Speaker 1:
From the library of the New York Stock Exchange at the corner of Wall and Broad Streets in New York City, you're inside the ICE House, our podcast from Intercontinental Exchange on markets, leadership, and vision in global business. The dream drivers that have made the NYSE an indispensable institution of global growth for over 225 years. Each week we feature stories of those who hatch plans, create jobs, and harness the engine of capitalism right here right now at the NYSE and at ICE's exchanges and clearing houses around the world. And now welcome inside the ICE House. Here's your host, Josh King of Intercontinental Exchange.
Josh King:
Finance has always relied on ownership and debts. In ancient Mesopotamia, the first loans were used for agricultural products which formalized some of the first laws around credit and interest rates. In the US, credit became ubiquitous at the turn of the 20th century when shopkeepers would let their customers like my mom and dad run their tab up at the [Woburn 00:01:06] hardware store and the Woburn market and pay off their debt when they got the bill.
Josh King:
For a long time businesses, unlike mom and dad look to banks and bonds rather than grocery stores and hardware stores to fund their capital expenditures and growth, but then the financial crisis changed all that. Banks moved away from certain loans and private lenders began to fill the void, helping small and medium-sized companies grow, expand, and survive. This uptake in private credit has occurred in a relatively short period, but according to industry research, the private debt market is expected to cross the one trillion threshold soon.
Josh King:
Over the past several decades, private credit has consistently generated attractive returns for its investors. And with higher yields becoming harder to find in public markets, investors have been piling into private credit opportunities. For many years though, these strategies were only available to institutional investors and wealthy individuals. Most retail investors couldn't access asset class, even though it offered competitive returns, diversification, and a lower risk investment compared to other asset classes. That was until companies like FS Investments and KKR entered the space. They brought products to market that had previously been either uninvestible or unattainable and they offered all kinds of companies the opportunity to take advantage of private debt.
Josh King:
FS Investments' entire mission centered on the idea of making alternative investments more accessible, and in KKR's more than 45-year history, going back to the origins of the firm that Jerome Kohlberg, Henry Kravis and George Roberts founded in 1976, it has redefined the alternative investment management space by investing in some of the world's most recognizable companies. Their joint venture now in FS KKR brings together some of the hardest hitters in the world. Leading the charge are Michael Forman, chairman and CEO of FS KKR Capital Corp, and Daniel Pietrzak, its co-president and chief investment officer.
Josh King:
For companies, private debt provides flexible capital to finance projects. These small businesses are the lifeblood of the US economy and are often foundational to the cities and towns that are located in. Having the ability to finance their future is critical to their success and to the communities around them. FS KKR has provided that support and transformed more than 150 companies. It's also offered retails investors the opportunity to capitalize on this asset class. And today we're pleased to be able to speak to the people at the helm of those decisions. Our conversation with Michael Forman and Daniel Pietrzak is coming up right after this.
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Josh King:
Our guests today are Michael Forman, chairman and CEO of FS KKR Capital Corp, and Daniel Pietrzak, its chief investment officer. You can find it at NYSE ticker symbol, FSK, one of the world's largest publicly traded business development companies or BDC. A BDC is a type of closed-end investment fund that offers credit to small and medium-sized businesses, and FS KKR is a joint venture between FS Investments and KKR and focuses on providing customized credit solutions to private middle-market US companies with approximately $16 billion in assets across the FS KKR BDC franchise. Welcome Michael and Dan inside the ICE House.
Daniel Pietrzak:
Thank you Josh.
Michael Forman:
[crosstalk 00:05:48].
Josh King:
So guys, interest from mainstream retail investors to access the private market has been growing for a bunch of years. This has led to the rise of securities and products that offer exposure to alternative investments. The vision for FS Investments' creation back in 2007 was to provide investors with access to alternative sources of income and growth that had historically only been available to institutions and wealthy individuals. Why was democratizing access to alternative investments so important?
Michael Forman:
You certainly captured our mission. Our mission has always been about access and providing retail investors and the investing public access to best-in-class alternatives. What the differentiator is, and we launched our first fund in 2009 is focusing on best practices, focusing on transparency, providing the same institutional experience to the investing public that the large institutions had always been accustomed to, and in fact demanded. And that was really the mission of FS. So to bring best-in-class alternatives to the investing public but treating the investing public as if they were large sovereign wealth funds, large pension funds and giving them that institutional experience.
Josh King:
Speaking of the work guys of democratizing finance, there are some pretty deep connections to what we in New York refer to as the second choice capital for the United States. Michael and FS Investments are based out of Philly. Dan, you attended Wharton and Lehigh. Michael, I know you grew up in New Jersey. What drew you to Pennsylvania? And in Michael's case, why did you choose to settle down there?
Michael Forman:
So I grew up actually in North Jersey. So a little bit more of a New York orientation. Went to law school Rutgers in Camden. Graduate law school, got my first job in Philadelphia and had been in Philadelphia since. When we decided to launch FS, which was in 2006, 2007, we saw no need to go to New York. We wanted to really differentiate ourselves a little bit from Wall Street. There was a great labor force. We're close to [Wharton 00:08:02], we're close to Temple, close to Drexel. We've embraced being in Philadelphia. There is a nice financial services ecosystem in Philadelphia led by firms like Vanguard, and it's worked very well for FS.
Daniel Pietrzak:
And Josh, I had a little bit of almost the reverse. You're right, I went to undergrad at Lehigh and then went to business school at Wharton, but I grew up about 10 miles outside of center city, Philadelphia in Southern New Jersey, and then made my way to New York and I've split my career between New York and London. But as Michael knows, I like going to Philadelphia as much as possible. So it's a bonus to the partnership.
Josh King:
And what drew you into the world of finance in the first place coming out of your school?
Daniel Pietrzak:
No one in my family was in finance. No one of my family had actually gone to college before me. I was always interested in numbers and the market and my undergraduate degree was actually in accounting. Lehigh's business school is excellent, that was a great program they had. I felt the urge to go to New York and I was at Pricewaterhouse for probably about two and a half years, and then moved into structured finance, leverage finance roles 20 plus years ago and I've been in and around illiquid credit since. So it's been a good journey.
Josh King:
So guys, KKR Credit which is a division of KKR, was founded in 2004 and has grown into a more than $78 billion business with more than 1200 investment professionals. Dan, you joined the team at KKR in 2016 and serve as a partner and portfolio manager of the private credit committee. Can you walk us through how KKR approaches opportunities in private credit?
Daniel Pietrzak:
The credit side of the firm was started in 2004. I think we've historically been known as a private equity focused firm. We've grown meaningfully. I think the last public stats actually have us more than $150 billion of AUM, roughly 120 investment professionals across the platform. We've taken, I would say the foundations of the firm, which is being a good partner to those that you're invested with, the deep dive, due diligence style, really sort of getting into the weeds on these companies trying to create good outcomes for these companies that we lend to.
Daniel Pietrzak:
The culture of KKR is one where it really does operate as one firm. So we have the benefit of, while we do have a big credit business with that, well north of a hundred investment professionals, we actually have access to the rest of the firm as well. We're very focused on providing our clients and our investors the best possible risk adjusted returns that we can, and our partnership in this joint venture and this BDC is doing exactly the same.
Josh King:
The story of FS KKR Corp coming together is one of two big names realizing that the whole is better than the two. How did the joint venture come about?
Michael Forman:
So we launched our first non-traded BDC and we were the first firm to launch an entree to BDC. Back then there was about $20 billion in the BDC space. Now there's about 125 to 150 billion. So it's seen a lot of growth since we launched our first product and we were the first one to market with this retail non-traded BDC, and at the time we had a different partner. Blackstone was our partner through their credit franchise GSO Capital, and that was a very good partnership that lasted 10 years.
Michael Forman:
KKR with their partner, CNL was our largest competitor in the non-traded space, democratizing private credit. Then we competed for some number of years with KKR and their partner. We made a manager switch in 2017 and we had the luxury of looking at the marketplace and deciding who we thought should be the best partner for this rather large full of capital. At the time it was about half of 13 billion and after a very long process, selected KKR. They were the firm that we felt were most culturally sympathetic to the way we did business at FS, who viewed clients in the same way as putting clients first, culture and performance being very, very important.
Michael Forman:
We partnered together in 2018. They combined their credit franchise in the non-traded space called CCT with our FSIC franchise and together we became the SSK franchise now with around $16 billion of assets under management.
Josh King:
So for our listeners who aren't completely familiar with BDC, paint for them a picture of the type of customers that you serve.
Michael Forman:
The business development companies are [inaudible 00:12:43] vehicles. No difference in mutual funds that folks buy all the time or ETFS all regulated by the 1940 act. They're creatures of Congress, so they're creatures of statute. They were birthed in the 1980s as a way to facilitate the flow of capital to middle-market American companies, really the backbone of the US economy, middle-market companies. So we make loans to those middle-market companies and our investors are... own interests in the BDC, and invest with us principally to get a yield, to get yield on their investments.
Michael Forman:
So if you look at FSK today, someone could buy a share. We're listed on the New York Stock Exchange and earn about 11% interest return on their investment together with hopefully some long-term capital appreciation. So you have to look at this as being really serving two masters. We're a lender, no different than the bank is a lender to middle-market companies, and our clients are investors who buy shares of FSK and typically they buy that because interest rates are less than 1% and they can get a yield on their investment of north of 11% today.
Daniel Pietrzak:
[00:06:29]I mean, most of the listeners are probably more familiar with REITs than BDCs. If you just simplified it, REITs generally own buildings, receive rental payments and pay out the rental payments to the investors, to the owners of that REIT. We're lending money to companies or we're investing into companies. We're paying out as dividends as Michael said, those interests coupons that we receive. And because these are regulated vehicles, we're required to pay out at least 90% of our income. So this is a stable dividend paying stock that has, I think, a real attraction to that retail investor.
Josh King:
We are all familiar with REITs and we know that they sort of take the form often of office building, multifamily, et cetera. Just to drill in a little bit more about what the middle-market space looks like in terms of the companies that you are lending, I think you define it as between 25 million to 100 million in EBITDA at the time of investment with a median EBITDA ranging from between 62 million and 74 million. Generally, what kind of companies are those that are going to be working with FS KKR, and what opportunity do you see in the space sort of in the next few years ahead?
Daniel Pietrzak:
So these are private companies, so they're not publicly traded on any exchange. They're generally either owned by a financial sponsor. There's been a fair amount of money raised from middle-market private equity firms, or it might be founder owned. You are correct, we've defined the space as $25 million of net earnings or EBITDA up to 100$ million as the range. We've decided to focus on the upper end of that range. We actually feel like there's less competition there. We think there's a little bit less risk in these companies. They generally have better management teams. They generally have better governance, probably less customer supplier concentrations.
Daniel Pietrzak:
We're lending across industry. It's not an industry sort of specific portfolio. Any prudent manager in a credit vehicle, specifically a private credit vehicle, is going to look for diversification. So if we look at our entity today, roughly there are top 10 loans make up only about 20% of the portfolio. When you're opening, you mentioned we have a north of 150 loans in that portfolio. These are senior secured, top of the capital structure loans to private companies that just might be on the larger side of what you would call US middle-market.
Josh King:
I mentioned, before we got on the air, my familiarity with KKR over many, many years, working with Joe Plumeri at Willis Group, which was a KKR portfolio company. Frank Bisignano at First Data, which was a KKR portfolio company. So I'm sort of well indoctrinated that side of the business, KKR's ability to source structure, execute, and scale opportunities. It's always been a huge selling point. Can you walk us through the origination network and what sets KKR apart from other private capital shops and how FSK Capital leverages that network?
Daniel Pietrzak:
I think the lifeblood of these private credit businesses is origination. We've meaningfully grown our team to be a full service lender. We are not picking up the phone and getting called by someone and buying a loan that they've made. Right. We have individuals on the team who are actually out there covering other financial sponsors, covering companies, everything we're doing is privately originated and privately negotiated sort of transactions and I think that's important. We're focused on trying to see as many deals as possible so we can be as selective as possible where we're deploying capital.
Daniel Pietrzak:
I think on the overall KKR platform side, we saw the opportunity here, let's call it seven years ago, plus where we really believe we need to be a size and sort of scale player, not just on our capital base, but in our human capital footprint as well. Right. So that's what we've done. Now, in terms of how it interacts with FSK, and I think this is the most important piece. We have one origination team looking to go out and find transactions. We have one team that's doing the structuring and execution. We have one team that's doing the monitoring thereafter. Our institutional funds invest in the same deals, the same tranches as FSK does, right? The same loan that's available for the largest either sovereign wealth fund or state pension plans is also being... part of that loan is being allocated to or funded inside of FSK.
Daniel Pietrzak:
FSK gets the benefit of the entire KKR private credit platform, the entire KKR sort of broader credit platform and quite frankly, the whole firm.
Josh King:
We were talking a little bit before we got on air about what it's been like for you, Dan at KKR's headquarters in Hudson Yards. I'm curious, you mentioned these three teams that are part of FS KKR. I'm curious what the team behind the deals look like. What do you look for in terms of recruiting, training people, where do the best members of these teams come from, who's helping access the companies that you're looking at and working on the due diligence of the dealers?
Daniel Pietrzak:
You're correct. We've been in Hudson Yards for what I guess is six months now. I think it's been an amazing move for the firm. I think being in a new office building is always nice, but it's been a game changer I think for us to get everybody on floors that are just contiguous. At our last office building we were across three different elevator banks. We're generally focused on experienced hires. There will be a handful of folks right out of college that we will take, but we're generally looking for experienced hires. They're either coming out of leveraged finance or sponsor coverage groups at investment banks, some of the larger investment banks that might be out there or they're coming from other buy-side shops.
Daniel Pietrzak:
We've been focused on the last three, four years about what I call institutionalizing our platform, hiring more and more people with serious origination experience, hiring people with decades of structuring and underwriting experience, hiring folks with a legal background to serve as our kind of structuring and documentation heads, hiring folks with a fair amount of experience on distressed or troubled companies. We're lending money to these names that are not the largest companies in the world. From time to time there will be a challenge, right? We need to do all we can to get our money back.
Daniel Pietrzak:
We're focused on building out these blocks. We're focused on creating a diverse team and we're focused on giving our team an exceptional experience here, whether it's training for those that might be on the more junior side or just career opportunities as people go along. I think we've been pretty fortunate to have a really good retention rate over the last several years and we hope that continues.
Josh King:
You mentioned that sometimes some of these deals go a little sideways. The majority of securities in your portfolio are senior secured first and second lien opportunities. Why focus on the higher end of the capital structure?
Daniel Pietrzak:
A couple of reasons. I mean, we have different pools of capital who can focus on lower parts of the capital structure, right? If we think of inside of FSK, what we're trying to accomplish, we are trying to pay an attractive dividend yield. Michael mentioned the current 11% plus. We're trying to do that also at the same time of protecting capital, right? If you're lending to a company and you are the first lien and you were secured by essentially all of their assets, even if something does go wrong, maybe a supply line goes down. Obviously there's a lot of supply chain issues these days, maybe they lost a big customer. What [inaudible 00:21:50], you're generally still going to get your money back, right? That's not always the case. Just thinking about it, where's the best risk adjusted return. Where do we see that? I think in the top of the capital structure you see a lot of good value.
Daniel Pietrzak:
And then I would remember, because I think this is important. BDCs are entities that have the ability to use leverage, right? That leverage though is constrained. There's rules and regulation that constrain it to two to one. So $2 of debt for every $1 of equity. Now that said, most of the folks in the industry including us run that at much more prudent levels. We've got a target of one to 1.25, really kind of hovering around the one, 1.1 times. I think that's allowing you to get to those returns. With the benefit of the structure that we have inside of FSK, the reality is we don't need to go to the bottom of the capital structure to get these returns.
Josh King:
After the break, we're going to dive deeper into BDCs. That's coming up right after this.
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Josh King:
Back now with Michael Forman, chairman and CEO of FS KKR Capital Corp, and Dan Pietrzak, its co-president and chief investment officer. Before the break, Michael and Dan were explaining the beginnings of FS KKR, how the team evaluates new investments and democratizing access to private capital. So gentlemen, Congress passed the Small Business Investment Incentive Act in 1980 to boost middle-market businesses. Originally BDCs were designed to provide capital to borrowers who were considered too small or too risky by traditional lenders. The gap was expanded after the financial crisis as banks de-levered their balance sheets, and today the landscape has matured significantly.
Josh King:
One of the benefits of debt is that it prevents dilution of the owner's equity stake in a company. What are some of the other advantages of using private debt as opposed to private equity as a source of capital?
Daniel Pietrzak:
I think your dilution point is real. I think if you think about any optimized company's balance sheet, I think the use of debt or leverage so long as it's prudent in size, right? And probably prudent in its terms, allows companies to grow, right? They build additional... it could be factories, it could be production lines, it could allow for consolidation, right? A fair amount of the deal activity that we see is because of a strategic transaction, either consolidation or maybe a business being sold from one sponsor to the other. I think there's real benefits to the equity holders of these companies to have a debt solution.
Daniel Pietrzak:
Now, the one question we do get a fair amount is to compare private debt to more public debt instruments like syndicated loans or high yield bonds. Private credit solutions or private debt solutions are not necessarily for every company. Some companies are very large or very good credit quality and they quite frankly get debt at a cheaper price, but we are there to provide certainty of execution. Some people enjoy having only one lender or a small club, right? When a syndicated loan could have 50 investors in that. I think Michael touched on this in terms of how we've evolved here.
Daniel Pietrzak:
I think if you asked a lot of people in the great financial crisis, '07, '08, '09, if private credit or private debt was here to stay, they probably would've thought it would have been a trade or not there in a handful of years. I think the reality is it's proven itself just to be another lending alternative, and a company can access more of a public debt instrument or it can come to the private market. So there's pros and cons of each and it's just another financing solution.
Josh King:
So a little more than five weeks ago, June 21st, 2021. I'm coming to work here at the New York Stock Exchange, look up at our columns, our beautiful facade, see that huge banner of FS KKR. It was our opportunity to host both the team from FS Investments and KKR at the big board to ring our opening bell celebrating this merger of FSK and FSKR which you had announced five days earlier. Why was the merger so important and how does a single BDC continue to drive value for shareholders?
Michael Forman:
We listed the first non-traded BDC in 2014, FSIC on the New York Stock Exchange. About three years thereafter KKR listed their BDC called CCT also on the New York Stock Exchange. KKR had a second version of CCT of another offering called CCT II, and we had three more BDCs, FSIC II, FSIC III and FSIC IV. So when we came together in 2018, we actually had six different vehicles, two of them public, four of them that hadn't even gone public yet. And over the course of the next three years, we set about the very careful process of combining these vehicles. We believe scale really matters in this business, and this makes us one of the largest BDC. So we merged FSK and FSKR together, and now we're one BDC. We have scale. We've had terrific performance over the last few quarters and we think we have a very bright future going forward.
Josh King:
So the late David Swenson, who you probably have followed in your past, the chief investment officer of Yale, popularized the endowment model as an investing philosophy. One of his trademarks was this heavier exposure to private capital, a trend that's become increasingly mainstream. How should investors think about private credit as part of their portfolio?
Daniel Pietrzak:
Well, I think they think about it along the lines of that, it is another form of private debt, another form of overall sort of private capital. I think you think about and investors thinking about their own personal portfolio construction, right? Investing in credit is less risky than investing in equities. This is on the institutional side, then we'll get to the retail side. Most of the institutional investors which have fueled the growth of the overall private credit space were simply looking at it as the opportunity to get additional yield or additional premium for investing in more illiquid assets, right? So most people call it an illiquidity premium. It made a lot of sense for them to rotate out of either high yield bonds or regular way loans, or quite frankly think about [inaudible 00:29:28] out of government bonds. And just more and more pressure was applied to do that as REITs continued to go down. You think of large institutional investors out there need a yield minimum to get to the other side.
Daniel Pietrzak:
Now, one of the things that I think is really interesting about the BDC as a product is you're getting the benefit of gaining access to that illiquidity premium. You're getting access to the same loans as I said before that are going into the institutional funds. We always like to think that we're probably getting paid two to three percentage points wide of just the regular way syndicated loan. So you're getting the benefit of that but you're buying shares in a BDC that is a publicly traded stock that is liquid while the loans themselves might not be liquid, you have the ability to buy or sell FSK.
Daniel Pietrzak:
You go back to what we talked about before, an 11 plus percent dividend yield today, and the REIT [inaudible 00:30:19] wind is just really attractive to most retail investors.
Josh King:
Investors are paying so much more attention these days to environmental, social and governance considerations, ESG guys. Integrating ESG management into the research and ongoing due diligence is becoming a lot more common among private capital investors, but it's not without its challenges. Can you speak about how FSK KKR approaches ESG and incorporates ESG factors into the credit decision making process?
Daniel Pietrzak:
It is very important. It's something that we spend a lot of time on. As a firm it is deeply embedded in our investing process. Now, think about it in sort of two ways. We are lending money to companies so we can not always dictate the outcome of how they may do things. From our perspective a lot of what we're doing is the upfront work, right? We have a list called the gating items lists where there's just industries we're not going to lend to. Even though we don't own the company, we're of the opinion we just don't want to be involved in those industries.
Daniel Pietrzak:
I think that's kind of first and foremost, and then we spend a lot of time tracking company performance. We do give companies that we lend to, even though we're not the equity owner, access to the entire KKR ecosystem. We can help them make their companies better. We can provide them advice. We can provide that access. So on our side, a lot of it is upfront and make sure we're not involved in industries or sectors or names or with individuals that we don't want to be involved with. And then it's doing what we can to help on the other side. But it's an important topic for us for sure at the firm.
Josh King:
So the last 12 months that we've all been through, call it last 16 months, incredibly difficult period, saw economic headwinds that no one could have predicted and so much uncertainty. At the beginning of the pandemic, some media folks were heralding the end of BDCs, but FS KKR is a real counterpoint to those arguments. You've rebounded spectacularly. If I've got my math right, there've been more than $851 million in new investments the first quarter of this year alone. Can you walk us through your strategy from last spring and summer, and how you approached investing during such a distressed period for private investors?
Michael Forman:
I would say the pandemic in some respects had the impact of pulling forward issues that one might've had in their portfolio. If companies were struggling, they probably struggled worse during the pandemic and we all know that there were winners and losers during that period. I think all of us were time-tested particularly during that end of the first quarter, beginning of the second quarter of 2020, the team functioned really well. While we had some issues in the portfolio, the portfolio has recovered and we've posted very good performance over the last few quarters and the originations have continued to pick up.
Michael Forman:
It was nice to see how the portfolio and the team would perform, and the management teams of our portfolio companies would perform through the pandemic, would perform through crisis and it was great to see the recovery that we've had over the last few quarters.
Daniel Pietrzak:
Yeah, and just to add to that. I think we went into March of 2020 being fairly cautious on a new investment side, right? We were underwriting though, when was a recession going to come. We weren't necessarily underwriting a global pandemic, but I think it did allow us to be backing good solid companies, in our mind companies that would get to the other side. It was interesting. You did have very good companies that were performing very well going to, some of them zero revenues essentially overnight. We were very focused as you would imagine on risk as a management team, we were having a daily call. I still remember this three o'clock every day for probably four or five months. We were thinking about the entity itself and FSK and how we were managing liquidity, but we're also thinking about individual loans.
Daniel Pietrzak:
We wanted to be a responsible lender, right? Some people needed certain either waivers or amendments to their loans. I think we wanted to be sympathetic to that. That said, we are a debt provider. So if somebody wanted a meaningful change, we were probably going to ask them to put in additional equity dollars to make our loan position a little less risky, but you're right. It's been a whirlwind 16 months. I think most of us, if you were sitting here in the middle of April, you would not have expected the rebound that we've seen here. Obviously the government stimulus has worked. You talked about Hudson Yards before. There wasn't a lot of people down here in March, pretty crowded down here right now. It feels like some pretty good economic tailwinds. And we've probably never been more active on a new business side.
Josh King:
The FT reported that government bond yields have reversed their steady climb and have plunged back to their lowest numbers since February, companies continuing to take advantage of cheap credit and are using it to finance investments that run the gamut from capital expenditures to refinancing opportunities. How does this low interest environment affect the opportunities available in the private markets?
Daniel Pietrzak:
Obviously it has allowed companies to use debt capital to sort of grow, right. We've seen in an environment where in these markets and going back almost to the yield points from before, there is a hunt for yield, so the cost of debt has also probably just gone down in terms of a spread perspective. I think you can probably get into an inflation conversation on the other side of this as well. But I think we do probably foresee rates low for an extended period of time.
Josh King:
The Fed has recently held its open market committee meeting officials beginning to discuss whether they should taper support for the US economy but have also left interest rates for now unchanged. Pundits and economists have been weighing on if the inflation we've seen recently is either transitory or going to be with us for the long-term. How are you thinking about the debate and how are you positioning the portfolio as a result?
Michael Forman:
One has to recognize that our loans are floating rate loans. So we've done fine in a historically low interest rate environment. We're the perfect hedge if one thinks interest rates are going up. We will do better in a rising interest rate environment. So our investors, the BDC investors are protected, but as it relates to the portfolio company [inaudible 00:36:48], Dan talks about the impact on the portfolio [inaudible 00:36:51].
Daniel Pietrzak:
We do see some things inside of the portfolio companies that does have us thinking about kind of the broad topic of inflation. Wage inflation has been a real topic. That can definitely weigh on financial results. It's been an interesting reporting season for companies for say the last 18 months, right? They're trying to figure out what is sustainable revenue, what was a COVID blip or what was the COVID maybe sort of bump to try to get to what the forward is. I think we feel pretty good though that inflation will be pretty muted over the near term. I think that said, I think we're happy to construct our portfolios with that risk in mind.
Daniel Pietrzak:
To Michael's point, FSK is getting the benefit of floating rate loans. I think where we can get it we're looking for access to real security packages, whether it might be secured by real estate, whether it might be secured by equipment or other things that will get the benefits in a rising inflation environment. It's definitely on the list of risks that we're mindful about, but I think we feel pretty confident that the macro just tailwinds over the next probably several years will be the more important, so part of that.
Josh King:
Dan, you recently wrote an article on KKR's website based on asset based finance, the lifeblood to millions of businesses and consumers. You commented that over the next several years the consumer and SME segments of private asset based finance is expected to grow more than 50% to 6.9 trillion. Can you walk us through how you and KKR are looking to capitalize on this opportunity in the market?
Daniel Pietrzak:
If you take one step back, the overall business here at KKR is called private credit. We think about that in sort of two forms. One is corporate, that's lending money to companies, firstly, and secondly [inaudible 00:38:33]. And the other piece is, as you mentioned, asset based finance. Most people when they originally were thinking about private credit, they just assumed we were talking about the corporate part of it, but the reality is that asset based finance market today is $4.5 trillion to your point, in our estimates going up to seven.
Daniel Pietrzak:
There's a couple of sort of parts there. One is, that part of the market was severely impacted from the financial crisis. If you look at investment banks, they were the main players in that space. If you look a lot of the deals that we've done over the last three, four or five years, it was banks doing them. If you think about though, the rules and regulatory changes that happen, you look at Volcker, you look at risk retention rules, you looked at risk appetites of banks, they fell away. So somebody needed to come in there and fill the void. And then that was exacerbated as well by, a fair amount of hedge funds were involved in the space, but they realized that managing funds with either daily or monthly liquidity and buying long duration assets usually is a recipe for bad things to happen at some point.
Daniel Pietrzak:
We wanted to come in and target that space. I think we've taken a thoughtful, but yet broad approach to it. It is a business that we're focused on globally, and probably really means the US and Western Europe it's focused on consumer mortgages, hard assets, secured non-bank lending contractual cash flows. We see a real sort of tailwind there from not just the banks continuing to take a step back from a lot of that as it is not that attractive from their own capital models. But with things like technology the ability of consumer finance companies, or auto companies, or what it might need to provide faster and greater access to capital to then like consumers, you see a fair amount of growth there.
Daniel Pietrzak:
We've raised dedicated capital to focus on that. We've made this a real portfolio construction item inside of FSK. It's just over 10% of the portfolio right now. That's probably where we'll get to in terms of a maximum number. We think it is really just the most interesting risk adjusted return part of the market today. There's not a lot of scale of competition and it's been a better investing environment post COVID.
Josh King:
What should we make an appointment for to see for the rest of 2021, 2022 for FSK. Michael, Dan, your final thoughts.
Daniel Pietrzak:
As Michael had mentioned before, I think we feel really good about our market position, right? Just where we're able to lend money to these companies. I think we feel really good about the existing portfolio. This merger was a big deal. Josh, to your point it was very exciting for us to be down at the exchange, ringing the bell. We have a simpler story now with one vehicle instead of two. As much as we all enjoy two earnings calls, I think one will be a little bit more fun for us. And then we have to keep on doing what we've been doing. We've put up a bunch of good quarters. If you look at some of our recent information inside the BDC platform in the last three years we've done almost $10, $11 billion of loans. We've had really good financial performance on those loans, and we want to continue to rotate the portfolio to more and more originated product from this advisor where I think we feel really good for what the rest of '21 and '22 hold.
Michael Forman:
Yeah, I would add to that. Just something kind of the inside baseball, the BDCs. We came together in 2018. Each of the franchises had struggled a little bit. Those portfolios have been very much cleaned up. The performance of the last few quarters has been quite good. The stock performance of last few quarters has been quite good. That being said, we still trade at a lower price to book, which is the metric that one measures BDCs than our peers. So we think that FSK is a really good risk adjusted return both in terms of getting today an 11% yield as well as the likelihood or the ability to participate in upside as we believe the stock price trades closer to book over time.
Michael Forman:
As I've said a couple of times, we're really excited about the future. The partnership between FS and KKR is definitely a one plus one equals three partnership and we've proven it by the performance we've delivered over the last few quarters.
Josh King:
One plus one equals three. Pretty much sums it up in one quick sentence guys. Thank you so much for joining us inside the ICE House.
Daniel Pietrzak:
Thank you.
Michael Forman:
Thank you.
Josh King:
And that's our conversation for this week. Our guests were Daniel Pietrzak and Michael Forman of FS KKR Capital Corporation. If you liked what you heard, please rate us on iTunes so other folks know where to find us. And if you've got a comment or question you'd like one of our experts to tackle on a future show, email us at [email protected] or tweet at us @ICEHousePodcast. Our show is produced by [Stephan Caprile 00:43:36] with production assistance from Pete Asch, [Ian Wolf 00:43:39], and [Ken Abel 00:43:40]. I'm Josh King, your host signing off from the library of the New York Stock Exchange. Thanks for listening. Talk to you next week.
Speaker 1:
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