Sixth Street Specialty Lending Q1 2025 Earnings Call Transcript

Quartr
Provided by Quartr
May 1, 2025

There are 14 speakers on the call.

Operator

Good day, and thank you for standing by. Welcome to the Sixth Street Specialty Lending, Inc. First Quarter twenty twenty five Earnings Conference Call. At this time, all participants are in listen only mode. After the speakers' presentation, there will be a question and answer session.

Operator

To ask a question during the session, you will need to press 11 on your telephone. You will then hear automated message if your hand is raised. To withdraw your question, please press 11 again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Cami Van Hoard, Head of Investor Relations.

Operator

Please go ahead.

Speaker 1

Thank you. Before we begin today's call, I would like to remind our listeners that remarks made during the call may contain forward looking statements. Statements other than statements of historical facts made during this call may constitute forward looking statements and are not guarantees of future performance or results and involve a number of risks and uncertainties. Actual results may differ materially from those in the forward looking statements as a result of a number of factors, including those described from time to time in Sixth Street Specialty Lending, Inc. Filings with the Securities and Exchange Commission.

Speaker 1

The company assumes no obligation to update any such forward looking statements. Yesterday, after the market closed, we issued our earnings press release for the first quarter ended 03/31/2025, and posted a presentation to the Investor Resources section of our website, ww.sixthstreetspecialtylending.com. The presentation should be reviewed in conjunction with our Form 10 Q filed yesterday with the SEC. Sixth Street Specialty Lending, Inc. Earnings release is also available on our website under the Investor Resources section.

Speaker 1

Unless noted otherwise, all performance figures mentioned in today's prepared remarks are as of and for the first quarter ended 03/31/2025. As a reminder, this call is being recorded for replay purposes. I will now turn the call over to Joshua Easterly, Chief Executive Officer of Sixth Street Specialty Lending, Inc.

Speaker 2

Good morning, everyone, and thank you for joining us. With me today are President, Bo Stanley and our CFO, Ian Simmons. For our call today, I will review our first quarter highlights and pass it over to Bo to discuss activity and the portfolio. Ian will review our financial performance in more detail, and I will conclude with final remarks before opening up the call to Q and A. In addition to today's earnings call and public filings, we also published a letter to our stakeholders.

Speaker 2

We may currently be in one of the most pivotal periods for The US and global markets since the global financial crisis. We believe we're operating under a new world order, and it's our job as investors to embrace this reality and proactively position our business based on probabilistic assessments to navigate the evolving environment. We encourage and welcome your feedback. While we recognize that the world has changed since March 31, we believe our business remains well protected on the asset side with limited direct exposure to tariffs and well positioned on the liability side. We already said a mouthful on these topics in our letter, so I'll limit my opening remarks today to briefly cover our first quarter results and framing how we think about the future earnings potential of our business.

Speaker 2

After the market closed yesterday, we reported first quarter adjusted net investment income of $0.58 per share, or an annualized return on equity of 13.5%, and adjusted net income of $0.36 per share, or an annualized return on equity of 8.3%. As presented in our financial statements, our Q1 net investment income and net income per share, inclusive of the unwind of noncash accrued capital gains incentive fee expense, was $0.62 and $0.39 respectively. Of

Speaker 3

the $0.22

Speaker 2

per share difference between net investment income and net income, only $05 per share was credit related. This was primarily markdowns on our existing non accrual loans, and therefore, there was no impact in net investment income. The remaining $0.17 per share was in two buckets. In the first bucket, which we characterize as geography related, there was $0.11 per share of prior period unrealized gains that moved out of last quarter's net income and into this quarter's net investment income, primarily related to investment realizations. In the second bucket, characterized as market related, there was $06 per share impact from widening credit spreads, which assuming no credit losses, will be reversed as investments are paid off or reach maturity.

Speaker 2

Looking ahead, we estimate that the quarterly earnings power of the business, assuming a base case of no additional non accrual investments and no spread impact on investment valuations, is approximately $0.50 per share. This includes interest income generated by the in the ground portfolio today plus limited activity based fee income. This translates to a return of equity of approximately 11.7% above the floor of the calendar year 2025 guidance we provided on our last earnings call of 11.5% to 12.5%. Given increases in repayment activity, there's potential upside to that figure if activity based fees return to our average prior to the start of the rate hike in cycle. We believe our asset quality today supports the forward earnings profile, which we anticipate will differentiate returns from the public BDC sector for three important reasons.

Speaker 2

First, we've continued to be a very disciplined capital allocator. Our portfolio yields are meaningfully higher than the sector average, with a weighted average yield and amortized cost of 12.5% in Q4 compared to 11.6% for our peers. We also have a significant small of our portfolio invested in loans with spreads below five fifty basis points, which Bo will discuss later. We believe our disciplined approach will allow us to outperform as the sector experiences a more significant decline in portfolio yields. This leads to the second point, which is that our patience and discipline over the past several quarters, combined with increased repayment activity, have provided us with significant capacity to invest in what we expect to be a more interesting investment environment.

Speaker 2

As we have seen in the past, periods of heightened volatility often present the most attractive investment opportunities. We are well positioned with the level of capital and significant amount of liquidity we have for the period ahead. And finally, we believe our returns will continue to be differentiated given our track record of lower credit losses relative to the sector. Yesterday, our board approved a base quarterly dividend of $0.46 per share to shareholders of record as of June 16, payable on June 30. Our board also declared a supplemental dividend of $06 per share relating to

Operator

our Q1 earnings to shareholders of record as of May 30, payable on June 20. Our net asset value per share adjusted for the impact of the supplemental dividend that was declared yesterday is 16.98

Speaker 2

We estimate that our spillover income per share is approximately $1.31 With that, I'll now pass it over to Bo to discuss this quarterly investment activity.

Speaker 4

Thanks, Josh. I'd like to start by sharing some perspectives on market beginning with a look at the underlying supply and demand dynamics that have shaped the current investment environment. Specifically, as it relates to The US direct lending market and focusing on BDCs as a proxy for direct lending vehicles, the supply and demand dynamics over the past several years have been characterized by an imbalance with the supply of capital outpacing demand. This has largely been fueled by the growth of the retail investor oriented perpetual non traded BDC structure, which accounted for roughly 80% of asset growth within the BDC sector in 2024. This inflow of capital has exerted downward pressure on new investment spreads leading to instances of suboptimal capital allocation.

Speaker 4

We anticipate that the current uncertainty and volatility will moderate the supply and demand imbalance by slowing inflows into the non traded vehicles and shifting the pendulum towards direct lending from the broad broadly syndicated loan market. While these factors may contribute to a more balanced supply and demand environment over time, we continue to believe that a meaningful resurgence in M and A activity remains a longer term prospect. However, our through the cycle business model and diverse originations channel enable us to deploy capital into an attractive investments across market cycles. In q one, we provided total commitments of a hundred and $54,000,000 and total funding of a hundred and 37,000,000 across six new portfolio companies and upsizes to four existing investments. We experienced $270,000,000 of repayments from seven full and four partial investment realizations resulting in $133,000,000 of net repayment activity.

Speaker 4

As Josh highlighted, market dynamics have changed significantly since Q1. That said, our new investments during the quarter underscore our firm commitment to remaining highly selective and disciplined in our capital allocation in all market environments. This is demonstrated in two ways, including lower levels of new investments funded during the quarter relative to our longer term average and the percentage of our new investments that were thematically driven non sponsor deals. On this first point, new investment spreads remained historically tight through the first quarter. We are an investor first firm, which means we prioritize shareholder returns and will not put capital to work for the sake of growing assets.

Speaker 4

And second is our ability to originate opportunities in the non sponsor channel, We were able to differentiate our capital to earn an appropriate risk adjusted return for our business. In q one, '80 '4 percent of new fundings were originated outside the sponsor channel. This includes new investments in our retail ABL theme, our energy portfolio, and an investment driven by long standing relationships within the Sixth Street platform with the founder. I'll spend a moment highlighting our largest investment during the quarter, Dork Logistics, which is a provider of logistics software and services for the rail and trucking industry. It is a founder owned business where our direct to company relationship led to an investment opportunity.

Speaker 4

As agent and sole lender, Sixth Street structured a bespoke solution that enabled the company to execute on its growth initiatives. This flexible approach reflects our ability to meet specific needs of our borrower while ensuring we are an appropriate risk adjusted return. On a blended basis across our securities, the weighted average yield and amortized cost for this investment was 13.9%. Our investment in Arrowhead Pharmaceuticals is another example of our differentiated investment capabilities. As a reminder from our last earnings call, we expected to receive a prepayment fee in q one driven by the previously announced agreement with Sarepta Therapeutics.

Speaker 4

Arrowhead repaid a portion of the loan and we received a prepayment fee which contributed $05 per share to net investment income in Q1. This resulted in a reversal of a portion of the unrealized gain on the balance sheet of December 31 as the impact moved out of last quarter's net income into net investment income this quarter. From an overall perspective, 89% of total funding this quarter were into new investments, with 11% supporting upsides to existing portfolio companies. This quarter's fund has contributed to our diversified exposure to select industries with six new investments across six different industries. In terms of asset mix, we remain focused on investing at the top of the capital structure with total first lien exposure of 93% across the entire portfolio.

Speaker 4

As part of our new investment in Bork Logistics, we structured the investment to include a first lien term loan and senior secured notes along with a small equity portion. All other new investments in q one were first lien consistent with our long term approach. Moving on to repayment activity, q one was the second consecutive quarter of elevated churn related to the new to payoff period we experienced beginning in early twenty twenty two. LTM portfolio churn through Q1 was 28 based on the beginning of period investment at fair value, which is the highest level in nine quarters. The increase in repayment activity contributed the highest level of activity based fee income, excluding other income we've had since Q4 twenty twenty one, totaling 16¢ per share in Q1 relative to our three year historical average of 5¢ per share.

Speaker 4

The biggest driver of this increase in Q1 was the Arrowhead prepayment fee as previously mentioned. Five of our six full payoffs are driven by refinancings. Of the five, four were refinanced by other direct lenders and spreads ranging from four fifty to five fifty basis points and did not present an appropriate return profile for

Operator

our

Speaker 4

shareholders. The other was refinanced in the broadly syndicated loan market at a spread of 325 basis points. As we have reiterated, we will continue to pass on participating in deals where the economics do not align with where BDCs of any format sit on the cost curve. To highlight the differentiated nature of our portfolio, only 5.4% of our portfolio by fair value is in senior secured loans with spreads below five fifty basis points. Further, less than 1% of our portfolio by fair value carries a spread below 500 basis points.

Speaker 4

Outside of the five refinancings, we had one additional payoff in Q1, which was in our energy portfolio. In February, Mock Natural Resources repaid its outstanding term loan. After a whole period of one point two years, we received call protection on the payoff and generated an unlevered IRR and MLM of approximately sixteen percent and one point two x respectively for SLX shareholders. Our dedicated energy team and expertise in this sector continue to be a differentiator for our business demonstrated by our weighted average unlevered IRR and MLM on realized investments of twenty two percent and one point two x respectively. Moving on to our portfolio yields, our weighted average yield on debt and income producing securities and amortized cost decreased slightly quarter over quarter from 12.5% to 12.3%.

Speaker 4

The decline reflects approximately 15 basis points from the decline in reference rates and five basis points from the spread compression on new investments. The weighted average spread over reference rate of new investment commitments in Q1 was 700 basis points, which compares to the spread of five forty one basis points on new issue first lien loans for the public BDC peers in Q4. Our ability to earn wider spreads is largely driven by 84% of our new fundings in Q1 falling into what we call our lane two and lane three buckets characterized by non sponsor originated investments. In Q1, this included our investments in Hudson Bay Company, Northwind Midstream, and York Logistics. Moving on to our portfolio composition and key credit stats across our core borrowers for whom these metrics are relevant, we continue to have conservative weighted average attach and detach points of 0.5 times and 5.1 times respectively.

Speaker 4

And their weighted average interest coverage remains constant at 2.1 times. As of Q1 twenty twenty five, the weighted average revenue and EBITDA of our portfolio companies was three eighty three million dollars and $112,000,000 respectively. Median revenue and EBITDA was $139,000,000 and $52,000,000 Finally, the performance rating of our portfolio continues to be strong with a weighted average rating of 1.11 on a scale of one to five with one being the strongest. Non accruals represent 1.2% of our portfolio at fair value with no new investments added to non accrual status in Q1. Before passing it over to Ian, I'd like to address the potential impact of the recent tariff announcements on our portfolio companies.

Speaker 4

While the situation continues to evolve and uncertainty across the broader economic landscape remains elevated, we believe there's limited direct risk from these tariff policies on our portfolio. The majority of our exposure is across software and services economies, which we believe will experience limited direct risk from these policy shifts. While we maintain a small exposure to our energy sector, which we expect will have derivative impact, Our commodity price exposure is typically hedged on the front end of the curve, mitigating short term price volatility. Today, the back end of the curve has not moved materially. We believe the potential derivative impacts on the real economy, growth, and valuations are the bigger risk.

Speaker 4

However, these impacts are likely to take a number of quarters to flow through and hence are more difficult to quantify at this stage. That being said, we feel good about where we sit in the capital structure of our borrowers and an average loan to value across our portfolio of 41%. To assess potential risk, we completed a comprehensive name by name tariff related analysis of our entire portfolio. Excluding our retail ABL investments, this review identified three out of 115 portfolio companies that could be directly affected. These investments represent 2% of our overall portfolio by fair value.

Speaker 4

And based on our current understanding, we anticipate only a mild impact on their top line and EBITDA performance. Regarding our retail ABL portfolio, which comprises 3.4% of our portfolio at fair value at quarter end, We acknowledge the potential for the impact on these consumer and retail businesses through higher cost of goods, lower margins, and demand destruction. However, our investment thesis on these companies remains intact as it's predicated on the value of the underlying collateral, not the cash flow related performance of the businesses themselves. We will continue to maintain close communications with management teams and sponsors during this period of heightened uncertainty to understand their strategies for navigating these potential headwinds. We will continue to monitor the situation closely, but remain confident in our underwriting standards and asset selections.

Speaker 4

With that, I'd like to turn it over to my partner Ian to cover the financial performance in more detail.

Speaker 5

Thank you, Bo. For Q1, we generated adjusted net investment income per share of zero five eight dollars and adjusted net income per share of $0.36 Total investments were $3,400,000,000 down slightly from $3,500,000,000 in the prior quarter as a result of net repayment activity. Total principal debt outstanding at quarter end was 1,900,000,000 and net assets were $1,600,000,000 or $17.04 per share prior to the impact of the supplemental dividend that was declared yesterday. Josh noted the strength of our balance sheet positioning earlier today, reflecting what has been a busy start to the year as we completed two capital market transactions during the first quarter. In February, we issued $300,000,000 of long five year notes at a spread of treasuries plus 150 basis points, which at the time matched the tightest spread level for BDC in the five year part of the curve.

Speaker 5

As we do with all our issuances, we swapped these fixed rate notes to floating at a spread of SOFA plus 152.5 basis points. While the execution level stands out in its own right and particularly so in the face of widening BDC credit spreads that we have seen since mid February, this issuance illustrates execution on our underlying philosophy of proactively managing our liquidity needs and our commitment to enhancing the depth of our investor base with each issuance. In March, we further enhanced our debt maturity profile by closing an amendment to our revolving credit facility. With the ongoing support of our bank group, we amended our $1,675,000,000 secured credit facility, including extending the final maturity of $1,525,000,000 of these commitments through March 2030. We are pleased with the outcome of this transaction as we successfully converted a legacy non extending lender to extending status, marginally decreased the drawn spread through the introduction of a new pricing grid and lowered the undrawn fee on the facility.

Speaker 5

The combination of the February bond issuance and the closing of the amendment to our credit facility extended the weighted average maturity on our liabilities to four point two years, which compares to an average remaining life of investments funded by debt of approximately two point three years. This element is important to our asset liability matching principle of maintaining a weighted average duration on our liabilities that meaningfully exceeds the weighted average life of our assets funded by debt. Following both these transactions, we believe our balance sheet is in excellent shape. As of March 31, we had approximately $1,000,000,000 of unfunded revolver capacity against $175,000,000 of unfunded portfolio company commitments eligible to be drawn. In terms of capital positioning, our ending debt to equity ratio from the balance sheet decreased quarter over quarter from 1.18 times to 1.15 times.

Speaker 5

The decrease was driven by the elevated repayment activity experienced in Q1. Further, we have no near term maturities with our nearest maturity obligation not occurring until August 2026. As you may have seen through an eight ks filing in February, we entered an ATM program to expand our capital raising toolkit. We have not issued shares through the program to date and have no plans of doing so with capital coming back to us through repayments. We believe the ATM program is beneficial for shareholders given the cost of issuing equity in this format is lower relative to the follow on offerings we have done in the past.

Speaker 5

Consistent with our disciplined approach to raising equity capital, we will look to utilize the ATM program when we have confidence that the new shares issued will be accretive to net asset value and return on equity. Pivoting to our presentation materials, Slide eight contains this quarter's NAV bridge, which Josh walked through earlier. Moving on to our operating results detail on Slide nine, we generated $116,300,000 of total investment income for the quarter compared to $123,700,000 in the prior quarter. Interest and dividend income was 98,900,000.0 down from prior quarter, primarily driven by the decline in interest rates. Other fees, representing prepayment fees and accelerated amortization of upfront fees from unscheduled pay downs, were higher at $14,000,000 compared to $5,100,000 in Q4, driven by the Arrowhead prepayment fee, coal protection, and accelerated amortization of OID on other investment realizations.

Speaker 5

Other income was $3,500,000 compared to $4,800,000 in the prior quarter. Net expenses, excluding the impact of the non cash reversal related to unwind of capital gains incentive fees, was 60,700,000.0 down from 65,900,000.0 in the prior quarter, primarily driven by the decline in base rates and a benefit from a lower weighted average cost of debt following the maturity of our 2024 notes in November and the subsequent issuance of our 2,030 notes in February. This contributed to our weighted average interest rate on average debt outstanding decreasing approximately 60 basis points from 7% to 6.4%. Returning to our ROE metrics before handing it back to Josh, we're reaffirming our target return on equity on adjusted net investment income of 11.5% to 12.5% for the full year, consistent with the assessment of our earnings potential outlined earlier on this call. To the extent we see widening of credit spreads, we would expect some downward pressure on net income and potential diversion between net investment income and net income metrics, given that spread movement is incorporated into the discount rate we utilize in determining fair value of our investments each quarter.

Speaker 5

That impact would unwind as investments approach maturity or are repaid. With that, I'll turn

Speaker 2

it back to Josh for concluding remarks. Thank you, Ian. I'll keep my conclusion brief today in hopes that people will take the time to read our letter, which is available on the Investor Resources section of the Sixth Street Specialty Lending website. In closing, I 'd to encourage our shareholders to participate and vote for our upcoming annual and special meetings on May 22. Consistent with previous years, we're seeking shareholder approval to issue shares below net asset value effective for the upcoming twelve months.

Speaker 2

To be clear, to date, we have never issued shares below net asset value under prior shareholder authorization granted to us for each of the past eight years. We have no current plans to do so. We merely view this authorization as an important tool for value creation and financial flexibility in periods of market volatility. As evidenced by the last eleven plus years since our initial public offering, our bar for raising equity is high. We've only raised equity when trading above net asset value on a very disciplined basis, so we would only exercise the authorization to issue shares below net asset value if there were sufficient high risk adjusted return opportunities that will ultimately be accretive to our shareholders through over earning our cost of capital and any associated dilution.

Speaker 2

If anyone has questions on this topic, please don't hesitate to reach out to us. We have also provided a presentation which walks through the analysis in the investor resource section of our website. We hope you find that supplemental information helpful as a way of providing a clear rationale for providing the company with access to this important tool. With that, thank you for your time today. Operator, please open up the lines for questions.

Operator

Thank you. At this time, we'll conduct a question and answer session. As a reminder, to ask a question, you'll need to press 11 on your telephone and wait for your name to be announced. And our first question comes from the line of Finian O'Shea of Wells Fargo. Your line is now open.

Speaker 6

Hey, everyone. Good morning. So Josh, we enjoyed your shareholder letter and wanted to ask about the downward pressure on spreads with the ongoing non traded BDC fundraising headwind. Can you talk about your resilience to that and how far it goes just imagining that more capital is making its way into the complex non sponsor so forth styled origination opportunities?

Speaker 2

Yeah. Hey, Ken. So I would I guess, let me start with Bain. I have no idea what retail flows are. I would suspect given the volatility in the market that retail flows have slowed.

Speaker 2

Time will tell. I think that data is dated. And I don't think there's good data post Labor Day. Also, as you know, with those vehicles, they're called semi liquid for a reason which is the problems of liquidity. So in times of volatility, if the analog is non traded resector, they've been a sucking down of liquidity out of the system, not a net flow, but time will tell.

Speaker 2

So, that's one piece of it. The second piece of it is, look, we manage the way we built our businesses. We've managed a relatively small amount of capital for the opportunity set. And we

Speaker 3

have a big top of the

Speaker 2

funnel, including the non sponsor and more complex transactions. That has made our business more resilient to the spread tightening movement because we're just not purely in the sponsor business. And then we've been really disciplined allocators of capital. And I think we deeply understand where we sit in the cost curve and our cost of equity. And so we're not going to allocate capital, just allocate capital and grow assets and therefore grow revenues.

Speaker 2

We believe that we have two basically important people in our ecosystem. First being the capital providers who are providing capital to us and entrusted that capital to earn a capital risk adjusted return of capital and cost of equity. The second being our counterparty community. And we can't be a good lender and a good counterparty unless we have capital. So we need to do both well, and we plan to keep doing both well.

Speaker 6

And just to zero in, like, top of the funnel, you haven't seen a material impact there from all the direct lending and private credit capital, which seems to be converging in style. Like is there just less that that meet the standards in terms of of spread and structure, for example, you know, even if it's something that would would more traditionally fall into your wheelhouse?

Speaker 7

Well, again,

Speaker 2

maybe we're saying the same thing, maybe we're not. The top of the funnel had the very, very top of the funnel has no impact. Now, we quickly might decide that is not for us. The top of the funnel was really and I think the impact on top of the funnel was broad based, which is the M and A cycle, which is obviously we've been very negative on that returning. And that is systematic across the industry.

Speaker 2

But yeah, decide more things are not for us early on. But because we have a big top of the funnel and other channels, we find places to put our shareholders capital in a responsible way that generates the required returns. That's been the business model. That business model has worked out. We also think we're going into a world where there will be more opportunity for complexity.

Speaker 2

And we're excited about that given the macro. So I feel really confident on our ability to continue to earn returns across cycles. If you look at historically, we put this in the letter and I don't think people get this. Like, we've actually done better in moments like this than we've done better in kind of regular way markets. The market volatility has provided us a return an ability because how we manage that balance sheet and the top of the funnel and the culture of Sixth Street, we've been able to generate outsized returns.

Speaker 2

I think in like volatile years, we generate almost 200 basis points of excess returns compared to non volatile years. And our outperformance in the industry actually grows significantly. So, we couldn't be more excited about the forward for our business. And that is from a design, how we've designed the business and how we put shareholders and capital on that list and then a priority and the capabilities we have given the market opportunity.

Speaker 6

When you say, like, very negative on M and A returning, do you just mean, you know, a couple quarters from what was supposed to be more like now? Or or do you think more protracted and anything you can unpack there for us?

Speaker 2

Yeah. So the industry has been beating the drum on M and A returning partly to justify, I think, the amount of capital they were against. And we've been negative on that. The constraint is not the amount the issue is not the direct power for private equity deals to get done. There's a ton of dry powder.

Speaker 2

The problem is that people pay too much for assets between 2019 and 2022. Time is that those assets, nobody wants to sell those assets without an acceptable return because it's not in their economic interest. And so, people need time and growth. There is a headwind to growth, which we think will extend the time. So do I know do I think there's going to be a whole bunch of non investment grade M and A in 2025?

Speaker 2

No. So I think maybe 2026 possibly. But the uncertainty in the macro and the drawdown on growth expectations is going to make non investment in M and A harder.

Speaker 8

Awesome. Thank you.

Operator

Thank you. One moment for our next question. And our next question comes from the line of Brian McKenna of Citizens. Your line is now open.

Speaker 9

Thanks. Good morning, everyone. So Josh, you've been very clear the last several quarters about how the firm has been focused on finding attractive risk reward opportunities and making sure you're getting paid the right economics for the risk you're taking. The environment has clearly shifted here. But I'm curious, how are your teams able to price risk when there's a meaningful pickup in uncertainty and volatility?

Speaker 9

And then there's clearly been a healthy reset in valuations here. So where are you seeing the most attractive deployment opportunities today?

Speaker 2

Yeah. Hey, Brian. Good morning. I appreciate that question. It's a loaded question.

Speaker 2

Look, I think the way we're able to price risk I don't think the private markets, at least what we're seeing today, are doing a very good job of pricing risk. Which is somebody showed me a slide this morning that said middle market spreads haven't moved but probably syndicated spreads have moved. And I don't know where the data came from but that feels pretty consistent. And that seems like a technical issue in the middle market, which is previous flows. People need to put the previous flows to work.

Speaker 2

But how we think about the world is we're deep fundamental investors. We look at where we sell the cost curve, what's our required equity, the illiquidity premium that we need, which is I can't change my mind when I'm making an investment. And we look at what we think that asset is worth and what is the value on that asset. And when we think that asset is worth, it kind of a normalized interest rate environment and a normalized growth environment. And so having kind of that deep fundamental view of the world and doing real work allows us to price risk in moments of volatility.

Speaker 2

In addition to that, Sixth Street is a big place. We have $100,000,000,000 of assets under management. We have large platforms in ABF, healthcare, sports media, telecom, energy, retail consumer, etcetera, etcetera, etcetera. So we're able to see relative value. Not only are we able to see the top of the funnel in a lot of different things, but where we'll see relative value across asset classes and what people are pricing in for growth and what discount rates are using.

Speaker 2

That's super helpful to keep a steady head on our shoulder and be able to commit capital when other people don't.

Speaker 9

Okay, great. That's helpful. And then you touched on this a little bit, but you look at TSLX and even the broader Sixth Street platform, I mean, you've really delivered impressive returns kind of through cycles looking back over your history. And I think some of the market actually forget volatility is a great thing for your business. So can you just remind us again, why does TSLX and really the broader Sixth Street model work so well in all parts of the cycle?

Speaker 9

And then why do periods of volatility ultimately drive value for all your stakeholders longer term?

Speaker 3

Yeah. This is By the way, I was shocked when we were looking I was

Speaker 2

in shock for us. Was shocked at the industry. The industry has actually done a decent job, which is in moments of volatility, the industry returns are robust compared to in moments of not volatility, which is they don't go down. I think they're basically flat to about 20 basis points, which is a little bit shocking. And that's structural in the sense that the capital is decently permanent.

Speaker 2

So they're not a forced sell. This is on the trading side. I think on the non trade time side, time will tell because there will be a liquidity pool. But the structure of the industry, which is that they have permanent capital and they're not that levered so they don't get closed out their option and the financing is robust, that they're able to withstand volatility. And so the industry itself and the capital structure of the industry and the permanency of the capital allows robustness.

Speaker 2

Think SLX, I think we actually have this idea of anti fragility, which we actually do better when there's stress. I think that's because we manage we've done a good job of allocating capital, which means that we have capital to allocate and move the volatility. Not only are we not a fore seller, but we actually grow our investments during that time when the rest of the world is risk off. And that is a function of A, being a good allocative capital, and B, understanding that we need a reserve for unfunded commitments. We need a reserve for investment capacity during those times, both capital and liquidity.

Speaker 2

And so that allows us to actually be on the front of our feet, balls of our feet during those times and really capture that opportunity. So I was shocked when I looked at the data for the industry. But it makes sense because the industry should be never a forced seller given the purpose of the capital. Again, the non traded space will be interesting because there will be capital stop flowing and there will be, my guess is, some type of liquidity pool, pool of liquidity that happens, which is the dialogue being again the non traded REIT space. Capital came out of the system during that moment of volatility.

Speaker 2

Capital did not come in for people to be aggressive as it relates to investment opportunities outside their capital structure or inside their capital structure.

Speaker 9

Appreciate it, Josh. I'll leave it there and congrats on the strong quarter.

Operator

Thanks. Thank you. One moment for our next question. Our next question comes from the line of Mickey Schnee of Ladenburg. Your line is now open.

Speaker 10

Yes, good morning, everyone. Josh, as usual, your prepared remarks were excellent and answered all of my top down questions. So I just have one modeling question. The first row of Slide nine, which is your interest in dividend income excluding fees, looks a little light relative to the 3% decline in the portfolio at cost and considering movements in spreads and so forth. And that could be due to things like the cadence of investments or some sort of a reversal.

Speaker 10

Or was there something else in there that we should be aware of?

Speaker 2

I'll put that to Ian. And we might have to come back to you. Don't I do not well, let's come back to you exactly on the sorry. In 2,000 and now it was twelvethirty one, that quarter 'twenty four, there was a large dividend income payment that is included that looks like not a non recurrent spread item. Right, Andy?

Speaker 2

Yes, that's right. So that probably creates a little bit of noise. That creates noise. A better way to look at it is a little bit of spread compression, a little portfolio shrinkage compared to September '30, '20 '20 '4. But there was a one time dividend payment related to an energy name, Ian?

Speaker 2

Yes. That's right. Mickey, almost had me.

Speaker 10

Sorry?

Speaker 2

You almost had me, but I think I got you the answer. There was a one time dividend payment. What was that payment? Five from February and the ending quarter to 12/31. We'll come back to you with the exact number.

Speaker 2

But that's there's a dividend payment, non recurring dividend payment with a $5,100,000 in the prior quarter. So so apples to apples is pretty consistent with a little bit of yield compression and the portfolio shrinkage. If you look at dividend and interest in dividend income, any pro form a that is twelvethirty onetwenty 20 four, right at above $113,000,000 minus $5,000,000 That would be more consistent with your modeling.

Speaker 7

Yes. Dividend income went from 5,800,000.0 in Q4 to 900,000.0 in Q1. Okay.

Speaker 10

I appreciate that. Thank you. That's it for me.

Speaker 2

Thanks, Peter.

Operator

Thank you. One moment for our next question. Our next question comes from the line of Kenneth Lee of RBC Capital Markets. Your line is now open.

Speaker 11

Hey, good morning and thanks for taking my Just given the prepared remarks around some of the newer investments, including, I guess, one in the retail ABL side, Could you further flesh out your outlook for lane two and lane three investments? Would it be fair to say that you're starting to see a lot more of these opportunities materializing right now? Or do we still have to wait a little bit more to see more stress across the sectors there? Thanks.

Speaker 2

I think so we've committed to one last quarter or this quarter that we'll fund here before year end a site that we think is very interesting and that it's public. I think there will be needs a little bit more stress, a little bit more time. But we're excited. We're starting to see stuff. Obviously, the broadly syndicated loan market is down.

Speaker 2

My guess is if you look at the data, I think that Moody's have revised their LME distress, which is a distress signal, broadly syndicated loan market up 2x, I think, or something like that. So I think those opportunities are coming our way.

Speaker 11

Great. Very helpful there. And just one follow-up, if I may. And this is just on the ATM equity program. And it sounds like the general approach towards any kind of potential capital raises is still very consistent with your previous approach.

Speaker 11

But just wondering whether you could be raising capital a little bit more frequently than in the past, because I believe that TSLX had very infrequently raised capital in the past. We just wanted to see if the frequency could potentially change there. Thanks.

Speaker 2

No change in how we raise the capital, the frequency we raise the capital, when we look through, I think you did it perfectly, which is it has to be both accretive on an ROE basis as it relates to our cost of equity and an asset value basis. And it is we're pretty I would say we were pretty stubborn about the ATM. But quite frankly, it's better for shareholders because the cost is lower. But there is zero change in how we do it and zero lens. And needs to only really make sense for shareholders.

Speaker 2

Ian, anything other?

Speaker 7

I think that's spot on. I think we were very deliberate about making the comment about no new shares issued this quarter because we didn't want people to assume that just because we had the tool, we would use it. It's more about making sure that we can be as effective as possible for shareholders. I mean, let's put it this way.

Speaker 2

We let the balance sheet roll down. And therefore, revenues to the manager get smaller because we don't think the opportunity set in this past quarter was good for our shareholders. We're surely not going to issue new capital when we would like an existing balance sheet roll out.

Speaker 4

Got you.

Speaker 11

That's very helpful there. Thanks again.

Operator

Thank you. One moment for our next question. Our next question comes from the line of Sean Paul Adams of B. Riley Securities. Your line is now open.

Operator

Hey, guys. Good morning.

Speaker 12

Obviously, your nonaccruals are quite low. Credit quality wise, you've been doing really well. Your letter made an excellent point on the deployment of capital to take advantage of nonstandard opportunities during volatile periods. However, that's based on an assessment of not having any trouble at home. On the impact of risk ratings, you guys seen any material migrations and internal risk ratings assigned within the portfolio?

Speaker 2

No, not really. And I would say the one thing we did not do just put just FYI do a great job in our letter. I'll take a criticism for it. I'll give you a little bit more detail on because I think you're asking a question about credit quality and at home. So let me hit tariffs real quick.

Speaker 2

We outlined exposure to direct exposure to tariffs in our letter, which is about 2%. The reality of it is that 60 basis points of that is already on non accrual. That's American achievement. There's another $4,000,000 position that we think has limited impact. And so there's really only one name, which is 1.3%.

Speaker 2

That name is not very levered today. That name is less than 5.5 times levered. 60% of its manufacturing is here in The US. It does force from overseas. We think we estimate that there might be a kind of 20% impact on EBITDA as things ultimately roll through and that they can't pass along costs.

Speaker 2

And so that brings the credit to like six and a half times lower, which is still acceptable for that credit and scale that credit. So I feel really good about the portfolio and our ability to pay offense. And you hit exactly right. The insight is exactly right, which is for you to be able to play offense, not only do you need capital and liquidity, you need bandwidth. And you need the bandwidth means that you don't have any problems at home.

Speaker 2

So we have capital. Capital. We have liquidity. And we have bandwidth.

Speaker 12

Got it. Thank you for the color. I appreciate it.

Operator

Thank you. One moment for our next question. Our next question comes from the line of Maxwell Frister of Truce. Your line is now open.

Speaker 3

Hi, good morning. I'm on for Mark Hughes. We've heard that banks are going a little more risk off. Do you anticipate any impact on the liability side of your balance sheet from this? Ian's comments on the facility and the note issuance suggest that answer is probably no.

Speaker 3

But any comments there?

Speaker 2

No, I mean, I think the answer is no. We just got our amendment done, an extension. We do that every twelve to fifteen months. We effectively took one non extender, extender, tightened pricing a little bit. And then we opportunistically issued financing.

Speaker 2

Like if you would have asked us when we were going to do our next bond deal six months ago, we would have said in September, we did it early. So we pre funded that maturity. And so we feel really, really good. In addition to that, we have a lot of in a downward sloping rate environment, we have liability sensitivity. So we swapped out all of our liabilities.

Speaker 2

So we should not have net interest margin compression, all things being equal, in the environment going forward. So we're we've managed the balance sheet. Ian's done a great job. We've managed the balance sheet. Ian and Christy, we've managed the balance sheet exactly in the right way.

Speaker 2

And so we're excited to shout out to the team, the Ian and Christie team. Thank you very

Speaker 4

much. Thank

Operator

you. One moment for our next question. Our next question comes from the line of Melissa Wieder of JPMorgan. Your line is now open.

Speaker 1

Good morning. Thanks for taking my questions. Wanted to follow-up on a point that you made. It was a brief point made in the shareholder letter, and it's really it is a bit more of a modeling question. But I think you referenced sort of making more space in terms of allowing more repayments rather than deploying capital so far in the second quarter.

Speaker 1

I want to make sure I was one, understanding that right. And then two, wanted to understand maybe the scale of that compared to some pretty sizable repayment activity in the last two reported quarters.

Speaker 2

Yeah. Look, I would say my guess is we'll be at the end of Q2 somewhere between flat and slightly down. I don't think it impacts modeling. Think it's like balance sheet might be down 30,000,000 to $40,000,000 or something like that. Repayment so look, we are going to it's obviously part of the economics of the system is keeping financial leverage, which drives capital efficiency and interest income, etcetera.

Speaker 2

And I think that's reflected in our guidance. So I don't think it's a I think it's on the margin.

Speaker 1

Okay. I appreciate that. And to your point about volatility historically creating good opportunities to deploy capital and generate higher returns versus sort of regular way markets. We know that there tends to be a bit of a lag between what's happening in the broadly syndicated market and what's happening in sort of the private credit area. We've obviously seen a lot of spread volatility, but it's only been remarkably one month that we've really seen that.

Speaker 1

So it sounds like you're not really seeing that volatility create more interesting opportunities in the private credit space quite yet. Am I reading your reading that right?

Speaker 2

Yeah, what I would say is the great thing about our platform is we don't have elsewhere. And so we will capture some of that spread. So A, you're right. There's a technical thing happening in the private credit market. A, you're right about that.

Speaker 2

And there's a lag. That's probably a lag. But we don't need it to happen just in the private credit market because we've been able to capture it elsewhere. And so if you look at in these moments of time, we will go to more liquid markets to capture the spread volatility.

Speaker 1

Okay. Appreciate that color. Thanks, Josh.

Operator

Thank you. One moment for our next question. Our next question comes from the line of Robert Dodd of Raymond James. Your line is now open.

Speaker 13

Hi, everyone. Two questions. First, on the it really comes down to the capital. Spillover is now a buck 31. Right?

Speaker 13

I mean, from an ROE perspective, with the excise tax friction, etcetera, and if you you know, isn't this the point in the cycle to to your point that you're you you might be down a little bit in q two or flat? Is this the point of the capital to to, the point of the cycle to shrink the capital base slightly, be accretive to ROE just on excise tax deduction alone potentially going forward. And maybe, you know, you you as you say in the letter, there's there's not an infinite number of opportunities that are appropriate for BDCs. So, again, is this kind of the point of the cycle where you wanna be more selective? So shrinking the capital base or distributing some of that spillover might make sense.

Speaker 2

So look, we're not at that point. We're not at that point where we need to return capital. That is obviously a lever. You save the excise tax. But remember to fund that distribution you're borrowing, the excise tax costs you 4% annually.

Speaker 2

The borrow costs you on a marginal basis 150 over SOFR. And so it is accretive on a leverage standpoint. It's dilutive on a NIM standpoint. And so but we're not close to that point. We actually think having capital in times of volatility is good.

Speaker 2

So it is effectively making you more capital efficient, but it is a negative arb as it relates to the cost of the excise tax and your borrow to fund the excise tax.

Speaker 13

NIM, yes. Not on NII or GAAP ROE necessarily. Right? Yeah. Understand.

Speaker 13

Understood. On to the second question, just to your letter, I mean, one of the underlying themes in that letter seems to to be, correct me if I'm wrong here, that you think global or globalization of trade may have peaked and be on a a a down cycle. Obviously, that is not something that happens usually for, like, a couple years. I mean, the the increase there's one of the charts in here. I mean, it was a multigenerational, trend upwards in global trade as a percentage, which obviously made a ton of sense then to go into services businesses because anything that was physical on on as globalization was rising and offshoring was rising, made sense to stay away from.

Speaker 13

So if if the core if that is a core thesis in the letter and the outlook for Sixth Street, How how does that change over the next, not, you know, year or two, but the next, you know, ten years, which is only really two iterations of of owning an asset given the repayment cycles? How does how does this view on global trade and essentially onshoring potentially change how you might allocate capital over a longer period of time? Or does it just not make any difference?

Speaker 2

No, look, I think that so most of our businesses are in services. And what I would say that the global the demobilization started to happen in 2010. Now there was a pickup in COVID, etcetera. But if you look at there's two things to look in that chart. One is the trend post 2010, which was declining, and then picked up and then most recently declining.

Speaker 2

And what I would say is the impacts were mostly services businesses. But the impact I think are more the way I think about it is it probably slows velocity of capital, which will slow growth. It leads to inflationary, which will affect discount rates on assets. And so the super cycle of return on equities, I think, and the value is going from and by the way, there are great private equity sponsors and great hedge fund managers and great equity managers that will pick up idiosyncratic. But the broad based tailwinds, the equities, I think that's changing, which is demobilization.

Speaker 2

The way I think about it is inflationary. One increased discount rates and assets and slow growth. And what made for a very accommodative equity return environment, which is low discount rates and high growth, those conditions no longer exist. And so I think what as it relates to our underwriting, you have to be clear minded about yesterday's valuations and yesterday's LTVs are different. They're going to be different.

Speaker 2

Just run a DCF, cut your growth by half, increase your discount rate by two, it's going to come out with a different value. And so that is where I think this generation of investors are going to have a little bit of challenges, they're going to look at yesterday's news, yesterday's comps, yesterday's multiples, and think those are a real thing. Guess what? The environment has changed.

Speaker 13

So to that point, would that mean you would expect even mean, this quarter, I think it was 11% sponsor backed. No. It was 11% follow ons. It was 15% sponsor backed, I think. Would you expect that?

Speaker 13

That's obviously significantly below your long term average. Is that kind of do you think gonna be the new more of the new norm going forward?

Speaker 2

No. I mean, I think the sponsors are super smart. We love them. They're sophisticated users of capital. They're great investors, but they're sophisticated users of capital.

Speaker 2

And I think that technical in

Speaker 3

the private credit space, which was a lot of flows and

Speaker 2

a lot of money putting stuff, wanting to put money, needing to put money to work in that channel. It hasn't shifted this quarter, but we love them and we're going to be right there with them when they need capital and scale and size. But we're going go where there's the best risk return. The technicals in the private credit market were not accommodated this quarter.

Speaker 13

Yeah. I'll follow-up with that one. Thank you.

Speaker 4

Thank you so much. Thank

Operator

you. One moment for our next question. Our next question comes from the line of Paul Johnson of KBW. Your line is now open.

Speaker 8

Yes, good morning. Thanks for taking my questions. Just one on credit if I may. IRG Sports and Entertainment, I believe that loan is maturing in this quarter. How is that company performing?

Speaker 8

Obviously seen a lot of interest in professional sports facilities, but

Operator

it

Speaker 8

was marked down just a little bit slightly in the quarter. You expecting to exit that?

Speaker 2

Yeah. I mean, so IRG is the main that we there's a whole bunch of assets that we're working to sell, including a significant I think it's 160 acres or something like that. A bit more. A little bit more outside of West Palm Beach. And so that will work to resolve that.

Speaker 8

Got it. Thank you for that. And then real quick on just on the cost of debt that you guys have, it was I believe it's down a little over 130 basis points or so over the last few quarters, which is a little bit more than what base rates have done over that time. Is there anything, I guess, that's benefiting the hedges or anything that's driving the cost of debt lower, I guess?

Speaker 2

I'll take a shot and then I'll give it to Ian. One is mix probably. The other one is hedges or hedges lag maybe. But one is mixed, funding mix. The new pricing of the revolver wouldn't have an impact on the LTM period.

Speaker 2

So it's probably a little bit of mix.

Speaker 7

Yeah. Paul, if you look at the last two quarters in particular, we had one maturity of an unsecured note. So that rolled off, and we funded that with the revolver drawdown. So that was a positive benefit, so lowering overall weighted average cost of debt. And then the new bond that was issued was only in the February, so it doesn't have as much of an issue, but that was also lower spread.

Speaker 8

Got it.

Speaker 7

And then the impact of base rates. So don't forget

Speaker 2

100% about the Got

Speaker 8

it. Okay. Thanks for that. That's helpful. Excuse me.

Speaker 8

And then last one, Josh, Ian, I'd love to get your thoughts on a relatively new development in the BDC space, but structured risk transfers, does that have any potential, I guess, to change funding costs at all within the BDC space? Do you see that as a positive development or just a signal of peak risk?

Speaker 2

So that is in the I thought it was yesterday. I think you're referring to the SRT done from a group of some risk transfer from banks to the private credit market. That what you're referring to?

Speaker 11

Yes.

Speaker 2

I suspect it was done for not for capacity issues, which is it allows banks to effectively get capital relief and expand more lending relationships. So on the margin, think it's helpful. I don't think it reduces pricing, but I do think it's helpful as it relates to expansion of capacity. The bank's model balance sheet into the space and then hopefully drive fees. And if they can book more balance sheet to the space from a capital relief trade.

Speaker 2

They get to get more fees and turn over that capital. So, my guess is that on the margin expands capacity or keeps capacity but doesn't do anything to pricing.

Speaker 8

Thank you. That's all for me.

Speaker 4

Thank

Operator

you. One moment for our next question. Our next question comes from the line of Finnean O'Shea of Wells Fargo. Your line is now open.

Speaker 6

Hey, everyone. Thanks for the follow on. I just wanted to go back to the question on the ATM. I think Bo you said no changes whatsoever sort of to the historical approach which has been something like every couple of years something like 5% of NAV. Does that mean you'll do that sort of same thing with perhaps an institutional direct or will it be more of a dribble out type ATM program?

Speaker 6

Thanks.

Speaker 2

Thanks, Vince. Sorry, that was Josh. That's a very good nuance question. I meant no changes philosophically how our framework and how we raise capital. The ATM does allow you to take capital just in time.

Speaker 2

Historically, what we've done, we've kind of actually pre funded the asset side of balance sheet. So people don't fill the J curve or drag and then raise capital and got it back into normal life. The ATM will give us the flexibility to drill those up out. We'll use that flexibility. But philosophically, we're not changing how we raise capital.

Speaker 2

In the sense that we're going to raise capital when it's accretive in that and where we think that capital will earn a return in excess of a return on equity. Will we it doesn't give you more flexibility to do smaller sized stuff and do just in time? Yes. Versus what we have historically done. We've kind of taken the leverage up and then brought it back down, which is I wouldn't say risky because we where we're trading, but this is probably slightly more efficient in that way.

Speaker 7

It's really a change in the execution that the philosophy hasn't changed.

Speaker 2

Yeah. A good way to give it.

Speaker 6

When you see like you've done it historically very judiciously and prudent, the dribbles seems a bit more of like an asset gathering approach, which I know you'd be against. So can you do it fast enough as you historically have when the deal flow is big?

Speaker 2

Yes. Your question is the right question. We're not saying we're exclusively using the ATM. What we're saying is it's a tool that is lower cost for shareholders exercise. There might be a time where we want to there's opportunity to grow the balance sheet step function.

Speaker 2

And we think it's really good. And the team is not going to allow us to do that. And would we go to the public markets? Yes, 100%. So it's just another tool.

Speaker 2

It's not an exclusive tool.

Speaker 6

Thanks for the color. That's all for me.

Operator

Thank you. I'm showing no further questions at this time. I would now like to turn it back to Josh Easterly for closing remarks.

Speaker 2

Great. My hope was I'm kind of joking. It's probably not going land. My hope was that letter would have made the question and the answer section shorter. Might have had the opposite impact.

Speaker 2

Shame on us and shame on me. But I really appreciate all the good questions, super thoughtful. We're excited about the lives ahead. This is what makes the job interesting, changing environment. Obviously, the environment keeps changing.

Speaker 2

And lifelong learners, this is what we kind of get up every day to do and the platform is here to execute. We hope people enjoy their summer. We hope that we'll catch up with people after Q2, or if not sooner, please feel free to reach out. Thanks so much.

Operator

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.

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Earnings Conference Call
Sixth Street Specialty Lending Q1 2025
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