FS Investment Corporation's (FSIC) CEO Michael Forman on Q2 2014 Results - Earnings Call Transcript

| About: FS Investment (FSIC)

FS Investment Corporation (NYSE:FSIC)

Q2 2014 Earnings Conference Call

August 18, 2014 09:00 AM ET

Executives

Michael Forman - CEO

Brad Marshall - Senior Portfolio Manager, GSO Blackstone

Jerry Stahlecker - President

Analyst

Jonathan Bock - Wells Fargo Securities

Troy Ward - KBW

Greg Mason - KBW

Arren Cyganovich - Evercore

Mickey Schleien - Ladenburg

Henry Coffey - Sterne Agee

Operator

Good morning and welcome to the FS Investment Corporation’s Second Quarter Earnings Call. Please note that FS Investment Corporation may be referred to as FSIC, the Fund, or the Company throughout the call. Today’s call is being recorded and an audio replay of the conference call will be available for 30 days. Replay information is included in a press release that FSIC issued on August 15, 2014.

In addition FSIC has posted on its Web site a presentation containing supplemental financial information with respect to its portfolio and financial performance for the second quarter ended June 30, 2014. A link to today’s webcast and the presentation is available by going to the Investor Relations section of the Company’s Web site at www.fsinvestmentcorp.com. Please note that this call is the property of FSIC. Any unauthorized rebroadcast of this call the property of FSIC. Any unauthorized rebroadcast of this call in any form is strictly prohibited. I would also like to call your attention to the customary disclosure to the FSIC filings with the Securities and Exchange Commission regarding forward-looking statements.

Today’s conference call includes forward-looking statements and projections and we ask that you refer to FSIC’s most recent filings with the SEC for important factors that could cause actual results or outcomes to differ materially from these statements and projections. FSIC 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 FSIC’s second quarter 2014 earnings release that was previously furnished to the SEC. 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 entitled measures reported by other companies. To obtain copies of the Company’s latest SEC filings, please visit FSIC’s website.

I’ll now turn the call over to Michael Forman, Chairmen and Chief Executive Officer of FS Investment Corporation. Mr. Forman, you may begin.

Michael Forman

Thank you, Vivian, and thanks to all of you who are listening and participating on this call this morning. On behalf of my colleagues at Franklin Square, I would like to welcome you to FS Investment Corporation’s second quarter earnings call. Before discussing our quarterly results, I’ll first provide a summary of FSIC’s key highlights. Following my remarks Brad Marshall, a Senior Portfolio Manager at GSO/Blackstone, FSIC’s sub advisor, and executive officer of FSIC will provide an overview of current market conditions and our investment activity for the quarter, and finally Jerry Stahlecker, President of FSIC will discuss our financial results in greater detail. We will then open the call for questions.

Since FSIC's listing on the New York Stock Exchange in April, we believe the broad reception FSIC has received thus far in the public markets speaks to the strength of the FSIC’s portfolio and business model. In connection with the listing, FSIC purchased $250 million of shares at a price of $10.75 per share in a modified Dutch auction tender offer which closed on June 4, 2014.

With the listing and the post-listing tender offer behind us, we have focused our efforts on optimizing our portfolio and cost structure. To that end since the close of the quarter, FSIC achieved another important milestone by completing its first unsecured bond offering. FSIC issued $400 million in aggregate principal of 4% notes due 2019. We believe that actively managing our liabilities will be an important long-term driver of success and we will continue look for ways to access the capital markets for the benefit of our stockholders. We will discuss both the tender offer and the bond offering in greater detail later in the call.

Turning to FSIC’s performance, our continued focus on capital preservation and commitment to delivering strong risk adjusted returns was evident in the strength of our results. FSIC’s second quarter earnings of $0.27 per share were driven primarily by investment income, fee income from direct originations, and opportunistic investments and net realized gains. After paying distributions of $0.22 per share, we had undistributed net investment income and realized gains on a tax basis of $0.67 per share as of June 30, 2014, an increase of $0.09 per share since the end of the first quarter.

Through the first six months of 2014, FSIC’s net asset value grew from $10.18 per share as of December 30, 2013 to $10.28 per share as of June 30, 2014. FSIC’s NAV was flat quarter-over-quarter due largely to the repurchase of shares at $10.75 pursuant to the post-listing tender offer and onetime expenses associated with the listing.

We recently paid a portion of our excess income and realized gains in the form of a special cash distribution of $0.10 per share on August 15, 2014, as previously announced. We expect our Board to declare a second $0.10 special cash distribution payable on November 14, 2014 to stockholders of record as of October 31, 2014.

Our articulated strategy is to establish a regular recurring distribution rate at a level we believe to be sustainable through different market environments and look to payout excess income and realized capital gains when available via special distributions.

Given our investment strategy and historical performance, we believe that realized capital gains and excess income generation are sustainable over time and we expect to continue to make special distributions to the extent we have excess income and gains. We believe this distribution policy provides us with a flexibility to manage the risk in the portfolio without imposing undue pressure on the investment strategy to support an excessive regular recurring distribution rate.

Of course there can be no assurance to future distributions. Throughout the second quarter, we continued to transition FSIC’s portfolio to directly originated investments. Originations were strong, with new direct originations of approximately $530 million, 76% of which were first-lien senior secured loans. Net direct originations for the quarter totaled over $415 million.

Our ability to draw upon the cross-organizational credit expertise of GSO/Blackstone allows us to develop customized credit solutions for middle market companies. Additionally, we are exploring ways to leverage GSO/Blackstone's brand to attract and evaluate management teams in need of capital, to build business lines that may complement our existing lending platform and provide further value for our stockholders.

Looking forward, we’ll also seek to grow our key partnerships and find ways to expand on these lending relationships. In doing so, we’ll continue to focus on structuring investments with attractive return profile and terms while avoiding competitive situations that do not need our risk reward criteria. Finally, we remain mindful of the regulatory environment in which we operate and the impact that new regulations might have on the BDC industry. We continue to be engaged in the regulatory developments facing our industry.

Let me now turn the call over to Brad Marshall to provide an overview of our investment activity for the second quarter. Brad?

Brad Marshall

Thank you, Michael. The loan market continued to experience strong demand in the second quarter despite growing outflows from bank loan mutual funds. As market expectations of an increase in short term rates were pushed to 2015 based on updated guidance from the Federal Reserve, the loan market experienced nearly 7 billion in outflows in the second quarter. However, demand from CLOs and other institutional investors helped to offset outflows and contributed to continued tight conditions and historically low clearing yields during the quarter.

As of June 30, 2014 the fair value of FSIC’s total investments was $4.2 billion. Our overall allocation to core strategies continue to grow as we rotated out of liquid assets and used cash proceeds to invest in assets that we expect will provide stronger risk adjusted returns. The proportion of core investment strategies, which includes direct originations and opportunistic investments, grew to 88% of the FSIC’s portfolio as of June 30th, 2014, compared to 83% as of March 31st, 2014.

As of June 30th, 2014 directly originated investments represented 66% of the FSIC’s portfolio compared to 57% as of March 31. 2014 on a fair value basis. During the quarter, total commitments to direct originations totaled approximately $530 million. Due to a small number of pay downs we exited approximately $114 million of direct originations in the second quarter, placing net direct originations at over $415 million for the quarter.

As of June 30, 2014 the average leverage for our direct originations through the respective tranche in which we invested excluding equity and collateralized securities was 4.1 times, which is generally consistent with the prior quarter.

As Michael mentioned, first lien senior secured loans remain in a focus, and this category of investment comprised 76% of new direct originations during the quarter, which helped to reduce second lien loans from 22% last quarter to 18% of the FSIC’s portfolio as of June 30th, 2014 based on fair value.

Excluding non-income producing assets, the gross portfolio yield prior to leverage on new direct originations made during the second quarter increased to 11.2% from 9.6% in the first quarter. The growth in gross portfolio yield on new direct originations was primarily driven by a couple of large investments that we believe offered attractive risk adjusted returns. FSIC’s gross portfolio yield on all investments prior to leverage declined to 9.9% as of June 30, 2014 from 10.2% as of March 31, 2014. This was primarily the result of one of our portfolio companies which was not directly originated being placed on nonaccrual.

This was our first and currently represents our only asset on nonaccrual and the issues the Company is currently facing are not outside the scenarios we considered at the time of the investment. The position represents just the 0.5% of FSIC’s total portfolio based on fair value. The total gross portfolio yield prior to leverage, excluding non-income producing assets was 10.3% as of June 30, 2014, and was unchanged since March 31, 2014.

Throughout the quarter, we continued to rotate out of broadly syndicated loans and into investments that we believe provide better risk adjusted returns. Broadly syndicated loans represented 12% of FSIC’s portfolio as of June 30, 2014, compared to 17% as of March 31, 2014 and 21% at 2013 year-end based on fair value. Against the backdrop of tight credit markets, we sought out companies with significant cash flow and scale that we believe can better withstand periods of economic weakness or those companies with which we had preexisting relationships.

For example, during the quarter we expanded on an existing lending relationship with Corel Corporation, a leading global provider of digital media graphics and software products. With recurring contracted sources of revenue, a history of predictable cash flow, and well executed cost controls. Corel has consistently outperformed financial expectations. Because of its high cash flow and low leverage, we were comfortable increasing our initial $110 million investment by over $50 million. The deliberate investment in companies with higher levels of revenue and cash flow, coupled with the expansion of existing relationships resulted in an increase in the average EBITDA of our directly originated investments.

As of June 30, 2014, the average annual EBITDA of our directly originated portfolio companies was $45.8 million compared to $38.7 million in the first quarter. To maximize our return we continue to take advantage of market strength to recognize gains in order to focus capital deployment into other opportunities, we believe offer better risk adjusted return. Net realized gains on investments totaled $6.7 million in the quarter ended June 30, 2014.

Additionally, we continue to seek out opportunities to improve our portfolio’s operating profits by enrolling requesting companies in Blackstone’s Group Purchasing Organization or GPO. For FSIC’s originated portfolio, companies that qualify for the program and seek to participate, Blackstone’s GPO allows those companies to leverage the collective buying power of Blackstone’s portfolio of companies to reduce operating expenses.

At one of our larger opportunistic investments, a review of expenses during the second quarter yielded approximately 1.5 million in annual cost savings. We expect a review of additional expense categories with this company to result in approximately $5 million to $7 million in incremental savings over the next two calendar years for this Company.

For FSIC, GPO is a differentiated advantage that positions us to win incremental mandates, achieve better pricing and terms, and get upside through equity participations in our financings. Since quarter end, we believe that weakness in the loan and high yield bond markets has created a more favorable investment environment for FSIC which has historically benefited during times of increased volatility and market disruptions.

While we continue to monitor the broadly syndicated markets for opportunities to deploy capital, should prices deteriorate, we remain focused on sourcing new direct originations. We will seek to maintain FSIC’s portfolio yield by maximizing the strength of our relationships and exploring opportunities that may serve to grow our robust lending platform.

Since the close of the second quarter through August 15, 2014, we have closed over $120 million of direct originations. Based on the existing pipeline and current investment environment, we expect to close on over $200 million of core investments in the third quarter. These new investments are expected to be funded by asset pay downs and the sale of existing assets.

I will now turn the call over to Jerry Stahlecker to discuss our performance for the quarter.

Jerry Stahlecker

Thanks Brad. As Michael touched upon, our portfolio continued to generate strong returns for our investors. Our increase in net assets resulting from operations or earnings per share for the second quarter was $0.27 per share compared to $0.31 per share in the first quarter of this year and $0.18 per share in the second quarter of 2013.

Net investment income for the second quarter was $0.23 per share, compared to $0.22 per share in the first quarter of this year and $0.29 per share in the second quarter of 2013. Excluding the accrual for capital gains incentive fees of approximately $0.01 per share and one time cost associated with the public listing of approximately $0.02 per share, our adjusted net investment income for the second quarter was $0.26 per share.

Our net increase in net assets resulting from operations, net investment income and adjusted net investment income, all exceeded our regular cash distributions of $0.22 per share for the second quarter ended June 30, 2014.

Going forward we generally expect our regular cash distribution to be covered by interest income. During the second quarter our total net realized and unrealized gain on investments was $11.3 million or approximately $0.04 per share.

Fee income for the second quarter totaled $18.5 million compared to $10.1 million in the prior quarter. The significant increase was largely due to a onetime non-recurring fee associated with one of our larger opportunistic investments. As previously discussed, in connection with the listing on June 4, 2014, FSIC purchased approximately 23 million shares of its common stock for an aggregate purchase price of $250 million through a modified Dutch auction tender offer. The purchase was funded primarily through our ING borrowing facility. The tender offer reduced FSIC’s NAV by approximately $0.046 per share.

As Michael touched upon, FSIC priced its first unsecured bond offering on July 7, 2014 issuing $400 million in aggregate principal of 4% notes due 2019. In connection with the offering, Standard & Poor's upgraded FSIC’s rating from BBB minus with a positive outlook to BBB flat with a stable outlook.

Proceeds from the offering were used to pay down existing secured floating rate credit facilities. While the use of fixed rate financing to pay off lower cost funding could negatively impact earnings based on current interest rate levels, we believe taking a long term view towards our capital structure is the right thing to do for our stockholders and plan to continue to evaluate financing options.

Immediately following the closing of FSIC’s unsecured bond offering and giving effect to the repayment of outstanding indebtedness under our financing facilities with the net proceeds from the offering, approximately 70% of our outstanding indebtedness was at a fixed interest rate with a weighted average effective interest rate of 3.1%.

As of June 30, 2014 we had approximately $1.9 billion in total debt outstanding with our secured financing diversified across maturities and counterparties. At quarter end our debt to equity ratio was 78%, which is slightly above our targeted range of 70% to 75%, largely due to the tender offer. Going forward we expect our leverage to return to targeted levels.

I’ll now turn the call back to Michael, to provide some final thoughts and closing remarks. Michael?

Michael Forman

Thanks Jerry, and I would like to thank you all for joining us today. As the largest manager of BDCs with over 12 billion in assets under management as of June 30, 2014, Franklin Square believes our experience, scale partnership with GSO/Blackstone and track record will continue to benefit FSIC investors. Looking forward to the third quarter, we plan to continue to rotate out of liquid securities and into investments that offer higher risk adjusted returns.

Our bias remains defensive. To that end we will continue to seek out companies with highly defensible business platforms and strong recurring revenues and cash flow. We expect to continue exploring opportunities to leverage our existing relationships and expand on our existing lending platform to structure investments at favorable terms to provide further value for our stockholders.

Given our current portfolio and significant pipeline, we believe we are well positioned to generate reliable and sustainable sources of income for our stock holders for the remainder of 2014 and years ahead. With that, we will now open the call for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And our first question comes from Jonathan Bock from Wells Fargo Securities. Jonathan, please go ahead.

Jonathan Bock - Wells Fargo Securities

Maybe starting really quickly with the portfolio; Brad, you mentioned an expectation of roughly I believe 4200 million in direct organizations this quarter, I think maybe $120 million of which are funded or committed. Can you give us a sense of where repayments are to date?

Brad Marshall

For the quarter?

Jonathan Bock - Wells Fargo Securities

Yes.

Brad Marshall

I can’t give you the exact number of our expectations for the quarter, Jonathan. We have one large repayment that will either be at the end of third quarter or the first of fourth quarter.

Jonathan Bock - Wells Fargo Securities

But then would it be fair I guess to assume third quarter growth somewhat similar, given where you are in your leverage level today as to what we experienced last quarter or would you expect from my own perspective unless to perhaps back off their growth estimates?

Brad Marshall

I would expect on a net basis it will be a positive. Growth will be in line with what we articulated in my comments somewhere north of $200 million. It doesn’t include Jonathan some of the opportunistic investments which have presented themselves because of the market volatility.

Jonathan Bock - Wells Fargo Securities

Okay, so maybe another question about opportunistic investments and when we think about what’s being directly originated, people generally have questions that Brad, this is a good opportunity, at least for us to try to further understand or say differentiate. If we’re looking at a Caesars right, a $1.7 billion as a financing of which $66 million is owned in FSIC, that or maybe U.S. Xpress, kind of give us the sense, since these are special large offerings, how one is really able to effectively dictate terms in an environment where the larger the loan, the more liquid the loan, the less apt we’ve seen or the less likely that loan is really going to be able to maintain the syntax of covenants and quality standards that investors have come to expect from people generally invested in the mid to lower middle market?

Brad Marshall

Sure and a couple of things Jonathan, and I think we’ve made this comment previously. Certain lenders or certain issuers or certain sponsors very much value the benefits they get being associated with the Blackstone brand. One, it gives them certainty of execution. Two, it gives them I guess the prestige of being associated with Blackstone and certainly issuers, certain sponsors like the knowing that they have a partner as a financing provider as opposed to the low cost provider. And I think that’s what we provide the sponsor community, is we’re a well-known entity, we’ve had a good brand and with the FSIC platform, we have additional capital to help grow that lending relationship. So we don’t stop at $150 million but we can grow that to $250 million, we can grow that to $400 million.

And then we have the GPO program which will be very actively implemented as U.S. Xpress. It’s being actively implemented at Kodak, its being actively implemented in Sorenson. And so when you offer that combined package to a sponsor to an issuer, then you tend to mandates, you tend to get better pricing, better terms and to your point, we will absolutely lose every mandate where the sponsor or the issuer is looking for the low cost solution. It’s now something we pursue. We look for those companies and those sponsors that value to benefits of our relationship.

Jonathan Bock - Wells Fargo Securities

Thank you. And then two questions on liquidity, you mentioned that the 12% BSL bucket and obviously people understand directionally that trend is down but given maybe some of the uniqueness of the platform and how capital being raised, Brad and Michael, is it your intention to perhaps reserve a little bit of liquidity in this environment in those high liquid loan categories just in case one needs to churn out of those to invest in directly originated transactions at some point when the market cracks in the future? Or is it your plan maybe near-term to just originate as much as one can out of that bucket in order to churn and drive the portfolio yield higher?

Brad Marshall

I think our goal is consistent with previous quarters that we are going to find the best risk adjusted returns for our investors and if that includes selling for all the syndicated assets rotate into direct originations or opportunistic investments, then we’ll continue to do so.

Michael Forman

I’d add to that Jonathan, we do have some opportunities that are more liquid in the opportunistic and event driven as well and we ultimately believe we'll realize on some of them, which could create some capacity too.

Jonathan Bock - Wells Fargo Securities

Got it. So, capacity now, which is important and I guess maybe a forward-looking question and I can tie this to just to your recent article. I think in an article with buyouts Mr. Klehr said and just as a direct quotation, we don’t want to cap the premium that FSIC could possibly trade at by having the market be afraid we’re going to effectively issue equity. And lots of people see that as their unique statement and in a market environment where may BDCs to date have over issued equity and under delivered on return. So, Michael could you give us a sense, is it your view to issue equity in this vehicle going forward or do you believe that one is driving enough dry powder through the private platform to make equity issuance in this vehicle really an odd event?

Michael Forman

Yes, I certain got by education when we went on the road show for FSIC and had the opportunity to meet with a number of the analysts and institutional investors that invest in this space and got a real feel for their view on BDC's issuance of equity and I understand why our peers often have to do that. We think we have a little bit differentiated way of raising capital within the FSIC platform. So we do not expect to be serial issuers of equity. We will maintain the right issue equity in adverse situations if need be but it is not part of our general model to issue equity in the market. Rather we'll continue to grow our platform as we intend to.

Operator

And our next question comes from Troy Ward from KBW. Troy, please go ahead.

Troy Ward - KBW

John asked to couple of my questions on the origination side but Brad, I want to follow up a little bit on the market you’re seeing today. You talked about outflows in the retail bond funds and then offset by CLOs and institutional demand. Can you kind of quantify the scale of that demand? Can the CLOs and the institutional demand that you’re seeing soak up -- has it soaked up all of the outflows and what do you anticipate, what’s your expectation for say for next six months if we continue to see outflows?

Brad Marshall

Yes. So I'll give you some numbers for the second quarter. It was $6.7 billion of outflows from loan mutual funds and we saw $39.8 billion of new CLOs created during the second quarter. So whatever outflows we saw from the mutual funds in loans, we saw more than compensated for in the CLO market and that compares to about $22 billion, $23 billion, $24 billion approximately of new loans created during the quarter.

So, certainly a lot of demand still in the loan market. There is a little bit of a difference though. CLO type assets are very different from a type of assets that BDC may buy. It does invariably impact the pricing and yields because it sets a bit of a benchmark but it’s not assets that we’ve been bidding on. The high yield market is where we see more volatility. I think in the past four weeks we’ve seen about $13 billion of outflows from the bond funds. So that volatility mix with a lot of geopolitical issues, with some uncertain international events going on in Portugal and Argentina certainly create a lot of buying opportunity on the more opportunistic side for FSIC and that’s -- it's these sort of opportunities and these environments where we tend to shine because we see so much deal flow in that space. So we expect that volatility Troy, to continue for the remainder of the year. The high yield market is firming the end of last week, into this week but we continue to expect pockets of volatility and take advantage of those going forward.

Troy Ward - KBW

And then one follow up on that Brad; what about CLO equity. I know you guys have a handful of CLO equity, about 4100 million in this platform but clearly across the sector there has been other BDCs adding CLO equity to their portfolios. What do you see at the current expectation for CLO equity and where do you see the return on CLO equity today?

Brad Marshall

We see the return on CLO equity declining. I think we’re a better seller of those securities than a buyer at this juncture. The past week has presented a good buying opportunity for those CLOs that were just newly issued, but very broadly -- spread terms in the broadly syndicated market remained fairly tight and very loose from a structural standpoint. So we’re -- I can’t speak for others but for us, we’re a better seller of those securities versus a buyer. And from a return standpoint to answer your question, it varies from depending on your assumption of somewhere between 9% to 11%.

Greg Mason - KBW

Hi, guys, this is Greg. I had a follow-up question on the income statement. The fee income was big this quarter for $18.4 million, up from $10 million last quarter, the Q said due to your direct originations growing. Can you just talk about that fee income? I believe you had amortized fees previously on new deals. Is there some kind of change in accounting or strategy there to cause the big fee income pop this quarter?

Jerry Stahlecker

Hey, Greg, it’s Jerry. As I think I mentioned on the call, the increase quarter-over-quarter was primarily the result of a onetime fee in connection with one of our opportunistic investments. So it was not an origination fee. It was a fee that was paid to us in connection with an anchor order transaction and consent. So that’s nonrecurring in nature. The issuer paid it as onetime upfront fee and so it’s not the type of fee that under the existing policy would get amortized over the life of the security.

Greg Mason - KBW

Right, so your policy still is for new direct originated deals that you’re amortizing those upfront fees over the life of the loan?

Brad Marshall

It depends on and again this is considerable, we’ve talked about it before is, there are some portion of the fees that are structuring fees, which are upfront and then origination fees are [indiscernible] and are amortized over the life of the security. So typically our origination fees, our structuring fees, the non-amortized fees on direct originations will be in the 1% to 2% range of any direct originations we have during the quarter. And if you look at our direct originations for the quarter and our fees, 1% to 2% of our originations during the quarter accounts for roughly half of our total fee income for the quarter and then as I said, the balance was a onetime fee relating to an opportunistic investment.

Operator

And our next question comes from Arren Cyganovich from Evercore. Arren Please. go ahead.

Arren Cyganovich - Evercore

Given you have such a large platform managing other BDCs as well as -- have you had any chance to do any co-investments with any of the other BDC platforms? And what are you seeing in terms of new opportunities that that provides you?

Michael Forman

Certainly as I think we’ve mentioned in prior calls, we have exemptive relief across our BDCs, which allow them to co-invest in originator proprietary transactions based upon available capital. It allows us to be a fairly large purchaser if there's big transactions. The current market conditions which I think Brad may have alluded to are very good for where we sit. There is a little bit of volatility in the market. We're seeing opportunities both in the anchor order, our event driven as well as in the proprietary originations and feel pretty good about where we are.

Brad Marshall

And just put a number to that, Cadillac Jack we invested $360 million during the quarter. That in FSIC, a loan would be too big in investment. So that’s an example of a deal that it was afforded to us because we could co-invest with the other BDCs.

Arren Cyganovich - Evercore

And Michael, you’ve mentioned in your prepared remarks something about leveraging the GSO/Blackstone brand with other management. So I wasn’t sure if this was something new that you were talking about or just further differentiating yourself with the GPO, that kind of, what were you referencing when you were talking about that?

Michael Forman

Well, obviously we look into opportunities. With respect to the GPO program we think that’s a clear differentiator generally and provides opportunities. We have looked at some other opportunities, on an opportunistic basis. We’ll have more on that going forward where we think because of the size and scale of the FSIC franchise generally, as well as a relationship with GSO/Blackstone, we see opportunities in the marketplace others would otherwise see.

Arren Cyganovich - Evercore

Got it, okay. And then in terms of credit quality at one new non-accrual that was not directly originated but what are you seeing in terms of the general portfolio company trends, debt to EBITDA, interest coverage on the portfolio company level?

Michael Forman

Yes, just generally across the portfolio, we see things trending consistent with the broader economy. Things are slowing grinding better. So we’re seeing leverage multiples come down across our pre-existing loans and so there is a few kind of outliers but on a broad basis we’re seeing things improve.

Arren Cyganovich - Evercore

Okay, are there any watch list loans that are popping up as well?

Michael Forman

Yes, I think our credit quality overall, notwithstanding the one loan, that one on non-accrual, if you go to our, and this was in our supplemental financial presentation, the overall quality of the portfolio basically stayed in line, fewer names overall on a dollar basis in categories four and five than in the prior quarter. So incrementally getting better. We did have the non-accrual that moved into Category 5 but generally -- 99% of our portfolio is generally performing in line with expectations. About 8% we keep closer eye on, but still generally performing in line with expectations.

Operator

And our next question comes from Mickey Schleien from Ladenburg. Mickey, please go ahead.

Mickey Schleien - Ladenburg

Yes. I just wanted to follow up on the comments regarding leverage. I think Michael pointed out that an equity offering would be unlikely but there was another comment that leverage would trend back down a little toward the 70% to 75% level. So does that mean that you’re going to have net divestments over the next couple of quarters to reduce leverage or if not that, then how is leverage going to come down?

Michael Forman

I think that the strategy which would be marginal reduction of the portfolio to bring leverage more in line with where we were historically. It's not something we feel we need to do on a dramatic basis but we’d like to get into the mid-70s. We're a little higher than that now. So we’ll be opportunistic with respect to that.

Mickey Schleien - Ladenburg

Okay, and Michael regarding the non-traditional strategy that you’re alluding to, is that something that you’re now able to do in conjunction with the unsecured bond offering that gives you more leeway to use the non-qualified bucket?

Michael Forman

No, I don’t think we’re looking at anything that’s out of the ordinary. As I said, the GPO program provides us some opportunities. We look at some other things but we’re not looking to move from where we’ve been historically.

Mickey Schleien - Ladenburg

Okay, can you give me an update on the plans or ongoing purchases by insiders, including the external advisor and stock advisor?

Michael Forman

We will -- in the next quarterly -- the 10b5-1 plan went into effect essentially late in the quarter and we will on a quarterly basis be providing information as to the purchases that are made and now our Form-4s that have been filed in the interim on behalf of Franklin Square and executives and GSO, where you can see the exact amounts of those purchases and then we’ll have a more meaningful update in the third quarter report as well. But the 10b5-1 plans went into effect consistent with what was previously announced. We’ve been fortunate, that stock has generally traded well and those plans will continue to run through this quarter.

Mickey Schleien - Ladenburg

Okay thanks for that. And a question for Brad. How would you characterize the remaining refinancing risk in the portfolio? Clearly you’ve moved out of -- almost completely out of BSO with some remaining -- considering the vintages and where the markets are today, and now they're backing up a bit. Just qualitatively how would you characterize the refinancing risk?

Brad Marshall

Yes, I would say our vintage is fairly good or fairly new. So we expect repayments to be in the 15% to 20% on an annual basis and we still have descent call protection on those originated investments that we've made and on those more opportunistic investments that we’ve made, they have even more call protection. So we generally feel good about the repayment I guess risk in the portfolio given the vintage and the types of investments that we've made.

Mickey Schleien - Ladenburg

Okay couple of last questions. Looks like you’ve exited the Harlan Sprague and RBS, which were two credits that were marked below -- pretty well below par the previous quarters. So I am just curious what your general philosophy is toward working out distress credits versus taking your medicine and moving on?

Brad Marshall

That’s a good question. Obviously every situation is unique. With RBS, we saw a bid that was meaningfully higher than where we had it marked and we thought given the nature of the sector and the trends in this business and more importantly the challenging ownership structure in this business, we felt it was best to move on and exit our position at a very attractive price. If you look at the securities, where we've decided to stick around and restructure our situations like Aculux [ph] or Sorenson, Kodak, AIRCOM; all those positions are where we took advantage of the fact that other people didn’t want to live through the complexity and the difficulty in working through a restructuring. We're very, very good at that. And so where we can capture a lot of upside opportunity for investors, not just recovery of our principal but even capture some upside like we’ve done in all four of those situations, we’ll absolutely go through the extra work to get those returns for our investors.

Mickey Schleien - Ladenburg

Thanks for that and last question, perhaps for Jerry. Did you close the Arch Street credit facility?

Jerry Stahlecker

Yes, we paid that down. We used the net proceeds of the note offering to pay down Arch Street facility and also pay down a portion of the Broad Street facility as well.

Mickey Schleien - Ladenburg

I understand but did you actually go ahead and close them? With respect to Arch Street, is it still open and available to you?

Jerry Stahlecker

Arch Street is closed.

Operator

And our next question comes from Henry Coffey from Sterne Agee. Henry, please go ahead.

Henry Coffey - Sterne Agee

Some of this, I'm sure you’ve gone over with other people, but I'm trying to get a sense a saying, when you talk about opportunities, you're generally just focused on opportunities in the CDO-CLO market or is there a broader range there?

Michael Forman

No. That's certainly not a focus of our portfolio. I think Brad earlier talked about his view and our view of CLO equity at this point. Opportunistic, we break into two categories, one are anchor orders, where we’re the lead leader order on a typically syndicated transaction at least a transaction where there is a number of participants where because of our size, because of our scale, because of the brand appeal a sponsor gets at having GSO Blackstone FSIC as a lead lender, we get better economics. So we might get an upfront fee. We might better yield on that. So that’s the anchor orders.

Event driven is where we use the breadth and scale of the GSO platform to buy debt securities which we think are mispriced and we’ll do that from time to time where we think where a debt security is trading below par, we think it’s mispriced, we think there is an opportunity there for us to make outsized gains. It’s been an important part of our strategy. The lead strategy continues to be direct originations but we will continue to focus on this part of the strategy as well.

Brad Marshall

And Henry just to put finer point on that, the 22% of our portfolio at quarter end was what we've characterized as opportunistic. Only 3% out of the 22% was in CLOs. So 19% was either anchor orders or other event driven opportunistic transactions.

Henry Coffey - Sterne Agee

And your aversion to that side of the market is because of pricing or structure or limitations that might place on your flexibility or what is the thought process?

Brad Marshall

It’s not on limitations, it’s more where we see the best risk adjusted returns. We don’t think 9% or 10% returns on CLO equity represents a good risk adjusted return for our investors. If that changes or if we find an opportunity where we can get a higher return, 12% 13%, then we think that's a better entry point for that type of investment.

Henry Coffey - Sterne Agee

Historically that has been true. You characterized some of your direct investing as more a defensive. Does that -- based on the sort of industries you’re choosing or where you would be in the capital structure or what is the -- again this is a kind of a question for me. I guess I’m getting -- new to the story but what is the dynamic there?

Brad Marshall

It’s a combination of getting better pricing, it’s getting better covenant packages, so better structure in the loan package and it’s really kind of dictating the process. We control the security that we own versus being part of a broadly syndicated group where you little control. These are all situations where we just feel like we're one getting better risk adjusted returns for our investors, better structures and better control.

Michael Forman

We’re typically first lien as well Henry and they're in -- we tend to be in larger companies with larger EBITDA [indiscernible] -- a little bit more insulated in terms of economic swings, given their size and market position. So that’s defensive as well.

Henry Coffey - Sterne Agee

And on your dividend, the undistributed dividend -- I'd hate to say it this way but sometimes it becomes problematic. Are there text consequences to deal with here or is the thought process to move the dividend up to a 100% in net investment income or -- I understand the specials on gains, but you’re still under distributing relative to your NII or are going to be announcing a dividend increase soon?

Michael Forman

We did incur some excise taxes last year Henry. Generally that's 4% excise taxes. We're able to invest that money at a much higher rate than the 4% excise taxes. So we think that it's overall accretive to our investors and so we continue to monitor that and we expect to continue to pay special distribution, but we don’t really want -- this is something we’ve talked about with a lot of people -- we don’t want the distribution policy to drive our investment policy. We want to look for the best risk adjusted returns, have a regular recurring distribution rate that we feel comfortable with, where we don’t feel like we’ve to reach for yield or reach for risk and to the extent that we out earn that through both income and gains, we’ll continue to pay special distributions and historically our special distributions have been roughly 1% to 2% per year additional distributions over and above our recurring monthly distribution rate.

Henry Coffey - Sterne Agee

You also talked about when we were discussing the whole issue of equity raise. Obviously it’s not an issue right now, you have a lot of cash to recirculate; but you said something about a preparatory way of raising equity. I’m just curious about that.

Brad Marshall

Yes, again Henry, the strategy here is that, we have FSIC I, that’s been there -- FSIC that’s been listed in the markets. We have FSIC II that was fully raised from our non-traded clients and we have FSIC III in the markets as well. So we don’t need to go to the public equity markets to increase the size and scale of our platform. We have other vehicles that we're raising capital and therefore we don’t have a need to do dilutive offerings or leased offerings that the market might perceive as dilutive. We have other vehicles that are raising capital.

Henry Coffey - Sterne Agee

So when it comes to I -- you’re just happy with it being at its current size?

Michael Forman

Yes, I think that’s right. I think certainly we’ll look to other credit opportunities going forward but there may be an opportunity going forward to merge one of the other vehicles into FSIC. That’s probably 12 to 18 months out at this point. So it’s not something that’s in the short to midterm. But we will not be doing this serial issue. We will not be serial or periodic issuer of equity in FSIC.

Henry Coffey - Sterne Agee

You're breaking bankers' hearts as you speak but I think it’s a strategy.

Operator

And we have a follow-up question from Jonathan Bock from Wells Fargo Securities. Jonathan, please go ahead

Jonathan Bock - Wells Fargo Securities

Michael you made mention of being the largest manager of BDCs and of course with our questions regarded equity issuance as well as I think Henry’s, can you give us a sense of the amount of capital that you’re raising per quarter in the private vehicles, I mean we can look at up just would love to get a sense of where that run rate is today?

Michael Forman

Yes and I am happy to do that Jon. That recognized we have some vehicles that are not BDCs are well that were raising in the market, but we look at raising somewhere around 500 million to 600 million a quarter in our core BDC strategy outside the public market in our non-traded core strategy.

Jonathan Bock - Wells Fargo Securities

Got it so it would probably give credence to the claim that if one is raising 500 million to 600 million in BDCs out of the public domain, raising 100 million or 200 million and BDC already established probably isn’t that big of a deal given that it’s really a onetime event, would you agree with that?

Michael Forman

Yes, I agree certainly as I said before we heard have message perhaps directly from our and the number the folks on this call as well the institutions, we’ve versioned to some of those offering and we recognized why folks do it. But we don’t need to do it. We understand that the market does not look positively on it and we think there is other ways grow the FSIC without doing that.

Michael Forman

Okay, I think that’s it for the questions. I am being singled. So thank you everybody for your participation on the call this morning. Always good catch up with our friends and look forward to talking to you on next quarterly call.

Operator

Thank you ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may now disconnect.

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