FS KKR Capital Corp

NYSE:FSK

Earnings Call Transcript 2019-Q1

[Operator]

Good morning, ladies and gentlemen, and welcome to FS KKR Capital Corp’s First Quarter 2019 Earnings Conference Call. [Operator Instructions] Please note that this conference is being recorded.

At this time, Robert Paun, Director of Investor Relations, will proceed with the introduction. Mr. Paun, you may begin.

[Robert Paun, Director of Investor Relations]

Thank you. Good morning, and welcome to FS KKR Capital Corp’s First Quarter 2019 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 on May 8, 2019.

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 March 31, 2019. A link to today’s webcast and a presentation is available on the Investor Relations section of the Company’s website under Events and Presentations. Please note that this call is a property of FSK. Any unauthorized rebroadcast of this call in any form is strictly prohibited.

Today’s conference call includes forward-looking statements and we ask that you refer to FSK’s most recent filing with the SEC for important factors 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 first quarter earnings release that was filed with the SEC on May 8, 2019. Non-GAAP information should be considered supplemental in nature and should not be considered in isolation or as a substitute for the related financial information prepared in accordance with GAAP. In addition, these non-GAAP financial measures may not be the same as similarly named measures reported by other companies. To obtain copies of the Company’s latest SEC filings, please visit FSK’s website.

Speaking on today’s call will be Michael Forman, Chairman and Chief Executive Officer of FSK; Dan Pietrzak, Chief Investment Officer of FSK; and Brian Gerson, Head of Private Credit for FS Investments. We’re also joined by Bill Goebel, Chief Financial Officer of FSK.

I will now turn the call over to Michael.

[Michael Forman, Chairman and Chief Executive Officer]

Thank you, Robert, and welcome everyone to FS KKR Capital Corp’s First Quarter 2019 Earnings Conference Call. On today’s call, I will provide an update on our core objectives and discuss some recent developments regarding our strategy going forward. Following my remarks, Dan Pietrzak will provide our perspective on the current lending environment and review our investment activity for the quarter. Brian Gerson will discuss our financial results for the first quarter and then we’ll open the call for Q&A.

I’d like to begin today’s call by making a few comments on the progress we’ve made since our strategic partnership closed a little over a year ago. We’ve accomplished a great deal collectively and have made significant strides in integrating our teams and transitioning our investment portfolio. With our new combined scale, we’ve made progress on several of our key portfolio construction objectives, including increased focus on directly originated credit and a reduction in equity exposure. We’ve closed on a number of large capital commitments, and from a liability perspective, closed on a $2.1 billion revolving credit facility, which significantly reduced FSK’s cost of financing. We believe we have built a strong base for long-term success. We have generated consistent deal flow through a robust origination pipeline as seen by the increased deal volume and capital deployment we’ve reported in the last four quarters.

And as a result of the merger of FSIC and CCT, we are operating our business more efficiently and we have reduced risk through greater portfolio diversification. While we are proud of our accomplishments and progress, we recognize we still have work to do and we’re focused on our long-term core objectives, which include delivering to our shareholders a competitive and stable dividend that is supported by recurring investment earnings, preserving capital and positioning FSK as a best-in-class BDC that is well aligned with shareholders.

For 2019, we continue to focus on several key initiatives that will drive near and long-term value for our shareholders and deliver on our core objectives. First, we remain disciplined in our underwriting approach and selectively allocating capital. We are focused on the upper end of the middle market and secured risks and we continue to generate deal flow from our broad sourcing platform, as well as generating opportunities from existing portfolio. Quality deal flow is critical as is selectivity, both of which enhance our competitive advantage in today’s lending environment.

Second and related, we are focused on credit quality and performance. We believe the portfolio today is better positioned than it was a year ago with increased diversification. We continue to work on our challenge credits doing all we can do to maximize value and stabilize NAV.

And third, we are focused on increasing investment income and driving yield by rotating out of non-income-producing assets and increasing our exposure to our strategic JV and asset-based finance investments. We have reduced our equity position over the past year and are working to reduce it even further. We also believe our JV and ABS transactions will provide incremental returns while diversifying the portfolio. Dan will speak about our portfolio construction, investment strategy and JV in more detail.

Next, I’d like to turn to our $200 million share repurchase program. We continue to believe buying FSK shares is a compelling opportunity with the stock trading at a meaningful discount to our net asset value. We also believe our continued execution of program sends a strong message that we are confident in the portfolio and committed to aligning ourselves with shareholders. Our track record in this regard speaks for itself. To-date, we have repurchased approximately $56 million of shares under the current program. This is in addition to significant repurchase activity that preceded the December merger of CCT and FSIC. Over the past 12 months, the combined FSK entity has repurchased approximately $156 million in shares and including CCT’s post-listing tender over $340 million since November 2017.

Now, I’d like to share a few comments about our strategy and plans for our leverage. Historically, we’ve taken a conservative approach to using leverage and expect we will continue this approach while using incremental leverage to enhance our flexibility, take advantage of attractive investment opportunities as they present themselves and deliver attractive risk-adjusted returns for investors. To this end, FSK filed a proxy statement on April 23 seeking shareholder approval to increase regulatory leverage to 150% asset coverage, among other items.

Consistent with our core objective to position ourselves as a best-in-class BDC, we will reduce our base management fee from 1.5% to 1% on asset finance with leverage that exceeds 1:1 debt to equity. If the proxy is approved by shareholders, we expect to increase as FSK’s leverage over time with initial near-term target of 0.95x debt to equity. Finally, it’s is important to note that our investment strategy will not change in the event we increase our leverage.

In summary, we believe we are well positioned to capitalize on the full benefits of our platform and deliver on our core objectives through strategic initiatives I have outlined. We are fully committed to aligning ourselves with shareholders and we remain optimistic on the future of this franchise. We look forward to updating you on our progress throughout the year.

I will now turn the call over to Dan to discuss our portfolio activity during the quarter.

[Dan Pietrzak, Chief Investment Officer]

Thank you, Michael, I will offer a few highlights on what we are seeing in the market and provide an update on our portfolio and investment activity during the quarter. The leveraged credit markets rebounded in the first quarter with both high-yield bond and senior secured loan indexes recovering their losses from the fourth quarter of last year alongside equities. All 3 markets posted a strong start to the year as investor sentiment for risk assets generally improved, the US economy continued to expand and the outlook for interest rate shifted.

The Federal Reserve’s more dovish stance dramatically reduced the odds of a near-term rate hike and a decline in short-term interest rates were in part responsible for steady inflows into high-yield bond mutual funds during the quarter. While this resulted in the sharp rebound and high-yield bonds, the combination of a more cautious fed and benign inflation data have the opposite effect on bank loan mutual fund flows, with investors rotating out of low duration floating-rate assets. By the end of March, bank loan mutual funds had experienced 19 consecutive weekly withdraws totaling $23.5 billion.

Today, the overall private credit lending environment remains competitive, but we believe we are well positioned with our size, scale, portfolio diversification, incumbency positions and origination capabilities to capitalize on opportunities. As Michael mentioned earlier, we remain focused on being disciplined in our credit selection and are executing transactions where we believe there is a compelling risk reward.

Moving to activity in the first quarter. KKR Credit continued to see a high level of deal volume with nearly 300 transactions evaluated. Total deployment in Q1 at FSK was $549 million up from $220 million in the fourth quarter. When including activity across FSIC and CCT, in Q4, total deployment was $498 million. Sales and paydowns at FSK were $510 million gross and $428 million net of $82 million of sales to the joint venture in the first quarter. This compares to sales and paydowns of $397 million gross and $353 million net of sales to the joint venture in the fourth quarter of 2018 for FSK. And when combined with FSIC and CCT Q4 activity, $543 million gross and $499 million net. As has been the case in prior several quarters, repayments of loan positions were driven by either company sales or capital markets refinancing as opposed to competitor refinancings.

Turning to the investor presentation on Slide 8. At March 31, our investment portfolio had a fair value of $7.4 billion consisting of 186 portfolio companies. Our total issuer account reduced over the quarter as we rotated out of some of our smaller traded positions and into 3 larger originated transactions. At the end of the first quarter, our top 10 largest portfolio companies by fair value represented 20% of the portfolio as compared to 36% of the FSIC portfolio prior to the merger.

We continue to focus on portfolio diversification, which we view as a key risk mitigation tool. Consistent with our focus on senior secured investments, our portfolios compromised of 75% – 74% senior secured loans with 54% first-lien loans as of March 31. Also consistent with our focused on financing borrowers at the upper end of the middle market, the median EBITDA of our borrowers was $54 million and the median leverage was 5.1x. This compares to a median EBITDA of $56 million and a median leverage of 5x at year-end 2018, which is roughly flat quarter-over-quarter.

As far as the portfolio return profile, the weighted average yield on accruing debt investments was 10.8% at March 31, 2019. This was flat from year-end 2018.

On our Q4 call, we spoke about our focus on investing in asset based finance opportunities and how investing in these transactions can provide incremental returns as we diversify our investment portfolio and utilize our noneligible portfolio company bucket. We continue to see attractive deals for diversified opportunities in this space. And during the first quarter, we funded several deals including Zeno K2 and Altavair, in the aircraft leasing sector, Toorak Capital in the US residential real estate sector, as well as recently entering to certain commitments that we will discuss on future earnings calls.

In the current market, we are targeting low double-digit returns on our asset base finance deals on an unlevered basis, in line with what we have seen historically, which we believe continue to be compelling returns on the risk-adjusted basis, especially given our views on downside protection.

Now, I’d like to turn to Slide 14 and discuss our joint venture. As we’ve highlighted in the past, we are actively focused on scaling our joint venture, a yield enhancer that allows us to expand the non-qualifying asset bucket of our portfolio, which is important given our access to the full KKR Private Credit platform including non-US based borrowers as well will provide capacity for certain lower-yielding direct origination assets. We believe that joint venture is attractive for FSK as it expands our fee income potential and also provides improved returns given management fees are charged on our equity investment in the joint venture versus gross assets.

Our joint ventures investments at fair market value grew 13% quarter-over-quarter from $581 million at year-end to $657 million at March 31, 2019. Our joint venture investment currently represents 4.1% of our total portfolio and we are targeting up to a 10% allocation over the medium term. We are actively exploring ways to accelerate the growth of the vehicle and expect that we will be able to increase the size of the joint venture while continuing to generate attractive risk-adjusted returns.

Another key initiative for the portfolio, as Michael mentioned, is to increase investment income and drive yield by reducing our equity exposure and rotating out of non-income-producing assets. Equity investments comprised 7.8% of the total portfolio on a fair value basis as of March 31, 2019, compared to 13% at the end of the first quarter of 2018. Approximately 38% of our equity investments by fair market value represent either platform investments, such as Home Partners or co-investments, where we purchased equity alongside a regular way credit. Approximately 44% of our equity investments by fair market value are made up of reperforming investments such as JWA and ASG while the remainder represents equity we received via restructurings. We continue to focus on lowering our equity exposure and expect equity positions to eventually comprise less than 5% of the portfolio.

Turning back to Slide 9. At the top of the slide, we have summarized our product suite and target investment size, which reflects our continued focus on the upper end of the middle market. We thought it would be helpful to review key highlights from a few transactions that occurred in the first quarter, as shown at the bottom of the slide.

On our last call, we mentioned 2 large deals that closed at the beginning of 2019; a $665 million financing to back H.I.G. Capital’s acquisition of Lipari Foods and a $1 billion plus financing backing Veritas Capital and Elliott Advisors acquisition of Athenahealth, which we split with another lender. FSK committed a $138 million of the financing facilities for the Lipari deal and $169 million of the financing facilities for the Athenahealth deal.

In addition to these 2 transactions, KKR Credit was the lead first-lien investor and lead arranger in a $650 million financing for Savers Inc., the largest for-profit thrift retailer in North America. The $650 million financing has been structured as a $540 million first-lien term loan, a $50 million second-lien term loan and a $60 million revolving credit facility.

KKR Credit invested $270 million of the first-lien term loan with closing leverage through our tranche of less than 4.5x. FSK converted $89 million of the financing while the rest of our BDC platform and other KKR managed accounts committed the remainder, approximately another $181 million.

I’ll now turn the call over to Brian to discuss our financial results during the quarter.

[Brian Gerson, Head of Private Credit]

Thanks, Dan. I’ll provide a summary of the financial results for the first quarter of 2019. You can find this information starting on Slide 4 of the earnings presentation. As a reminder, this is the first quarter of full results from the combined FSK entity following the closing of the merger between FSIC and CCT in December of last year.

For the 3 months ended March 31, 2019, net investment income was $0.18 per share. Net realized and unrealized gains and losses were positive $6 million or $0.01 per share in the first quarter. This was comprised of realized losses of $15 million and unrealized gains of $21 million. During the quarter, market and credit based portfolio appreciation was somewhat muted by negative unrealized marks on certain investments, which totaled approximately $0.07 per share.

At March 31, 2019, approximately 0.4% of FSK’s portfolio was on nonaccrual on a fair value basis, down from 1% at year-end 2018 and down from 1.9% pro forma for the combined entity prior to the close of the merger at September 30, 2018. During the quarter 1 investment was placed on nonaccrual. Additionally, we had 2 investments removed from nonaccrual due to restructurings, which were Aspect Software and MB Precision.

Turning to dividend. As Michael spoke about earlier, one of our core objectives is to provide a competitive and stable dividend that is supported by recurring investment earnings. During the quarter, we paid a regular $0.19 per share dividend, representing a 9.7% annualized yield based on our March 31, 2019, NAV. We continue to feel good about the $0.19 dividend, as we look to further reduce our equity exposure and rotate out of non-income-producing assets along with increasing our exposure to our strategic joint venture and asset base finance investments.

We believe all of these actions can provide incremental returns as well as diversify our investment portfolio. Our Board of Directors declared a second quarter dividend of $0.19 per share, which will be paid on or about July 2, 2019, to stockholders of record as of the close of business on June 19, 2019. The Fund’s net asset value was $7.86 per share as of March, 31 2019, as compared to $7.84 per share at December 31, 2018. The main drivers of the change in NAV can be seen on Slide 6 of the earnings presentation, which include positive unrealized gains offset by realized losses, positive benefits of hedging activity in foreign currency and swaps and the benefit of the share repurchases.

Turning to the balance sheet. As of March 31, 2019, total investments at fair value were $7.4 billion, total cash was $92 million and total assets were $7.7 billion. These numbers are relatively in line with our reported year-end 2018 results.

Moving to the right side of the balance sheet. Total debt was $3.4 billion with total committed debt of $4.6 billion diversified across lenders. Our net debt-to-equity at the end of the quarter was 80% as compared to 79% at year-end 2018. Our weighted average cost of debt was approximately 4.6% at March 31, 2019, in line with the end of the fourth quarter.

We have a $400 million 2019 unsecured bond, which matures in July. While we have $1.2 billion of undrawn capacity under our existing revolving credit facilities as of March 31, we continue to evaluate several other alternatives for the bonds refinancing including the bank, CLO and unsecured bond markets. Last week, we launched our first middle market CLO and we intend to sell the AAA and AA tranches and retain the remaining securities. We believe that this is an attractive source of financing with matched funding and no mark to market at an attractive rate.

I’ll now turn the call back to Michael.

[Michael Forman, Chairman and Chief Executive Officer]

Thanks, Brian, and thank you to everyone for your time today. As always, we appreciate your support. We’re looking forward to updating you throughout the year as we make progress on our core objectives. With that, we will now open the call for questions.

[Operator]

[Operator Instructions] Our first question is from Rick Shane with JP Morgan. Your line is open.

[Rick Shane, JP Morgan]

Hey guys, good morning and thanks for taking my question. I just wanted to ask sort of one high level question. We’re obviously seeing the industry repositioned for higher leverage and you guys are seeking approval. I’m curious as this is developing if you are actually seeing the already competitive landscape increase in intensity?

[Dan Pietrzak, Chief Investment Officer]

Rick it’s Dan Pietrzak. I think fair question. There has been a lot of money raised for the space. I think the two offsets to that those, there has been a lot of money raised for middle market private equity, which is a clear kind of user of this, number one, and number two, I think where we’ve tried to position the business at this upper end of the middle market, we just see it as less competitive. We see the less people who can write these full-size checks. I think you can see from some of the case studies we gave in terms of deals we completed in the quarter, the real size. And I think we’ve just seen more competition in that sort of $25 million to sort of $35 million, $40 million EBITDA space. So I think it’s a good question, I think it’s one that is quite fair to ask, but I think we’re positioned pretty well to avoid some of that.

[Rick Shane, JP Morgan]

And do you see your competition in that market in part and it’s interesting you showed a couple of transactions in the first quarter, some of that were clubbed out and some that you led, do you see your competition in that market really is the 144A market?

[Dan Pietrzak, Chief Investment Officer]

No, I mean – and if you just look at the deals that we sort of did, I mean, the Lipari deal was one where we did speak for the whole thing, we were the sole lender. I think we were able to do that because of the excessively quick turnaround time; you had a company to sponsor looking for a solution. The Athena deal was a really interesting transaction. The first lien was sold into the more traditional syndicated markets. We split that deal, the bottom pieces with another sort of large private lender, and then the same for Savers. So I think as we are talking with some of these larger companies, at times they could definitely access what I’ll call the syndicated loan market. I think we’re not necessarily trying to compete with that and the needs and reasons why the private credit space exists, whether it’s carve out, whether it’s certainty of execution, whether it’s a bespoke situation like Savers, and that’s where we’re looking to play.

[Rick Shane, JP Morgan]

Got it. Thank you very much guys.

[Operator]

And our next question is from Casey Alexander with Compass Point. Your line is open.

[Casey Alexander, Compass Point]

Good morning. Couple of questions, one, you did give a target potential leverage ratio of 0.95 times, and obviously, you’re trying to work down equity and non-income-producing assets. If you are successful in pushing down those non-income-producing assets below 5%, would at that time you consider is somewhat higher target leverage ratio given that you have more of the portfolio as income producing?

[Dan Pietrzak, Chief Investment Officer]

Casey, it’s Dan. I think couple of things. So one, when we do talk about the 0.95 times, I think, Michael’s comments in the script, we’re kind of near-term, I expect that’s over sort of 12 months to 18 months, right. We’re going to be mindful about credit risk and not just be doing loans to meet our target to the leverage number. I think we’ve been happy with the progress that we’ve made on both the equity bucket and that non-income-producing bucket, which obviously there is some overlap to those names. There’s a bit more work to do there. Hopefully, you saw in our prepared remarks, we did give some color about how we thought about the equity bucket.

I think could we go above 0.95 times, sure. Is maybe more of a natural target even sort of 1:1, I think, yes. At the same time though, we’re not going to be aggressive uses of leverage and we’re going to want to keep that dry powder available for what I’ll call market disruptions and more interesting opportunities to invest and deploy.

[Casey Alexander, Compass Point]

Secondly, how would potentially doing a securitization or a CLO of your own assets compared to the cost of your credit facility? I’m assuming that you’ve kind of studied that that dynamic.

[Dan Pietrzak, Chief Investment Officer]

And we have. I mean, I think we’ve been pretty happy with our liability structure to-date. I think we are focused on diversification as you can imagine, and we are definitely looking at sort of accessing that space. I think it’s probably a little bit too early to talk about kind of your pricing now, but clearly we’re going to try to create a certain amount of balance with all the different tools that we have available to make sure that the right pricing, the right duration, look to reduce mark-to-market risk where we can, et cetera.

[Casey Alexander, Compass Point]

And lastly, we’re almost halfway into the second quarter. How does it look from deployment and also from a repayments standpoint?

[Dan Pietrzak, Chief Investment Officer]

No, a good question. I think you’ve seen we had a good sort of Q1, right. I probably think more about the numbers as that deployed number versus the net number after what we sold into the JV. So I think it was probably net positive sort of 130 we’re really out where we want to be vis-a-vis kind of leverage today. We’re definitely seeing more pressure on repayments in Q2. There is some deals that I think without the market volatility may have gotten refinanced at some point in Q4, potentially even in Q1. Certain situations like that we’re able to capitalize but I think there is more pressure on repayments as we sit here in Q2. And I’m not surprised that considering the volatility in the last few quarters.

[Casey Alexander, Compass Point]

Okay. Thanks for taking my questions

[Dan Pietrzak, Chief Investment Officer]

Thank you.

[Operator]

And our next question is from Finian OShea with Wells Fargo Securities. Your line is open.

[Finian O'Shea, Wells Fargo Securities]

Hi, guys good morning. Thanks for taking my question. Dan, can you give some color on the market environment, how things have rebounded? Can you expand a little more for us on the economic side, if you were to think about say you’re median or performing in line with expectations-type portfolio company, which is most of everybody’s book. Are there any mounting or emerging pressure points there? Or are we seeing general very robust health on the portfolio credit side?

[Dan Pietrzak, Chief Investment Officer]

I think you got a couple of questions in there, Fin, and let me take a shot, but feel free to add to it. The market remains competitive. I think it’s difficult to have recall a market that’s probably not competitive. That said, I do think that what happened in Q4, took a little bit of froth out of things that probably slowed down some M&A activity and maybe some sort of higher quality deal activity in Q1, but I we’re starting to see some of that volume and at least dialogs kind of pickup.

The market has, I would say, come back. I mean, I think the markets are available and deep on the syndicated side for new loans to be sold into. I think we’re still seeing a little bit of pressure for the harder situations, are the more sort of bespoke, which is probably good for us. And then as it relates to company performance, we’ve got a lot of names on the credit platform as you know across the different buckets of capital that we manage. I think we’re generally still seeing positive and good numbers. The macro numbers the US put out have been strong. That said, I think we’re pretty mindful. We remain light cycle credit and we need to be pretty defensive about what we’re doing.

[Finian O'Shea, Wells Fargo Securities]

And then just one on the liability side, just thinking about the commitment share for the BDC and some of your and Brian’s commentary on financing strategy, it sounds like you will kind of replace other stuff and keep most of that commitment. So is that fair to say that you’ll approach, not saying that is a right or wrong strategy, of course, there’s pros and cons but are you – is it safe to say you will be taking a very conservative financing structure going forward?

[Dan Pietrzak, Chief Investment Officer]

I can start this and Brian can add to it. I think conservative is a fair word. I think there’s different definitions of conservative, right. We are going to like maturity and we are going to like balance of diversification across both loan types and lenders and then probably diversification amongst kinds of products as well. And Michael mentioned, I mean, we remain very proud of the revolver we put in place, both in terms of the size, where it’s priced, the flexibility it gives us. The market is deep on, I think, the bilateral bank market side. We’re obviously looking into the CLO space to see if something is done there. I think we remain interested in the unsecured market. But I think the better word is probably balanced and conservative.

[Brian Gerson, Head of Private Credit]

Clearly looking at the right-hand side of the balance sheet, that’s a key lever for us to drive NII and manage our risk. And not a lot more to add to Dan’s comment other than continue to diversify and watch our maturities and improve the balance sheet as we go.

[Finian O'Shea, Wells Fargo Securities]

And then just one more, if I may. Tying in some of really the comments from all you on strategy and the JV, we’re seeing now of course a lot of your peers deciding the JV no longer makes sense given 2:1 leverage and you’re kind of just moving in that direction, but I think setting the 0.95 times target was 1 year from now. So would you say that you’re viewing this – do you view there to be value of a leveraged senior asset bucket in the BDC or might we see you a year from now when this is ramped just kind of move on it and the whole time it was sort of a warehouse facility as we saw with several of your peers? Any color on that proposition.

[Dan Pietrzak, Chief Investment Officer]

Well, I think Fin, it’s a very fair question especially with what kind of leverage going up. As you know, our JVs have been a bit different than sort of most. We’ve been using it more to make sure we’re capturing the full origination of the entire KKR Credit platform, which can include non-eligible portfolio companies. I think we’re thinking about it a little bit more today to include still privately originated but certain sort of lower-yielding assets to both be able to position ourselves well in the market but put on sort of good risk-adjusted returns.

So we’re not viewing it as a warehouse, we’re viewing it as a real part of our strategy. And I think it all does with the other end of Michael’s comments that we don’t expect our strategy to change with this increased in leverage. We want to run this what we believe will be a conservative leverage number, that sort of 0.95 times near-term target and the JV just forms part of all that.

[Finian O'Shea, Wells Fargo Securities]

That’s all from me. Thank you guys.

[Operator]

And our next question is from Paul Johnson with KBW. Your line is open.

[Paul Johnson, KBW]

Good morning guys. Thanks for taking my question. I wanted to ask about a specific credit Belk – your portfolio company Belk. It seems like it’s a very traditional retail investment that’s – obviously that sector is coming to some pretty significant secular challenges over the last few years; it’s a second-lien investment. I think you guys also made some additional retail investments this quarter. Just curious, I mean, could you provide any kind of color around this investment and why it’s had a stress market as well as is the transaction that you are the leader in or was this a syndicated deal?

[Dan Pietrzak, Chief Investment Officer]

Paul, thanks for the question. We get flooded in a couple of parts. I mean, I think Belk is a fair name. It’s on our watch list as well. I think if you go and look at kind of recent performance, same-store sales numbers were pretty good, at least relative to kind of the sector. The company has historically produced a fair amount of cash flow. The company has historically bought a fair amount of debt and kind of retired that, which has been helpful from an overall leverage position. And I think the structure of that loan is a bit unique and it does have some security attached to it, mainly in the form of real estate.

So I think you put that all together, I think we’re still comfortable with the position. I think we’re quite mindful it can be volatile from a mark-to-market position; the first lien I think trades fairly actively. So it’s something we got our eye on for sure. It was a privately-placed second lien. It was us than another sort of large credit player who ended up sort of taking that down. So it’s not a broad sort of holder group.

And then maybe the second part of your question was just about broader retail. We’re clearly of the opinion like everyone else out there. Mall-based retail has been under real stress where we have seen some marks in the portfolio and some challenges in the portfolio over the past quarters as it relates to that space. I think we can be constructive on certain names that are on retail, but we’re going to find them to either be different, while we put Savers in that bucket. We would find maybe there is a quite strong collateral package where you’re not that worried about the actual performance of the store or the brand itself. All you’re going to do is something that has a lot of real structure. There is a handful of names that we’ve looked out are done – that we’ve done it and really, let’s call, two turns of leverage with real amortization, not sort of excess cash flow sweeps, like contractual 2.5% per quarter type amortization. So if we can get those, we will do it; if we can’t, we’ll walk away.

[Paul Johnson, KBW]

Okay. Thanks that’s very good detail.

[Operator]

[Operator Instructions] And our next question is from Terry Ma with Barclays. Your line is open.

[Terry Ma, Barclays]

Hey good morning. If you reach your near-term target leverage of 0.95x given the current environment and you kind of successful in reducing your equity exposure to, call it, sub-5% and also executing on some of your strategic initiatives like the JV, what kind of target ROE should we expect or are you targeting?

[Dan Pietrzak, Chief Investment Officer]

So I think you’re right on the levers, right. I think we feel good about being able to get to that target, but like I said, we did want to give the color about 12 months to 18 months. I think we feel good about getting the equities sort of book down and although, like I said, we did try to give some more color into the details of sort of breakdowns of that book. And I think ramping the JV will also take a certain lot of time, but we feel good about that. Assuming the market holds up, assuming market conditions are our consistent, sort of upper single digits type ROE thinking about some type of normalized loss number.

[Terry Ma, Barclays]

I’m sorry, you said upper single digits?

[Dan Pietrzak, Chief Investment Officer]

Yes. I mean, I’m hesitant to give any sure sort of the forward numbers out there, but that’s the way we sort of think about it. Even if you break down the loan book, right, your regular way first lien loan [indiscernible] today. Your second lien loans really plus 8 you think where our LIBOR is, you think what sort of leverage we feel confident are, sort of dividend number of 9.7%. So I think it’s all in that sort of context.

[Terry Ma, Barclays]

In terms of longer-term leverage targets, I think some of your peers have thrown out numbers as high as 1.25 times in the quarter, 1.5 times debt-to-equity. Does FSK have appetite for that type of leverage target longer-term?

[Dan Pietrzak, Chief Investment Officer]

It really doesn’t and that’s for one simple reason. From Michael’s comments, we don’t intend on changing business model here. This is a privately-originated, privately-negotiated transaction entity. I think if you start to get to those kind of leverage numbers with these types of loans, you’re going to be getting a little bit too aggressive on the liability side and that’s something that I think any of us would encourage or be comfortable with. So can we go above 1 times, yes, could we get to 1.25 times and positions of market volatility where we want to capitalize on it, absolutely. But I don’t think that will be a stated target from us.

[Terry Ma, Barclays]

Okay. Got it. That’s helpful. Thank you.

[Operator]

Thank you. And ladies and gentlemen, this ends our Q&A session and conference for today. Thank you for participating and you may all disconnect. Have a wonderful day.