Sixth Street Specialty Lending, Inc. Q4 FY2022 Earnings Call

Good morning, and welcome to the Sixth Street Specialty Lending, Inc. Fourth Quarter and Fiscal Year ended December 31, 2022, Earnings Conference Call. As a reminder, this conference is being recorded on Friday, February 17, 2023. I will now turn the call over to Ms. Cami VanHorn, Head of Investor Relations.

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 numerous factors, including those described from time to time in Sixth Street Specialty Lending, Inc. filings with the Securities and Exchange Commission. 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 fourth quarter and fiscal year ended December 31, 2022, and posted a presentation to the Investor Resources section of our website, www.sixthstreetspecialtylending.com. The presentation should be reviewed in conjunction with our Form 10-K filed yesterday with the SEC. Sixth Street Specialty Lending, Inc.'s earnings release is also available on our website under the Investor Resources section. Unless noted otherwise, all performance figures mentioned in today's prepared remarks are as of and for the fourth quarter and fiscal year ended December 31, 2022. 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.

Thanks, Cami. Good morning, everyone, and thank you for joining us. With us today is my partner and our President, Bo Stanley; and our CFO, Ian Simmonds. For our call today, I will review our full year and fourth quarter highlights and pass it over to Bo to discuss our originations activity and portfolio metrics. Ian will review our financial performance in more detail, and I will conclude with final remarks before opening the call to Q&A. After the market closed yesterday, we reported fourth quarter adjusted net investment income of $0.64 per share or an annualized return on equity of 15.5% and adjusted net income of $0.56 per share or an annualized return on equity of 13.6%. As presented in our financial statements, our Q4 net investment income and net income per share, inclusive of the unwind of the noncash accrued capital gains incentive fee expense, were both $0.01 per share higher at $0.65 and $0.57, respectively. For the full year 2022, we generated net investment income per share of $2.01 or return on equity of 12% and a full year adjusted net income per share of $1.27 or return on equity of 7.6%. The difference between net investment income and net income for the year was driven overwhelmingly by unrealized losses as we incorporated the impact of wider credit market spreads on the valuation of our portfolio. The impact of increased risk premiums was presented throughout nearly every asset class in 2022. During the calendar year, LCD's first and second lien spreads widened by 135 and 686 basis points respectively. There has been a lot of talk about the lack of volatility in private asset marks. In this regard, we agree with Cliff Asness's description of this as volatility laundering. As we said in the past and for the reasons we outlined in our previous public shareholder letter, we believe that using inputs from the market is not only critical but required in determining the fair value of assets. Of the $0.75 per share difference between our net investment income and net income results for 2022, the majority, or 57%, was related to unrealized losses resulting from credit spread movements alone that we expect to recover over time as credit spreads tighten or investments are paid off, and 20% was driven predominantly from the decline in equity valuations. The remaining difference between net investment income and net income is primarily related to: one, the unwind on our interest rate swaps that are not subject to hedge accounting; and two, the reversal of unrealized gains that flow through net investment income upon realization. The overall health of our portfolio remains strong with no changes in nonaccruals from the last quarter. For the third consecutive quarter, our Board has increased our quarterly base dividend, raising the figure by $0.01 per share to $0.46 per share to shareholders of record as of March 15 and payable on March 31. Year-over-year, we've increased our base dividend by 12.2%. We are also pleased to share that our Board declared a supplemental dividend of $0.09 per share related to our Q4 earnings to shareholders of record as of February 28, payable on March 20. In the near term, we expect that net investment income will exceed our newly established base level due to our increased earnings power. However, we determined $0.46 per share to be an appropriate level based on looking at the forward interest rate curve through 2025, which is subject to changes in the market. 2022 was a year characterized by spread income as a driver of earnings given repayment activity slowed in the wake of increased market volatility. Portfolio turnover, which is calculated as total repayments over total assets at the beginning of the year, was 26% in 2022 compared to 43% and 41% in 2021 and 2020, respectively. The wider spread environment naturally caused a slowdown in repayment activity. As a result, fee-generating income represented a smaller portion of our total investment income for the year relative to historical trends. We generated a return on assets, calculated as total investment income divided by average assets, of 11.6% for 2022 compared to 11.3% in 2021, which was a year defined by a record level of repayment activities. This further highlights the positive impact of the rise in reference rates in driving incremental returns for our shareholders. Our year-end net asset value per share, adjusted for the impact of the supplemental dividend that was declared yesterday, is $16.39, and we estimate that our spillover income per share is approximately $0.77. We would like to reiterate that our supplemental dividend policy is motivated by: one, rig distribution requirements; two, not burning our returns with the excess friction costs incurred through excise tax; and three, the goal of steadily building net asset value per share over time. Before passing it to Bo, I'll spend a moment on how we're thinking about the broader macroeconomic environment. Big picture, we're cautious. But when we think about our portfolio, we are constructive on how we are positioned for the road ahead. The U.S. economy faces a number of headwinds in 2023 that are largely the result of inflation and the resulting shift in monetary policy in 2022. The restrictive monetary environment will surely have an impact on growth. The idea of a near-term Fed pivot remains challenging until job growth slows and the consumer weakens. In summary, it feels like we're living in a transitionary period, with restrictive Fed policy that will continue to dampen growth until we see an increase in unemployment and further demand disruption. A broad-based slowdown in the economy, coupled with the current rate environment, will cause some stress for borrowers. This highlights the importance of why we are focused on business models with high variable cost structures and with those that have pricing power. 82% of our portfolio by fair value was comprised of software and business services companies at quarter end and are generally characterized by high levels of recurring revenue, predictable cash flows, variable cost structures and pricing power. Our portfolio has shown resiliency to date, and we believe the underlying business models of our borrowers are robust and durable. However, we believe economic cycles do exist. As such, we will continue to focus on staying on top of the capital structure and operate in the middle of our target leverage range. With that, I'll pass it over to Bo to discuss this quarter's investment activity.

Thanks, Josh. I'd like to start by laying on some additional thoughts on the direct lending environment, and then more specifically, how it relates to the positioning of our portfolio in a way we're thinking about current opportunities in the market. 2022 was a year that underscored the value proposition of private credit for borrowers. New issued leverage loan volume reached a 12-year low and was down 63% from 2021 as public credit markets were largely unavailable. As a result, private credit providers stepped in as a main source of financing solutions, given the ability to provide speed and certainty of execution despite instability in the broader markets. One of the main themes over the last few quarters has been the growing market share of direct lenders and the large syndicated sponsor financings. Direct lenders, with the ability to write sizable checks, are benefiting from the opportunity to participate in larger transactions, which otherwise would have been financed in the broadly syndicated loan market. Notably, these investment opportunities present attractive risk-reward dynamics as the deal terms have moved in a more lender-friendly direction, indicated by wider spreads, tighter documents and lower leverage. We believe this shift in the underwriting terms reflects the appropriate compensation to lenders given the uncertain environment we're investing in today. We are well positioned to take advantage of this opportunity in the market, given our ability to invest alongside affiliated Sixth Street companies. As capital has generally become more constrained, the power of the Sixth Street platform has allowed us to finance larger, more established companies while remaining selective. We believe this creates a competitive advantage in today's investing environment as the number of direct lenders willing and able to participate in larger transactions is limited. In addition to the strong originations activity supporting this opportunity in the market in Q4, we have a robust pipeline for the first half of 2023, including several large financings that have already been publicly announced. As we have the ability to co-invest with Sixth Street affiliated funds on these transactions, we have flexibility to determine the optimal final hold sizes for our balance sheet. Turning now to our investment activity for the quarter, Q4 was productive, with total commitments of $241 million and total fundings of $212 million across seven new portfolio companies and upsizes to five existing investments. We experienced $282 million of repayments from seven full and three partial investment realizations. The increase in repayment activity was largely driven by idiosyncratic payoffs of our two largest investments by fair value as of 9/30 that we discussed on our last earnings call, violating the front line, which represented 58% of repayments for the quarter. For the full year of 2022, we provided $1.1 billion of commitments and closed $864 million of fundings. Total repayments were $654 million for the year, resulting in net portfolio growth of $210 million. Year-over-year, our portfolio grew by 11%, which reflects our deliberate effort to grow responsibly. We were able to remain selective in the investments that we make, given the size of our capital base, but not require us to be asset gatherers, but rather bottoms-up fundamental investors focused on driving return on capital for our investors. 82% of total commitments this year were sponsored transactions within our specialized sector sub-teams. We continue to execute on our software and business services themes, where we believe we have a competitive advantage and where the underlying companies have attractive revenue characteristics, high-quality customer bases and robust business models. At December 31, our top industry exposure by fair value was to business services at 14.4%. We'd like to take a moment to provide an update on one of our retail ABL investments that has recently been in the press, Bed Bath & Beyond. As mentioned during our Q3 2022 earnings call, we had aged a FILO term loan commitment in September of 2022 to support the operational turnaround by the company and provide additional liquidity. As a result of this transaction, we hold a $55 million paramount commitment as of 12/31 of the FILO term loan, which represents less than 2% of our total assets as of year-end. On February 6, the company announced it was raising up to $1.025 billion of new equity capital through a public offering. This offering allows the company to avoid bankruptcy found in the near term, which is a positive for all the company's stakeholders, including employees. Along with the capital raise, Sixth Street made an additional investment in a more senior position in the capital structure. Our position, which is already underwritten to liquidation value, is improved as a result of the new capital raise and our more senior position in the capital structure. Obviously, this remains an ongoing situation that at this moment, we feel good about the security. Our retail ABL capabilities have been a distinguishing feature of our investment strategy since we began the company back in 2011. We have executed over 25 transactions and invested over $1 billion of capital through TSLX. On these investments, we have taken 9 through the bankruptcy process without any losses. From a performance perspective, gross unlevered return on fully realized retail ABL investments is 20.8% as of 12/31. We have a core competency in managing these types of investments, and we'll look to continue to execute on this strategy through the same playbook we established years ago. Moving on to the repayment side, one realization that we'd like to highlight is our investment in TherapeuticsMD, which demonstrates the positive impact of proactive asset management for our shareholders. Since our initial investment in 2019, the company faced multiple challenges, including impacts from COVID-19, resulting in underperformance relative to expectations. As the situation evolves, Sixth Street worked with the company as advisers toward a path asset, including multiple amendments and a large partial paydown prior to our exit. In December 2022, Sixth Street's debt was fully repaid when the company licensed full commercial rights of its products. TXMD will continue to be a public company receiving milestone payments and 20 years of royalties on sales. Through active portfolio management and extensive experience in the healthcare space, TSLX generated approximately 15.5% IRR and 1.4x MOM on the investment with a beneficial outcome for both parties. From a portfolio yield perspective, our weighted average yield on debt and income-producing securities at amortized cost increased to 13.4% from 12.2% quarter-over-quarter. The increase primarily reflects a rise in the weighted average reference rate reset of 115 basis points over the quarter. The weighted average yield at amortized cost on new investments, including upsizes for Q4, was 12.6% compared to a yield of 11.9% on exited investments. Looking at the year-over-year trends, our weighted average yield on debt and income-producing securities at amortized cost is up about 320 basis points from a year ago. The significant increase in our yields in 2022 illustrates a positive asset sensitivity for our business from increased base rates beyond our floors in addition to our selective origination approach across themes and sectors. Moving on to the portfolio composition and credit stats across our core borrowers for whom these metrics are relevant. We continue to have conservative weighted average attach and detach points of 0.9 times and 4.5 times respectively. And weighted average interest coverage decreased from 2.6x to 2.2x. The decrease in interest coverage is in line with our expectations from the impact of rising rates on the cost of funds for our borrowers. Our interest coverage metric assumes we apply reference rates as at the end of the year to the run rate borrower EBITDA, we believe this is a better representation of our position of our borrowers as opposed to a look back metric, such as LTM. One additional nuance we'd like to highlight on interest coverage relates to the positioning of our portfolio towards software and business services. These businesses generally see more limited fixed charge requirements, such as capital expenditures. Other more capital-intensive industries experienced higher fixed charges in addition to financing costs, meaning interest coverage metrics likely understate fixed obligations of those businesses. As of Q4 2022, the weighted average revenue and EBITDA of our core portfolio companies was $152 million and $46 million, respectively, representing an increase in both metrics from Q3. Finally, the performance rating of our portfolio continues to be strong, with a weighted average rating of 1.12 on a scale of one to five, with one being the strongest, representing no change from last quarter's ratings. We continue to have minimal non-accruals with only one portfolio company on non-accrual representing less than 0.01% of the portfolio at fair value and no new names added to non-accrual during Q4. With that, I'd like to turn it over to Ian to cover our financial performance in more detail.

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 $0.65, resulting in full year net investment income per share of $2.13. Our Q4 net income per share was $0.57, resulting in full year net income per share of $1.38. There was a $0.11 per share unwind of previously accrued capital gains incentive fees in 2022, which is a non-cash reversal. Excluding the $0.11 per share unwind for this year, our adjusted net investment income and adjusted net income per share for the year were $2.01 and $1.27, respectively. At year-end, we had total investments of $2.8 billion, total principal debt outstanding of $1.5 billion and net assets of $1.3 billion or $16.48 per share, which is prior to the impact of the supplemental dividend that was declared yesterday. Our ending debt-to-equity ratio was 1.13x, down from 1.16x in the prior quarter, and our average debt-to-equity ratio also decreased slightly from 1.15x to 1.14x quarter-over-quarter. For full year 2022, our average debt-to-equity ratio was 1.03x up from 1x in 2021 and well within our previously stated target range of 0.9 to 1.25x. Our liquidity position remains robust with $866 million of unfunded revolver capacity at year-end against $178 million of unfunded portfolio company commitments eligible to be drawn. Our year-end funding mix was represented by a 53% unsecured debt. Post quarter end, we satisfied the maturity of our $150 million January 2023 unsecured notes through utilization of undrawn capacity on our revolving credit facility. The settlement marginally decreased our weighted average cost of debt and had no impact on leverage. Moving to our presentation materials. Slide 10 contains this quarter's NAV bridge. Walking through the main drivers of NAV growth, we added $0.64 per share from adjusted net investment income against our base dividend of $0.45 per share. There was a $0.11 per share reduction to NAV as we reversed net unrealized gains on the balance sheet related to investment realizations and recognized these gains into this quarter's income. The reversal of unrealized gains this quarter was primarily driven by the early payoff of Biohaven, which resulted in an unwind of $0.12 per share from unrealized gains to net investment income for the quarter. There were minor positive impacts from changes in credit spreads on the valuation of our portfolio and a positive $0.01 per share impact from portfolio company-specific events. Pivoting to our operating results detailed on Slide 12, we generated a record level of total investment income for the quarter of $100.1 million, up 29% compared to $77.8 million in the prior quarter. The increase was driven by a rise in the contractual interest income earnings power of the business, as well as other income related to the Biohaven payoff specifically. Walking through the components of income. Interest and dividend income was $85.8 million, up 15% from the prior quarter. Other fees representing prepayment fees and accelerated amortization of upfront fees from unscheduled pay down, were $11 million, up from $429,000 in the prior quarter due to higher portfolio repayment activity. Other income was $3.4 million, up from $2.7 million in the prior quarter. Net expenses, excluding the impact of noncash reversal related to unwind of capital gains incentive fees, were $47.5 million, up from $40.3 million 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 4.3% to 5.6% and higher incentive fees as a result of this quarter's over-earning. During 2022, base rates increased by approximately 425 basis points. And the impact on earnings became evident in the back half of the year given lag in reference rate resets for borrowers. Given the low financial leverage embedded in BDCs, asset sensitivity has a larger impact than liability sensitivity and proved to be a tailwind for our business as we saw increased asset-level yields drive return on equity. For a year characterized by spread income, the rise in interest rates and wider spreads resulted in the business exceeding the upper end of our beginning year ROE adjusted net investment income target of 11.5% or $1.92 per share for 2022. Net unrealized losses, largely from the impact of spread widening experienced in Q2 on portfolio marks, had a significant impact on our net income for the year, which we expect to unwind as credit spreads tighten or investments are paid off. Based on our expectations for our net asset-level yields, the movement in reference rates, cost of funds and financial leverage, we expect to target a return on equity for 2023 of 13% to 13.2%. Using our year-end book value per share of $6.39, which is adjusted to include the impact of our Q4 supplemental dividend, this corresponds to a range of $2.13 to $2.17 for full year 2023 adjusted net investment income per share. As we said, we expect to over-earn our $1.84 per share annualized base dividend in the near term, and we'll continue to distribute overearnings to shareholders through our supplemental dividend framework. With that, I'd like to turn it back to Josh for concluding remarks.

Thank you, Ian. We believe we are transitioning from an era of easy money to a new macro super cycle that we believe will magnify volatility relative to recent history. With such volatility, we'll come to spurts in returns and will elevate the importance of management's capabilities and skills. The ironies, however, even in low volatility and low rate environment, returned this version has already existed. Now we can only expect it to increase. Our rates for the foreseeable future will most definitely cause stress for certain borrowers, followed by an uptick in defaults from the historical low levels we've experienced more recently. That being said, we anticipate credit issues to be heavily related to borrowers with weaker underlying business models, and we are confident in the durability of our portfolio companies. We believe our track record over the past 12 years since inception supports our ability to continue to generate industry-leading returns for our shareholders. We have generated an annualized return on equity on net income since our March 2014 IPO of 13.1%. We attribute a large portion of our success that our shareholders have enjoyed to our ability to over-earn our cost of capital by avoiding credit losses and appropriately pricing spreads on investments that take into account the cost embedded in operating our business. We remain constructive on the opportunity set ahead of us. We continue to experience elevated all-in yields on our assets, and we expect credit costs to remain low given our investment selection discipline and the health of our existing portfolio. We began the year with significant liquidity and capacity to drive incremental ROEs, and are optimistic about opportunities to enhance our capital structure through the course of the year. With that, thank you for your time today. Operator, please open the line for questions.

Our first question comes from Mark Hughes with Truist. Your line is open. Please go ahead.

Hi, Mark.

Mark, your phone might be on mute.

Yes, my phone is on mute. I'm so sorry. Good morning.

Good morning, Mark.

My question was, how are you thinking about fee revenue in 2023? You've provided some good guidance on net interest income. I'm just curious about your thoughts on the fee environment moving forward.

Yes, it's a good question, Mark. It's really hard to tell because it's influenced by repayment velocity. To give you some numbers, in 2020, we can categorize fees into accelerated OID, prepayment fees, amendment fees, and other income. Historically, in 2022, those fees were about $0.37 per share. In 2021, they were approximately $0.54 or $0.56 per share. For 2023, our guidance numbers indicate that these fees will be significantly below those levels, around $0.22 per share. This is largely focused on another year of spread income. If there's increased velocity in the book, it could be much higher, but it will still be significantly below the levels of 2022 and 2021.

Yes, I appreciate the details. When considering the curve and the fact that the base dividend is maintained at $0.46 looking ahead to 2025, how much cushion do you have over the dividend for the next couple of years?

Yes, we just reviewed the figures for 2023, which is primarily driven by spread income, and our earnings per share guidance reflects that.

2013.

2013 and 2017. The base dividend level is?

A $1.84.

$1.84. So there's really a lot of cushion. In 2024, similarly, again, we don't really model significant level. We think about upside in fee income as kind of be an upside to our guidance. So in 2024, those levels of fee income are basically the same. And again, our base dividend is $1.84 and we think we're significantly above that as well. So we knew we're going to over for the next couple of years, but we don't want to put ourselves in a position where we would have to cut the dividend. And so we set dividend where we see a significant cushion in the next couple of years. We were just looking at the curve.

Thank you very much.

Thank you. And one moment for our next question. Our next question comes from the line of Finian O'Shea with Wells Fargo. Your line is open. Please go ahead.

Hi, everybody. Good morning. A question on the large club deals. It looks like we have one this quarter with Avalara not signaling in on that name. But I don't think those are too typical for you to partake in. Can you talk about the threshold for what makes that kind of deal compelling? Is it company quality or terms as to why you so seldom invest in those? And then on the downside, perhaps, can you talk about structural elements you do give up? How much less control you might have and so forth? Thank you.

Good morning, Fin. I hope you’re doing well. We’ve discussed the changes in the upper middle market and large cap space due to the current environment. A year ago, we saw that market as competitive with limited relative value compared to the broadly syndicated market, but that has completely shifted. Now, we find that the marginal capital can secure better terms and finance larger companies effectively. As you're aware, we've been involved in a number of recently announced deals, including Emerson and Max Car, both of which we are leading. There is significant value to be found, as the marginal capital is capable of influencing pricing and structural improvements. Given the macroeconomic landscape, we are financing these businesses in a low-rate environment with more predictable growth compared to historical trends. We appreciate the value available in this market, although it requires collaboration with like-minded partners, which we believe is beneficial. Bo, do you have anything to add?

I would like to mention that you asked a specific question about what we are giving up. In light of the significant value of capital, many of the terms in these upper middle market deals have become considerably stricter over the past six months and are quite similar to what you're observing in your middle market documentation. Therefore, you have a substantial margin of safety with low loan-to-value ratios and a scaled business generating very appealing adjusted returns in the current environment.

Makes sense.

Sure. That's helpful. Thanks so much.

Thank you. And one moment for our next question. And our next question comes from the line of Mickey Schleien with Ladenburg. Your line is open. Please go ahead.

Yes, good morning everyone. Josh, in the fourth quarter, we continue to see middle market loan spreads widen, which is obviously good for your financial performance, assuming the credit quality holds up, but it is stressing borrowers, as you mentioned in your remarks, with interest coverage declining to 2.2. So I'd like to understand, when we think about those trends, what is your outlook on how private lenders will behave this year in terms of spreads and the amount of leverage they're looking for on deals?

Yes, so Mickey, I think when you look at the LCD first lien and second lien spreads, they actually tightened in Q4 slightly. So - but year-over-year, they're significantly widened, which we've hit. So I just want to - want to frame up. We did not see - so when you look at unrealized gains and unrealized losses, they were negligible given that you actually had spreads tightened quarter-over-quarter slightly. Look, credit quality is top of mind. At what points - it looks like historically driven performance or outperformance or underperformance it's credit losses for the industry. It's been the biggest piece that - when you think about the unit economics of the sector, return on assets, is a point of differentiation. Fees and expenses are basically all pinned near each other. Financial leverage is pinned near each other. Cost of leverage is pinned near each other. So it's really return on assets and credit costs that ultimately drive returns to the sector. And that's going be a function of the portfolio that we're built in, their own place now. And we think our portfolio is differentiated and robust given the nature of those businesses. But it is - in this economic environment where you have slowing growth and higher rates, you are most definitely going to have tails in credit. We have yet to see those in our portfolio, but they are most definitely emerging and they are accepting and most definitely emerging in the broadly syndicated loan market. So it's all about credit. I hope I answered your question.

Appreciate that Josh, that's it from me this morning.

Thanks, Mickey.

Thank you. And one moment for our next question. And our next question comes from the line of Kevin Fultz with JMP Securities. Your line is open. Please go ahead.

Hi, good morning, and thank you for taking my questions. As Bo mentioned in his prepared remarks, volatility in the public markets and the pullback from banks has created an increased opportunity for direct lenders to finance larger deals. I'm just curious what your appetite is to act as a syndication provider to potentially generate additional fee income?

Yes look, when there's an opportunity, surely, we'll take advantage of that. And so, we'll surely take advantage for that. That's historically been a relatively low level of attribution of our income. I think over the years it's been somewhere between, at the high end, if you look back $0.05 since 2013 in the low end zero, and this year $0.01. So I mean, there surely will be an opportunity. I wouldn't lean in - as a massive driver of outperformance of earnings.

Okay, that's fair. And then last one, you utilized the revolver to repay the 2023 notes. I'm just thinking about the right side of balance sheet and your funding mix. Do you see additional opportunity to further optimize or diversify your funding profile in this environment? And I guess if so, what structure is the most appealing?

Yes, so credit - let me take a step back. And I think we've done a really good job of this, which is we've always built into the economics of our business, holding more liquidity than the rest of the space. And when you look at revolver size compared to assets or as a metric or availability compared to unfunded commitments, we've always created flexibility, so we were never a force issuer. And so, when you look at our business model this year, we have a lot of flexibility about when we issue or if we issue in the unsecured market, which quite frankly, we think is the most attractive way to access markets, additional capital outside the revolver - and but we have the flexibility to do so given how much liquidity that we hold. And then we burden the unit economics for and our shareholders - have paid for. What's really amazing when you take a step back is that we generated outsized return on equity compared to the space. We're holding more liquidity and paying for that liquidity option than everybody else in the space. And I think that gives us a lot of flexibility. It gives us flexibility not to be a force issuer. It gives us the flexibility in COVID to actually have liquidity to be able to invest in the market, which created outsized return on equities for the following two years. And so we will most definitely be opportunistic. But how we've built our balance sheet, just we've created a whole bunch of flexibility that we think benefits our shareholders, Ian anything to add?

I think the flexibility and being willing to pay for that flexibility just really proved its worth. I guess it's now three years ago, and we like that model. And we're comfortable with what that cost burdens us with, given the flexibility it affords us.

Okay. That all make sense, Ian I will leave it there, congratulations for a really nice quarter.

Great, thank you so much.

Thank you. And one moment for our next question. And our next question comes from the line of Ken Lee with RBC Capital Markets. Your line is open. Please go ahead.

Hi, good morning, and thanks for taking my question. Just wonder if you could talk a little bit more about the asset-backed lending opportunities that you see over the near-term. And whether you could either be taken more offensive or defensive stance around such opportunities given the macro backdrop? Thanks.

Yes. We like that space a lot, the asset-based lending space. If you look at retail specifically, we thought in COVID, there was going to be a significant opportunity. That opportunity went away very, very quickly. We did a couple of deals in COVID. And then post-COVID, given kind of what happened on the macro level, consumer is very strong. Consumers only could spend money by buying goods versus services or experiences. In the retail space, that segment - that those companies had better earnings and better balance sheets than they ever had. That is changing. The consumer is starting to weaken. And the retailers who have goods and services - I mean who have goods and sell goods and have inventory they have less market share of the consumer's wallet. And so, we expect that sector to continue weakening, which will provide an opportunity for us to provide capital into that space. And so, we like that. It's asset management intensive. It's - which you have to have a core competency in doing it, which we think we do. But we think that opportunities will grow and we'll continue to allocate capital to it where we find good risk-adjusted returns.

Got you, very helpful there. And then just one follow-up, if I may within the portfolio, non-accrual rates are still de minimis. I wonder if you could talk a little bit more about what you're seeing in terms of amendment activity in the portfolio? Thanks.

Yes, I would say it picked up slightly, but still really, really benign compared to COVID so no really significant material amendments. We are seeing amendments, related to software transition, which we think is most definitely positive from LIBOR. All the new loans or LIBOR our software base, but I would say, from a credit perspective, it's picked up a little bit, but nothing material to speak off.

Got you, very helpful there, thanks again.

Thank you. And one moment for our next question. Our next question comes from the line of Erik Zwick with Hovde Group. Your line is open. Please go ahead.

Thanks, good morning. Just a question on the pipeline, it sounds like you've got pretty good visibility for at least the next six months. Curious if you could provide a little color into the industry mix in the pipeline today? And if it's fairly consistent with the current portfolio if there's any, industries or sectors that you are targeting or staying away from today?

Yes look, so I would say it's consistent with some outliers. Emerson is an industrials business, which is a little bit of an outlier for us. So, we like that business a lot. We think Blackstone did a great job in buying that business. I think it's really, really interesting, which we led. And we think it's kind of mid-cycle earnings and the capital structure both for this time. Maxo is also a public to private, I think private is again, slightly in different businesses - is a satellite business. We like that business model. We like the visibility of revenues. We like the sponsor a lot. And then, we'll always mix in kind of our small energy stuff. But other than that, we're mostly focused on business services and software, but we have pretty good visibility in the pipeline in the next six months as you mentioned.

Thanks, I appreciate that detail there. And just one more quick one from me - I'm just curious where floors are today for new commitments? Were you able to put those in?

They are most definitely - unfortunately, I don't think they - we've been able to push them up. They're - most definitely in the 75 basis points to 100 basis points. I think 80 basis points - 75 to 100. I wish we've looked up and we will be able to push them up, but the market is not there yet.

Thanks for taking my questions today.

Thank you. And one moment for our next question. And our next question comes from the line of Melissa Wedel with JPMorgan. Your line is open. Please go ahead.

Thanks, good morning, a lot of my questions have been asked already. But I thought it would be interesting to touch on just sort of the activity levels in Q4. Certainly, we were surprised by net exits during the quarter. So given that you're expecting a few larger exits already that you had talked about during the third quarter call. I'm curious if there - with some as deal slippage into the first quarter or if that sort of commentary on how you're seeing the opportunities at right now?

So look, look - I didn't totally get the question. I think so - put most of our exits in Q4, we knew in Q3, and we tried to help people on our Q3 earnings call, which was front line...

Biohaven.

Biohaven, and I think there was a couple more - but those were the big drivers of the Q4 exit.

Right.

And Melisa - the prepayment fees and amortization of upfront fees.

Yes apologies if - my question wasn't clear. I guess what was looking to explore a little bit more was the level of capital deployment during the quarter, especially since you knew about some of the larger exits. So the fact that it was a slower fourth quarter for you guys compared to previous years. Is that a function of deal slippage into the first quarter or is that really commentary on the opportunity side?

I got it. It's actually - when you look at our activity levels in Q4, I would say they were significantly up. The fund so - the commitment we made in Q4 are way over historical levels. They happen to be related to mostly take privates that have time periods on that will close in the first half of - 2023. So - the opportunity that it was as strong as it's ever been. It just happens to be that they were shaded large-cap take privates, which have low regulatory process for that inventory to be turned into funding so - that commitment to be turned into funding.

Got it, thanks Josh.

Thank you. And one moment for our next question. Our next question comes from the line of Ryan Lynch with KBW. Your line is open. Please go ahead.

Hi, good morning. I just have one question. You talked about on one hand kind of big picture, you're cautious given the dynamics of inflation and shift in monetary policy and how that impacts growth. And on the other hand, you talked about your portfolio being mostly in software business with high variable cost structures and pricing power. So I'm just curious, as you study your portfolio and monitor it closely at this kind of current changing dynamic environment, what are some of the key metrics or trends that you guys are monitoring? And is there anything that you guys are seeing thus far that is sort of a concerning trend?

No. So I think revenue growth was like 7% for the quarter. We obviously look at revenue growth on an annualized basis. So revenue growth has most definitely slowed, although still positive. We look at things such as both margin, churn, customer acquisition costs. I would say on the churn side, flat quarter-over-quarter. We grew in the customer acquisition cost by a little bit. But the portfolio, I think, has is in pretty good shape. And by the way, people talk about things in averages. It's kind of a long way to think about it because you're kind of stuck with the tails. And so I think when you look at our portfolio and look at the tails, we feel pretty good that there's no significant tails. But Bo, do you have anything to add on that?

I would like to mention that we also consider bookings as an important indicator of future revenue growth. We experienced a noticeable demand slowdown in Q3 and are carefully observing Q4 across our portfolio, particularly in the business services area. The initial results for bookings in Q4 have actually been quite strong. However, there is some uncertainty about whether this reflects a surge in demand from customers wanting to utilize their budgets before the year ends. Nevertheless, the early signs for bookings across the portfolio in Q4 are encouraging.

It's reassuring to hear. On that note, have your software companies started to adjust their fixed costs? We've noticed significant layoffs in public software companies, which indicates the strength of the business. Have your portfolio companies begun making those adjustments, or is the business doing well enough that it hasn't been necessary?

Yes, I think some companies are beginning to examine their costs, which we view positively. In the post-COVID environment, particularly until last year in a zero interest rate setting, there was a lot of economic momentum. This allowed for financial viability in various investments that perhaps shouldn’t have been made across both public and private markets, including within companies themselves. As a result, we're noticing a slight shift where some businesses are reassessing their cost structures. While it is not at the same level as what we've seen in large tech firms, it's definitely happening, and it's indicative of strong management.

So trying to get more efficient. We would expect that. The great thing about the businesses. They have a very terrible business model.

Okay. That's all for me this morning. I appreciate it.

Ryan, regarding the topic we discussed, while software businesses may have greater financial leverage, they incur fewer fixed charges due to low CapEx requirements. Therefore, it's essential to evaluate leverage based on EBIT or EBITDA minus CapEx, or operating cash flow minus CapEx. When analyzing these metrics, I believe those businesses are either aligned with or have less leverage compared to sectors like industrials or specialty chemicals. It's important to consider all fixed charges, not just those associated with financial leverage, when assessing cash flow.

Got you. Understand the point. I appreciate the time today.

Thank you.

Thank you. And one moment for our next question. And our next question comes from the line of Robert Dodd with Raymond James. Your line is open. Please go ahead.

Hi, everyone. I have two questions. The first is about the guidance, which ties back to Mark Hughes's response. The guidance includes $0.22, but if we look at the lowest four-quarter period you've experienced, it was 35, which is still 50% higher than 22. Additionally, there have only been three quarters in your history with less than five. Are you being extremely conservative, or do you believe there is a high risk that the market in 2023 will be even more disrupted than it was in 2022? If that's the case, low activity levels would make sense. Is your perspective shaped by the market conditions, or is it simply a matter of being very conservative?

That's a great question. I believe you asked a similar question last year. We don't model activity levels; we haven't historically done so. While we have updated guidance during the year based on activity, we don't start with a model at the beginning since it’s challenging due to factors like credit spreads and specific events in our portfolio. If we are aware of those factors, we would incorporate them into our models. However, we don’t model directional credit spreads that influence portfolio churn, and this has been the practice historically. This year is no different. When considering activity levels such as OID and prepayment fees, we usually assume a turnover rate of two to three on an individual basis, which affects those fees. In a tightening market environment, the average portfolio life tends to decrease, leading to higher activity levels. In essence, we do not include this in our models. It's not about having a particular market view; it’s simply the way our models are structured, making it challenging to provide a precise prediction.

I appreciate that comment. It's not an earlier market view, which opens more opportunities.

If you ask for my best opinion, I would say that the market will be divided, allowing good companies access to capital in 2023 and 2024, which is likely to increase activity levels. People will need to navigate the challenges. However, credit spreads are beginning to tighten, as seen in the fourth quarter and year-to-date. This trend could indicate higher activity levels or increased portfolio turnover in our book.

Understood. You don't have a lot of tails in your portfolio, which is great. Regarding the repayment of the unsecured debt in January, you're at about 40% unsecured in your capital stack, which is acceptable and on the lower end of your historical levels. It's also at the lower end of what the rating agencies prefer. This is not expected to decrease again until November 2024. With that said, how do you feel about your target for this percentage, considering the current expensive environment for unsecured debt? Are you comfortable at $40?

I believe we are in a good position. We have strengthened our balance sheet, and we have significant revolver capacity and liquidity. While we have incurred costs associated with that capacity, including commitment fees on the unused portion and upfront fees, we see it as a worthwhile investment to navigate periods when the unsecured market isn't as appealing. Recently, spreads have improved considerably, and we plan to be opportunistic going forward. Currently, we are at the lower end of our range, but if our portfolio grows, we expect it to remain steady because additional growth will be financed through the revolver on the secured side. We could remain flat if there is no growth. We definitely plan to return to the unsecured market as we believe we are one of the few with at least a BBB flat rating, alongside another entity. We value that market and have access to it, ensuring we will take advantage of opportunities there. We have factored the costs of our insurance into our financial strategy for our shareholders. I hope that clarifies your question. Ian, do you have anything to add?

I think it does answer the question. Just maybe more directly, Robert, we're pretty comfortable just given the options that we have available to us.

Got it. It answered my question. Appreciate it. Thank you.

Thank you. And I am showing no further questions. And I'd like to turn the conference back over to Josh for any further remarks.

Great. So thank you so much for the interactive call. We appreciate people getting on the new format of the call vis-à-vis web or the change of like of that one. But we really appreciate it. And we look forward to chatting people with people in the spring, and I hope everybody has a light end of the winter and in the beginning of spring, we'll be back for our Q1 earnings call soon. Thanks so much.

Thanks, everyone.

This concludes today's conference call. Thank you for participating. You may now disconnect. Everyone, have a great day.