Sixth Street Specialty Lending, Inc. Q4 FY2023 Earnings Call

Good morning and welcome to Sixth Street Specialty Lending Inc.'s Fourth Quarter and Fiscal Year ending December 31, 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. As a reminder, this conference is being recorded on Friday, February 16, 2024. 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 a number of factors, including those described from time to time in Sixth Street Specialty Lending Inc.'s 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, 2023, 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 third quarter 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.

Thank you, Cami. Good morning, everyone, and thank you for joining us. With us today is 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 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&A. After the market closed yesterday, we reported fourth-quarter adjusted net investment income of $0.62 per share or an annualized return on equity of 14.5% and adjusted net income of $0.58 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 non-cash accrued capital gain instead of fee expense, were less than a penny 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 included 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% and a full-year adjusted net income per share of $2.66, or return on equity of 16.2%. Longtime 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 two years, we remain pleased with our performance relative to the sector and in context of a complex macroeconomic environment. Over the last two years, we experienced the fastest rate hiking cycle in history, contributing to increased volatility and economic uncertainty. Despite these headwinds, we generated an average annualized return on equity on adjusted net income of approximately 12% for fiscal years 2022 and 2023. While we don't have a complete set of peer data available yet, we believe these returns are nearly double that of our peers over the same two-year period, which is supported by a two-year return on equity on 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. We leaned into an investment environment where the deployment opportunities generated 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. Despite the challenging operating environment over the last two years from the 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 one 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. 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 our existing portfolio with any level of speed as macroeconomic conditions change. We feel confident about the strengths of our in-the-ground portfolio today for two key reasons. First, is the deliberate asset allocation in our portfolio characterized by 91% first lien senior secured loans to businesses with strong underlying unit economics. And second is the 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 loan-to-value ratios. Yesterday, our board approved the 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 and net asset value per share, pro forma 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 policies motivated by careful consideration of a number of factors, including the RIC distribution requirements, not burdening our returns with excess friction costs incurred through excess taxes, and our goal of steadily building net asset value per share over time. In connection with the board, we analyze this framework on an ongoing basis. Before passing it to Bo, I'll spend a moment on how we're thinking about the broader macroeconomic environment and the impact for the sector. As we've said in our last two earnings calls, we believe BDCs are 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 peaked until 2009. As the credit cycle continues to evolve in 2024, we expect to see three impacts for the sector. First is a decline in net investment income driven by the downward shape of the forward interest rate curve. Second, is an uptake in non-accruals from credit deterioration, resulting in further declines in net investment income. And third, is a downward pressure on net asset value driven by the potential for lower fair values from credit weakness and dividend policies and excessive 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. 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 outperform 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.

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 leveraged buyouts financed in the private credit market was more than six times the number financed in the broadly syndicated market in 2023, highlighting a clear preference for the private credit product. While private credit market share was up significantly in 2023, we expect to see more balance in 2024 as the 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 ten years and was down 37% from the trailing ten-year average. Despite a general slowdown in M&A transactions, we benefited from the large market share shift from the broadly syndicated to the private credit market. As the broadly syndicated loan 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 solely reliant on M&A, sponsor activity, or specific sectors. Further, we are not reliant upon certain credit market conditions to prudently put capital to work, while remaining highly selective. In Q4, we provided total commitments of $360 million and total fundings of $278 million across nine new portfolio companies and upsizes to five existing investments. We experienced $145 million of repayments from four full and four partial investment realizations. For the full-year 2023, we provided $959 million of commitments and closed $808 million of fundings. New investments represented 94% of total funding in 2023, with only 6% supporting upsizes to existing portfolio companies. Total repayments were $469 million for the year, resulting in net portfolio growth of $339 million. 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 second highest net deployment year, resulting in year-over-year portfolio growth of 18%. Given the tightening cycle and spreads, we expect to see an 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 first 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 Sixth 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. Exposure in our portfolio to software businesses 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, Sixth Street arranged and closed on a senior secured credit facility to existing borrower Kyriba as part of a refinancing transaction. Over the life of the initial Sixth 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 a company coupled with Sixth Street’s 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 a gross unlevered asset level IRR and multiple of 13% and 1.7 times respectively for our shareholders. We'd like to now take a moment to provide a quick update on one of our retail AVL 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 refinancing. 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 four years. We expect this may drive an increase in opportunistic refinancings, which have the potential to lead to incremental activity-based fees. In Q4, two 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 costs of capital. These investments each resulted in gross unlevered asset level IRRs of 16%. From a portfolio yield perspective, a weighted average yield on debt and income-producing securities at amortized costs decreased slightly quarter-over-quarter from 14.3% to 14.2%. The weighted average yield at amortized costs 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 and income-producing securities at amortized cost is up about 90 basis points from a year ago. The 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 across our core borrowers from whom these metrics are relevant, we continue to have a conservative weighted average attached and detached points of 0.9 times and 4.7 times respectively. And the weighted average interest coverage remained constant at 2.0 times. 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 million and $79 million respectively. Finally, the performance rating of our portfolio continues to be strong, with a weighted average rating of 1.16 times on a scale of one to five, with one being the strongest, representing an improvement from last quarter's rating of 1.17 times, driven by growth in the portfolio from new investments. We continue to have minimal non-accruals with only one portfolio company representing less than 1% of the portfolio at fair value and no new names added to non-accrual status during Q4. With that, I'd like to turn it over to my partner, 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 $0.62 resulting in full-year net investment income per share of $2.31. Our Q4 net income per share was $0.58 resulting in full-year net income per share of $2.61. 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 and $2.66 respectively. At year-end, we had total investments of $3.3 billion, total principal debt outstanding of $1.8 billion, and net assets of $1.5 billion 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 1.03 times 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. In terms of our balance sheet positioning at year-end, we had $820 million of unfunded revolver capacity against $226 million 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 million long five-year bond offering in early January. Adjusted for the issuance, our funding mix reached approximately 70% unsecured, increased our unfunded revolver capacity to approximately $1.1 billion 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 $347.5 million of 2024 notes, which occurs in November. With over $1 billion 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 on net asset value. There was a $0.15 per share decline in NAV from net unrealized losses driven by portfolio company-specific events. Other changes included a $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 third consecutive quarter of $119.5 million, up 4% compared to $114.4 million in the prior quarter. Walking through the components of income, interest and dividend income was $112.1 million, up from $107.5 million 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 $3.5 million compared to $2.5 million in Q3, driven by call protection on two of our largest payoffs. Other income was $3.9 million, compared to $4.4 million in the prior quarter. Net expenses, excluding the impact of a non-cash reversal related to unwind of capital gains incentive fees, was $65 million, up from $61.4 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 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 business development companies (BDCs). As interest rates increased, the floating rate assets that comprised the majority of BDC portfolios contributed to higher all-in yields for the sector. 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 BDCs are likely peaked in 2023, we feel that our business is positively positioned to 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. 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 without 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 net investment income 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% to 14.2%. 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. 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. Beyond the dedicated direct lending team, we leverage the knowledge and sector expertise across the Sixth Street platform, including our energy, healthcare, and 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 financial 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 our position 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. 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 276% 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. Operator, please open the line for questions.

Thank you. Our first question comes from Mickey Schleien from Ladenburg Thalmann.

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 upmarket. 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?

Hey, Mickey, good morning. Thank you. Look, I think what we've seen is the best risk-adjusted return and frankly the most activity levels have been upmarket. Maybe that changes, but we have seen, at least from our perspective, the kind of lower middle market and 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. My guess is that ebbs and flows over time, and with SLX, I think our shareholders get both. We can go upmarket and, given that we have a big platform and big pools of capital, SLX shareholders can participate in the upper market deals. And then given the mid-market deals where we still write $30 million to $50 million provisions 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. 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 in the market. But we've gone where the risk-adjusted returns and activity levels have been. My guess is that changes.

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?

Sure, Mickey. Accelerated OID and prepayment, it was about $0.04 per share.

That was recognized, not accrued.

Recognized, yes.

Okay, thank you for that. Those are all my questions.

Thanks, Mickey.

Thank you.

Thank you. Our next question comes from the line of Brian McKenna from Citizens JMP.

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. 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?

Yes, it’s a great question. So I think on the direct lending side, no doubt last year was our largest deployment year across the Sixth Street platform and funds. I would suspect that it's saying 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. I think as Bo mentioned, it was like 25%. What was the statistic you mentioned about M&A volumes?

Yes, there was a 10-year historic low down 37%.

It was a close situation for various reasons. Firstly, the interest rate curve has seen less volatility, impacting private equity dry powder and putting pressure on DPI for private equity to return money to LPs. There are many factors that will affect activity levels. I believe that the share of the private credit market will decrease, while Sixth Street's market share in private credit is likely to remain stable or even increase due to our capabilities. Last year was a unique opportunity for capital deployment. I think it's important for Sixth Street shareholders to understand that we effectively deploy capital, maintain a strong balance sheet, and our stock trades above book value. This allowed our shareholders to benefit during times like last year when we successfully raised capital, while many others struggled to do so. Currently, 40% of our assets are from a more appealing vintage following the recent rate hikes. Most of this vintage did not make it into the current publicly traded BDC shareholder base. I take great pride in our achievements and am grateful for the support from SLX shareholders, who gained access to this valuable vintage.

Yes, got it. Super helpful. And then just to follow-up, you know, asset-based financing is another area of focus across the broader alternatives industry. So how are you thinking about this opportunity at Sixth Street? Are you looking to expand capabilities here? 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, you know, kind of regular way direct lending deals that you're doing in the course of the year?

We have a significant focus on asset-based financing and have made progress in this area. We partnered with Michael Dryden, who previously led this business at Credit Suisse, and we built a team with expertise in various asset classes related to asset-based financing. Recently, we closed a $325 million secured term loan for a borrower utilizing asset-based financing collateral. The yields on these deals were likely in the mid-teens, which I estimate to be around 15%, and included a mix of senior and junior capital. We are enthusiastic about our capabilities and the team at Sixth Street, which enhances the value for SLX shareholders by offering the benefits of a broad-based platform that a specialized standalone manager of a $3 billion BDC might provide.

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

Thanks so much.

Thank you. Our next question comes from Finian O'Shea from Wells Fargo.

Good morning, Fin.

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. I'll leave it there.

Yes. So just for people to know, Six Street Lending Partners is a private BDC that's predominantly institutionally backed just like SLX, focused on the large cap space. And so how we define kind of, you know, soft lead duties offer is above $200 million credit facilities, SSLP has a first look below $200 SLX, given the size of the relative balance sheet. Given the co-investment order, I want to answer your question specifically, given the co-investment order requires once a public fund, so those would be SSLP or SLX invest 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 a portfolio company. So you will see some small positions. And if there's a duty effectively a duty to offer, SSLP, above $200 million, SLX will take a small piece of that, so they might be able to participate in future transactions. If it's below $200 million, those credit facilities typically grow, SSLP will take a very small position, SLX will fill; so the degree by number is high, but the degree of portfolio overlap by position size is small.

That sounds great. I have a quick follow-up regarding Bed Bath & Beyond, which you mentioned might be a special case, but it's still fairly apparent. Could you provide some information about the remaining collateral? What does the timeline look like? Please, go ahead.

My guess is that we have received approximately 26% of our original investment back, including principal and interest. The collateral consists of various pools, including letters of credit from our vendor program with banks, insurance, and workers' compensation, as well as litigation pools. There are different types of timelines involved, but we believe that it is still well-supported at this point.

Great. Thanks so much.

Thank you. Our next question comes from Kenneth Lee from RBC Capital Markets.

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 be a little bit more balanced? Thanks.

Yes. I believe that most of our funding this year was new, around 94% of it. We acted as the agent for most of that. I don't have specific details, but I think we might see more activity from our balanced portfolio companies in making add-ons. We have started to notice some of that. There’s a name we will discuss later today along with two others that present upside opportunities. However, I can't predict exactly what will happen. Last year, all new investments, changes in control, buyouts, or financing had to occur in the private credit market, and we definitely capitalized on that.

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.

Yes. Overall, I would say that the bank's balance sheet remains relatively stable, particularly for larger banks with substantial deposits. The trend of shifting deposits to treasuries seems to have plateaued and may even be slightly reversing, leading to greater deposit stability in banks. Consequently, we are witnessing banks returning to purchasing securities, including CLOs and AAAs. This situation is somewhat different from last year. Smaller banks or those with significant commercial real estate exposure might face fewer liquidity issues than they did previously. Banks that had liquidity challenges last year, like First Republic and Signature, may now encounter more credit issues, particularly related to commercial real estate, since most banks don't hold non-investment grade corporate credits on their balance sheets.

Got it. Very helpful, there. Thanks again.

Thank you. Our next question comes from the line of Melissa Wedel from JPMorgan.

Good morning. Thanks for taking my questions. First, I wanted to clarify an answer, I think, Josh, that you had on one of the earlier questions around the 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 growth originations or net or whether you were talking about market share?

Yes. First of all, I was discussing the entire Sixth Street platform. The platform generated approximately $4 billion to $5 billion in growth last year. This is influenced by appetite in the SLX. While the question was about growth, it pertained to the broader platform. I believe repayments will increase this year, as we experienced the lowest repayment year last year. Our portfolio turnover was 15%, compared to an average of 40%. Historically, the average loan has lasted about 2.5 years, but last year it extended to around five or six years. Therefore, I anticipate that growth will remain similar to slightly lower. We are investors and will pursue opportunities that benefit our stakeholders. Nevertheless, growth is likely to be lower due to the expected increase in portfolio turnover.

I appreciate the clarification. As a follow-up, I wanted to revisit something Ian mentioned regarding the outlook for the upcoming year, particularly in relation to the ROE framework. It seems one of the underlying assumptions is that spreads will remain relatively stable, with activity levels being a possible variable factor. I'd like to hear your thoughts on spread stability in an environment where we are witnessing a reopening of the broadly syndicated market. Is that a reasonable assumption, or could we see spreads narrow a bit more? Thank you.

Yes. I believe we are somewhat protected on spreads, at least in the near term concerning earnings. The earnings outlook, even at the higher end of our guidance, isn't particularly high regarding net investment income per share. If spreads narrow significantly, I anticipate there will be an increase in activity-level income in the portfolio. For 2023, activity-level income was approximately $0.10 per share, driven by accelerated OID and prepayment fees. In 2022, this figure was $0.27 per share, and in 2021, it was $0.47 per share. Even for our estimates in 2024, the outlook remains fairly subdued. Therefore, for 2024, if spreads do narrow and we experience some pressure on the net interest margin, we can expect an increase in activity levels.

Got it. Thank you.

Thank you. Our next question comes from Erik Zwick from Hovde Group.

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 about or shying away from today?

Yes, that's a good question. I would describe it in a few ways. In 2024, I am optimistic that we will see opportunities in our balance sheet, which has not been strong in the past. We are working on some initiatives that we believe will yield solid risk-adjusted returns, albeit complex ones. That's one point. Another point is that we've increased our involvement in industrial and industrial services recently, and that should reflect positively in our results. We value those sectors, which are currently experiencing earnings at or just above mid-cycle, although not at peak levels. In terms of retail cash flow deals, we aren't particularly enthusiastic, but we see potential opportunities there as well. The consumer is adjusting their spending habits, as evidenced by recent shifts from goods to experiences, indicating that there is still room for growth as they utilize their excess savings more judiciously. Thus, I believe this will create good prospects moving forward. We will also maintain our focus on sector themes like software, among others. Overall, I expect more industrial activity and the return of intricate transactions in 2024.

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

Of course.

Thank you. Our next question comes from Robert Dodd from Raymond James.

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

I think the exact page 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 or up from there. But is that helpful? Yes.

Thank you for that information. In your prepared remarks, you mentioned some refinancing or repricing activity in the fourth quarter, but those were from 2021 and 2022. While they did create some accelerated income, it wasn't significant. Could you share your thoughts on how things might unfold in 2024? If spreads tighten, will the 2023 refinance help improve your income more significantly, especially with younger assets compared to older ones? Any insights on this would be appreciated.

Yes. look, I think it's a great question. Obviously, there's more OID, unamortized OID and call protection in the ‘23 versus the older vintages. So do you have that right? So you most definitely can see that happen. That has not been modeled in. What you might have picked up in our guidance is that the dispersion is higher. I think this year, in our guidance has ever been before.

That's right.

And it's because of the things that we're talking about on the last three questions. One is this more volatile curve. We've got two big moves this past week. There are spreads and prepayment penalties. What I would say is in our base at whatever, $0.28 per share. We don't have that much on accelerated OID in prepayment fees. It's like $0.13 per share. So I don't know the disperse of wider for sure; our guidance moves wider for sure. And because the environment seems to continue to be volatile.

I appreciate that. The cover that. I mean, if the market is highly active $0.13 in one quarter, but I'll just leave I think guidance. You're typically pretty conservative. So understood. Thank you.

Thanks, Robert.

Thank you. Our next question comes from Maxwell Fritscher from Truist Securities.

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?

Yes, there is definitely more competition and increased capital raises. While I don't particularly favor categorizing capital sources, it's evident that the market dynamics change over time. The good news is that the asset class has gained recognition due to its favorable risk-adjusted returns for various allocators and investors, which in turn increases competition. We will need to continually adapt and improve our offerings to provide excellent service to our issuers while ensuring we do the same for our shareholders and stakeholders. There is undoubtedly more competition.

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 if that's just normal course of business.

Normal course.

I think there was some idiosyncratic investments, but it's a normal level of activity.

Yes, I believe part of our role is to act as investors. When there’s an opportunity to make a small equity investment that adds value for our shareholders, we will pursue it in businesses we find promising. Our approach is to not apply this strategy universally; we are investors, after all. There are times when we identify equity opportunities that we can assess and support, and other times when we cannot. However, whenever feasible, we will include small investments on our balance sheet.

Got it. Thank you.

Thank you. Our next question comes from Ryan Lynch from KBW.

Hey, good morning.

Hey, good morning.

First question I had was about the data on purchase price multiples decreasing for new transactions, as it seems private equity is beginning to look for exits and return capital. Have you noticed a similar decline in leverage levels on those transactions in the market, given that the loan to value on those businesses has been quite low over the past year? Also, regarding our loan to values staying low, is that a significant factor for you, or is the absolute leverage level on these businesses more important compared to the equity checks and loan to values?

Yes, that's a great question. I think valuations are quite varied right now and generally trending down. This is primarily due to rising discount rates. When you apply a higher discount rate to a series of cash flows, it results in a lower net present value. Consequently, this impacts the current EBITDA or operating cash flow, leading to lower valuations overall. The weighted average cost of capital has definitely increased with treasury movements. Additionally, many companies now have less capacity to take on and service debt due to higher interest costs. Loan to value ratios remain relatively stable, though we evaluate them based on our perspective of what the business is truly worth. This assessment might not align with what sponsors are paying. We also don’t derive much reassurance from the size of the equity check as they have a different risk-return profile than ours. Overall, while I went into detail, our view is that debt capacity is down because rates are up, loan to value ratios are stable, and valuations have slightly declined, but there is still a wide range of variability.

Okay, that's helpful information. The other question I had is about the market with BSL starting to pick back up. I'm curious if you are seeing any new terms being introduced in deals that direct lenders are implementing to win business. We have heard about concepts like portability being included in new deals. Are you noticing any unusual terms or terms that are reemerging that you aren't comfortable with as lenders are competing more with the BSL markets?

Well, look, I don't know if it's a BSL thing. I mean, I think we fall terms getting generally giving looser because there was a whole much more private credit raise in the last six months or year. 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 kind of light screen, springing covenants on revolver draws in large-cap private credit? Yes. But I think the market does an okay job, deep in job of making sure it's for the right credit. So most definitely in terms are continued, let's say, weakened, but continue to evolve. And that's part of hopefully what we bring to the table, being able to underwrite and make those decisions. Bo, anything to add there?

You’re right. While the terms for documentation are loosening, they are still somewhat better than the late peak levels seen in 2020 and 2021. However, increased competition, particularly from the direct lending market, is causing a general relaxation of terms. We usually participate only in deals where we have a say in the documentation, and we avoid deals that include provisions we are not comfortable with.

I have one last question. You've always been open to taking on complex deals, and you've handled some asset-backed transactions in the past. I'm curious if you have any expertise on your platform or interest in real estate transactions that might fall within TSLX's scope, such as direct loans. There's likely to be many opportunities in that sector. Do you have the expertise in that area, whether it's a direct loan or possibly structured products like CLOs? I would like to know more about your interest and expertise in this field.

Yes. We have significant verticality and have invested billions of dollars in real estate. This became a major focus after the global financial crisis. One of my long-time friends and colleagues from Goldman Sachs, Julian Fultzberry, who is co-CIO alongside Alan and me, has continued to emphasize real estate and enhancing our existing expertise. Regarding its fit within SLX, we will need to give it some thought. However, we are confident in our expertise and believe this will be a distinct area for us. Clearly, it represents a challenging asset, and it is certainly a defined category for us. While it isn’t limited at this moment, it is a resource that is constrained. We will determine our approach moving forward.

Okay, makes sense. That's all from me. I appreciate the time today.

Thank you.

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

Again, thank you so much for your time. We really appreciate people's support. I hope people have an excellent present day weekend if you observe it, and we look forward to seeing people on the screen.

Thanks, everyone.

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