approximately €80 million towards the transaction. Having the ability to work exclusively with a strategic partner like PayPal is a testament to the strength and maturity of KKR Credit’s asset-based finance business. In terms of interest coverage, at the end of the third quarter, our portfolio companies had a median interest coverage of 1.5x. For clarity, this calculation uses base rates as of June 30, 2023, to align with portfolio company financials. While the higher rate environment has impacted certain companies, overall credit performance continues to be stronger than many market observers anticipated. As companies in the larger end of the private credit market have demonstrated their ability to pass along price increases while simultaneously navigating their labor and other input costs.

Despite the challenging macro environment, we continue to see portfolio company revenue and earnings growth. We remain focused on large, high-quality borrowers with strong operating margins and deep equity cushions. The weighted average EBITDA of our portfolio companies was $212 million as of September 30, 2023. Additionally, our portfolio companies reported a weighted average year-over-year EBITDA growth rate of approximately 6% across companies in which we have invested in since April of 2018. And with that, I’ll turn the call over to Brian to discuss our portfolio in more detail.

Brian Gerson: Thanks, Dan. As of September 30, 2023, our investment portfolio had a fair value of $14.7 billion, consisting of 200 portfolio companies this compares to a fair value of $14.8 billion and 195 portfolio companies as of June 30, 2023. At the end of the third quarter, our 10 largest portfolio companies represented approximately 19.5% of the fair value of our portfolio which is consistent with prior quarters. We continue to focus on senior secured investments as our portfolio consisted of approximately 60% first lien loans and 68% senior secured debt as of September 30. In addition, our joint venture represented 9.6% 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 68% of our total portfolio and senior secured investments totaled approximately 76% of our portfolio as of September 30.

The weighted average yield on occurring debt investments was 12.2% as of September 30, 2023, compared to 12.1% as of June 30. As a reminder, the calculation of weighted average yield is adjusted to exclude the accretion associated with the merger with FSKR. Similar to recent quarters, the increase in our weighted average yield during the third quarter was primarily associated with the continued rise in base rates, including the effects of our investment activity during the third quarter as of September 30, 2023 and approximately 86% of our total investment portfolio is comprised of investments originated either by KKR Credit or the FS/KKR Advisor. During the third quarter, excluding the impact of merger accounting, we experienced net portfolio appreciation on investments of approximately $23 million.

During the quarter, we placed 1 debt investment on nonaccrual. The company is named Barry Farming and it is 1 of the largest vertical farming businesses in the U.S. a smaller position in our portfolio as the first lien loan has a cost basis of $52 million and a fair value of $13 million as of September 30. We also received a $15 million pay down at par during the quarter. As of September 30, 2023, non-accruals represented 4.8% of our portfolio on a cost basis and 2.4% on a fair value basis compared to 4.8% on a cost basis and 2.5% on a fair value basis as of June 30, 2023. We believe it is helpful to provide the market with information based on the assets originated by KKR Credit. As of the end of the third quarter, non-accruals related to the 86% of our total portfolio which has been originated by KKR Credit and the FS/KKR Advisor were 2.3% on a cost basis and 0.6% on a fair value basis.

Additionally, since the start of the FS/KKR Advisor almost 6 years ago, the adviser has originated over $22 billion of investments and has experienced an annualized cost basis nonaccrual rates of less than 1%. And with that, I’ll turn the call over to Steven to go through our financial results.

Steven Lilly: Thanks, Brian. Our total investment income increased by $3 million quarter-over-quarter, to $465 million. The primary components of our total investment income during the quarter were as follows: total interest income was $374 million, a decrease of $2 million quarter-over-quarter primarily driven by the $500 million in asset sales we mentioned last quarter. Dividend and fee income totaled $91 million, an increase of $5 million quarter-over-quarter as our joint venture experienced approximately $3 million in onetime fees and dividends. Our total dividend and fee income during the quarter is summarized as follows: of recurring dividend income from our joint venture, other dividends from various portfolio companies totaling approximately $21 million during the quarter and fee income totaling approximately $12 million during the quarter.

Our interest expense totaled $117 million, a decrease of $1 million quarter-over-quarter due to the decline in net debt to equity from 113% at June 30 to 110% at September 30. Our weighted average cost of debt was 5.3% as of September 30. Management fees totaled $56 million and incentive fees totaled $47 million, both unchanged quarter-over-quarter. Other expenses totaled $11 million during the third quarter, a decrease of $1 million. The detailed bridge in our net asset value per share on a quarter-over-quarter basis is as follows: our ending 2Q 2023 net asset value per share of $24.69 was increased by GAAP net investment income of $0.84 per share and was increased by $0.11 per share due to an increase in the overall value of our investment portfolio.

Our net asset value per share was reduced by our $0.70 per share quarterly distribution and the $0.05 per share special distribution. The sum of these activities results in our September 30, 2023, net asset value per share of $24.89. From a forward-looking guidance perspective, we expect fourth quarter 2023 GAAP net investment income to approximate $0.74 per share and we expect our adjusted net investment income to approximate $0.77 per share. Detailed fourth quarter guidance is as follows: our recurring interest income on a GAAP basis is expected to approximate $377 million. We expect recurring dividend income associated with our joint venture to approximate $53 million. We expect other fee and dividend income to approximate $23 million as we expect normal course asset-based finance dividends to be incrementally lower in the fourth quarter.

From an expense standpoint, we expect our management fees to approximate $56 million. We expect incentive fees to approximate $42 million. We expect our interest expense to approximate $117 million and we expect our other G&A expenses to approximate $10 million. During the fourth quarter, we expect our excise taxes will approximate $22 million. We expect the net effect of excise taxes to be partially offset by the accretion of our investments due to merger accounting which is why our projected fourth quarter GAAP net investment income is $0.04 per share below our anticipated adjusted net investment income. Our gross and net debt to equity levels were 115% and 110%, respectively, at September 30, 2023, compared to 118% and 113% at June 30, 2023.

At September 30, our available liquidity was $3.6 billion. Approximately 59% of our drawn balance sheet and 42% of our committed balance sheet was comprised of unsecured debt. In October, we further enhanced our liquidity and debt maturity profile by closing an amendment to our senior secured revolving credit facility. The amendment provides for, among other things, an increase in total commitments to $4.67 billion and an extension of the maturity date to the fourth quarter of 2020. We were very pleased to complete this amendment as it is reflected both of the strength of the FSK platform as well as the long-term relationships we are fortunate to maintain with the investment community. And with that, I’ll turn the call back to Michael for a few closing remarks before we open the call for questions.

Michael Forman: Thanks, Steven. In closing, we are pleased with our third quarter results and our year-to-date performance as our net asset value at the end of the third quarter was flat compared to the start of the year. Our adjusted net investment income in the quarter exceeded both our public guidance as well as our total dividend. Our underlying portfolio companies are performing well from a credit perspective and we deployed capital into compelling new transactions. With available liquidity of $3.6 billion and a strong balance sheet, we have ample capital to invest in attractive risk-adjusted opportunities we are seeing in the market. On behalf of the team, we thank you all for joining the call and for your continued support. And with that, operator, we’d like to open the call for questions.

Operator: [Operator Instructions] Our first question comes from John Hecht with Jefferies.

John Hecht: One of you guys talked — and I think it’s kind of the second time early talked about the pipeline activity increasing. I’m wondering if you can kind of describe — I mean, we’ve heard of, I guess, some increase in M&A activity and maybe some LBO activity. I’m wondering, can you characterize the kind of sources of the pipeline? And then what’s the competition around that pipeline? Is that shifting at all relative to the last 4 to 6 months as well?

See also 14 Best Cyclical Stocks To Invest In and 20 Most Common Places to Get Kidnapped.

Q&A Session

Dan Pietrzak: John. I’d put it into a couple of different sort of buckets of terms of the pipeline activity. One of it’s just been we’ll call it, sort of live processes, albeit that’s probably still not maybe to the level that you would expect in any sort of normalized market but a certain amount of green shoots there. And then some of it has also been, we’ll call it, either early reads or companies that we know are kind of gearing up for a sales process as we get further into ’24. So my sense is you’re going to see the — and we said this on the last call, it will take, I think, several quarters for us to kind of get through the system where things kind of actually fund. But I think you’ll see the majority or at least where we’re sitting today, the majority of that activity in kind of probably Q2 through Q4 of ’24 in terms of additional kind of actual closed and funded deal flow.

In terms of competition, I’m assuming that means kind of who’s kind of funding the deals. I do think the market is decently competitive right now. I think that’s a little bit of the technical. There just hasn’t been a lot of deals and people kind of want to do some and stay funded and get to their target leverage or sort of deployment numbers. But I think the quality of those deals remains very high and having the ability to earn kind of plus 12% on them for kind of good, large companies, 1 sort of risk with good sized equity checks. We still feel quite constructive on the market opportunity.

John Hecht: Okay, that’s helpful. And then, second question is maybe just could you give us an update on the asset-based finance pocket or pool and as well as the credit opportunities partners. I just — I know particularly asset-based finance, you’ve been particularly busy this year. I wonder, is that activity persisting?

Dan Pietrzak: Yes. I mean so on the asset-based finance side, it has been a very kind of busy time for us there. I think our platform is meaningfully built out with over 50 people dedicated to the space. We’ve got a fair amount of AUM dedicated to that space and the ability to kind of play up and down the capital structure which I think is a real nice competitive advantage for us. I think we always think about that market as having a lot of white space. We estimated sort of $5 trillion today, sort of on its way to $7 trillion. So that’s sort of quite positive. But what’s been going on with the regional banks has been a real sort of tailwind to that, either in allowing us to acquire asset portfolios or essentially fill the void from where they’ve taken a step back.

So I think we’ve been quite happy with what we’ve seen there. I think on the joint venture, I think the team has done a good job of in seeing that sort of continue to grow in terms of assets. I think we’ve got quite a strong liability sort of structure there. I think we like the returns that is still being sort of put from that or sort of off of that joint venture. And it just has real size and my number might not be perfect here. But we’d be, I think, maybe the seventh largest BDC if we were on a stand-alone basis, just sort of our joint venture. So I think we like the size and scale we have there as well.

Operator: Our next question comes from Casey Alexander with Compass Point Research & Trading.

Casey Alexander: Yes. Just one question, maybe two. How to position Solera that was picking in the second quarter and was supposed to pick for two quarters, we’ve now moved into the fourth quarter. Has that 1 reverted now back to cash pay? And how is that company doing?

Dan Pietrzak: Casey, the position has reverted back to cash pay. It did that at the end of Q3 but you won’t see the impact kind of really, we’ll call it come through the numbers. So that’s why the pick income would have been sort of elevated in the quarter as it was in the second quarter. You will see that it’ll move entirely to sort of cash pay and that was I think, almost 30% are out of the sort of total sort of pick amount and the company performance is strong in our mind.

Casey Alexander: Yes. Okay, good. Great. Secondly, are you willing to add some on balance sheet exposure? I mean most of the exposure that you’ve added over the last several quarters has all gone to the JV. The JV is now at about 10% — and maybe you addressed this a little bit but where can you grow the overall portfolio? Do you still have to go to the JV? Or can you add some to the on-balance sheet exposure?

Dan Pietrzak: No. I think you should expect to see the on balance sheet number sort of grow as well. Just I think we did add 2 89 to the joint venture this quarter. I don’t think anything went to the joint venture for the last quarter. I think we’re kind of well inside our target leverage number at FSK, I think we’re pretty happy with what we see in terms of dry powder in the entity, including the revolver sort of extended. So I think you should expect to see while still with inside that sort of target range, as kind of continuing to add assets on FSK’s balance sheet as we sort of move forward.

Operator: Our next question comes from Kenneth Lee with RBC Capital Markets.

Kenneth Lee: In terms of the upper middle market segment, I wonder if you could just talk a little bit more about what you’re seeing in terms of trends around covenants or terms for some of the more recent investments and whether you’re seeing any change there?

Dan Pietrzak: I think that sort of term upper end of the middle market has a pretty sort of broad definition, right? I think we’re sort of talking to folks, that’s probably more in the $100 million to $150 million of EBITDA. But I think in recent sort of quarters, it’s even gone sort of beyond that as the syndicated loan market has been shut and private debt has really been, I think, the only game in town I do think we started the year as an extremely, we’ll call it, lender-friendly environment, I think we’ve probably come off that a bit and we mentioned about seeing a certain amount of spread compression. That said, I think more and more companies continue to access private debt as a financing source I think especially doing that in times of volatility and they’re looking for certainty of sort of financing.

But I think just a lot of folks are being sort of drawn to this market versus the broadly syndicated market. The broadly syndicated market is never going to go away. I think private debt just become kind of an equal sort of peer there. So, I think we’re still seeing very good structures I think the market has had a good amount of discipline as it relates to some of the documentation weaknesses that we may have seen in the broadly sort of syndicated market but just a little bit tighter on pricing, as we mentioned in our prepared remarks.

Kenneth Lee: Got you. That’s very helpful there. And then 1 follow-up, if I may. In terms of the supplemental distributions — wonder if you could just share some initial thoughts on visibility, confidence and the potential line of sight around supplementals for next year?

Dan Pietrzak: Yes and I’ll start to this and Steven Lilly might want to add to it. Obviously, we’ve had the sort of base in the supplemental and then we had the $0.15 of special for 2023. I think that, that is a good story in our mind. We’ve told the market we were going to pay sort of additional earnings as they were sort of earned by sort of FSK. I think that will put roughly at $2.95 of sort of total dividends paid for the year which I think is quite attractive for our investors and obviously a big sort of focus for ours. We feel confident to extend that special. That’s the $0.10 that was mentioned in the prepared remarks. I think by definition, that means we feel confident about the supplemental as well kind of in the near term. And I think you should expect the basin supplemental to remain in the coming quarters.

Operator: Our next question comes from Ryan Lynch with KBW.

Ryan Lynch: I had several questions on kind of the transaction with the PayPal consumer loans. I know it’s kind of a small transaction but it’s definitely interesting. So I guess, first off, how are those loans being placed on your balance sheet? I saw a small equity investment of $2 million but — are those loses going to be directly placed on your balance sheet? Or are they going to be in some sort of like SPV entity.

Dan Pietrzak: Yes. And Ryan, happy to talk about that. I mean, I don’t think it was actually a small investment, considering we’re going to buy €40 billion over the coming years. Obviously, this was a strategic transaction for both us and for PayPal. And there’s a fair amount of, I think, public sort of statements out there that we can kind of point to. I think that said, the receivables are short which is why that $40 billion number does seem high. The book will probably turn 6x per year. The €80 million that’s kind of mentioned in the script was FSK share of the overall sort of deal and the deal is the receivables are essentially going into an SPV, there are certain banks providing financing to that SPV and then FSK and the other KKR credit accounts are providing the remainder of the capital. That $2 million piece was just the initial funding but you should expect it to ramp fully over the coming quarters.

Ryan Lynch: Okay. And then so the $80 million that’s going to FSK, that was kind of I was talking about the smalls. Is that expected to grow over time? Or how do you kind of view your overall exposure to these loans? And maybe it’s too early to tell. And then I guess also, what should we expect with sort of the — it sounds like it turns over a lot which would make sense. What are sort of the return expectation for these types of loans?

Dan Pietrzak: Yes. I mean I think you should expect that number to be sort of the target at least for the near sort of medium term. It might very well sort of grow from there as the program continues to take off. I think like most things in our asset-based finance bucket, we view them as extremely attractive from we’ll call it, a downside protection basis, we think because these are either secured receivables or short-duration receivables, we have a great amount of confidence in the repayment profile. But that we’re generally trying to do deals inside this strategy at kind of, let’s call it, mid-teens plus, right? So view it as great diversification to a corporate credit book, well protected from when we think about sort of the downside and effectively return enhancing versus just regular way direct money.

Ryan Lynch: Okay. And then 1 last 1 on it. Are these sort of loans that were previously going to — I know it’s Europe, so maybe it’s not relevant but I’m thinking you mentioned earlier that kind of the slowdown of regional banks sort of lending? Are these the types of loans that would fit into like regional bank, these consumer financing type loans that this is the reason that is kind of stepping in to fill that void or where were these loans have previously been going in.

Dan Pietrzak: Yes. That wouldn’t have been the case for a transaction like this. I mean you don’t have the same regional banking model in Europe than you have in the U.S. So that sort of concept is generally not the same. This was talked about a bunch on sort of the PayPal side. This was all funded on PayPal’s balance sheet before this deal.

Ryan Lynch: Okay, got you. And then, I just had one question outside of the PayPal discussion. You talked about a lot of companies and deals sort of gearing up now that will take a while to sort of incubate and could come to fruition maybe in the second quarter and beyond in 2024. I’m just curious, what sort of do you think assumptions that these companies are making in order for these deals to transact? And maybe said it differently, are these deals dependent on sort of rate cuts or stabilizing base rates? Or is the current environment if it just stays steady with rates stay where they are, the environment sort of stays stable — do you think that that’s good enough to have these deals sort of come to fruition? Just from a high level, I know every deal is specific but just kind of high level.

Dan Pietrzak: No, it’s a fair question. I think just sort of stable will be, we’ll call it, enough of a catalyst or market conditions to allow that to get done. I think you’ve had valuation mismatches for some time now between out of the seller and sort of the buyer. I think those have, we’ll call it started to narrow. I think at least of our view is we’re in an environment of higher rates for longer. And I don’t think the inflation story is done but I think it’s become — we’ll call it much more manageable and sort of under control. And I do think you have the other sort of point out there. In the private equity community, I think there is a growing amount of pressure for realizations and money to be returned to LPs. And then there’s also a lot of dry powder sort of sitting on the sidelines, right?

So that’s why I think if we could just stay in a — we’ll call it a stable type kind of macro which obviously is a lot going off. So maybe that will be sort of hard. But I think we say that, that will be the catalyst to get that done. We’ll get these deals coming to market as we get through ’24.

Operator: Our next question comes from Melissa Wedel with JPMorgan.

Melissa Wedel: I was hoping to follow up on a couple of the comments that were made, I believe, during the prepared remarks. 1 speaking to the strength of the opportunity set in asset-based finance. But then I think Steven also mentioned expecting lower asset base finance dividend income in 4Q. I was hoping we could just dig into that a little bit.

Dan Pietrzak: Yes. It’s a good and fair question. I would probably separate the 2 just for 1 second. I think the market opportunity or the investing opportunity is quite strong. It’s systematic that we believe a lot in and this place that we’ve been kind of very sort of we’ll call it focused on. I think each of the deals is a little bit different. Sometimes the deals when deployed have to get to scale before they can start to pay a dividend. So you can have a certain we’ll call it, sort of timing mismatch. And then there’s a handful of deals that we are looking to we’ll call it, do certain positive things on the liability or sort of financing side which will kind of restart that process where dividends might be slower. But if I think about it more in terms of a timing mismatch that a permanent to the point — on the dividend side.

Melissa Wedel: Got it. That’s helpful I was also hoping we could touch on 1 portfolio company. I believe Grace was on the nonaccrual list previously. It looks like it was removed and marked up back to par in 3Q. I was hoping we could just touch on that. Was that a restructuring? Do they get current. Could you give us some detail there?

Dan Pietrzak: Yes. I mean it’s been probably a multipronged restructuring over the last probably 24 months and Brian might want to sort of add to this. But I think we’ve reached what we call the next phase of that. This was a legacy adviser position that had sort of a meaningful amount of challenges. The business has kind of shrunk sort of materially. And I think there was some additional sort of capital put into it as it relates to this quarter as well which kind of triggered it sort of going off that nonaccrual list but it’s a pretty small position at this point.

Operator: Our next question comes from Robert Dodd with Raymond James.

Robert Dodd: Going back to the ABS, the dividend income for Q4. Obviously, I mean, [indiscernible] call it these days. The dividend went down this quarter. Is any of the relatively lower, still very healthy. of dividends from the asset-backed finance connected to the real estate market, we’re going to obviously have exposure in directly there? Or is there something else just normally seasonal — and that’s obviously, to your point on, that’s the timing issues and things like that. But is there a real estate back plan?

Dan Pietrzak: And I mean I’ll answer the question but if I missed something, let me know because it was a little bit hard to hear a couple of points in there. I mean I think on the example of sort of Toorak, I mean Toorak, the underlying loan performance has been quite strong. And I think we’ve been sort of happy to see that. But like a lot of sort of asset classes out there right now, that would fall on to 1 where the cost of financing, so it generally has gone up more than the yields on the underlying loans. So that has had put some sort of, we’ll call it, stress on net income or sort of ROE there. They do have the benefit of having been a very frequent issuer and having the ability to those deals revolve. So as loans repay, they can continue to add to those.

But I think this goes a little bit to Melissa’s question as we think about kind of forward financing some of those structures might kind of trap cash in the entities for sort of a longer period of time. So I’d say it’s not seasonal. We try to run that book as neutral as we can from sort of a rate perspective. But there’ll be some amount of kind of refinancing risk there or sort of term out sort of point that to be mindful.

Robert Dodd: Understood. And that does answer the question for me. On — 1 more — you talked about, obviously, there’s a little bit of spread compression now. The syndicated market seems to be showing some signs of life not all the way back yet by at I mean what are your thoughts over the more conceptual over the next 12 months call? Is there a risk spreads in the private credit market that if the syndicated market comes back more aggressively, that puts meaningful spread compression risk in the private credit side. Given base rates are so high, you can obviously — that could be handled without a problem. Does that create a dynamic where the spread compression risk is maybe elevated if the syndicated market comes back while base rates are very high.

Dan Pietrzak: Yes. I mean, it’s a very fair question. I don’t think so. But I don’t think so for a couple of reasons. I think there’s a bit of a floor level to where this market sort of might vary well get to. Now part of that is driven by a bunch of the pools of capital that sort of invest here might be sort of levered pools but I think you’re always going to have a certain amount of a gap between the private debt market and the syndicated market. I think — I think we’ve talked about this on some prior calls. I think if you looked at deals that were done, the beginning of kind of ’22, the market spread was probably 5.75 [ph] kind of on average. I think that would have gapped out in the beginning part of this year to probably 6.75 [ph] on average.

And that’s a pretty big move considering the benchmark also jumped almost 450-plus basis points and that’s something just comparing that basis point number versus the floor that was in kind of the deals. So now I think you’re back down to you’re looking at deals today that are probably kind of 6 to 6.25 [ph]. But I think that’s — I think those are going to be range bound generally in there. And I think it will be somewhat subject to deal volumes, the desire for people sort of to deploy capital and that there’s been maybe excess capital raise that’s looking to get deployed quickly.

Operator: Our next question comes from Bryce Rowe with B. Riley.

Bryce Rowe: I wanted to start with some questions on just the nonaccrual bucket and some of the specific nonaccruals. I think last quarter, you talked about winter and NBG going through a restructuring or bankruptcy process. Can you provide us an update on those as you look at the kind list, not much change in either 1 of those from a fair value and cost perspective, at least within that nonaccrual category.

Dan Pietrzak: Yes, happy to, Bryce and Brian might want to add to these as well. But I think on the winter side, we announced on the last call, this kind of agreement reached as it relates to a restructuring those processes take time. I think we do expect that to get done, hopefully, at some point in Q4, sort of early sort of Q1. But that’s progressing along I think as we would expect and I think we’ve been happy with what we’ve seen in terms of stable performance at the company level. I think the NBG process is pretty much complete. But anything you want to add, Brian?

Brian Gerson: Yes. On NBG, we restructured that business around their lighting fixtures business. which has historically been a relatively strong performer within their portfolio. That’s really the basis of our investment going forward — working closely with the management team on optimizing results, working through costs, working through sales, all those sorts of things. So that’s sort of gone through the restructuring. Now we’re on the other side and now it’s going to come down to execution.

Bryce Rowe: Okay. Okay. That’s helpful. And then maybe 1 more on the nonaccruals. I mean Global Jet dominates the nonaccrual list. I think it’s 60% plus of the nonaccruals fair value marked at a relatively high 75% to 80%. I mean, Dan, what would it take to get that account back to accrual status. Any kind of update you can provide there?

Dan Pietrzak: Yes, I think you’re spot on, on your numbers. I mean it is 40% of the cost number and I think it’s 65% of the fair market value. We’ve talked about the name a couple of different points on the calls. I think the management team inside the company has done a very nice job. I think the underlying asset class, private jets has had a fair amount of tailwinds, no pun intended on the other side of COVID. And remember, there — it’s a leasing business mainly but a lending business as well. Their obligors are both high net worth but also some of the larger kind of corporates in the world. So the performance has been, I think, quite strong. We’ve actually taken a fair amount of cash dividends out of the company and that’s been a return of capital over the last handful of quarters.

I think that’s probably more likely the path forward for ’24. But I don’t think the book has a delinquency in it right now. So I think the question — or the — maybe the harder thing for that business has just been who their competition has been and what the available ROE has been. But again, I think they’ve done a really good job to get to where they are today.

Steven Lilly: Yes. And I’d just add, I think specifically, their ROE has improved significantly. Several years ago in sort of low single digits now it’s in the high single digits. Still is likely to be a little bit better but it’s certainly come a long way and we’re pleased to see the performance of the book.

Operator: Our next question comes from Erik Zwick with the Hovde Group.

Erik Zwick: First question for me. Just curious about your thoughts on the outlook for the weighted average yield for the portfolio going forward, just given your comments about some spread compression for new originations and I guess, interest rates stay kind of in this general range here is — have we kind of seen are we near the peak for this cycle? Or is there opportunity to realize a little bit more as some older vintages with lower yields and lower spreads kind of roll out and you replace them with new and just curious on any thoughts there.

Dan Pietrzak: Yes. I’m not sure, Eric. Your instinct is entirely wrong in terms of probably being kind of near a peak. I think kind of quarter-on-quarter, there’s probably a little bit of we’ll call it further upside, if you just like a kind of spot SOFR at June 30 spot SOFR at kind of 9/30 and some of these loans have kind of reset periods that might be sort of 90 days. So it takes a little while for it to go through the system. I think on the other side of that, maybe to the positive, you I think once we do start to see repayment, some of that could be on the lower-yielding stuff that was sort of maybe put on lower yielding sort of inside the confines of the book or maybe it gets refinanced for some of the companies that are highly performing.

But then, I do think we’re in this environment of rates higher for longer. I think that’s got a great tailwind for income for FSK which we’re sort of quite happy about but I’m not expecting we’ll call it, meaningful upticks from here as it relates to kind of short-term result for rates.

Erik Zwick: That’s helpful. And then 1 last 1 for me and I may have missed it in the prepared remarks. Can you update us on your current spillover position?

Dan Pietrzak: Yes. Steven, do you want to take that?

Steven Lilly: Yes, Eric, we’re continuing to be north of 2.5 quarters’ worth of dividends which is 1 of — we sort of hit that target, we’ve said on prior calls which was the impetus for our special distribution that we started during — earlier this year in 2023. And obviously, we just announced in conjunction with earnings that, that will continue for at least another 2 quarters during the first half of 2024. So pleased to have met that target. It’s another we think of as a sort of a nice asset to have and then share that excess with shareholders.

Operator: Our next question comes from Mark Hughes with Truist.

Mark Hughes: Just 1 question. Any material change in the prospects to generate the fee income once the market loosens up you’ve been holding the loans longer, you and everyone else. And presumably, the prepayment fees would be correspondingly lower. How sensitive is that income stream through the passage of time here?

Dan Pietrzak: I mean it’s an interesting point, Mark. And one, I think clearly, origination volumes, I think, for us and the industry broadly have been sort of lower, right? I think you can see that in the fee income numbers that you see. But if you do look back kind of to the same quarter a year ago, I think your fee income was 2x or 2.5x the size of sort of where it is today. So I do think that’s a nice, let’s call it, natural — even if we do see a certain amount of repayments, those repayments could generate, depending on when the loan was put on a certain amount of exit fees but then the new deals will generate a certain amount of kind of new deal fees as well. And I don’t think — I think the current quarter was $12 million of fee income. I think that’s lower than any kind of normal and historical sort of average. So there is a bit of balance there. I think it’s a very good point.

Operator: Our next question comes from Jordan Wathen with Wells Fargo Securities.

Jordan Wathen: Can you just give us some context on the decision to keep pure fishing second lien on accrual last quarter? It looks like that June 30 mark might have been informed by some discussions about exiting that position at a loss.

Michael Forman: And Jordan, just can you repeat the question because you faded out a bit at the end.

Jordan Wathen: Last quarter, you kept pure fishing second lien on accrual. It looks like this quarter, you exited that at a loss and that market at June 30 may have been informed by discussions with the sponsor about exiting that position at a loss. So I’m just curious, basically, why did you keep that asset on accrual last quarter? Is there any…

Dan Pietrzak: I think there’s sort of 2 points to this. The number one, you are correct. Probably most importantly, we have exited that position. I think that was in many ways, a good sort of outcome or a good result at the end of the day. And I think a bit of a testament to how we kind of risk manage the book. I think we were the asset continued to sort of pay cash. I do think the long-term prospects of that business will be — we’ll call it positive. I think it’s got some real sort of brands kind of attached to it. I think those were the drivers of the kind of accrual points and then the drivers of the sale was just kind of prudent risk management but it’s an exited position now.

Operator: I’m showing no further questions at this time. I’d now like to turn it back to Dan Pietrzak for closing remarks.

Dan Pietrzak: Well, thank you, everyone, for taking the time to join the call today. We’re available for any follow-up points as needed and we wish you and your families a happy and healthy holiday season. Thanks, again.

Operator: Thank you for your participation in today’s conference. This concludes the program. You may now disconnect.