SEC Form N-CSR filed by First Trust Senior Floating Rate Income Fund II

First Trust

Senior Floating Rate Income Fund II (FCT)

Annual Report

For the Year Ended

May 31, 2023

 

 

 

Table of Contents

Shareholder Letter

First Trust Senior Floating Rate Income Fund II (FCT)

Annual Letter from the Chairman and CEO

May 31, 2023

Dear Shareholders,

First Trust is pleased to provide you with the annual report for the First Trust Senior Floating Rate Income Fund II (the “Fund”), which contains detailed information about the Fund for the twelve months ended May 31, 2023.

Between developments at the Federal Reserve (the “Fed”), stock market returns, and the myriad of economic data that we have processed here at First Trust over the past six months, I have no shortage of developments to share with you. Let’s begin with the Fed. In a widely expected move, the Fed voted to keep the Federal Funds target rate unchanged at their meeting on June 14, 2023, ending a streak of ten straight interest rate increases over the past 15 months. That said, the Fed also hinted that at least two more interest rate hikes are likely if they are going to bring inflation down to their desired level of 2.0%. Inflation, as measured by the 12-month rate of change in the Consumer Price Index, stood at 4.0% as of June 20, 2023, well below its most recent high of 9.1% in June 2022. Despite tighter monetary policy, the U.S. added 1.57 million jobs this year, a 2.5% annualized growth rate, and real gross domestic product rose at a 1.3% annualized rate in the first quarter of 2023, according to Brian Wesbury, Chief Economist at First Trust.

Driven by developments in Artificial Intelligence, the S&P 500^® Index has had an exceptional start to the year, posting a total return of 15.8% for the year-to-date period ended June 16, 2023. The tech-centric Nasdaq-100 Index^® has seen a staggering 38.5% total return over the same period. When the stock market increases by 20% or more from its most recent low, it is often referred to as a “bull market.” On June 8, 2023, the S&P 500^® Index closed at 4,293.93, 20.04% above its most recent low of 3,577.03 (which occurred on October 12, 2022). We’ll leave it to the pundits to debate how long this bull market will last, but history shows that bull markets typically fare better when there are longer pauses between interest rate hikes, according to Bloomberg.

Meanwhile, the effects of higher inflation and the Fed’s restrictive monetary policy appear to be taking a toll on the U.S. consumer. U.S. household debt reached a record $17.05 trillion in the first quarter of 2023. Furthermore, total balances for U.S. credit card holders did not decline in the first quarter of the year, marking the first time that has happened since 2001. ATTOM, a property data analytics company, reported that U.S. foreclosure activity (including default notices) for the month of May 2023 increased by 14%, to 35,195 properties, from the same period a year ago, according to its own release. That said, not all the news is negative. The Fed reported that the net worth of U.S. households stood at $148.8 trillion at the end of the first quarter of 2023, up $3 trillion from when it stood at $145.8 trillion at the end of the fourth quarter of 2022, according to MarketWatch. Most of the increase in household net worth can be attributed to the rebound in the stock market. The value of equities held by U.S. households jumped by $2.4 trillion in the first quarter of 2023. As the great economist Milton Friedman famously said, the effects of monetary policy are long and variable. In my opinion, time will reveal the full impact of the tighter economic policies of the past 15 months on the consumer and the U.S. economy.

Thank you for giving First Trust the opportunity to play a role in your financial future. We value our relationship with you and will report on the Fund again in six months.

Sincerely,

James A. Bowen

Chairman of the Board of Trustees

Chief Executive Officer of First Trust Advisors L.P.

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Table of Contents

First Trust Senior Floating Rate Income Fund II (FCT)

“AT A GLANCE”

As of May 31, 2023 (Unaudited)

Fund Statistics
Symbol on New York Stock Exchange	FCT
Common Share Price	$9.56
Common Share Net Asset Value (“NAV”)	$10.96
Premium (Discount) to NAV	(12.77)%
Net Assets Applicable to Common Shares	$284,657,340
Current Monthly Distribution per Common Share(1)	$0.0920
Current Annualized Distribution per Common Share	$1.1040
Current Distribution Rate on Common Share Price(2)	11.55%
Current Distribution Rate on NAV(2)	10.07%

Common Share Price & NAV (weekly closing price)

  

 

Performance
		Average Annual Total Returns
	1 Year Ended 5/31/23	5 Years Ended 5/31/23	10 Years Ended 5/31/23	Inception (5/25/04) to 5/31/23
Fund Performance(3)
NAV(4)	6.01%	3.42%	4.16%	4.12%
Market Value	-4.14%	2.22%	2.59%	3.13%
Index Performance
Morningstar® LSTA® US Leveraged Loan Index(5)	5.91%	3.69%	3.77%	4.51%

(1)	Most recent distribution paid through May 31, 2023. Subject to change in the future.

(2)	Distribution rates are calculated by annualizing the most recent distribution paid through the report date and then dividing by Common Share Price or NAV, as applicable, as of May 31, 2023. Subject to change in the future.

(3)

Total return is based on the combination of reinvested dividend, capital gain and return of capital distributions, if any, at prices obtained by the Dividend Reinvestment Plan and changes in NAV per share for NAV returns and changes in Common Share Price for market value returns. From inception to October 12, 2010, Four Corners Capital Management, LLC served as the Fund’s sub-advisor. Effective October 12, 2010, the Leveraged Finance Team of First Trust Advisors L.P. assumed the day-to-day responsibility for management of the Fund’s portfolio. Total returns do not reflect sales load and are not annualized for periods of less than one year. Past performance is not indicative of future results.

(4)

On January 3, 2023, the fair value methodology used to value the senior loan investments held by the Fund was changed. Prior to that date, the senior loans were valued using the bid side price provided by a pricing service. After such date, the senior loans were valued using the midpoint between the bid and ask price provided by a pricing service. The change in the Fund’s fair value methodology on January 3, 2023, resulted in a one-time increase in the Fund’s NAV of approximately $0.046 per share on that date, which represented a positive impact on the Fund’s performance of 0.42%. Without the change to the pricing methodology, the performance of the Fund on a NAV basis would have been 5.53%, 3.32%, 4.11%, and 4.10%, in the one-year, five-year, ten-year and since inception periods ended May 31, 2023, respectively.

(5)	Formerly, S&P/LSTA Leveraged Loan Index.

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Table of Contents

Portfolio Commentary (Continued)

First Trust Senior Floating Rate Income Fund II (FCT)

Annual Report

May 31, 2023 (Unaudited)

Performance Analysis

		Average Annual Total Returns
	1 Year Ended 5/31/23	5 Years Ended 5/31/23	10 Years Ended 5/31/23	Inception (5/25/04) to 5/31/23
Fund Performance3
NAV(4)	6.01%	3.42%	4.16%	4.12%
Market Value	-4.14%	2.22%	2.59%	3.13%
Index Performance
Morningstar® LSTA® US Leveraged Loan Index(5)	5.91%	3.69%	3.77%	4.51%

 
Performance figures assume reinvestment of all distributions and do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. An index is a statistical composite that tracks a specified financial market or sector. Unlike the Fund, the index does not actually hold a portfolio of securities and therefore does not incur the expenses incurred by the Fund. These expenses negatively impact the performance of the Fund. The Fund’s past performance does not predict future performance. 

During the 12-month period ended May 31, 2023, the Fund returned⁽³⁾ 6.01%, based on net asset value (“NAV”) and -4.14%, based on market price. This compares to the Morningstar^® LSTA^® US Leveraged Loan Index’s (the “Index”) return of 5.91% over the same period.

The Fund’s discount to NAV widened 923 bps from one year ago. At the start of the period, the Fund’s market price traded at a -3.54% discount to NAV; by the end of the period, the Fund’s market price traded at a -12.77% discount to NAV.

The primary contributors to performance relative to the Index over the LTM period were the Fund’s security selection and overweight allocation within the Software industry and the Insurance industry.  Within the Software industry, the Fund’s overweight positions in a digital advertising company and companies that provide application software drove performance.  Within the Insurance industry, the Fund benefited from overweight positions in multiple insurance brokerage companies.  Additionally, the Fund’s use of leverage enhanced performance as senior loans generated positive returns in the LTM period.  The Fund strategically reduced leverage from 28.31% to 14.43% by selling into strength as the Index returned 5.91% in the LTM period.

(3)

Total return is based on the combination of reinvested divided, capital gain, and return of capital distribution, if any, at prices obtained by the Dividend Reinvestment Plan and changes in NAV per Common Share for NAV returns and changes in Common Share price for market value returns. Total returns do not reflect sales load and are not annualized for period of less than one year.

(4)

On January 3, 2023, the fair value methodology used to value the senior loan investments held by the Fund was changed. Prior to that date, the senior loans were valued using the bid side price provided by a pricing service. After such date, the senior loans were valued using the midpoint between the bid and ask price provided by a pricing service. The change in the Fund’s fair value methodology on January 3, 2023, resulted in a one-time increase in the Fund’s NAV of approximately $0.046 per share on that date, which represented a positive impact on the Fund’s performance of 0.42%. Without the change to the pricing methodology, the performance of the Fund on a NAV basis would have been 5.53%, 3.32%, 4.11%, and 4.10%, in the one-year, five-year, ten-year and since inception periods ended May 31, 2023, respectively.

(5)	Formerly, S&P/LSTA Leveraged Loan Index.

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Report of Independent Registered Public Accounting Firm

To the Shareholders and the Board of Trustees of First Trust Senior Floating Rate Income Fund II:

Opinion on the Financial Statements and Financial Highlights

We have audited the accompanying statement of assets and liabilities of First Trust Senior Floating Rate Income Fund II (the “Fund”), including the portfolio of investments, as of May 31, 2023, the related statements of operations and cash flows for the year then ended, the statements of changes in net assets for each of the two years in the period then ended, the financial highlights for each of the five years in the period then ended, and the related notes. In our opinion, the financial statements and financial highlights present fairly, in all material respects, the financial position of the Fund as of May 31, 2023, and the results of its operations and its cash flows for the year then ended, the changes in its net assets for each of the two years in the period then ended, and the financial highlights for each of the five years in the period then ended in conformity with accounting principles generally accepted in the United States of America.

Basis for Opinion

These financial statements and financial highlights are the responsibility of the Fund’s management. Our responsibility is to express an opinion on the Fund’s financial statements and financial highlights based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Fund in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement, whether due to error or fraud. The Fund is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Fund’s internal control over financial reporting. Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the financial statements and financial highlights, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements and financial highlights. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and financial highlights. Our procedures included confirmation of securities owned as of May 31, 2023, by correspondence with the custodian, agent banks and brokers; when replies were not received from agent banks and brokers, we performed other auditing procedures. We believe that our audits provide a reasonable basis for our opinion.

Chicago, Illinois

July 25, 2023

We have served as the auditor of one or more First Trust investment companies since 2001.

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INVESTMENT ADVISOR

First Trust Advisors L.P.

120 East Liberty Drive, Suite 400

Wheaton, IL 60187

TRANSFER AGENT

Computershare, Inc.

P.O. Box 505000

Louisville, KY 40233

ADMINISTRATOR,
FUND ACCOUNTANT, AND
CUSTODIAN

The Bank of New York Mellon

240 Greenwich Street

New York, NY 10286

INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM

Deloitte & Touche LLP

111 South Wacker Drive

Chicago, IL 60606

LEGAL COUNSEL

Chapman and Cutler LLP

320 South Canal Street

Chicago, IL 60606

Item 2. Code of Ethics.

Item 3. Audit Committee Financial Expert.

As of the end of the period covered by the report, the registrant’s board of trustees has determined that Thomas R. Kadlec and Robert F. Keith are qualified to serve as audit committee financial experts serving on its audit committee and that each of them is “independent,” as defined by Item 3 of Form N-CSR.

Item 4. Principal Accountant Fees and Services.

(a) AUDIT FEES (REGISTRANT) -- The aggregate fees billed for each of the last two fiscal years for professional services rendered by the principal accountant for the audit of the registrant’s annual financial statements or services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements were $59,000 for 2022 and $59,000 for 2023.

(b) AUDIT-RELATED FEES (REGISTRANT) -- The aggregate fees billed in each of the last two fiscal years for assurance and related services by the principal accountant that are reasonably related to the performance of the audit of the registrant’s financial statements and are not reported under paragraph (a) of this Item were $0 for 2022 and $0 for 2023.

AUDIT-RELATED FEES (INVESTMENT ADVISOR) -- The aggregate fees billed in each of the last two fiscal years of the registrant for assurance and related services by the principal accountant that are reasonably related to the performance of the audit of the registrant’s financial statements and are not reported under paragraph (a) of this Item were $0 for 2022 and $0 for 2023.

(c) TAX FEES (REGISTRANT) -- The aggregate fees billed in each of the last two fiscal years for professional services rendered by the principal accountant for tax compliance, tax advice, and tax planning to the registrant were $21,515 for 2022 and $14,070 for 2023. These fees were for tax consultation and/or tax return preparation and professional services rendered for PFIC (Passive Foreign Investment Company) Identification Services.

TAX FEES (INVESTMENT ADVISOR) -- The aggregate fees billed in each of the last two fiscal years of the registrant for professional services rendered by the principal accountant for tax compliance, tax advice, and tax planning to the registrant’s advisor were $0 for 2022 and $0 for 2023.

(d) ALL OTHER FEES (REGISTRANT) -- The aggregate fees billed in each of the last two fiscal years for products and services provided by the principal accountant to the registrant, other than the services reported in paragraphs (a) through (c) of this Item were $0 for 2022 and $0 for 2023.

ALL OTHER FEES (INVESTMENT ADVISOR) -- The aggregate fees billed in each of the last two fiscal years for products and services provided by the principal accountant to the registrant’s investment advisor, other than services reported in paragraphs (a) through (c) of this Item were $0 for 2022 and $0 for 2023.

Pursuant to its charter and its Audit and Non-Audit Services Pre-Approval Policy, the Audit Committee (the “Committee”) is responsible for the pre-approval of all audit services and permitted non-audit services (including the fees and terms thereof) to be performed for the registrant by its independent auditors. The Chairman of the Committee is authorized to give such pre-approvals on behalf of the Committee up to $25,000 and report any such pre-approval to the full Committee.

The Committee is also responsible for the pre-approval of the independent auditor’s engagements for non-audit services with the registrant’s advisor (not including a sub-advisor whose role is primarily portfolio management and is sub-contracted or overseen by another investment advisor) and any entity controlling, controlled by or under common control with the investment advisor that provides ongoing services to the registrant, if the engagement relates directly to the operations and financial reporting of the registrant, subject to the de minimis exceptions for non-audit services described in Rule 2-01 of Regulation S-X. If the independent auditor has provided non-audit services to the registrant’s advisor (other than any sub-advisor whose role is primarily portfolio management and is sub-contracted with or overseen by another investment advisor) and any entity controlling, controlled by or under common control with the investment advisor that provides ongoing services to the registrant that were not pre-approved pursuant to its policies, the Committee will consider whether the provision of such non-audit services is compatible with the auditor’s independence.

Item 5. Audit Committee of Listed Registrants.

Item 6. Investments.

Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End Management Investment Companies.

The Proxy Voting Policies are attached herewith.

Item 8. Portfolio Managers of Closed-End Management Investment Companies.

(a)(1) Identification of Portfolio Manager(s) or Management Team Members and Description of Role of Portfolio Manager(s) or Management Team Members

Information provided as of August 4, 2023

The First Trust Advisors Leveraged Finance Investment team manages a portfolio comprised primarily of U.S. dollar denominated, senior secured floating-rate loans. The Portfolio Managers are responsible for directing the investment activities within the Fund. William Housey is the Senior Portfolio Manager and has primary responsibility for investment decisions. Jeffrey Scott assists Mr. Housey and there are also Senior Credit Analysts assigned to certain industries. The Portfolio Managers are supported in their portfolio management activities by the First Trust Advisors Leveraged Finance investment team, including a team of credit analysts, designated traders, and operations personnel. Senior Credit Analysts are assigned industries and Associate Credit Analysts support the Senior Credit Analysts. All credit analysts, operations personnel and portfolio managers report to Mr. Housey.

William Housey, CFA

Managing Director of Fixed Income, Senior Portfolio Manager

Mr. Housey joined First Trust Advisors L.P. in June 2010 as the Senior Portfolio Manager for the Leveraged Finance Investment Team and has 27 years of investment experience.  Mr. Housey is a Managing Director of Fixed Income and is also a member of the First Trust Strategic Model Investment Committee and the Fixed Income Sub-Committee.  Prior to joining First Trust, Mr. Housey was at Morgan Stanley Investment Management and its wholly owned subsidiary, Van Kampen Funds, Inc. for 11 years where he last served as Executive Director and Co-Portfolio Manager.  Mr. Housey has extensive experience in the portfolio management of both leveraged and unleveraged credit products, including senior loans, high-yield bonds, credit derivatives and corporate restructurings.  Mr. Housey received a B.S. in Finance from Eastern Illinois University and an M.B.A. in Finance as well as Management and Strategy from Northwestern University’s Kellogg School of Business. He also holds the FINRA Series 7, Series 52 and Series 63 licenses.  Mr. Housey also holds the Chartered Financial Analyst designation.  He is a member of the CFA Institute and the CFA Society of Chicago.  Mr. Housey also serves on the Village of Glen Ellyn, IL Police Pension Board.

Jeffrey Scott, CFA

Senior Vice President and Portfolio Manager

Mr. Scott is a Portfolio Manager and a Sector Specialist Credit Analyst for the Leveraged Finance Investment Team at First Trust Advisors L.P.  He has 33 years of experience in the investment management industry and has extensive experience in credit analysis, product development, and product management. Prior to joining First Trust, Jeff served as an Assistant Portfolio Manager and as a Senior Credit Analyst for Morgan Stanley/Van Kampen from October 2008 to June 2010. As Assistant Portfolio Manager, Jeff served on a team that managed over $4.0 billion of Senior Loan assets in three separate funds: Van Kampen Senior Loan Fund; Van Kampen Senior Income Trust; and Van Kampen Dynamic Credit Opportunities Fund. His responsibilities included assisting with portfolio construction, buy and sell decision making, and monitoring fund liquidity and leverage. Mr. Scott earned a B.S. in Finance and Economics from Elmhurst College and an M.B.A. with specialization in Analytical Finance and Econometrics and Statistics from the University of Chicago. He also holds the Chartered Financial Analyst designation and is a member of the CFA Institute and the CFA Society of Chicago.

(a)(2) Other Accounts Managed by Portfolio Manager(s) or Management Team Member and Potential Conflicts of Interest

Information provided as of May 31, 2023

* Information excludes the registrant.

Potential Conflicts of Interests

Potential conflicts of interest may arise when a portfolio manager of the Registrant has day-to-day management responsibilities with respect to one or more other funds or other accounts. The First Trust Advisors Leveraged Finance Investment Team adheres to its trade allocation policy utilizing a pro-rata methodology to address this conflict.

First Trust and its affiliate, First Trust Portfolios L.P. (“FTP”), have in place a joint Code of Ethics and Insider Trading Policies and Procedures that are designed to (a) prevent First Trust personnel from trading securities based upon material inside information in the possession of such personnel and (b) ensure that First Trust personnel avoid actual or potential conflicts of interest or abuse of their positions of trust and responsibility that could occur through such activities as front running securities trades for the Registrant. Personnel are required to have duplicate confirmations and account statements delivered to First Trust and FTP compliance personnel who then compare such trades to trading activity to detect any potential conflict situations. In addition to the personal trading restrictions specified in the Code of Ethics and Insider Trading Policies and Procedures, employees in the First Trust Advisors Leveraged Finance Investment Team are prohibited from buying or selling equity securities (including derivative instruments such as options, warrants and futures) and corporate bonds for their personal account and in any accounts over which they exercise control. Employees in the First Trust Advisors Leveraged Finance Investment Team are also prohibited from engaging in any personal transaction while in possession of material non-public information regarding the security or the issuer of the security. First Trust and FTP also maintain a restricted list of all issuers for which the First Trust Advisors Leveraged Finance Investment Team has material non-public information in its possession and all transactions executed for a product advised or supervised by First Trust or FTP are compared daily against the restricted list.

Information provided as of May 31, 2023

The compensation structure for internal portfolio managers is based upon a fixed salary as well as a discretionary bonus determined by the management of FTA. Salaries are determined by management and are based upon an individual’s position and overall value to the firm. Bonuses are also determined by management and are generally based upon an individual’s or team’s overall contribution to the success of the firm, assets under management and the profitability of the firm. Certain internal portfolio managers have an indirect ownership stake in the firm and will therefore receive their allocable share of ownership related distributions.

Item 9. Purchases of Equity Securities by Closed-End Management Investment Company and Affiliated Purchasers.

Not applicable.

Item 10. Submission of Matters to a Vote of Security Holders.

There have been no material changes to the procedures by which the shareholders may recommend nominees to the registrant’s board of directors, where those changes were implemented after the registrant last provided disclosure in response to the requirements of Item 407(c)(2)(iv) of Regulation S-K (17 CFR 229.407) (as required by Item 22(b)(15) of Schedule 14A (17 CFR 240.14a-101)), or this Item. 

Item 11. Controls and Procedures.

Item 12. Disclosure of Securities Lending Activities for Closed-End Management Investment Companies.

Not applicable.

Item 13. Exhibits.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

^* Print the name and title of each signing officer under his or her signature.