SOR - NYSE

Hello, and welcome to today's webcast. My name is Sarah, and I will be your event specialist today. [Operator Instructions] Please note that today's webcast is being recorded. [Operator Instructions] It is now my pleasure to turn today's program over to Ryan Leggio. Ryan, the floor is yours.

Thanks so much, and we apologize for the brief delay, everyone. Thank you for taking the time to join today's call as we provide a fund and portfolio update and address the pre-submitted questions. I want to give a special welcome to the many newer shareholders who are joining us on the call today. In just a moment, you will hear from Steven Romick. Steven joined FPA in 1996 as a managing partner and has been a portfolio manager of the fund since December 2015. I want to mention that we continue to be excited about Source's long-term prospects and hope you share that sentiment after today's webcast. We made significant progress on the goals we laid out on our last webcast a little less than a year ago and believe we are well positioned to make further progress this year. As a reminder, we will not be taking live questions during the webcast but are more than happy to connect with any current or potential shareholders in the coming days, should you have follow-up questions or comments. As a disclosure requirement, we show the slide of the trailing performance as of December 31, 2021. Additional details on the fund, including performance, holdings and commentaries, can be found in the Source Capital section of FPA's website, fpa.com. I would like to point out that as of January 31, 2022, the fund is 4-star rated by Morningstar overall and over the past 3 years due to the fund's risk-adjusted performance versus its Morningstar allocation peers. We believe this strategy is well positioned to continue to deliver attractive risk-adjusted results over the long term. It is my pleasure at this time to turn over the call to Steven Romick. Steven, over to you.

Thank you so much, Ryan, and thank you for taking the time to listen to this brief update on FPA's Source Capital closed-end fund. Source's portfolio management team is working to achieve a balance with capital appreciation and income while being mindful of the downside, that is a permanent impairment of capital. The distribution yield remains attractive with a 6.42% unlevered distribution rate based on the fund's year-end 2021 closing market price. Our goal is to continue to manage distributable income to a level that delivers a competitive risk-adjusted distributable yield. As a statement of our commitment to Source Capital, FPA Partners and employees increased their investment in the fund last year and now own shares valued approximately $4 million. The fund's closing structure, with its more stable capital base, allows us to take a longer-term view and invest in certain less liquid opportunities in the service of our goals. Private credit is an example of that. And the fund's exposure to private loans continues to increase, ending 2021 with almost 25% exposure, if we were to include the capital commitments to fund investments. That's more than double the 11.7% at year-end 2020. The funded exposure ended 2021 at 14.6%, up from 7.5% at the end of the previous year. We have underwritten the fund's private credit exposure to a targeted yield of at least 8%, allocated to a mix of private partnerships and individual loans. The distributable yield should benefit as the private partnerships get more invested and would be further enhanced should we successfully find additional private loan opportunities, but we haven't recently found the risk reward of the recent deals we evaluate to be attractive. The actions taken to date have allowed Source Capital's discount to narrow. After trading as low as 3.8% discount during 2021, its lowest discounts in over a decade, it ended the year at a 5.47% discount, down from 11.96% at year-end 2020. To the extent the discount widened significantly in the future, we intend to opportunistically repurchase the fund's own shares. Hopefully, these actions, among others, coupled with successful execution of our strategy over time, will continue to allow the fund's discount to trade closer to NAV over full market cycles. The ability to invest in both public and private credit as well as equities provides to fund an unusually wide range of securities from which it shift that can help us achieve our objective. That has been aided by opportunistic share repurchases and will hopefully be further enhanced by the addition of leverage as the fund gets more invested in credit. FPA's fixed income team continues to migrate the yield of its public credit book higher, and we hope for that to continue, market permitting. Tom Atteberry, the Co-Head of the Fixed Income team, will be transitioning to a senior adviser role midyear, but the product is in excellent hands with Abhi Patwardhan continuing to help. Not much else has changed. The Board of Source Capital has approved to maintain a monthly fund distributions at the current rate of $0.185 per share through May 2022. This equates to an annualized 6.42% unlevered distribution rate, as previously stated. As previously reported, but worth repeating, if the fund's discount to NAV, net asset value, exceeds 10%, then the fund will conduct a tender for 10% of its shares outstanding at 98% of NAV. This commitment stands for 2022 and 2023. Periodic share repurchases and the eventual use of the fund's credit line as a function of opportunity should also benefit shareholders. Here is a snapshot of the portfolio at year-end as compared to a global balance benchmark. Source Capital ended 2021 with 62% in equities, 33% in credit, and the balance of about 5% in cash. Thanks to the fund's exposure to higher-yielding private and public credit, we estimate that its gross yield run rate is approximately 3.25%, higher by about 1.25% from the end of 2020 and almost 2x the yield of the global balance index exhibited here. We hope to continue to increase the fund's yield as we further increase the yield of the fund's credit book, draw down cash and ultimately add leverage via the credit line that was established last year. That's the end of a very brief prepared remarks. We are always available here to answer your questions. We've asked in advance for people to submit questions, and there's really only one that come over the [ transom ] here in advance.

So this question, there's actually a couple of them tied to the same subject, which regards to fund's SPAC exposure. Just please address the SPAC investment strategy in more detail on how successful this has been so far for the portfolio. Many SPACs are selling a fraction to the original market prices, so we're interested in how the investment team has navigated the capital destruction up till now. While it's important to note that those SPACs are trading a fraction, the prices happened after the announced deals for the most part. So that hasn't been really -- that has not been part of our strategy. For those unfamiliar with our investment in these what's known as special SPACs, that are special purpose acquisition companies, we assembled a basket that was around 7% of the fund at year-end. We bought these SPACs roughly at or below their trust value before a deal has been announced, which provides us with a free option in the event that other investors take a favorable view if and when the SPAC announces its targeted acquisition. If the market takes a [ dim ] view of the proposed transaction, we can simply exercise the redemption rights to receive the trust value of the shares in cash. Quite often, we're also buying a share in a SPAC with a unit for warrants attached. In this instance, we have the opportunity to retain the warrants and participate in the future upside of a SPAC, even if we choose to sell or redeem the shares prior to the closing of the actual acquisition. It's a great setup. Heads, we win, and tails, we don't lose. We look at SPAC as a high-yield substitute but with a higher expected yield and less downside risk, particularly given that high-yield bonds today in the U.S. are in the low 4s before any level of defaults. And in Europe, they're just in the low 2s. This trade has worked within expectation, thus far. In 2021, Source's SPAC bucket contributed 0.6% to the fund's gross return. A back-of-the-envelope calculation, given the average 6.8% weight during the year, suggests around 8.8% return for the SPACs in the aggregate, although it's not something we've specifically calculated. Ryan, let me turn the call back to you.

Thanks, Steven. And again, thank you, everyone, for joining the call. I just want to emphasize one point that Steven made, which is, if you have any additional questions or if we missed your question, please reach out to your FPA relationship representative or you can reach out to me directly. And my contact information is both on the screen in front of you and on our website. With that, we thank everyone for joining our brief Source webcast today and turn the call back over to the moderator for closing disclosures. Thank you.