Sixth Street Specialty Lending Q4 2023 Earnings Call Transcript

Quartr
Provided by Quartr
February 16, 2024

There are 17 speakers on the call.

Operator

Good morning, and welcome to Sixth Street Specialty Lending, Inc. 4th Quarter and Fiscal Year Ended December 31, 2023 Earnings Conference Call. I will now turn the call over to Ms. Cammy Van Horn, Head of Investor Relations.

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 Q4 fiscal year ended December 31, 2023, and posted a presentation to the Investor Resources section of our website, www.6thstreetspecialtylending.com. The presentation should be reviewed in conjunction with our Form 10 ks 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 Q4 fiscal year ended December 31, 2023. 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

Thank you, Kimmy. Good morning, everyone, and thank you for joining us. With us today is our President, Beau Stanley and our CFO, Ian Simmonds. For our call today, I will review our full year and Q4 highlights and pass it over to Beau to discuss activity in 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.

Speaker 2

After the market closed yesterday, we reported 4th quarter adjusted net investment income of $0.62 per share or an annualized return on equity of 14.5 percent and adjusted net income of $0.58 per share or annualized return on equity of 13.6 percent. As presented in our financial statements, our Q4 net investment income and net income per share inclusive of the unwind of the non cash accrued capital gain incentive fee expense were less than $0.01 per share higher. The difference between this quarter's net investment income and net income per share was primarily driven by the reversal of prior period unrealized gains related to investment realizations. Other drivers include unrealized losses from portfolio company specific events, which were largely offset by realized and unrealized gains, largely from the impact of tightening credit spreads on the valuation of our investments. For the full year 2023, we generated adjusted net investment income per share of $2.36 representing a return on equity of 14.4 percent and a full year adjusted net income per share of $2.66 or return on equity of 16.2%.

Speaker 2

Long time followers of our business will know that we measure success based on returns. And 2023 was a strong year for shareholder returns. Excluding the post COVID year rebound in 2021, full year return on equity on adjusted net income of 16.2% reflects the highest calendar annual return on equity since our IPO in 2014. While this partially reflects the round tripping of 2022 results, we viewed on a combined basis over the last 2 years, we remain pleased with our performance relative to the sector and in context of a complex macroeconomic environment. Over the last 2 years, we experienced the fastest rate hiking cycle in history contributing to increased volatility and economic uncertainty.

Speaker 2

Despite these headwinds, we generated an average annualized return on equity on adjusted net income of approximately 12% for fiscal years 20222023. While we don't have a complete set of pure data available yet, we believe these returns are nearly double that of our peers over the same 2 year period. That is supported by a 2 year return on equity on a net income of 6.5% for our peers through September 30, 2023. We believe that the return profile we delivered is largely the result of our disciplined approach to capital allocation. During 2023, we capitalized on attractive opportunities set by growing the balance sheet and issuing equity in May while operating at the upper end of our target leverage range throughout the year.

Speaker 2

We leaned into an investment environment where the deployment opportunity is generated with earnings in excess of our marginal cost of capital. Our track record for efficiently allocating shareholder capital has been rewarded as evidenced by our stock trading above book value. As a result, our shareholders benefit from access to the more recent asset vintage. We believe this exposure will continue to drive differentiation in our returns relative to the industry. We are humbled by what we've achieved in the past, but I'd like to spend time on how we're positioned in the future, starting with the health of the portfolio.

Speaker 2

Despite the challenging operating environment over the last 2 years from elevated interest rates, higher inflation and uncertain geopolitical events, the portfolio has shown resilience and remains in good shape. The weighted average revenue and EBITDA of our core portfolio companies both increased 6% quarter over quarter. We continue to have only 1 portfolio company on non accrual, which represents less than 1% of the total portfolio by cost and fair value. Interest coverage remains stable on a weighted average basis of 2.0 based on interest rates as of quarter end. Given the shape of the forward interest rate curve, we expect this to be the trough for interest coverage of our portfolio companies.

Speaker 2

While we highlight the overall health of the portfolio, the tails are getting bigger. We anticipate this will be a theme for 2024 for the sector as idiosyncratic credit issues arise and portfolios and losses drive divergence in returns, which I'll discuss further in a moment. The reality for private credit managers is the illiquid nature of the investment assets and the requirement to be long only makes it challenging to reposition existing portfolio with any level of speed as macroeconomic conditions change. We feel confident about the strength of our Inland portfolio today for 2 key reasons. 1st, is the deliberate asset allocation in our portfolio characterized by 91% 1st lien senior secured loans to businesses with strong underlying unit economics.

Speaker 2

And second is a significant exposure we have to recent vintage assets, which makes up nearly 40% of our debt investments by fair value as of quarter end. These investments were underwritten after the start of the rate hiking cycle and for higher quality companies with lower LTVs. Yesterday, our Board approved a base quarterly dividend of $0.46 per share to shareholders of record as of March 15, payable on March 28. Our Board also declared a supplemental dividend of $0.08 per share relating to our Q4 earnings to shareholders of record as of February 29, payable on March 20. Our quarter end net asset value per share pro form a for the impact of the supplemental dividend that was declared yesterday is $16.96 and we estimate that our spillover income per share is approximately $1.04 We would like to reiterate our supplemental dividend policy is motivated by careful consideration of a number of factors, including the RIC distribution requirements, not burdening our returns with excess friction costs incurred through excise tax and our goal of steadily building net asset value per share over time.

Speaker 2

In connection with the Board, we analyze this framework on an ongoing basis. Before passing it to Beau, I'll spend a moment on how we're thinking about the broader macroeconomic environment and the impact for the sector. As we said on our last two earnings calls, we believe BDCs were at peak earnings and we reiterate this view based on the shape of the forward interest rate curve. More broadly, our outlook for the sector remains cautious as we know from history that credit deterioration takes time and therefore losses lag. This was evidenced during the global financial crisis, which began in 2007 and defaults didn't peak until 2,009.

Speaker 2

As the credit cycle continues to evolve in 2024, we expect to see 3 impacts for the sector. 1st is a decline in net investment income driven by the downward shape of the forward interest rate curve. 2nd is an uptick in non accruals from credit deterioration resulting in further declines in net investment income. And 3rd is a downward pressure on net asset value driven by the potential for lower fair values from credit weakness and dividend policies in excess of earnings that result in a return of capital. The good news for our business is that we feel confident in our asset selection and credit quality given our approach for being highly selective in our ability to lead in attractive investment environments.

Speaker 2

Additionally, we view the potential for lower interest rates and tighter spreads will likely increase portfolio turnover. This will result in potential for incremental economics through activity based fees to offset the decline in net investment income from lower base rates. And finally, we are highly confident in our ongoing ability to over earn our base dividend, which Ian will discuss in more detail. With that, I'll pass it over to Bo to discuss this quarter's investment activity.

Speaker 3

Thanks, Josh. I'd like to start by laying on some additional thoughts on the direct lending environment and more specifically how it relates to the positioning of our portfolio and the way we're thinking about current opportunities in the market. 2023 was another productive year for private credit as the asset class continued to grow in terms of both supply and demand. On the supply side, private debt fundraising continued to outpace most private asset classes and investors allocate more capital to the sector. As for demand, the number of LVOs financed in the private credit market was more than 6 times the number financed in the broadly syndicated market in 2023, highlighting a clear preference for the private credit product.

Speaker 3

While private credit market share was up significantly in 2023, we expect to see a more balance in 2024 as syndicated market becomes more active again. In terms of activity levels, transaction volumes are meaningfully lower in 2023. For context, total U. S. LBO transaction volume reached its lowest level in over 10 years and was down 37% from the trailing 10 year average.

Speaker 3

Despite a general slowdown in M and A transactions, we benefited from the large market share shift from the broadly syndicated to the private credit market. As the BSL market regains share in the future, we feel confident in our ability to find deployment opportunities driven by the all cycle business model that we have created. This means that even when transaction volumes are lower or market share shifts, we remain active through our omnichannel sourcing approach that is not layered solely to M and A, sponsor activity or specific sectors. Further, we are not reliant upon certain credit market conditions prudently put capital to work, while remaining highly selective. In Q4, we provided total commitments of 3 $16,000,000 and total fundings of $278,000,000 across 9 new portfolio companies and upsizes to 5 existing investments.

Speaker 3

We experienced $145,000,000 of repayments from 4 full and 4 partial investment realizations. For the full year 2023, we provided $959,000,000 of commitments and closed $808,000,000 of funding. New investments represented 94% of total funding in 2023, with only 6% supporting upsizes to existing portfolio companies. Total repayments were $469,000,000 for the year, resulting in net portfolio growth of $339,000,000 dollars In 2023, portfolio churn was 15%, which is less than half of our long term average of 41% since IPO. This slowdown in portfolio turnover contributed to our 2nd highest net deployment year, resulting in year over year portfolio growth of 18%.

Speaker 3

Given the tightening cycle in spreads, we expect to see increased level of repayment activity in 2024, creating incremental capacity for new investment opportunities. On funding trends in Q4, 97% of our new investments were in 1st lien loans, reinforcing our long term focus on investing at the top of the capital structure. All nine new investments were cross platform deals, where we leveraged the size of Six Street's capital base to lead and participate in transactions that presented attractive risk adjusted return opportunities for high quality credits. Our sector selection remained largely consistent with a broader software theme across the portfolio, including several new investments in Fintech Companies. As we've said in the past, we are more focused on the resilience of the underlying business models rather than the specific sectors or industries.

Speaker 3

Exposure in our portfolio to software business is driven by the attractive fundamental characteristics we see in these companies, including variable cost structures, mission critical solutions, recurring subscription based revenues and high switching costs. To highlight one of the largest transactions during the quarter, 6th Street aided and enclosed on a senior secured credit facility to existing borrower, Kyriba, as part of a refinancing transaction. Over the life of the initial 6th Street investment in 2019, Kyriba has shown strong growth resulting in deleveraging and has become a leader in cloud native treasury management software. Our long term relationship with the company coupled with 6 weeks' ability to commit to the entire facility provided an opportunity to continue to grow with a company we like and know well. The exit of the original facility generated gross unlevered asset level IRR and MLM of 13% and 1.7x respectively for our shareholders.

Speaker 3

We'd like to now take a moment to provide a quick update on one of our retail ABL investments, Bed Bath and Beyond. Since our last update, we've continued to receive periodic principal payments through the liquidation process. At quarter end, the outstanding par balance represents only 1.3% of our total assets. Moving on to repayment activity. The majority of the payoffs experienced during the quarter were older vintage names that were driven by refinancings.

Speaker 3

As spreads tightened in the back half of the year, we started to see borrowers take advantage of the opportunity to lower their cost of financing. This has continued into 2024 as January marked the highest level of repricing activity in the leveraged loan market in 4 years. We expect this may drive an increase in opportunistic refinancings, which have the potential to lead to incremental activity based fees. In Q4, 2 of our largest payoffs, Price Chopper and Carlstar, which were 2021 and 2022 investments respectively, included call protection as the borrowers capitalized on the ability to access lower cost of capital. These investments each resulted in gross unlevered asset level IRRs of 16%.

Speaker 3

From a portfolio yield perspective, our weighted average yield on debt and income producing securities at amortized cost decreased slightly quarter over quarter from 14.3% to 14.2%. The weighted average yield at amortized cost on new investments, including upsizes for Q4 was 13.6% compared to a yield of 13.8% on exited investments. Looking at the year over year trends, our weighted average yield on debt income producing securities at amortized cost is up about 90 basis points from a year ago. A significant increase in our yields in 2023 illustrates the positive asset sensitivity of our business from increased base rates in addition to our selective origination approach across themes and sectors. Moving on to the portfolio composition and credit stats.

Speaker 3

Across our core borrowers for whom these metrics are relevant, we continue to have a conservative weighted average attach and detach points of 0.9x and 4.7x respectively, and the weighted average interest coverage remained constant at 2.0x. As a reminder, interest coverage assumes we apply reference rates at the end of the quarter to run rate borrower EBITDA. As of Q4 2023, the weighted average revenue and EBITDA for our core portfolio companies was $230,000,000 $79,000,000 respectively. Finally, the performance rating of our portfolio continues to be strong with a weighted average rating of 1.16 on a scale of 1 to 5, with 1 being the strongest, representing an improvement from last quarter's rating of 1.17, driven by growth in the portfolio from new investments. We continue to have minimal non accruals with only 1 portfolio company representing less than 1% of the portfolio at fair value and no new names added to non accrual status during Q4.

Speaker 3

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

Speaker 4

Thank you, Bo. We finished the year with a strong quarter from an earnings and investment activity perspective. In Q4, we generated net investment income per share of $0.62 resulting in full year net investment income per share of 2.31 dollars Our Q4 net income per share was $0.58 resulting in full year net income per share of 2.61 dollars We accrued $0.05 per share of capital gains incentive fees in 2023. However, none of this amount was payable at year end. Excluding the $0.05 per share that was accrued this year, our adjusted net investment income and adjusted net income per share for the year were $2.36 $2.66 respectively.

Speaker 4

At year end, we had total investments of $3,300,000,000 total principal debt outstanding of $1,800,000,000 and net assets of $1,500,000,000 or $17.04 per share, which is prior to the impact of the supplemental dividend that was declared yesterday. Our ending debt to equity ratio was 1.23 times, up from 1.15 times in the prior quarter, and our average debt to equity ratio also increased slightly from 1.18 times to 1.22 times quarter over quarter. For full year 2023, our average debt to equity ratio was 1.2 times, up from 1.03x in 2022. We operated at the upper end of our previously stated target leverage range during the year and issued equity to take advantage of an attractive investment environment despite lower portfolio churn. We have started to see repayment activity pick up in 2024, which we expect will continue.

Speaker 4

In terms of our balance sheet positioning at year end, we had $820,000,000 of unfunded revolver capacity against $226,000,000 of unfunded portfolio company commitments eligible to be drawn. Our funding mix was represented by 52% unsecured debt. Post quarter end, we further enhanced our funding mix and liquidity profile through a $350,000,000 long 5 year bond offering in early January. Adjusted for the issuance, our funding mix reached approximately 70% unsecured, increased our unfunded revolver capacity to approximately $1,100,000,000 and further improved our debt maturity profile. As discussed on last quarter's call, following the issuance of unsecured notes in August 2023, we have effectively pre funded our nearest maturity of $347,500,000 of 20.24 notes, which occurs in November.

Speaker 4

With over $1,000,000,000 of liquidity on our secured revolver following the January offering, we have plenty of capacity to satisfy this maturity. As a result, we feel that our balance sheet is in excellent shape. Moving to our presentation materials, Slide 10 contains this quarter's NAV bridge. Walking through the main drivers of NAV growth, we added $0.62 per share from adjusted net investment income against our base dividend of $0.46 per share. The impact of tightening credit spreads on the valuation of our portfolio had a positive $0.13 per share impact to net asset value.

Speaker 4

There was a $0.15 per share decline in NAV from net unrealized losses driven by portfolio company specific events. Other changes included $0.04 per share reduction to NAV as we reversed net unrealized gains on the balance sheet related to investment realizations and a $0.01 per share uplift from net realized gains on investments. Pivoting to our operating results detail on Slide 12, we generated a record level of total investment income for the 3rd consecutive quarter of $119,500,000 up 4% compared to $114,400,000 in the prior quarter. Walking through the components of income, interest and dividend income was $112,100,000 up from $107,500,000 in the prior quarter, driven primarily by higher all in yields. Other fees representing prepayment fees and accelerated amortization of upfront fees from unscheduled paydowns were also higher at $3,500,000 compared to $2,500,000 in Q3, driven by call protection on 2 of our largest payoffs.

Speaker 4

Other income was $3,900,000 compared to $4,400,000 in the prior quarter. Net expenses excluding the impact of a non cash reversal related to unwind of capital gains incentive fees was $65,000,000 up from $61,400,000 in the prior quarter. This was primarily due to the upward movement in reference rates, which increased our weighted average interest rate on average debt outstanding from 7.5% to 7.8% and higher incentive fees as a result of this quarter's over earning. During 2023, higher interest rates provided an earnings tailwind for BDCs. As interest rates increased, the floating rate assets that comprise the majority of BDC portfolios contributed to higher all in yields for the sector.

Speaker 4

We earned $2.36 per share of adjusted net investment income, which reflects our highest annual operating earnings since inception. While we believe that operating earnings for BDC is likely peaked in 2023, we feel that our business is positively positioned continue to outperform the sector in 2024 driven in part by our liability structure. As a reminder, 100% of our liabilities are floating rate as we use interest rate swaps on our fixed rate unsecured bonds to swap them to floating. Given the shape of the forward interest rate curve today and the expectation that rates will decline in 2024, our cost of funding will also decrease. As a result, the earnings profile of our business will show less sensitivity to falling rates relative to our peers.

Speaker 4

That being said, we recognize that being levered at approximately one to one times debt to equity minimizes the impact from liability sensitivity for us and the industry. Ultimately, we believe it is all about the left hand side of the balance sheet as asset selection has greater impact. Before passing it back to Josh, I want to provide a framework for how we are thinking about guidance for this year. We are mindful that the movement of spreads will be a key variable for NII in 2024, including the impact it has on the level of activity based fees we expect to earn. Based on our financial model, which incorporates the forward curve and assumes spreads and leverage remain constant, we expect to target a return on equity on net investment income for 2024 of 13.4 percent to 14.2%.

Speaker 4

The lower end of this range reflects muted activity based fees similar to what we experienced in 2023, while the upper end reflects a more normalized level of activity based fees. Using our year end book value per share of $16.96 which is adjusted to include the impact of our Q4 supplemental dividend, this corresponds to a range of $2.27 to $2.41 for full year 2024 adjusted net investment income per share. Given our belief that the sector has reached peak earnings, we are mindful of the earnings power of the business as interest rates decline with respect to our dividend level. Assuming our balance sheet remains constant as of quarter end, we expect every 25 basis points decline in reference rates to lower net investment income by $0.03 per share on an annualized basis. Based on the forward curve, this framework illustrates that our base dividend of $1.84 per share remains well protected through 2026.

Speaker 2

Back to you, Josh. Thank you, Ian. There's a lot to be excited about for the year ahead. As you heard from Bo and Ian, the pipeline continues to build and the balance sheet is in excellent shape. More importantly, we believe we have the right team and resources to differentiate our business to benefit shareholders going forward.

Speaker 2

Beyond the dedicated direct lending team, we leverage the knowledge and sector expertise across the 6th Street platform, including our energy, healthcare, retail asset based lending teams. This broad range of sector expertise not only widens the top of our origination funnel, but also allows us to provide financing solutions for more complex and unique investment opportunities. As one of a few lenders with these capabilities, we can generate alpha from these transactions. We remain focused on finding the best risk adjusted return opportunities for our stakeholders and feel that SLF is well positioned to do so. In closing, I want to take a moment to thank each and every shareholder of our business for your continued support over the last decade.

Speaker 2

Next month marks our 10 year anniversary since our initial public offering in March 2014. Over this period through the end of 2023, we have generated an annualized return on adjusted net income of 13.5% and a total return for shareholders of 2 76% on a dividend reinvested basis. We have achieved these results by protecting our stakeholders capital through sound capital allocation and minimizing credit losses. We are proud of the track record we've delivered over this period of time and believe we are well positioned to continue building upon what we have achieved thus far. With that, thank you for your time today.

Speaker 2

Operator, please open the line for your questions. Thank

Operator

Our first question comes from the line of Mickey Schleien from Ladenburg Thalmann.

Speaker 5

Yes, good morning, everyone. Josh, there's a lot of demand, as you mentioned, for private debt capital from larger borrowers. And I see that the portfolio's average EBITDA has about doubled over the last couple of years. I'm assuming some of that is just organic growth of your borrowers, but some of it is probably due to going up market. And I'm curious how you're viewing the terms available in the upper middle market versus the middle market where you've had excellent results historically.

Speaker 6

Hey, Mickey, good morning. Thank you. Look, I think what we've seen is the best risk adjusted return and quite frankly, the most activity levels has been upmarket. Maybe that changes, but we have seen, at least from our perspective, the kind of lower middle market, middle market not as active as the big market. And our capital has been more valuable in the upper middle market given up until now the broadly syndicated loan market was shut down.

Speaker 6

My guess is that ebbs and flows over time. And with SOF, I think our shareholders get both and we can go up market. And given that we have a big platform and big pools of capital, SLX shareholders could participate in the upmarket deals. And then given the mid market deals where we're still writing $30,000,000 to $50,000,000 positions are also important to SLX. So I think we can we're uniquely positioned where we can toggle between markets and we can participate in both.

Speaker 6

Not many players can do that. Some are so large that they don't care about the middle market. Some are small that they don't have the balance sheet to participate up market. But we've got where the risk adjusted returns and activity levels have been. But my guess is that changes.

Speaker 5

Thanks for that Josh. That's helpful. And just one follow-up. Ian, could you repeat how much accelerated OID and prepayment fee income was accrued in the quarter?

Speaker 7

Sure, Mickey. Accelerated OID and prepayment was about $0.04 per share. That was recognized, not recognized. Yes. That's

Speaker 6

actually heard.

Speaker 5

Okay. Thank you for that. Those are all my questions.

Speaker 6

Thanks, Ricky.

Operator

Thank you. One moment for our next question.

Speaker 8

Our next question comes from

Operator

the line of Brian McKenna from Citizens JMP.

Speaker 9

Great. Thanks. Good morning, everyone. So I believe last year was a record year of deployment for the broader Sixth Street platform. And Josh, I think you've said in the past, you prefer investing environments where there's a lack of capital and liquidity broadly in the market.

Speaker 9

So with sentiment in the capital markets recovering here to start the year, how should we think about deployment activity throughout 2024 for the firm relative to 2023?

Speaker 6

Yes, that's a great question. So I think you on the direct lending side, no doubt last year was our largest deployment year across the 6th Street platform and funds. I would suspect that I would suspect it's same slightly down maybe. I think activity levels, general activity levels in the environment are going to be better, but market share is going to be down. And so last year activity levels were really, really muted.

Speaker 6

Think as Bo mentioned, it was like 25%. What was the statistic you mentioned about M and A volumes?

Speaker 3

Yes. There were 10 years of store close down 37 percent.

Speaker 6

Yes. I think that's most definitely for a variety of reasons. One is less volatility in the interest rate curve. So people, private equity, dry powder, pressure on DPI for private equity sponsors to get money back to LPs. There's a lot of reasons why that's going to change on the activity level front.

Speaker 6

I think private credit market share will go down. And I think Sixth Street's market share in the private credit will probably stay the same and go up given our capability. So I would say it's probably similar to the same. Last year was a really unique opportunity to deploy capital. And look, I don't know if this is clear in the transcript, but I think there's a circle for Six Street shareholders, which is we deploy capital well, we protect the balance sheet, the stock trades above book value, then those shareholders are actually able to participate in times like last year because we were able to raise capital, fewer able to raise capital in that environment.

Speaker 6

And 40% of the assets today are assets in the post rate or from a post rate hiking cycle of a more interesting vintage, to be honest. So most of that vintage were not did not end up in the current publicly traded BDC shareholder base. And so I'm very proud of what we've been able to do and I'm very thankful for the SLX shareholder support. And ultimately, they got access to that vintage, the last year's vintage.

Speaker 9

Yes, got it. Super helpful. And then just to follow-up, ABF is another area of focus across the broader alternatives industry. So how are you thinking about this opportunity at 6th Street? Are you looking to expand capabilities here?

Speaker 9

Is there the potential to add some of these assets to TSLX's portfolio over time? And then could you maybe just walk through how these yields on these types of deals compare to the relative kind of regular way direct lending deals that you're doing in the

Speaker 6

Q4? Yes. Or maybe it's in pre quarter, but I think we added 1 last quarter. So ABS is a large focus for us. We have a spectacular partner.

Speaker 6

We always had the capability in business. We had a spectacular partner named Michael Dryden, who ran that business at Credit Suisse that we hired before the issues at Credit Suisse. And we've built out a team and expertise across kind of the different idiosyncratic asset classes in the ABF. We actually closed, it's called, I think it shows up as CLGF Holdings on November 7, at 325 $1,000,000 secured term loan in for a borrower that's basically ABS collateral. So that shows up.

Speaker 6

And that those yields,

Speaker 2

I think, were give me one second.

Speaker 6

I will come back to you. But what is that? I think my guess is mid teens. It was a mix of senior and junior capital. Yes, that's 15% kind of weather, I guess.

Speaker 6

So, look, we have those capabilities. We're excited about it. We're excited about the team at Six3. And I think that's part of the benefit for SLF shareholders is they get the benefit of this broad based platform that quite frankly a monoline standalone owned manager have a $3,000,000,000 BDC kind of provide shareholders.

Speaker 9

Got it. I'll leave it there. Thank you, guys.

Speaker 6

Thanks so much.

Operator

Thank you. One moment for our next question. Our next question comes from the line of Finian O'Shea from Wells Fargo.

Speaker 6

Good morning, Fin.

Speaker 10

Hey, good morning. How are you? So first question with SSLP, the private BDC up and running now, can you touch on the degree of overlap that they've had in origination so far? And then maybe how different the deals look like how far apart are they in say enterprise value?

Speaker 3

I'll leave it there.

Speaker 6

Yes. So just for people to know, 6th Street Lending Partners is a private BDC that's predominantly institutionally backed just like SOS focused on the large cap space. And so how we define kind of soft fleet duties to offer is above $200,000,000 credit facilities, FSLP has a first look below 200 SLX, given the size of the relative balance sheet. Given the co investment order, if I want to answer your question specifically, given the co investment order requires once public fund, so those would be SSLP or SLX invested in a company, they have to invest to continue to make follow on investments. And so the degree of overlap is high in that by name of portfolio company.

Speaker 6

So you will see some small total provisions. And if there's a duty effectively a duty to offer an SSLP above $200,000,000 SOF, we'll take a small piece of that. So they might be able to participate in future transactions. If below $200,000,000 those credit facilities typically grow, SSLP will take a very small position, SLF will fill. And so the degree by number is high, the degree of portfolio overlap by like position size.

Speaker 10

Awesome. That's very good color. Just a small follow-up on Bed Bath and Beyond. You seem to flag that as a bit of a special case here maybe, but it's still pretty well marked. So I guess, can you give us some color on what the remaining collateral looks like?

Speaker 10

What kind of timeline share guide?

Speaker 6

I thought we my guess so today we've received about 56% including principal interest back on our original investment. The collateral pools are a whole bunch of pools ranging from receiving LCs back from on the vendor program with banks from insurance workers' comp LCs coming back to litigation pools. And so there's varying headcounts and timelines, but we as of now, we think that it's so pretty well supported.

Speaker 10

Great. Thanks so much.

Operator

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

Speaker 11

Hey, good morning. Thanks for taking my question. In terms of the originations this year, last year there was a considerable mix within new investments versus upsized or add on financing. Wondering for this year, whether you would expect a similar mix or could it be a little bit more balanced? Thanks.

Speaker 6

Yes. So I think our fundings this year, most of it was new, I think, like 94% of it was new. We were the agent on the majority of that. I don't have a call. My guess is that it will probably be more balanced.

Speaker 6

Portfolio companies becoming more active and doing add ons, We've started to see a little bit of that. I think we're talking about name later today where there's I guess 2 names later today that are upside opportunities. But I don't really have a crystal ball. The reality is last year, anything that was new, a change of control, new buyout or financing had to be done in the private credit market. And so we took advantage of that for shareholders.

Speaker 11

Got you. Very helpful there. And then just in terms of a follow-up, any updated outlook on potential opportunities from banks optimizing their balance sheets due to the changing regulatory framework? Thanks.

Speaker 6

Yes. Look, I would say, broadly speaking, and this is Tom Baughton strikes, bank balance sheets feel more stable, at least the large the money center banks. I think the deposit shifting that was happening where deposits were flowing in the treasuries has kind of peaked and slowed and might slightly be reversing on the margin and so deposits are much more stable in banks. And so we are seeing banks come back into purchasing securities, including CLO, AAA, etcetera. So that's been a on a base standpoint, I think that's been slightly different than last year.

Speaker 6

I think the smaller banks or those banks that have significant commercial real estate exposure, obviously are going to might not have liquidity issues like they did last year. So banks who had issues last year had liquidity issues and not so First Republic, obviously, Signature, you can go through the list. Banks this year, I think, are going to have more credit issues. Those credit issues will be around some my guess is commercial real estate, most banks don't hold non investment grade corporate credit on balance sheet.

Speaker 11

Got you. Very helpful there. Thanks again.

Operator

Thank you. One moment for our next question.

Speaker 8

Our next question comes from the

Operator

line of Melissa Weddle from JPMorgan.

Speaker 12

Good morning. Thanks for taking my questions. First, I wanted to clarify an answer, I think, Josh, that you had to one of the earlier questions around origination outlook for the year. I think you were referencing roughly the same or maybe a little lower. I wasn't sure if you were referring to sort of gross originations or net?

Speaker 12

And were you talking about market share?

Speaker 6

Yes. First of all, I was talking about the I think the question was related to the entire 6th Street platform. And so the platform last year, I think on the growth side, they're probably $4,000,000,000 to $5,000,000,000 of kind of origination. So obviously, some of that as discussed based on kind of appetite of winning NanoCellX. I will ask the question I was referring to was growth, but it was in the broader platform.

Speaker 6

Net, my guess is repayments will pick up this year. We had the lowest repayment year, I think, ever last year. As I think Bo mentioned in the script, it was 15% portfolio turnover versus the average of like 40%. And so the average loan historically has been around for 2.5 years or something. And last year, which is not the math you should do, it would have been the average loan would have been around for 5 years, something like that or 6 years, 7.5 years, 6 years.

Speaker 6

So I think my guess is growth will be the same to slightly lower maybe, I don't know. We're investors, we're going to do things that we think are interesting for our stakeholders. But net surely will be lower because portfolio turnover will pick up.

Speaker 12

Okay. I really appreciate that clarification. As a follow-up, I wanted to circle back to something Ian had said about the outlook for the upcoming year and sort of thinking about the ROE framework. It seems like one of the embedded assumptions there is that spreads on spreads will remain roughly stable with sort of the variable factor maybe being around activity levels. I guess I wanted to just get your thoughts on sort of spread stability if in an environment where you're seeing a reopening of the broadly syndicated loan market.

Speaker 12

And is that a fair assumption? Or could we see things narrow a bit more? Thank you.

Speaker 6

Yes. Look, I think we're kind of hedged on spreads, at least in the near term on earnings. Look, I think the earnings when you think about the activity level, even at the top end of our guidance wasn't that high, as we always say NII per share. If you see spreads come in significantly, my guess is there's going to be a lot more activity level income in the book. So activity level income in 2023 was, call it, I'm doing the math, I mean, on Accelerated OID and prepayment fees $0.10 per share.

Speaker 6

In 2022, it was $0.27 per share. In 2021, it was 0.4 $7 per share. So even in our 2024 estimates and the range is still pretty muted. So what I would say is at least for 2024, if spreads do come in and we see some pressure net interest margin, you surely will see activity levels pick up activity needs to pick up.

Speaker 12

Got it. Thank you.

Operator

Thank you. One moment for our next question. Thank you. Our next question comes from the line of Eric Zwick from Hovde Group.

Speaker 6

Good morning, all. Just a quick follow-up on the pipeline. I'm curious as you look at it today, if there are any particular industries that are either comprising a larger share or look particularly attractive? And kind of on the flip side, if there's any industries that you're cautious or shying away from today? Yes.

Speaker 6

So good question. Look, I think there's I would frame it a couple of ways. I think there are in 2024, I'm more hopeful that our good company about bad balance sheet opportunity set, which has historically been a kind of a wane for us will come back. We're working on a couple of things that we think will provide good risk adjusted return that are complicated. So I think that's one theme.

Speaker 6

That is a theme. So good companies, bad balance sheets, capital structures that were put in place in a zero rate environment that's no longer a zero rate environment. The second theme is we have done actually more industrials and industrial services in the recent in I think last quarter and this quarter that will show up in the book. And so we like those businesses. We think they're kind of at mid cycle slightly, maybe above mid cycle earnings that are underwritable.

Speaker 6

They're surely not at peak earnings. And so we like kind of the dynamics there. Retail cash flow deals still we all love, but retail hopefully will be another good opportunity for us. The consumer continues to shift wallet share. I think you saw the negative trend earlier this week on retail sales shifted from goods to experiences.

Speaker 6

The balance sheet for void during COVID, given the consumer can only spend their excess savings on goods, They're coming back down to earth. So I think that's going to be a good opportunity. And then we'll continue to operate in our sector themes such as software, etcetera. But I do think you'll see more industrials. I do think you'll see the more complicated transactions show back up in 2024.

Speaker 6

That's great color. I appreciate it. Thanks for taking my question.

Operator

Thank you. One moment for our next question.

Speaker 8

Our next question comes from

Operator

the line of Robert Dodd from Raymond James.

Speaker 13

Good morning, everyone. So first one, maybe simple, maybe I missed it. Can you give us for the ROE and the earnings guidance, what forward curve is factored into that? I mean today it's 3 cuts, a month ago it was 6 cuts. I mean can you give us an indicator of what you what you've got for the future?

Speaker 13

Yes.

Speaker 6

I think the exact date, by the way, which we got some help earlier, it was probably a week ago or what was last Tuesday was the forward curve we used and rates are slightly up from there. But yes, the forward curve has been very, very tricky. But we use the forward curve as of last Tuesday and I think rates fall off a little bit and are up from there. But hopefully Yes,

Speaker 13

got it. Got it. Thank you. And then the other one, I think in your prepared remarks, you said, I mean, there were some refinancing activity already in or repricing, however, one word in the Q4, but those were 21s, 22s. So they generate accelerated income, but not as much.

Speaker 13

If spread can you give us an idea of what you're thinking about how it could play out in 2024? I mean, if spreads do come in, did the 2023 start refinancing if spreads are tightened up, which would generate considerably more income if they're younger versus older? I mean, any impact on

Speaker 6

that? Yes. Look, I think you see I think it's a great question. Obviously, there's more OID, unamortized OID in call protection in the 23s versus the older mid digits. So you have that right.

Speaker 6

So you most definitely can see that happen. That is not modeled in. What you might have picked up in our guidance is that the dispersion is higher, I think, this year in our guidance than it ever has been before.

Speaker 7

That's right.

Speaker 6

And it's because of the things that we're talking about on the last three questions. One is, there's more volatility on the curve. The curve had 2 big moves this past week. There are spreads and prepayment penalties. What I would say is in our base at $2,000,000 whatever $28,000,000 per share, we don't have that much in on accelerated ID and prepayment fees.

Speaker 6

It's like $0.13 per share. So I don't know the dispersion is wider for sure. Our guidance was wider for sure. And because the environment seems still continues to be volatile.

Speaker 13

I appreciate that and the color. I mean, if the market is highly active, dollars 0.13 is 1 quarter, but I'll just leave that I think the guidance you're typically pretty conservative. So understood. Thank you.

Speaker 6

Thanks, Robert. Thanks, Robert.

Operator

Thank you. One moment for our next question. Our next question comes from the line of Maxwell Fritchard from Truist Securities.

Speaker 14

Hi, good morning. I'm calling in today for Mark Hughes. Are you seeing any more competition in winning deals from the stepped up fundraising and direct lending that Bo had mentioned, particularly if the broadly syndicated market becomes more competitive?

Speaker 6

Yes. I mean, look, there's most definitely more competition and there's been more capital raised. I think the overall whatever you want to call it, capital, credit dry powder compared to private equity dry powder, I'm not a big I don't love that kind of theme because the moments in time, it doesn't always play out, but that still holds. But there's most definitely more competition. I think the good news and the bad news is that the asset class has been credentialized because it's provided a decent or good risk adjusted return for all different types of allocators and investors.

Speaker 6

But that leads to more competition. And so we'll continue really need to adapt and evolve and iterate, so we can continue to provide a great product service to our issuers with speed and certainty and understanding their business and also make sure we do that for our shareholders and stakeholders. So there's most definitely more competition.

Speaker 14

Got it. That's helpful. Thank you. And so in the quarter for the new funding, there was a small step up in equity investments. And I was just wondering if there's anything there or

Speaker 3

if that's just normal course of business?

Speaker 6

Normal course. I think there's some idiosyncratic

Speaker 3

to invest, but it's normal level of activity.

Speaker 6

Yes. I mean, look, I think part of what we try to be, we're investors. And if we if there's a chance to make a small equity and co that's been really accretive for shareholders, we'll do it on businesses we like. Our model is don't do it on everything. We're investors.

Speaker 6

Sometimes there's equity stories we understand and we can underwrite it, sometimes there's not. But when we can, we'll put small pieces on the balance sheet.

Speaker 14

Got it. Thank you.

Operator

Thank you. One moment for our next question.

Speaker 8

Our next question comes from

Operator

the line of Ryan Lynch from KBW.

Speaker 6

Hey, good morning.

Speaker 15

First question I had was, we've

Speaker 6

seen some

Speaker 15

of the data of some of the purchase price multiples coming down for new transactions as I think private equity is finally starting to want to exit investments for return capital. I'm just curious, have you seen the same decline in leverage levels on those transactions that you guys are seeing in the market, whereas the loan to value on those businesses, which have been very low over the last year, would still be in that same level? And the other question on that is, are loan to values staying low? Is that really is that important to you? Or is it more important just the absolute leverage levels on these businesses versus the equity checks and loan to values?

Speaker 6

Yes. First of all, it's a good question. Look, I think valuations are all over the place. I don't I think we've seen them all over the place. I think generally they're down.

Speaker 6

They should be down. Discount rates are up. So if you take a series of cash flows and you apply a higher discount rate to them, you're going to end up with a lower NPV. That lower NPV over a same current EBITDA or operating cash flow number is going to be lower. So I think generally valuation should be down directionally because of the discount rates.

Speaker 6

Weighted average cost of capital has most definitely gone up given the move in treasuries. When we think about and then I would say given the move in again, risk free, companies have less, generally speaking, have less capacity to take on debt and service debt given the higher interest cost. And so, I think you most definitely have seen all those things. And I think LTVs are pretty stable. I would say the one thing I would frame up on LTVs is we don't look at LTVs.

Speaker 6

We look at LTVs, but through our lens, which is what do we think the business is actually worth. That may be consistent with what a sponsor is paying for it or not paying for it. And we don't really get a whole bunch of comfort on the size of the equity check because they have a different kind of risk return profile than we do. We're kind of always short we've written a call option and we're short of put and they don't have that dynamic. So I would say and I know I went deep, I would say we look at LTVs, it's through our lens, debt capacity is down because the rates are up, LTVs are pretty stable and valuations are finally down, but they're all they continue to be all over the place.

Speaker 15

Okay. That's helpful color. The other question I had is with the market, with BSL starting to that market start to pick back up, I'm just curious, are you seeing any sort of new terms that are coming in to deals that direct lenders are implementing in order to win deals? We've seen read and heard things like portability and things like that being put into new deals. Are you seeing any sort of like unusual terms or terms kind of reemerge that you guys aren't super comfortable with in order for lenders to win deals as they're now more competing with the BSL markets?

Speaker 6

Well, look, I don't know if it's a BSL thing. I mean, I think we've followed terms getting generally getting looser because there was a whole bunch of more private credit raised in the last 6 months or years. So I think terms generally have weakened. I think you have to look at it in the context of an idiosyncratic credit. And so is there more covenant light covenants on revolver draws in large cap private credit?

Speaker 6

Yes. But I think the market does an okay job, decent job of making sure it's for the right credit. So most definitely terms are continue to, I want to say, weaken, but continue to evolve. And that's part of hopefully what we bring to the table is being able to underwrite and make those decisions. Bo, anything to add there?

Speaker 6

No, I think you hit it.

Speaker 3

What I would say is even though document terms are loosening, I think they're still on the margin better than they were kind of in the late cycle peak ish levels in 2020, 2021. But with more competition, we're mainly from the direct lending market. You're seeing the general loosening of terms. We typically only play in deals, in fact, we only play in deals where we have a seat at the table and documentation and we will not do deals if there's provisions that we're not comfortable with.

Speaker 15

Okay. I just had one last one for me. You guys have never been

Speaker 16

you guys have always not been you guys have been willing to

Speaker 15

step into some complex deals in the past. You guys have certainly done some asset backed deals that have been complex. I'm just curious, do you have any sort of expertise across the platform and or any desire for any transactions in the real estate space that could ever reach into TSLX's bucket, whether that's a direct loan. Obviously, there's going to be a lot of pieces to pick up in that space. It could be an opportunity, but I'm just not sure if you have that expertise or desire, whether it's a direct loan or even as I know in the past you've played in some of the structured products with CLOs, maybe it's a structured product in that space.

Speaker 15

Just curious what's the appetite there or expertise in that area?

Speaker 6

Yes. We have tons of expertise. We've invested 1,000,000,000 and 1,000,000,000 of dollars in real estate as a large theme post the global financial crisis. As people might have read, one of my longtime friends and colleagues at Goldman came on, Julian Fulsberg, the co CIO with Alan and myself across the platform. He's most definitely in confusion to focus on real estate and building out the expertise or augmenting the expertise we already have.

Speaker 6

As it relates to does it fit in SLX, we'll have to get some thought into that. But we surely have the expertise and we surely think it's going to be a unique area. Obviously, that is a bad asset. And so and it's a that's a constrained bucket for us. I mean, it's not constrained now, but it's a constrained resource.

Speaker 6

And so we'll also figure that out.

Speaker 15

Okay. Makes sense. That's all for me. I appreciate the time today. Thank you.

Operator

Thank you. One moment for our next question. Our next question comes from the line of Bryce Roe from B. Riley.

Speaker 16

Thanks. Good morning. Just wanted to hit on some questions on the right side of the balance sheet. If you think about some of the repayment activity that you think will be a little bit more elevated in 2024 versus 2023 and put that in the context of where your debt to equity is at this point. Do you think you can kind of manage to that higher end of your targeted debt to equity range, meaning that I guess net originations will be lower like you mentioned?

Speaker 6

Yes. I think I mentioned growth originations will be lower. My guess is net will be the same. So I think we'll be able to manage into our into that range. But I think people were asking growth, but I think net will be able to manage that into that range.

Speaker 16

And Josh, are you comfortable operating at the higher end of that range or would you prefer to be in the lower end?

Speaker 6

I think we're comfortable in the range. So we publicly stated our range up to 1.25, and I think we're comfortable with that. At moments we've got above that, I think people remember we were 1.33% and did an equity raise to bring it back into the top end of the range. I think we're comfortable in the range.

Speaker 4

Okay.

Speaker 6

I know we're comfortable in the range.

Speaker 16

Yes. And then one more for me. You all mentioned pre funding the 2024 maturity. Does that kind of insinuate that you'll see the secured piece of the debt stack go up when we get to the end of the year? Or do you kind of like where you sit right now pro form a for the raise earlier here in 2024?

Speaker 6

Yes. I'll let Ian I'll color up and he can comment specifically. So I think our base case is SLX is not back into the market this year in the bonds. But the market changes and we reserve the right to be opportunistic, but that is the base case, which means that our secured debt, we will borrow on the revolver to repay the 2024s. And so our funding mix will slightly change.

Speaker 6

That has 2 impacts, 1 is secured versus unsecured funding mix. The other impact is that's our lowest cost of capital. And so it will bleed slightly into a lower cost of capital as we do that. And the

Speaker 7

other thing I'd add to that, Bryce, is we talked about getting to 70% unsecured in our mix pro form a for the January deal. If you look back at where TSLX has been historically, we've been in the 80s. So when there are moments in time where it's opportunistic and it's beneficial for us to increase that funding mix, then we like that unsecured market. Yes, the base case

Speaker 6

is funding on the revolver. We prefunded like we said in script, we effectively prefunded that and got that off the table is the base case, which over time should lower our cost of capital.

Speaker 16

Got it. Thank you all for taking the questions.

Speaker 6

Thanks.

Operator

Thank you. At this time, I would now like to turn the conference back over to Josh Easterly for closing remarks.

Speaker 6

Again, thank you so much for your time. We really appreciate people's support. I hope people have a excellent Presidents' Day weekend, if you observe it. And we look forward to seeing people in the spring. Thanks, everyone.

Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.

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Earnings Conference Call
Sixth Street Specialty Lending Q4 2023
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