FS Credit Opportunities Corp. Q3 FY2024 earnings call

• Performance: Strong net returns, outperformed peers. Distributions covered by net investment income. Discount narrowed.
• Market overview: Private credit performance strong due to US economy, but public credit also benefited. Default rates diverged (high yield bonds low, loans high).
• Investment activity: Fully invested in Q3. Purchases ($270M) vs sales ($233M). Leveraged FS Investments platform. 59% new investments in private (all first lien loans), 41% in public (65% first lien loans).

The Fund delivered a net return of 3.35% based on NAV in the third quarter of 2024. Year-to-date as of September 30, 2024, the net return was 12.31% based on NAV, outperforming high yield bonds by ~430 basis points and loans by 580 basis points. The Fund paid distributions of $0.18 per share in the third quarter, with net investment income covering distributions. As of November 22, 2024, the annualized distribution yield was 10.3% based on NAV and 11.1% based on the stock price. Portfolio composition as of September: public credit comprised 42% of the portfolio, private credit 58%. By asset type, ~82% was senior secured debt, 6% subordinated debt, 3% asset-based finance, and 9% equity and other investments. Excluding asset-based finance, the largest sector ratings at quarter-end were consumer services, healthcare equipment and services, and commercial and professional services.

• Focus on businesses with strong cash flows, modest leverage, and experienced management. Prefer senior debt with strong terms. Leverage scale of FS Investments. Cautious on new investments due to tight spreads and weak covenants.
• Distribution policy: Ongoing review of distribution policy, considering earnings, rates, credit spreads, and fee-based income.

• Market volatility from geopolitical conflicts and US rate path.
• Inflation and regulatory changes affecting sectors.
• Credit quality issues with low-quality loan market composition.

Q: Insights on forward-looking dividend policy?

A: Distribution policy reviewed ongoing, considering earnings, rates, credit spreads, fee-based income, and spillback dollars.

Q: Relative value in private credit after liquidity premium?

A: Both private and public credit tight, private credit still has 150-175 basis point premium over like-for-like public, with structural premium in docs.

Q: Impact of weak covenants on deal volumes?

A: Weak covenants in public loans spill into private, causing higher bar, needing more deals but active in good ones.

Q: Allocation increase in private credit?

A: Attractive due to spread and structural premium, dispersion in private allows more alpha. Spreads in private investments up to 700 basis points.

Q: Macro environment effect on portfolio?

A: 63% portfolio is floating rate, set up well if rates stay or tick up. Monitor yield curve and sector dislocations.

Q: Non-accrual investments?

A: Non-accruals ~3% of FMV, one new in LaserShip due to macro revenue shortfalls and over leverage post-COVID.

Q: Fee structure vs peers?

A: Incentive fee and management fee, with 58% private investment making fees justified as more tailored than BDCs.

Q: Refinancing progress?

A: Successfully refinanced leverage facility with Barclays at SOFR plus 215, down from plus 265, reduced undrawn capital fee.