Sixth Street Specialty Lending, Inc. Q1 FY2025 Earnings Call

Good day, and thank you for standing by. Welcome to the Sixth Street Specialty Lending, Inc. First Quarter 2025 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentations, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Cami VanHorn, Head of Investor Relations. Please go ahead.

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 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 first quarter ended March 31, 2025, and posted a presentation to the Investor Resources section of our website. The presentation should be reviewed in conjunction with our Form 10-Q 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 first quarter ended March 31, 2025. As a reminder, this call is being recorded for replay purposes. I will now turn the call over to Joshua Easterly, Chief Executive Officer of Sixth Street Specialty Lending, Inc.

Good morning, everyone, and thank you for joining us. With me today are President, Bo Stanley; and our CFO, Ian Simmonds. For our call today, I will review our first 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. In addition to today's earnings call and public filings, we also published a letter to our stakeholders. We may currently be in one of the most pivotal periods for the U.S. and global markets since the global financial crisis. We believe we are operating under a new world order, and it's our job as investors to embrace this reality and proactively position our business based on prudent assessments to navigate the evolving environment. We encourage and welcome your feedback. While we recognize that the world has changed since March 31, we believe our business remains well protected on the asset side with limited direct exposure to tariffs and well positioned on the liability side. We already said a mouthful on these topics in our letter so I'll limit my opening remarks today to briefly cover our first quarter results and frame how we think about the future earnings potential of our business. After market closed yesterday, we reported first quarter adjusted net investment income of $0.58 per share or an annualized return on equity of 13.5% and adjusted net income of $0.36 per share or an annualized return on equity of 8.3%. As presented in our financial statements, our Q1 net investment income and net income per share, inclusive of the unwind of noncash accrued capital gains incentive fee expense was $0.62 and $0.39, respectively. Of the $0.22 per share difference between net investment income and net income, only $0.05 per share was credit related. This was primarily markdowns on our existing nonaccrual loans, and therefore, there was no impact on net investment income. The remaining $0.17 per share was in two buckets. In the first bucket, which we characterize as geography related, there was $0.11 per share prior period unrealized gains that moved out of last quarter's net income and into this quarter's net investment income primarily related to investment realizations. In the second bucket, characterized as market related, there was $0.06 per share impact from widening credit spreads, which, assuming no credit losses, will be reversed as investments are paid off or reach maturity. Looking ahead, we estimate that the quarterly earnings power of the business, assuming a base case of no additional nonaccrual investments and no spread impact on investment valuations, is approximately $0.50 per share. This includes interest income generated by the in-the-ground portfolio today plus limited activity-based fee income. This translates to a return of equity approximately 11.7% above the floor of the calendar year 2025 guidance we provided on our last earnings call of 11.5% to 12.5%. Given increases in repayment activity, there's potential upside to that figure if activity-based fees return to our average prior to the start of the rate hike cycle. We believe our asset quality today supports this forward earnings profile, which we anticipate will differentiate returns from the public BDC sector for three important reasons. First, we've continued to be very disciplined capital allocators. Our portfolio yields are meaningfully higher than the sector average with a weighted average yield at amortized cost of 12.5% in Q4 compared to 11.6% for our peers. We also have a significant portion of our portfolio invested in loans with spreads below 550 basis points, which Bo will discuss later. We believe our disciplined approach will allow us to outperform as the sector experiences a more significant decline in portfolio yields. This leads to the second point, which is our patience and discipline over the past several quarters, combined with increased repayment activity, have provided us with significant capacity to invest in what we expect to be a more interesting investment environment. As seen in the past, peers of heightened volatility often present the most attractive investment opportunities. We are well positioned with the level of capital and the significant amount of liquidity we have for the period ahead. And finally, we believe our returns will continue to be differentiated given our track record of lower credit losses relative to the sector average. Yesterday, our Board approved a base quarterly dividend of $0.46 per share to shareholders of record as of June 16, payable on June 30. Our Board also declared a supplemental dividend of $0.06 per share relating to our Q1 earnings to shareholders of record as of May 30, payable on June 20. Our net asset value per share adjusted for the impact of the supplemental dividend that was declared yesterday is $16.98. We estimate that our spillover income per share is approximately $1.31. With that, I'll now pass it over to Bo to discuss this quarter's investment activity.

Thanks, Josh. I'd like to start by sharing some perspective on the market beginning with a look at the underlying supply and demand dynamics that have shaped the current investment environment. Specifically, as it relates to the U.S. direct lending market and focusing on BDCs as a proxy for direct lending vehicles, the supply and demand dynamics over the past several years have been characterized by an imbalance with the supply of capital outpacing demand. This has largely been fueled by the growth of the retail investor-oriented perpetual non-traded BDC structure, which accounted for roughly 80% of asset growth within the BDC sector in 2024. This inflow of capital has exerted downward pressure on new investment spreads, leading to instances of suboptimal capital allocation. We anticipate that the current uncertainty and volatility will moderate the supply and demand imbalance by slowing inflows into the non-traded vehicles and shifting the pendulum towards direct lending from a broadly syndicated loan market. While these factors may contribute to a more balanced supply and demand environment over time, we continue to believe that a meaningful resurgence in M&A activity remains a longer-term prospect. However, our through-the-cycle business model and diverse originations channel enable us to deploy capital into attractive investments across market cycles. In Q1, we provided total commitments of $154 million and total fundings of $137 million across six new portfolio companies and upsizes to four existing investments. We experienced $270 million in repayments from seven full and four partial investment realizations resulting in $133 million of net repayment activity. As Josh highlighted, market dynamics have changed significantly since Q1. That said, our new investments during the quarter underscore our firm commitment to remain highly selective and disciplined in our capital allocation in all market environments. This is demonstrated in two ways, including lower levels of new investments funded during the quarter relative to our longer-term average and a percentage of our new investments that were thematically driven non-sponsored deals. On this first point, new investment spreads remained historically tight through the first quarter. We are an investor-first firm, which means we prioritize shareholder returns and will not put capital to work for the sake of growing assets. And second is our ability to originate opportunities in the non-sponsored channel, where we were able to differentiate our capital to earn an appropriate risk-adjusted return for our business. In Q1, 84% of new fundings were originated outside the sponsor channel. This includes new investments in our retail ABL team, our energy portfolio, and an investment driven by long-standing relationships within the Sixth Street platform with a founder. I'll spend a moment highlighting our largest investment during the quarter, York Logistics, which is a provider of logistics software and services for the rail and trucking industry. It is a founder-owned business where our direct-to-company relationship led to an investment opportunity. As agent and sole lender, Sixth Street structured a bespoke solution that enabled the Company to execute on its growth initiatives. This flexible approach reflects our ability to meet the specific needs of our borrower while ensuring we achieve an appropriate risk-adjusted return. On a blended basis across our securities, the weighted average yield and amortized cost for this investment was 13.9%. Our investment in Arrowhead Pharmaceuticals is another example of our differentiated investment capabilities. As a reminder from our last earnings call, we expected to receive a prepayment fee in Q1 driven by the previously announced agreement with Sarepta Therapeutics. Arrowhead repaid a portion of the loan, and we received a prepayment fee, which contributed $0.05 per share to net investment income for Q1. This resulted in a reversal of a portion of the unrealized gain on the balance sheet from December 31 as the impact moved out of last quarter's net income into net investment income this quarter. From an overall perspective, 89% of total fundings this quarter were into new investments with 11% supporting upsizes to existing portfolio companies. This quarter's fundings contributed to our diversified exposure to select industries with six new investments across six different industries. In terms of asset mix, we remain focused on investing at the top of the capital structure with total first lien exposure of 93% across the entire portfolio. As part of our new investment in York Logistics, we structured the investment to include a first lien term loan and senior secured notes along with a small equity portion. All other new investments in Q1 were first lien consistent with our long-term approach. Moving onto repayment activity. Q1 was the second consecutive quarter of elevated churn related to the net payoff period we experienced beginning in early 2022. LTM portfolio churn through Q1 was 28% based on the beginning of period investment at fair value, which is the highest level in nine quarters. The increase in repayment activity contributed to the highest level of activity-based fee income, excluding other income, we've had since Q4 2021, totaling $0.16 per share in Q1 relative to our three-year historical average of $0.05 per share. The biggest driver of this increase in Q1 was the Arrowhead prepayment fee, as previously mentioned. Five of our six full payoffs were driven by refinancings, four of which were refinanced by other direct lenders and spreads ranging from 450 to 550 basis points, which did not present an appropriate return profile for our shareholders. The other was refinanced in the broadly syndicated loan market at a spread of 325 basis points. As we have reiterated, we will continue to pass on participating in deals where the economics do not align with where BDCs of any format sit on the cost curve. To highlight the differentiated nature of our portfolio, only 5.4% of our portfolio by fair value is in senior secured loans with spreads below 550 basis points. Further, less than 1% of our portfolio by fair value carries a spread below 500 basis points. Outside the five refinancings, we had one additional payoff in Q1, which was in our energy portfolio. In February, Mach Natural Resources repaid its outstanding term loan. After a hold period of 1.2 years, we received call protection on the payoff and generated an unlevered IRR in MLM of approximately 16% and 1.2x, respectively, for asset-like shareholders. Our dedicated energy team and expertise in this sector continue to be a differentiator for our business, demonstrated by our weighted average unlevered IRR in MLM unrealized investments of 22% and 1.2x, respectively. Moving on to our portfolio yields. Our weighted average yield on debt and income-producing securities at amortized cost decreased slightly quarter-over-quarter from 12.5% to 12.3%. The decline reflects approximately 15 basis points from the drop in reference rates and 5 basis points from the spread compression on new investments. The weighted average spread over reference rate of new investment commitments in Q1 was 700 basis points, which compares to the spread of 541 basis points on new issue first lien loans for the public BDC peers in Q4. Our ability to earn wider spread is largely driven by 84% of our new fundings in Q1 falling into what we call our Lane 2 and Lane 3 buckets, characterized by non-sponsored investments. In Q1, this included our investments in Hudson's Bay Company, Northwind Midstream, and York Logistics. Moving on to our portfolio composition and key credit stats across our core borrowers for whom these metrics are relevant, we continue to have conservative weighted average attach and detach points of 0.5x and 5.1x, respectively. Their weighted average interest coverage remains constant at 2.1x. As of Q1 2025, the weighted average revenue and EBITDA of our portfolio companies was $383 million and $112 million, respectively. The median revenue and EBITDA was $139 million and $52 million. Finally, the performance rating of our portfolio continues to be strong with a weighted average rating of 1.11 on a scale of one to five with one being the strongest. Non-accruals represent 1.2% of our portfolio at fair value with no new investments added to non-accrual status in Q1. Before passing it over to Ian, I'd like to address the potential impact of the recent tariff announcements on our portfolio companies. While the situation continues to evolve and uncertainty across a broader economic landscape remains elevated, we believe there is limited direct risk from these tariff policies on our portfolio. The majority of our exposure is across software and services economies, which we believe will experience limited direct risks from these tariff policy shifts. While we maintain a small exposure to the energy sector, which we expect will have derivative impact, our commodity price exposure is typically hedged on the front end of the curve, mitigating short-term price volatility. To date, the back end of the curve has not moved materially. We believe the potential derivative impacts on the real economy growth and valuations are the bigger risk. However, these impacts are likely to take a number of quarters to flow through and hence, are more difficult to quantify at this stage. That being said, we feel good about where we sit in the capital structure of our borrowers at an average loan-to-value across our portfolio of 41%. To assess potential risk, we completed a comprehensive name-by-name, care-related analysis of our entire portfolio. Excluding our retail ABL investments, this review identified three out of 115 portfolio companies that could be directly affected. These investments represent 2% of our overall portfolio by fair value. And based on our current understanding, we anticipate only a mild impact on the top line and EBITDA performance. Regarding our retail ABL portfolio, which comprises 3.4% of our portfolio at fair value at quarter end, we acknowledge the potential for the impact on these consumer and retail businesses through higher cost of goods, lower margins, and demand destruction. However, our investment thesis on these companies remains intact as it's predicated on the value of the underlying collateral, not the cash flow-related performance of the businesses themselves. We will continue to maintain close communications with management teams and sponsors during this period of heightened uncertainty to understand their strategies for navigating these potential headwinds. We will continue to monitor the situation closely, but we remain confident in our underwriting standards and asset selections. With that, I'd like to turn it over to my partner, Ian, to cover the financial performance in more detail.

Thank you, Bo. For Q1, we generated adjusted net investment income per share of $0.58 and adjusted net income per share of $0.36. Total investments were $3.4 billion, down slightly from $3.5 billion in the prior quarter as a result of net repayment activity. Total principal debt outstanding at quarter end was $1.9 billion and net assets were $1.6 billion or $17.04 per share prior to the impact of the supplemental dividend that was declared yesterday. Josh noted the strength of our balance sheet positioning earlier today, reflecting what has been a busy start to the year as we completed two capital market transactions during the first quarter. In February, we issued $300 million of long five-year notes at a spread of treasuries plus 150 basis points, which at the time matched the tightest spread level for a BDC in the five-year part of the curve. As we do with all our issuances, we swapped these fixed-rate notes to floating at a spread of SOFR plus 152.5 basis points, while the execution level stands out in its own right, and particularly so in the face of widening BDC credit spreads that we have seen since mid-February. This issuance illustrates execution on our underlying philosophy of proactively managing our liquidity needs and our commitment to enhancing the depth of our investor base with each issuance. In March, we further enhanced our debt maturity profile by closing an amendment to our revolving credit facility. With the ongoing support of our bank group, we amended our $1.675 billion secured credit facility, including extending the final maturity of $1.525 billion of these commitments through March 2030. We are pleased with the outcome of this transaction as we successfully converted a legacy non-extending lender to extending status, marginally decreased the drawn spread, introduced a new pricing grid, and lowered the undrawn fee on the facility. The combination of the February bond issuance and the closing of the amendment to our credit facility extended the weighted average maturity on our liabilities to 4.2 years, which compares to an average remaining life of investments funded by debt of approximately 2.3 years. This element is important to our asset liability matching principle of maintaining a weighted average duration on our liabilities that meaningfully exceeds the weighted average life of our assets funded by debt. Following both these transactions, we believe our balance sheet is in excellent shape. As of March 31, we had approximately $1 billion of unfunded revolver capacity against $175 million of unfunded portfolio company commitments eligible to be drawn. In terms of capital positioning, our ending debt-to-equity ratio from the balance sheet decreased quarter-over-quarter from 1.18x to 1.15x. The decrease was driven by the elevated repayment activity experienced in Q1. Further, we have no near-term maturities with our nearest maturity obligation not occurring until August 2026. As you may have seen through an 8-K filing in February, we entered an ATM program to expand our capital raising toolkit. We have not issued shares through the program to date and have no plans of doing so with capital coming back to us through repayments. We believe the ATM program is beneficial for shareholders given the lower cost of issuing equity in this format compared to the follow-on offerings we have done in the past. Consistent with our disciplined approach to raising equity capital, we will look to utilize the ATM program when we have confidence that the new shares issued will be accretive to net asset value and return on equity. Pivoting to our presentation materials, Slide 8 contains this quarter's NAV bridge, which Josh walked through earlier. Moving on to our operating results detailed on Slide 9. We generated $116.3 million of total investment income for the quarter compared to $123.7 million in the prior quarter. Interest and dividend income was $98.9 million, down from the prior quarter, primarily driven by the decline in interest rates. Other fees, representing prepayment fees and accelerated amortization of upfront fees from unscheduled paydowns, were higher at $14 million compared to $5.1 million in Q4 driven by the Arrowhead prepayment fee, call protection, and accelerated amortization of OID on other investment realizations. Other income was $3.5 million compared to $4.8 million in the prior quarter. Net expenses, excluding the impact of a noncash reversal related to the unwind of capital gains incentive fees, were $60.7 million, down from $65.9 million in the prior quarter, primarily driven by the decline in base rates and a benefit from a lower weighted average cost of debt following the maturity of our 2024 notes in November and the subsequent issuance of our 2030 notes in February. This contributed to our weighted average interest rate on average debt outstanding decreasing approximately 60 basis points from 7% to 6.4%. Returning to our ROE metrics before handing it back to Josh, we're reaffirming our target return on equity on adjusted net investment income of 11.5% to 12.5% for the full year, consistent with the assessment of our earnings potential outlined earlier on this call. To the extent we see widening of credit spreads, we would expect some downward pressure on net income and potential diversion between net investment income and net income metrics given the spread movement is incorporated into the discount rate we utilized in determining the fair value of our investments each quarter. That impact would unwind as investments approach maturity or are repaid. With that, I'll turn it back to Josh for concluding remarks.

Thank you, Ian. I'll keep my conclusion brief today and hope that people will take the time to read our letter, which is available on the Investor Resources section of the Sixth Street Specialty Lending website. In closing, I'd like to encourage our shareholders to participate in both our upcoming annual and special meetings on May 22. Consistent with previous years, we're seeking shareholder approval to issue shares below net asset value effective for the upcoming 12 months. To be clear, to date, we have never issued shares below net asset value under prior shareholder authorization granted to us for each of the past eight years. We have no current plans to do so. We merely view this authorization as an important tool for value creation and financial flexibility during periods of market volatility. As evidenced by the last 11-plus years since our initial public offering, our bar for raising equity is high. We've only raised equity when trading above net asset value on a very disciplined basis. So, we would only exercise the authorization to issue shares below net asset value if there were sufficient high-risk adjusted return opportunities that will ultimately be accretive to our shareholders through over-earning our cost of capital and any associated dilution. If anyone has questions on this topic, please don't hesitate to reach out to us. We have also provided a presentation which walks through the analysis in the Investor Resources section of our website. We hope you find that supplemental information helpful as a way of providing a clear rationale for providing the Company with access to this important tool. With that, thank you for your time today. Operator, please open up the line for questions.

Thank you. At this time, we’ll conduct a question-and-answer session. And our first question comes from the line of Finian O’Shea of Wells Fargo. Your line is now open.

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

Yes, Finn, I want to start by saying that I don't have a clear understanding of retail flows. Given the current volatility in the market, I suspect retail flows may have slowed down. Time will tell. The available data seems outdated, and I don't believe there is reliable data post-liquidation. As you know, those investment vehicles are termed semi-liquid for a reason, highlighting potential liquidity issues. During volatile times, if we look at the non-traded REIT sector as an example, they have been pulling liquidity from the market rather than contributing to net flows, but again, time will tell. On another note, we have developed our businesses by managing a relatively small amount of capital for the opportunities we pursue. We have a wide range of prospects, including non-sponsor and more complex transactions. This strategy has made our business more resilient to movements in spread tightening since we are not solely focused on the sponsor business. We have also been very disciplined with our capital allocation and understand our position on the cost curve and our cost of equity. Thus, we won't allocate capital just for the sake of growth in assets and revenues. We consider two key groups in our ecosystem. The first is our capital providers who trust us to manage their capital and deliver an acceptable risk-adjusted return. The second is our counterparty community. To be a good lender and counterparty, we need to effectively manage both aspects, and we intend to continue doing both successfully.

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

Well, we might be expressing similar thoughts or not. The very top of the funnel doesn't have any impact. However, we may quickly determine that something is not suitable for us. The influence at the top of the funnel is widespread, particularly concerning the M&A cycle, which we have been pessimistic about returning, and this trend is consistent across the industry. We decide early on that many options are not for us. Nevertheless, because we have a large top of the funnel and utilize other channels, we find responsible opportunities to invest our shareholders' capital, generating the necessary returns. This has been our business model and it has proven effective. We also believe we are entering a phase with more opportunities for complexity, which we find exciting given the current economic environment. I feel very confident in our ability to continue delivering returns throughout various cycles. Historically, as we noted in our letter, we have performed better during times like this than in more stable markets. Market volatility has afforded us the chance to produce strong returns due to our balance sheet management, the top of the funnel, and the culture at Sixth Street, allowing us to achieve significant returns. In years of volatility, we typically generate almost 200 basis points of excess returns compared to calmer years, and our outperformance relative to the industry increases substantially. We are very optimistic about the future of our business. This is a result of the way we've structured our operations, prioritizing our shareholders and capital, alongside the capabilities we possess in light of market opportunities.

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

Yes. The industry has been talking about M&A making a comeback, partly to validate the capital they have raised. We have a negative outlook on this. The issue isn't the availability of capital; there's plenty of it for private equity deals. The real problem is that people overpaid for assets between 2019 and 2022. Now, no one wants to sell those assets unless they can achieve an acceptable return, which isn't in their economic interest. People require time, and growth is facing challenges, which we believe will prolong this situation. So, do I expect a significant amount of non-investment-grade M&A in 2025? No. Maybe in 2026, but the uncertainty in the macro environment and the decline in growth expectations will make non-investment-grade M&A more difficult.

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

So, Josh, you've been very clear the last several quarters about how the firm has been focused on finding attractive risk-reward opportunities and making sure you're going to pay the right economics for the risk you're taking. The environment has clearly shifted here. But I'm curious, how are your teams able to price risk when there's a meaningful pickup in uncertainty and volatility? And then, there's clearly been a healthy reset in valuation here. So, where are you seeing the most attractive deployment opportunities today?

Yes, Brian, thank you for the question. It's an important one. I believe the way we approach pricing risk is crucial. From what we observe, the private markets don't seem to be effectively pricing risk at this time. I saw a slide earlier indicating that while middle market spreads have remained stable, syndicated spreads appear to have shifted. I’m not certain about the source of that data, but it aligns with our observations. This situation seems to be a technical challenge in the middle market, where there's a need to utilize previous flows. Our perspective is that we are deep fundamental investors. We evaluate our position on the cost curve, our required equity, and the illiquidity premium we need, which means I must commit once I invest. We also assess how we value that asset and its loan-to-value ratio, considering what we believe the asset is worth in a normalized interest rate and growth environment. Our thorough fundamental analysis equips us to price risk effectively during periods of volatility. Additionally, at Sixth Street, we manage $100 billion in assets and have significant platforms across various sectors like ABS, healthcare, sports media, telecom, energy, and retail. This enables us to not only observe many opportunities across the market but also to analyze relative value among asset classes, assessing how growth expectations and discount rates are being priced. This insight is invaluable in maintaining a clear perspective and allowing us to commit capital when others may hesitate.

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

Yes, I was surprised when I examined the industry. The industry has shown remarkable resilience during volatility, with returns remaining stable or even increasing slightly, which was unexpected. This stability is largely due to the presence of permanent capital, meaning firms aren’t forced to sell their assets. On the trading side, this structure allows them to endure market fluctuations effectively. The non-trade side will reveal more over time, particularly as liquidity begins to change. The industry's design, characterized by permanent capital and low leverage, enables firms to manage volatility without being pushed to sell. For us at SLX, we find that we thrive under stress. We've successfully allocated our capital, giving us the means to invest during turbulent times while others are retreating from risk. This strategy involves keeping reserves for future investments, ensuring we are prepared during such periods. Hence, we can actively pursue opportunities while maintaining liquidity. I was genuinely astonished by the industry data, yet it makes sense considering the stable nature of the capital involved. The non-traded sector will be intriguing to observe, especially as capital starts to stop flowing, potentially creating liquidity challenges similar to what we've seen in the non-traded REIT space where investments froze during volatile moments.

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

Josh, as usual, your prepared remarks were excellent and answered all of my top-down questions. So, I just have one modeling question. In the first row of Slide 9, which is your interest and dividend income, excluding fees, looks a little light relative to the 3% decline in the portfolio at cost and considering movements in spreads and so far. And that could be due to things like the cadence of investments or some sort of a reversal? Or was there something else in there that we should be aware of?

I'll hand it over to Ian, and we may need to revisit your question. I don't have the exact details at the moment, but regarding the quarter ending on December 31, 2024, there was a significant dividend income payment that is included and that was not a one-time item, right, Ian?

Yes, that's right. So that probably creates a little bit of noise.

That creates noise or better, the analog to look at it is a little bit of spread pressure in the lower portfolio to engage compared to September 30, 2024, but there was a one-time dividend payment related to an energy name, right, Ian?

Yes, that's right.

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

Just given the prepared remarks around some of the investments, including, I guess, one in the retail ABL side. Could you further flesh out your outlook for Lane 2 and Lane 3 investments? Would it be fair to say that you're starting to see a lot more of these opportunities materializing right now? Or do we still have to wait a little bit more to see more stress across the sectors there?

I think. So, we've committed to one last quarter before the will fund here before year-end, a fact that we think it's very interesting and that it’s public. I think there will need a little bit more stress, a little bit more time. But we’re excited. We’re starting to see stuff. Obviously, the broadly syndicated loan market is down. My guess is if you look at this data, I think that Moody's have revised their LME kind of distress, which has been distressing board the cable loan market up 2x, I think or something like that. So, I think those opportunities are coming our way.

Great. Very helpful there. And just one follow-up, if I may, and this is just on the ATM equity program. And it sounds like the general approach towards any kind of potential capital raises is still very consistent with your previous approach. But just wondering whether you could be raising capital a little bit more frequently than in the past? Because I believe that TSLX had very infrequently raised capital in the past. I just wanted to see if the frequency could potentially change there.

There is no change in how we raise capital or the frequency with which we do so. It remains essential for us to ensure that our approach is accretive on a return on equity basis in relation to our cost of equity and on an asset value basis. We have been quite firm about the ATM, but honestly, it's better for our shareholders due to the lower cost. There is absolutely no change in our method, and it really does make sense for shareholders. Ian, do you have anything to add?

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

I mean, let's take it this way. We let the balance sheet roll down, and therefore, revenues to the manager get smaller. We don't need the opportunities that in the past quarter were driven for our shareholders. We're surely not going to issue new capital when we were like an existing balance sheet will avail.

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

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

No, not really. One thing we didn't do well in our letter was provide enough detail regarding credit quality and our home situation. Let me quickly address tariffs. We mentioned our direct exposure to tariffs in our letter, which is about 2%. However, 60 basis points of that is already on non-accrual. There is also a $4 million position that we believe has a limited impact. Essentially, there's only one name that accounts for 1.3%, and it's not highly leveraged today, sitting below 5.5x leverage. Additionally, 60% of its production is based in the U.S., with some overseas operations. We estimate that there might be about a 20% impact on EBITDA if costs cannot be passed along, which would result in a leverage of around 6.5x, still acceptable for this credit and its scale. Therefore, I don't have concerns about our portfolio or our ability to manage our obligations. You accurately pointed out that to effectively manage, you need both capital and liquidity, along with sufficient bandwidth, meaning no issues at home. We have capital, liquidity, and bandwidth.

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

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

No, the answer is no. We recently made an amendment for an extension, which we do every 12 to 15 months. We held one non-extender meeting and slightly tightened pricing. We also took the opportunity to issue financing sooner than originally planned; if you had asked us about a bond deal six months ago, we would have said September, but we did it early, effectively prefunding that maturity. We feel really good about the situation. Additionally, in a lower interest rate environment, we have liability sensitivity, which means we've swapped out all of our liabilities. Therefore, we shouldn't experience net interest margin compression moving forward, all else being equal. We've managed the balance sheet well, and Ian has done a great job. I'm excited to commend the team, including Ian and Christine, for our management of the balance sheet.

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

I wanted to follow up on a point you made in the shareholder letter, which was brief but important. This is more of a modeling question. You mentioned creating more space by allowing for increased repayments instead of deploying capital in the second quarter. I want to confirm that I understood this correctly. Additionally, I would like to understand the scale of this compared to the significant repayment activity in the last two reported quarters.

Yes. I believe we'll be at the end of Q2, likely around flat to slightly down. I don't think it will impact our model. The balance sheet might decrease by about $30 million to $40 million due to repayments. This is part of our financial strategy, which aims to maintain financial leverage, enhancing capital efficiency and interest income. I think this is already reflected in our guidance, and I view it as a minor issue.

Okay. I appreciate that. And to your point about volatility historically creating good opportunities to deploy capital and generate higher returns versus sort of regular way markets. We know that there tends to be a bit of a lag between what's happening in the broadly syndicated market and what's happening in sort of the private credit area. We've obviously seen a lot of spread volatility, but it's only been remarkably one month that we've really seen that. So, it sounds like you're not really seeing that volatility create more interesting opportunities in the private credit space quite yet. Am I reading your reading that right?

Yes. I tell you that the great thing about our platform is we don't have elsewhere. And so like will capture some of that pricing. So, a, you're right, there's a technical thing happening in the private credit market. So, a, you write about that. And it is a lag, that’s probably a lag. But we don't need it to happen just in the private credit market because we've been able to capture it elsewhere. And so, if you look at these moments of time, we will go to more liquid markets to capture the spread volatility.

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

Two questions. First, regarding year-end capital, the spillover is $1.31, correct? From a return on equity perspective, considering the excise tax friction, is this the right moment in the cycle where you might see a slight decline or neutral position in Q2? Is this the right time to slightly reduce the capital base to enhance return on equity, potentially benefiting from the excise tax deduction going forward? Additionally, as mentioned in the letter, there aren't limitless opportunities suitable for business development companies. So, is this an appropriate point in the cycle to be more selective? If so, reducing the capital base or distributing some of that spillover could be a sensible approach.

Yes. So, look, we're not at that point, right? We're not where we need to return capital. That is obviously a lever you save the excise tax. But remember, to fund that distribution new borrowing, the excess tax costs at 4% annually, the borrower cash on a marginal basis, 150 or so for. And so, it is accretive on a leverage standpoint, but it's dilutive on a net interest margin standpoint. And so, we're not close to that point. We actually think having capital and time of volatility is good. So, it is effectively making you more capital efficient, but it is a negative ARB as it relates to the cost of the excise tax and you borrow to fund the asset tax.

Regarding net interest margin, I understand that it's not about net interest income or capital entirely. Moving to your second question about your letter, it seems to suggest that you believe the globalization of trade might have peaked and could be entering a downward phase. Typically, such a shift doesn't occur quickly; rather, it's part of a long-term trend. One of the charts included shows a multigenerational increase in global trade as a percentage, which justified the move into service businesses, particularly as globalization and offshoring were on the rise. If this perspective on global trade is central to your letter and Sixth Street's outlook, how do you see it evolving over the next year or two, or even over the next decade, which in this context translates to two full asset ownership cycles given repayment timelines? How might this perspective on global trade and the trend towards onshoring influence your capital allocation strategy in the long run, or does it not significantly impact your decisions?

No. Most of our business is in services, and I believe the process of demobilization began in 2010. There was a peak during COVID, but if you examine the chart, you'll notice two key trends. First, post-2010, there was a decline that later picked up but then gradually declined again. I think the primary impact is on services businesses. It seems to slow capital flow, which in turn slows growth and leads to inflation, affecting asset discount rates. The super cycle of return equities appears to be changing due to this demobilization. Inflation is increasing discount rates on assets and hindering growth. The favorable conditions for equity returns, marked by low discount rates and high growth, no longer apply. Consequently, in terms of our underwriting, it's crucial to recognize that past valuations and loan-to-value ratios are not relevant anymore. If you run a discounted cash flow analysis, reducing growth estimates by half and increasing the discount rate by two will yield a different value. This is where I think current investors will face challenges; they may be focused on historical data, metrics, and multiples that no longer reflect reality. The environment has indeed changed.

To that point, would that mean you would expect even this quarter, I think it was 11% sponsor back. No, it was 11% follow-on. It was 16%, 15% sponsor back, I think. Would you expect that that's obviously significantly below your long-term average? Is that kind of what you think will be more of the new norm going forward?

No. I mean, I think the sponsors are super smart. We love them. They’re sophisticated users of capital. They’re great investors, but they’re sophisticated users of capital. And I think that technical in the private credit space, which was a lot of flows and a lot of money putting stuff, wanting to put money, needing to put money to work in that channel. It hasn’t shifted this quarter, but we love them and we’re going to be right there with them when they need capital and scale and size. But we’re going to go where there’s the best risk return. The technicals in the private credit market were not accommodating this quarter.

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

Just one on credit, if I may. IRG Sports and Entertainment, I believe that loan is maturing in this quarter. How is that company performing? You've obviously seen a lot of interest and professional sports facilities, but it was marked down just a little bit slightly in the quarter. Are you expecting to exit that?

Yes. IRG is the main focus for us. We have several assets that we are looking to sell, including a large piece of land, approximately 160 acres, just outside of West Palm Beach. This will help us address the situation.

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

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

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

Lower spreads.

Lower spreads and the impact of base rates. So don't forget 100% of that.

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

So, up until yesterday, I believe you're talking about the structured risk transfer that involves some risk movement from banks to private credit or from banks to asset managers. Is that what you meant?

Yes.

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

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

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

I'm Josh. That's a very good nuanced question. I meant no changes philosophically in our framework of how we raise capital. The ATM allows us to access capital at the right moment. Historically, we've prefunded that part of the balance sheet. So, people have experienced a J curve or drag before we raised capital and brought it back, but the ATM will give us more flexibility for smaller, timely raises. We’re not changing our approach to raising capital in the sense that we seek to raise capital when it enhances NAV and where we believe that capital will generate a return above the return on equity. However, do we provide more visibility for smaller transactions and timely access? Yes, compared to our historical approach. We’ve typically increased leverage and then reduced it, which I wouldn’t classify as risky given our trading position, but this is probably a more efficient approach.

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

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

Yes, your question is correct. We're not claiming that we're solely relying on the ATM. What we mean is that it's a tool that offers a lower cost for shareholder exercises, and there may be times when we want to take advantage of an opportunity to grow the balance sheet significantly, which the ATM won't enable us to do. When we engage with the public markets, that will absolutely be the case. So, it's just an additional tool, not the only one we're using.

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

Great. I was joking that it probably wouldn't work, but my hope was that the letter would shorten the question-and-answer section. It might have had the opposite effect. So, we take responsibility for that. I really appreciate all the insightful questions. We're excited about the future. This is what makes the job engaging—the constantly changing environment. Clearly, things keep evolving, and as lifelong learners, that's what motivates us daily, and the platform is ready for action. We hope everyone enjoys their summer and that we'll connect with people after Q2, or sooner if you'd like. Thank you very much.

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