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Edited Transcript of FSIC earnings conference call or presentation 2-Mar-17 3:00pm GMT

Thomson Reuters StreetEvents

Q4 2016 FS Investment Corp Earnings Call

Philadelphia Mar 2, 2017 (Thomson StreetEvents) -- Edited Transcript of FS Investment Corp earnings conference call or presentation Thursday, March 2, 2017 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Chris Candelas

FS Investment Corporation - Head of Capital Investments and IR

* Michael Forman

FS Investment Corporation - Chairman and CEO

* Brad Marshall

FS Investment Corporation - Senior Portfolio Manager

* Gerry Stahlecker

FS Investment Corporation - President

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Conference Call Participants

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* Rick Shane

JPMorgan - Analyst

* Jonathan Bock

Wells Fargo Securities - Analyst

* Arren Cyganovich

DA Davidson - Analyst

* Christopher Testa

National Securities - Analyst

* Ryan Lynch

KBW - Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen and welcome to the FS Investment Corporation's fourth-quarter and 2016 annual earnings conference call.

(Operator Instructions)

Please note, this conference is being recorded. At this time I would like to hand the floor to Chris [Candelas], Head of Capital Markets and Investor Relations, who will proceed with the introduction. Thank you, Mr. Candelas, I hand the floor to you.

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Chris Candelas, FS Investment Corporation - Head of Capital Investments and IR [2]

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Thank you. Good morning and welcome to FS Investment Corporation's fourth-quarter and 2016 annual earnings conference call. Please note that FS Investment Corporation may be referred to as FSIC, 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 FSIC issued on March 1, 2017.

In addition, FSIC has posted on its website a presentation containing supplemental financial information with respect to its portfolio and financial performance for the quarter ended December 31, 2016. A link to today's webcast and the presentation is available on the Investor Relations section of the Company's website at www.FSInvestmentCorp.com under presentations and reports. Please note that this call is 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 in FSIC's filings with the SEC regarding forward-looking statements. Today's conference call includes forward-looking statements. 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. 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 fourth-quarter earnings release that was filed with the SEC on March 1, 2017. Non-GAAP information should be considered supplemental in nature and should not be considered in isolation or as a substitute for 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 FSIC's website.

Speaking on today's call will be Michael Forman, Chairman and Chief Executive Officer of FSIC; Brad Marshall, Senior Portfolio Manager of FSIC and a Senior Managing Director at GSO Blackstone, FSIC's Sub-advisor; and Gerry Stahlecker, President of FSIC. We will then open the call for questions. I'll now turn the call over to Michael.

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Michael Forman, FS Investment Corporation - Chairman and CEO [3]

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Thank you, Chris, and welcome, everyone, to FS Investment Corporation's fourth-quarter and full-year 2016 earnings conference call. We appreciate your interest in FSIC. On today's call, I will provide a summary of FSIC's key highlights and strategies, after which Brad will provide an overview of our investment activity. Then, Gerry will discuss our financial results in greater detail.

Net investment income for the fourth quarter of 2016 was $0.21 per share, compared to $0.20 per share for the third quarter of 2016, and $0.23 for the fourth quarter ended December 31, 2015. For the full-year 2016, net investment income was $0.85 per share, compared to $1.10 per share for the full year of 2015. Adjusted net income for the fourth quarter of 2016 was $0.23 per share, compared with $0.20 per share for the third quarter of 2016, and $0.24 per share for the quarter ended December 31, 2015. For the full year of 2016, adjusted net income was $0.87 per share, compared to $1.03 per share for the full year of 2015.

The rise in net investment income between the third and fourth quarters of 2016 was largely attributable to increased fee income as a result of greater direct origination, volume, and repayments. Fee and dividend income totaled $17.2 million in the fourth quarter of 2016, compared to $4.2 million in the third quarter, and $11.8 million in the quarter ended December 31, 2015. As of December 31, 2016, FSIC's total accumulated undistributed net investment income on a tax basis was approximately $0.63 per share. FSIC's net asset value at the end of the fourth quarter was $9.41 per share, compared to $9.42 per share as of September 30, 2016, and $9.10 per share as of December 31, 2015.

Year-over-year NAV growth was driven primarily by a general tightening of credit spreads and a rebound in our largest energy positions and in Caesar's entertainment. It is important to note that we, along with our Board of Directors, work with independent third-party valuation service providers to mark 100% of the investment portfolio to market each quarter.

At December 31, 2016, approximately 97% of the fair value of the total investment portfolio was allocated to our core investment strategies. These strategies include direct originations which generally offer the potential for higher yields and stronger covenant protections that may be found in the broadly syndicated markets and opportunistic investments where we believe there's an opportunity to earn an attractive return on our investment by capitalizing on marketplace inefficiencies.

This level of investment in our core strategies has remained relatively unchanged for the past several quarters, and approximates our target allocation. We've also maintained a focus on investing in senior secured and floating-rate debt, which at the end of the fourth quarter represented approximately 72% and 67%, respectively, of the portfolio based on fair value. With that I'll now turn the call over to Brad to discuss our investment activity during the quarter. Brad?

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Brad Marshall, FS Investment Corporation - Senior Portfolio Manager [4]

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Thank you, Michael. Given the continued strength of the credit market and the materialization of the underwriting thesis for some of our opportunistic transactions, we were a net seller of assets during the fourth quarter. Because we saw deals getting done in the quarter, at what we believe our aggressive terms, we chose a conservative approach. We expect to be fully deployed by the end of the first quarter of 2017, but we will continue to be cautious from a risk-adjusted return perspective.

Total purchases for the quarter were $495 million, 83% of which were first-lien senior secured loans. Exits of $716 million during the fourth quarter were driven primarily by refinancings and the prepayment of certain direct originations. For the year ended December 31, 2016, total purchases were approximately $1.2 billion against total exits of approximately $1.6 billion.

Loan yields continued to tighten in the fourth quarter of 2016, resulting in higher refinancing activity as more corporate issuers sought to reduce their cost of capital. As the portfolios generally fully ramp, an uptick in refinancing activity can be a near-term positive catalyst for FSIC. Any increase in refinancing activity may result in higher fee income over the short term from pre-payments and new direct originations from redeploying that capital.

We continue to use the size and scale of GSO's direct-lending platform and FSIC's capital base to identify source and structure investments with attractive return profiles. As of December 31, 2016, the gross portfolio yield prior to leverage and excluding non-income producing assets was 10.1%, relatively unchanged from 10.2% for the prior quarter. The average leverage of our direct originations through the respective tranche in which we invested, excluding equity and collateralized securities, was 4.8 times, unchanged from September 30, 2016.

All of our directly originated portfolio companies have access to Blackstone's group purchasing organization program which leverages the collective buying power of Blackstone's portfolio companies to reduce operating expenses. This potentially leads to improved EBITDA margins for the participants, and ultimately better credit metrics for our portfolio companies and, in turn, stronger performance for FSIC. As of January 9, 2017, FSIC portfolio companies that participated in the program had an average savings on addressed spend of 20%, increasing EBITDA for those companies by an average of 4%.

As of December 31, 2016, we had two companies on nonaccrual, which in aggregate represented only 0.2% of the portfolio based on fair value and 1.6% of the portfolio based on amortized costs. We are working with these companies in order to maximize our recoveries. Four of the five investments on non-accrual as of September 30, 2016 -- Lifestream Resources, Logan's Roadhouse, SandRidge Energy, and Warren Resources -- were restructured and exited bankruptcy during the fourth quarter. Note that Ridgeback Resources, now one of our portfolio companies, owns and operates the former assets and business of Lifestream.

Since FSIC's inception, where FSIC's portfolio companies have defaulted on their debt, the Fund's average recoveries have been in excess of their corresponding cost basis, which means FSIC has made money in aggregate when the company has defaulted. We work hard as an equity owner and, as GSO's part of the Blackstone Group, we have many tools at our disposal in order to maximize our recoveries in the event of a default.

Equity comprised approximately 14% of the portfolio as of December 31, 2016, based on fair value, down from approximately 15% as of September 30, 2016. This decrease was largely due to the repayment of our preferred equity holdings and Plains Offshore and Safariland. Looking forward, given the strong market multiples, we would expect our equity positions to be monetized in whole or in part over the next few years.

Let me now turn to our energy portfolio. Energy-related investments as of December 31, 2016, comprised approximately 12% of FSIC's investment portfolio based on fair value. Despite the repayment of our Plains Offshore position, energy represented approximately the same percentage of the portfolio based on fair value as it did on December 30, 2016. This is primarily due to appreciation in our Ascent Resources and FourPoint Energy investments. While our energy investments had until recently been perceived by some as one of the riskiest parts of our portfolio, we believe now they collectively represent some of the strongest.

The net changes in unrealized appreciation on energy investments during the fourth quarter of 2016 totaled approximately $34.9 million, or $0.14 a share. On a full-year basis through December 31, 2016, the net change in unrealized appreciation on energy investments of approximately $107.1 million contributed approximately $0.44 a share to NAV appreciation. I will now turn the call over to Gerry to provide additional details on our results.

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Gerry Stahlecker, FS Investment Corporation - President [5]

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Thanks, Brad. Net investment income for the fourth quarter of 2016 was $0.21 per share, compared to $0.23 per share for the fourth quarter of 2015. For the full year of 2016, net investment income was $0.85 per share, compared to $1.10 per share for the full year of 2015. Adjusted net investment income for the fourth quarter of 2016 was $0.23 per share, compared to $0.24 per share for the quarter ended December 31, 2015. Again, for the full year of 2016, adjusted net investment income was $0.87 per share, compared to $1.03 per share for the full-year 2015.

As Michael noted earlier, the income during the fourth quarter was higher than the previous quarter, primarily due to direct originations and pre-payments, some of which had slipped from the third quarter into the fourth. Subject to the timing of anticipated pre-payments and new direct originations, we expect fee income to be lower than average during the first quarter of 2007 (sic) which may result in a modest quarter-over-quarter decline in net investment income.

We expect to use a portion of the accumulated and undistributed net investment income if there is a need to bridge any resulting shortfall between net investment income generated in the quarter and our first-quarter distributions. Given the current issuer-friendly environment and tight market conditions, we may experience an increased number of refinancings in the portfolio. While this could drive a short-term uptick in fee income received from prepayments and the redeployment of capital under new direct originations, it may also place longer-term pressure on our distribution if we must reinvest in what proves to be a persistent tight-yield environment.

In the fourth quarter of 2016, we declared a regular quarterly distribution of approximately $0.22 per share, which was paid on January 4, 2017. For the first quarter of 2017, we declared a regular quarterly distribution of approximately $0.22 per share to be paid on or about April 4, 2017 to stockholders of record on March 22, 2017.

NAV was $9.41 per share as of December 31, 2016, compared to $9.42 per share as of September 30, 2016, and $9.10 per share as of December 31, 2015, resulting in a fourth-quarter NAV return of approximately 2.1% and a 2016 NAV return of approximately 13.2%. Net change in unrealized appreciation on investments during the fourth quarter of 2016 totaled approximately $44.7 million, or $0.18 per share, which was attributable to broad-based appreciation across the portfolio, particularly in our energy investments.

Net realized losses during the fourth quarter were $44.4 million, or $0.18 per share, driven primarily by the restructuring of our Logan's Roadhouse senior secured bonds into a second-lien term loan and common equity. At quarter end, FSIC's debt-to-equity ratio was 74.1%, compared to 75.6% as of September 30, 2016, and 83.1% as of December 31, 2015. I'll now turn the call back to Michael.

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Michael Forman, FS Investment Corporation - Chairman and CEO [6]

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Thanks, Gerry. As the largest net manager of BDCs, with more than 16 billion in BDC assets under management as of September 30, 2016, we at FS Investments believe our scale relationships and experience continue to benefit FSIC shareholders. Given the strength of our portfolio and historical performance, we believe we're well positioned to generate strong returns for our stockholders. We look forward to an exciting and rewarding 2017. Thank you for your trust and investment in FSIC. With that, we will now open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

Rick Shane, JPMorgan.

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Rick Shane, JPMorgan - Analyst [2]

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This is a unique time; when I look at multiples in the space, I would describe that probably 40% of the companies in the sector are in a position to issue equity at this point and 60% are trading below NAV and are not. You talk about significant repayments coming, and I realize that in the near term there's a little bit of pressure related to the NII versus the dividend. I don't think there is dividend pressure.

One of the things that we've observed in the past is that the best BDC's deploy and raise capital somewhat asynchronously. It is not an obvious time from a balance sheet perspective for you to issue new equity, but from a markets perspective, it is available. How do you think about, perhaps, building a little bit of dry powder, realizing the current conditions for potentially raising capital may not persist?

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Michael Forman, FS Investment Corporation - Chairman and CEO [3]

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Thanks, Rick. Let me try that, and I appreciate the question. It is something we think about all of the time. We're in the unique position that we continue to raise capital in our non-traded vehicles, and we're doing that currently. So we are not forced to raise capital in the public markets in order to growth scale and size in the marketplace.

We've always looked at the analysis of whether we think we can raise capital and deploy that capital in a manner that would be accretive to our shareholders. We haven't seen that opportunity. We think about it very hard, particularly as we continue to trade at such a significant premium to NAV, and analyze it based upon the markets.

We share your view. The time when you can raise money in the public markets is often in the tightest of markets, so there is an asymmetry there, as I think you characterized it. We will continue to analyze that. If our pipeline gets to the point where it is so robust that we think we need additional capital to make the investments we will be issuing in the public markets opportunistically, but we're not going to do it unless we think it is in our shareholders' best interest.

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Brad Marshall, FS Investment Corporation - Senior Portfolio Manager [4]

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Rick, I would add to that; it is Brad. The turnover in the portfolio and the pace of that turnover is providing us with a lot of dry powder at this moment to take advantage of those good deals that we do see in our pipeline.

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Rick Shane, JPMorgan - Analyst [5]

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Got it. Again, I realize that it is a little bit counterintuitive in the current environment to be taking in capital, but say we were to experience a dislocation somewhere in the next 6 to 12 months, then in hindsight that could have been the right opportunity. Following on that question, and I think everybody looks at issuing equity versus the Mendoza line of trading at or above or below NAV. Do you look at it at all on a relative multiple basis and think about it in terms of cost of capital versus your peers and your ability to achieve advantageous hurdle rates because of your relative multiple?

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Gerry Stahlecker, FS Investment Corporation - President [6]

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Rick, it is Gerry. As Michael talked about, we looked at whether or not raising the capital is ultimately going to be accretive to our existing investors. And that is a function of two things. It is a function of the premium at which you are issuing shares to NAV, and it is a function of where you think you've got the ability to deploy that capital from a return standpoint in the marketplace and whether that incrementally is going to accrete to our existing shareholders as opposed to be dilutive.

You talk about the mismatch; when you are trading at a significant premium is often the time where you don't have those opportunities in the short term. And you're right that six months from now we could be in an environment where you have those accretive investment opportunities. But we don't know what the market is going to look like six months from now. It could be just as tight as it is today, and we have significant dry powder in the portfolio as of year end; our cash balance was about $250 million. We had $250 million of undrawn leverage capacity so I think it would be a difficult argument to make when we have $500 million of dry powder to go out there raising money in this tight environment.

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Rick Shane, JPMorgan - Analyst [7]

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Okay, great. Guys, it's very clear. I appreciate the answers, thank you.

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Operator [8]

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Jonathan Bock, Wells Fargo Securities.

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Jonathan Bock, Wells Fargo Securities - Analyst [9]

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Gerry, I appreciate your frankness because the one point that I got out of your discussion was that the distribution could potentially come under stress in light of the current environment we're in, particularly if it persists. We look at simple math the way you do, and it would appear that the dividend itself is on an unsustainable path in this current environment given your over-reliance on fees, the high percentage of PIK income, as well as the potential for perhaps maybe a few other nits or nats in the portfolio that might present a challenge over the next few months.

The question I will pose to Gerry, to you and to Michael, is, what else, other than additional fee income, can you do to right size this coverage of the dividend and make it sustainable on a go-forward basis? And the undistributable net investment income is not an answer investors appreciate.

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Michael Forman, FS Investment Corporation - Chairman and CEO [10]

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Thank you, John; it is Michael. And Gerry and I will take that. I would say unsustainable is a pretty strong word. I think markets are dynamic, so a lot depends upon what happens in the market. At this point, we're comfortable with the distribution rate. We have been able to cover it with fee income on a quarter-to-quarter basis.

In terms of the undistributed income, we're going to have to make a distribution in any event under the tax law. If we were in a position that we would cut the distribution, then we would have to make a special distribution. So some of that is going to have to be used -- is going to have to be distributed in any event.

We're in a position where we're waiting to see how the markets develop. We have never been one to reach for risk. We focus on capital preservation. I would say that we have a little bit higher allocation to equity than we would like; a lot of that was intentional. Some of it was based upon restructures, which we believe are going our way. As we are able to sell down that equity, we can then reinvest those positions in income-producing assets.

We are in a wait-and-see mode. We're comfortable where we are today. If the market continues to be this tight for another couple of quarters, Jonathan, we are going to have to reevaluate things.

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Jonathan Bock, Wells Fargo Securities - Analyst [11]

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I appreciate that. Regarding unsustainable, maybe I should -- we actually do see a path to where this can easily be remedied, right? Selling equity is a little hard when you are not the majority in your equity positions. But FSIC 2 is both underlevered, has less equity, and a similar portfolio yield. Michael, I think you mentioned that you are planning to merge FSIC 2 into FSIC 1 over the year of 2017, if I'd look at the transcript. Why isn't that the potential remedy? Because I think that literally fixes the problem.

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Gerry Stahlecker, FS Investment Corporation - President [12]

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I would look at the math again a little bit though, Jonathan. If you look at the dividend yield for FSIC 2 compared to FSIC 1, and you merge -- you treat those -- look at them on a merged basis. On a merged basis, the blended yield between the two would be lower. And while FSIC 2 may be lower levered than FSIC 1, I don't think that incremental difference is going to bring up the blended distribution rate between those two. If we were to merge those portfolios today based on the income generation, then I think you would be more likely to see a lower distribution rate.

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Michael Forman, FS Investment Corporation - Chairman and CEO [13]

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Jon, just to add to that, what we have told our non-traded shareholders, the FSIC 2 shareholders, is that we need to get our NAV up a little bit and we need to get our distribution yield up a little bit. FSIC 2 had a terrific 2016, so we think we're making progress. Whether that is a 2017 or an 2018 event really depends upon the markets and the performance of FSIC 2. We do think, ultimately, assuming our Boards elect to move forward with that kind of merger, and it receives shareholder approval, that would be something we could expect. I'm not sure of the timing and it could be a late 2017 or 2018 issue, but we still have a little bit of work to do with FSIC 2.

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Jonathan Bock, Wells Fargo Securities - Analyst [14]

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That's fair. Maybe just two small follow-ups there, because I know you mentioned the Board. Given the unique relationship that you have, and Michael, folks can appreciate it, how many deals originated by FS specifically that went into FSIC portfolio were deals not sourced by GSO? Take this past year for -- trailing 12 month, for example, do you have a ballpark estimate?

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Michael Forman, FS Investment Corporation - Chairman and CEO [15]

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The way our relationship has always worked, Jon, is we rely upon the subadvisor to source the deals, and then the folks at FS make final investment approval. And that has been the nature of the advisor/subadvisor relationship we have. When we source deals, deals come our way all the time, we send it to GSO to underwrite, and then they either underwrite it up or down and then send it off to us. That is the nature of the relationship; they take care of sourcing, they do the initial underwriting, FS makes all final approvals with respect to the portfolio, and runs all of the other aspects relating to the fund.

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Jonathan Bock, Wells Fargo Securities - Analyst [16]

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Got it. The only other question is, as we look at the private BDC universe, whether it is CNL and their relationship with KKR, certainly or others, one of the questions that comes out -- Michael, I noticed that your Board has a significant amount of folks that are involved with the FS infrastructure, franchise folks, independent members. Does it make sense to add the subadvisor to that Board in order to effectively complement the decisions that you are already making, largely because portfolio, the portfolio construction, et cetera, it's so important, it would seem like relative to CNL that could be reflected here as well. What are your thoughts on that going forward?

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Michael Forman, FS Investment Corporation - Chairman and CEO [17]

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We have certainly been the leader in the BDC space. We think we have a model that is time-tested and worked very well, so we think the current structure has benefited our shareholders. We have delivered terrific performance. The Board is comfortable with the advisor/subadvisor relationship, and sees, as far as I know, no reason to change.

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Jonathan Bock, Wells Fargo Securities - Analyst [18]

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Okay, thank you.

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Operator [19]

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Arren Cyganovich, DA Davidson.

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Arren Cyganovich, DA Davidson - Analyst [20]

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Brad, you mentioned you expect to be fully deployed by the end of 1Q 2017. What did you mean by that from a context of leverage or using up the cash that you have available right now?

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Brad Marshall, FS Investment Corporation - Senior Portfolio Manager [21]

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I think Gerry threw out some numbers -- what our cash balance and unused leverage was at the end of the year. We expect that, over the next month and for the quarter, we will use up that cash and get leverage back to where it has been historically, which is around 0.75. That is historically where we have run the portfolio. That was my reference.

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Arren Cyganovich, DA Davidson - Analyst [22]

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Okay, that makes sense. In terms of your repayment activity during the first quarter, are you expecting to have it higher than normal because of the refi environment you are talking about? First quarter tends to be a seasonally slower type of quarter.

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Brad Marshall, FS Investment Corporation - Senior Portfolio Manager [23]

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I think that is right. It will be somewhat slower. I think most of the pre-payment activity that we're looking at spills over into Q2 and Q3 based on what we are hearing from our partners. so Q1 was really about deploying some of that cash and leverage left over from the end of the year.

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Arren Cyganovich, DA Davidson - Analyst [24]

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Got it, okay. Not to harp on this too much, but how long would you be willing to wait in this environment if things don't change and it stays in a tight environment? You have the pressure on your recurring interest income in the portfolio, where you would have to make a decision of cutting the dividend. I think you said you have $0.63 of spillover, which investors may not care for, but it is a nice protection against the near-term changes.

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Gerry Stahlecker, FS Investment Corporation - President [25]

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As you know, with the way the tax laws work, the first distributions we make during the year are basically distributions of that spillover income. So the current distribution rate of $0.22 per quarter, essentially the first three quarters of distributions this year would basically eat through that spillover, and then anything over and above that is funded from current year earnings. So, as Michael mentioned when Jon asked about it, we're going to have to distribute that -- it's sort of FIFO accounting on your income. So that is going to get distributed regardless.

And then the question is, at that point we will evaluate what the environment looks like and where we are able to deploy capital and what we think the long-term sustainable rate of the portfolio is at that point in time, and likely in the third quarter then have to make a decision about whether or not there is a change in the ongoing distribution rate. For the first three quarters, whether we cut and pay a special, we still have to distribute that money in the first nine months of the year.

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Arren Cyganovich, DA Davidson - Analyst [26]

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Thanks, that's helpful.

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Operator [27]

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(Operator Instructions)

Christopher Testa, National Securities.

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Christopher Testa, National Securities - Analyst [28]

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Just a quick question on the capital structure. Obviously you have repaid the JPMorgan repurchase facility. Should we be expecting an additional fixed-rate issuance sometime in the next couple of quarters or so, or has pricing become too prohibitive for that?

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Gerry Stahlecker, FS Investment Corporation - President [29]

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I think if you look at our leverage, we have got $1.7 million of outstanding borrowings as of year end. We have got about $250 million of undrawn capacity under the revolver. The rating agencies certainly like to see your total leverage being under 0.8 times levered. So if you look at the fact that we have got long-term unsecured indebtedness and you look at what we just did with the refinancing of the JPMorgan facility at the end of the year and beginning of this year in terms of refinancing JP through a combination of a new term loan with JP and then the facility with HSBC.

There isn't really a lot of flexibility there to add on additional long-term unsecured fixed-rate debt, on top of which, as you mentioned, with long-term rates moving up, the pricing that we have seen in the market hasn't been all that attractive. We were opportunistic in doing a small add-on to one of our bonds. We had reverse inquiries and we were able to do it at an attractive level. I think the liability side of the balance sheet that you see today, I expect to see it relatively static in the near term.

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Brad Marshall, FS Investment Corporation - Senior Portfolio Manager [30]

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Just to add to that, I think the mix between secured debt and unsecured debt and the mix between fixed and floating, I think we like that mix right now, and it works well with our assets that we currently have on our balance sheet.

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Christopher Testa, National Securities - Analyst [31]

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Okay, great, that's helpful. Just looking at potential earnings drivers, do you guys have any thoughts -- is there an inclination on your behalf to potentially start an off-balance-sheet joint venture, given you are already operating in the upper middle market and generate good deal flow to help boost yields as spread compression remains the dominant theme in the market?

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Brad Marshall, FS Investment Corporation - Senior Portfolio Manager [32]

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I will tackle that one. I think we look at all of the different structures that different BDCs are doing, and I think our view or our take at this point is that those securities or that risk that those managers are taking on is more junior debt-oriented given they are taking the bottom part of those structures. So it looks a lot more like CLO equity or junior debt, and given what we have articulated to investors that we'd like to stay at the top of the capital structure, that would be inconsistent with that message. While we think it is a neat way to back lever a portfolio, we don't think it meets the risk profile we have articulated.

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Gerry Stahlecker, FS Investment Corporation - President [33]

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I think if you look at some of the transactions that are being done in the marketplace today in terms of how tight the yields are on some of those loans and the amount of leverage underlying those loans, then taking those and putting them into effectively a levered CLO structure and being the bottom part of it is adding a fair amount of risk to the portfolio. And we have always really focused on risk-adjusted returns and we don't want to reach for undue risk just to generate those incremental returns.

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Christopher Testa, National Securities - Analyst [34]

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Okay, that's helpful. Also, curious, any thoughts that you have on the DOL fiduciary rule being put on the back burner, and what, if any, impact that's had on your fundraising abilities for your non-traded products?

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Brad Marshall, FS Investment Corporation - Senior Portfolio Manager [35]

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It's really early to tell what is going to happen with all of that. It probably just creates additional uncertainty, and there has certainly been a fair amount of uncertainty in those worlds. We are waiting to see how that all settles out, and certainly we have always, on the non-traded side, been a proponent of a fiduciary standard and operating as fiduciaries for our clients. Some of the other mechanisms of the DOL were a little bit harder to manage through, but I think it is too early to tell where that all goes. So we are watching, like everybody else.

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Christopher Testa, National Securities - Analyst [36]

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Okay, great. Last one for me, just curious, what would have been the primary uses of capital in the first quarter so far and the fourth quarter from the deal flow you are seeing?

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Brad Marshall, FS Investment Corporation - Senior Portfolio Manager [37]

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Predominantly -- consistent with the fourth quarter, predominantly in senior secured debt. We're refinancing one transaction that is junior debt, but that is just a refinancing of an existing deal. All of the new deals are at the top of the capital structure.

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Christopher Testa, National Securities - Analyst [38]

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I meant the uses of capital for the borrowers.

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Brad Marshall, FS Investment Corporation - Senior Portfolio Manager [39]

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Sponsor M&A, so sponsors buying companies, predominantly.

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Christopher Testa, National Securities - Analyst [40]

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Okay. One more, if I may, sorry. The upper middle market and core middle market deal flow through 2016 was down pretty sharply and the lower middle market was up. Just wondering what you can attribute to that being the case, and what you see as the catalyst to get the upper and core middle market back up to the levels of lower middle market activity?

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Brad Marshall, FS Investment Corporation - Senior Portfolio Manager [41]

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We don't track the lower middle market activity that closely. I would say in the pure middle market, we're starting to see a pickup. It was an active fourth quarter that spilled into the first quarter, and we're starting to see that activity pick up.

I think more certainty around taxation will help activity even more, given that the further you move up to the middle market, the more international these businesses may be as it relates to sourcing, as it relates to sales, and taxation changes will certainly play into some of these companies. I think that may help pick up activity, but we have seen -- absent that, we have seen a pickup in activity going into the second and third quarter this year.

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Christopher Testa, National Securities - Analyst [42]

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Great, that's all for me. Thanks for taking my questions.

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Operator [43]

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Ryan Lynch, KBW.

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Ryan Lynch, KBW - Analyst [44]

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I have a couple of questions. I want to reconcile a couple of statements that you guys made today. Brad, I think you talked about there was some aggressive terms in the fourth quarter, so that resulted in you guys being a net seller of investments. You also talked about an uptick in refinancing and repayment in Q1 2017, but also being fully deployed by the end of Q1 2017. Can you just talk about what you're seeing in terms of deal environment in Q1 2017 that you believe you can fully relever your portfolio even with some additional repayments in the quarter?

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Brad Marshall, FS Investment Corporation - Senior Portfolio Manager [45]

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The deals that we're closing actually in the first quarter are mostly carryover from the fourth quarter, deals that have taken a little bit longer to close than we had anticipated. Those are just new sponsor-back LBO deals. The deals that we're looking at that are going into the second quarter are predominantly deals within our existing portfolio companies. So companies that are looking to make acquisitions need additional financing.

And what we're seeing in more broadly auction LBO sponsored back deals, we're seeing very competitive proposals, very aggressive terms, and we are being less constructive on those opportunities, and really trying to narrow in on those deals where the sponsor or the company is valuing our capital and not just looking for the lowest cost of capital. The way we do that is through the size of the FSIC complex balance sheet, as well as some of the value-add services that Blackstone and GSO offer, and trying to generate extra spread through those collective offerings.

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Ryan Lynch, KBW - Analyst [46]

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Okay. Switching to your energy portfolio, 2016 was a little bit of a tale of two ends. You had in the first half of the year your energy portfolio was written down and struggled a little bit. In the second half it had some nice recoveries for 2016. You did restructure a few weaker energy investments. Just with the recovering oil prices, more drilling activity going into 2017, what is the outlook of your energy portfolio in 2017, and do you believe that there could be some further recoveries or further strength like we saw in the second half of 2016 as you move into 2017 for your energy portfolio?

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Brad Marshall, FS Investment Corporation - Senior Portfolio Manager [47]

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What I would say about our energy portfolio and it really comes down to two primary positions, and that is Ascent and Four Points. Both companies continue to perform well, are well capitalized going into 2017. They have hedged out a lot of their commodity price exposure, so they are much, from a credit standpoint, much more stable, and I think our perspective is that the outlook is positive. These are companies that faced commodity markets that do swing a little bit, but in terms of their balance sheet, in terms of how their underlying wells are performing and in terms of how they have hedged out some of their risk, we think 2017 will be a positive year for them.

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Ryan Lynch, KBW - Analyst [48]

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Okay, one last technical question is pretty quick I think. You guys have an investment in LEAS acquisition or Leads acquisition, you guys have a couple of investments. One of them it looks like it is denominated in euros I believe, and it's written down to 78% of your cost basis in the quarter, and it has been written down around the low 80%s for several quarters. The other two look like they are denominated in US dollars and they are not written down. I was wondering, is the write-down in that investment, I believe that one of them is denominated in euros, is that just purely due to currency fluctuations or is anything going on there?

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Brad Marshall, FS Investment Corporation - Senior Portfolio Manager [49]

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No, company's performing well. That is currency related. We borrow in euros so we hedge out that currency exposure so -- but we reflect -- on the asset, we reflect the markdown based on currency, but you see it made up elsewhere.

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Ryan Lynch, KBW - Analyst [50]

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Okay, great, thanks, those were my questions.

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Operator [51]

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At this time, there are no further questions. I'll return the floor for closing remarks.

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Michael Forman, FS Investment Corporation - Chairman and CEO [52]

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Thank you, everybody, for your time and attention this morning. We appreciate the continued loyalty, and look forward to talking to you all soon.

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Operator [53]

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Thank you for your participation in today's FS Investment Corporation's fourth-quarter and 2016 annual earnings conference call. You may now disconnect.