Earnings Call
Sixth Street Specialty Lending, Inc. (TSLX)
Earnings Call Transcript - TSLX Q1 2022
Operator, Operator
Ladies and gentlemen, thank you for standing by and welcome to the Sixth Street Specialty Lending, Inc. Q1 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, 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 speaker, Ms. Cami VanHorn, Head of Investor Relations. Please go ahead.
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 first quarter ended March 31st, 2022 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 press 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 31st, 2022. As a reminder, this call is being recorded for replay purposes. I will now turn the call over to Joshua Easterly, Chief Executive Officer of Sixth Street Specialty Lending, Inc.
Joshua Easterly, CEO
Thank you. Good morning, everyone and thank you for joining us. With us today is my partner and our President, Bo Stanley; and our CFO, Ian Simmonds. For our call today, I’ll provide some highlights of this quarter’s results and pass it over to Bo to discuss this quarter’s origination activity and portfolio. Ian will review our quarterly financial results in more detail. And I will conclude the final remarks before opening the call to Q&A. After market close yesterday, we reported first quarter financial results, the adjusted net investment income per share of $0.49, corresponding to an annualized return on equity of 11.6% and adjusted net income per share of $0.56, corresponding to an annualized return on equity of 13.2%. As discussed in previous quarters, at quarter end, we had approximately $0.21 per share of cumulative accrued capital gains incentive fees on the balance sheet and approximately $0.13 per share of this amount would be payable in cash if our entire portfolio were to be realized as at quarter end. The remainder of that accrued fees are tied to unrealized gains from the valuation of our debt investments, inclusive of call protection, which if prepaid would require recognition of fees and investment income and trigger reversal of previously accrued capital gains incentive fees related to these investments. This non-cash expense which was not paid or payable was approximately $0.02 per share for Q1. From a reporting perspective, our Q1 net investment income and net income per share inclusive of these accrued capital gains incentive fee expenses was $0.47 and $0.54, respectively. This quarter’s net investment income reflects continued strength in the core earnings power of our portfolio, above the guidance we provided in our last earnings call. Net investment income was supported by our fees coming from our portfolio activity alongside interest and dividend income levels driven by sustained portfolio yields. The difference between this quarter’s net investment income and net income was a result of net unrealized gains primarily from portfolio company specific events. Looking ahead, we are facing an operating environment which has changed significantly over the last few months. Increase in inflation, rising interest rates, geopolitical factors and impacts from the global pandemic will certainly present a headwind for the US and global economy. However, similar to our positioning heading into the uncertainty of COVID in early 2020, we have invested in high-quality durable businesses on the asset side and we maintain a disciplined approach to building and maintaining liquidity inclusive of understanding of our unfunded commitments on the liability side. We further enhanced our liquidity profile during the quarter through extension expansion of our existing revolving credit facility, which Ian will discuss in further detail later on the call. From a macroeconomic perspective, the impact of the interest rate environment is on top of mind. Although we saw meaningful upward movement in interest rates during Q1, we haven’t seen the impact yet on our financial results for two primary reasons. On the asset side, the floors of our debt investments act as downside protection of falling rate environments, which we had seen up until recently. In a rising environment as we experienced in Q1, our floors mask the impact of an increase in total reference rates rise above our average floor levels. Once through our floors, we are able to benefit from the asset sensitivity of our matched floating-rate exposures. On the liability side, our weighted average cost of debt outstanding remained relatively flat for this quarter given the mechanics of how the swap contracts of our unsecured liabilities are reset at the end of the preceding quarter, resulting in a one quarter lag of rates impact on our income statement. Given the speed at which interest rates have risen to date, the increase we expect to see in the weighted average cost of debt will be offset from the asset side as reference rates rise further above our average floors in 2022. Although we anticipate the rising interest rate environment to play out favorably as a lender positioned to benefit from the positive asset sensitivity of our balance sheet, we also are very cognizant of the potential impacts on our borrowers. Today, the coverage remains strong across our portfolio companies, and we’re confident in the underwriting we have performed. As we said in the past, we are focused on investing atop the capital structure and in high-quality businesses and industries that we like and know well. At quarter end, net asset value per share was $16.88, a $0.15 per share or 1% from pro forma net asset value per share at year end of $16.73. This growth was primarily driven by continued over-earning of our base dividend and net unrealized gains from investments. Over the trailing two-year period, reported net asset value has increased by 8.4% and in a total of $5.94 of distributions have been distributed, resulting in total economic return book value of 46.5%. Yesterday, our Board approved a base quarterly dividend of $0.41 per share to shareholders of record as of June 15th, payable on July 15th. Our Board also declared a supplemental dividend of $0.04 per share relating to our Q1 earnings to shareholders of record as of May 31st, payable on June 30th. Our Q1 ’22 net asset value per share pro forma for the impact of the supplemental dividend is $16.84. We estimate our spillover income per share was approximately $0.50. Before I pass it over to Bo, I wanted to note on April 8th, Fitch Rating agencies published their annual review of BDC sectors, and we are pleased to share Sixth Street Specialty Lending received a one notch ratings upgrade from BBB minus to BBB flat with a stable outlook. Of the 16 firms in the sector, TSLX is the only firm to receive such an upgrade, regarded as a strong performer by Fitch. The upgraded firms are seen as benefiting from decades' worth of strong consensus performance, supported by our sector-leading returns. With that, I’ll now pass it over to Bo to discuss its quarterly investment activity.
Bo Stanley, President
Thanks, Josh. I’d like to start by sharing some observations on the broader market backdrop, in particular, the inflationary environment and upward movement in rates since our last earnings call in February. These macroeconomic factors, coupled with Russia’s invasion of Ukraine, led to heightened volatility and uncertainty in the financial markets during the quarter. Public markets reacted quickly with equities and high yields ending the quarter down 4.5% for the S&P500 and 4.6% for the US High Yield Index, representing their worst quarter since Q1 of 2020. These fluctuations in the public markets ultimately led to a period of price discovery for private buyers and sellers, resulting in a slowdown in M&A activity in Q1. As we expected, the decline in M&A activity was matched with muted leveraged loan volume relative to historical periods. These trends compared across the middle markets where new issue loan volumes were down 51% from a year ago. Low volumes were also driven by issuers taking time to reconsider the immediacy of the capital needs, reflecting the widening of first lien and second lien spreads by a peak of 47 and 124 basis points, respectively through mid-March. At quarter end, there were some reversions of spread movement with first lien and second lien spreads 31 and 5 basis points tighter than their peaks, respectively. With more volatility likely ahead, we expect to see buyers looking to the private markets as an alternative to traditional capital markets, leading to opportunities where we can provide our differentiated capital solutions and expertise. Pivoting now to the inflationary environment, if we take a step back and look at what is driving the price increases, much of this can be explained by the scarcity of certain goods, raw materials, and commodities. Over the last 6 to 12 months, we’ve seen the impact across several sectors such as real estate, automotive, and energy, as demand has exceeded supply in these industries, driving up prices for the consumer. Given we have low exposure to these industries that are heavily weighted towards software business services, we generally haven’t seen margin compressions or supply chain issues thus far impacting our portfolio companies. Demand has also been strong as the consumer sector has benefited from high wage growth and prior fiscal transfers from government support provided throughout COVID. Household wealth has soared on the back of strong house price increases and prior equity gains. With rent growth and demand for services increasing post-COVID, the longevity of higher inflation will be key to the outlook. We continue to monitor and construct our portfolio with inflationary pressures in mind. Turning to portfolio activity, our commitments in funding slowed in Q1 after a busy 2021, totaling $79.3 million and $52.8 million, respectively. This was distributed across two new and existing portfolio companies. Our new investments this quarter were both first lien loans in the software services space and businesses providing value-added technology and solutions. We were also active during the quarter by supporting our existing portfolio companies on their strategic growth and capital needs, including our new investments in Lucidworks, with 71% of this quarter’s funding serving our existing borrowers. In terms of new borrowers, we closed $130 million senior secured financing alongside Sixth Street’s European direct lending fund just before the acquisition of Unily by JVC growth. Unily is a provider of employee experience software with a strong recurring revenue base and low historical churn, which has a large addressable market. We believe that our expertise and experience in this sector allow us to move quickly and provide certainty to borrowers amid strong competition in the direct lending space. On the repayments side, there were $144.4 million of paydowns across five, four, and three partial investment realizations. Two of our realizations were upstream E&P companies in the energy sector, Verdad Resources and MD America, which made up 26% of pay off activity during the quarter. We’ll briefly highlight these two investments as an example of our capabilities within the Sixth Street platform. Our investment in Verdad was in the form of a $225 million term loan facility that we led in coordination with our energy team and reflects our opportunistic investment approach, providing first lien reserve-based loans to upstream companies that provide a strong risk-return profile. Since our investment in 2019, the company’s credit profile improved materially due to the attractive development returns in an improved commodity price environment, ultimately allowing the company to refinance through the bank market at a lower cost of capital. As a refresher on MD America, we made our initial investment led by our energy team in November of 2018, where we closed on a $200 million first lien term loan, of which Sixth Street held 40% of the deal. Since our initial investment, there’s been a series of amendments ultimately resulting in the company filing for Chapter 11 in October 2020. Our asset management capabilities, along with our flexible capital base, allowed us to be a value-added partner, resulting in a successful emergence from bankruptcy in December of 2020, with the lenders receiving 100% of the first reorder equity. During Q1, we completed the sale of MD America to WildFire Energy, representing a full exit for Sixth Street's 40% ownership interest in the company. At the time of our investment in 2018, we underwrote to a 12.8% IRR and a 1.30x multiple, and ultimately generated a 24% IRR and a 1.82x multiple, further demonstrating our ability to create value for our shareholders in complex situations. After these two repayments, our energy exposure decreased to 1.7% of the portfolio at fair value. One other notable exit during the quarter was our investment in Designer Brands, which is one of our asset-based lending portfolio companies. We made our initial investment in Designer Brands back in August of 2020 when the retail sector was suffering from the shutdowns prolonged by the global pandemic. Because of our strong balance sheet positioning, we were able to play offense during this time by providing capital for borrowers in need across several COVID-impacted industries. During the quarter, the company retained the outstanding balance of its term loan credit facility, and we’re receiving a 3% prepayment premium on the outstanding balance. Since inception and including this quarter’s Designer Brand exit, we’ve generated an average gross unlevered IRR of 20.1% across our fully realized asset-based lending investments. On activity levels generally, we saw a pickup beginning in March, and we are optimistic about our originations and funding pipelines heading into the rest of 2022. The direct lending landscape remains competitive, and we continue to pick our spots to remain selective in our opportunity set, which is expanding alongside the growth of the Sixth Street platform. As demonstrated by the returns generated during this quarter from our E&P and retail ABL names, we’ll look to opportunistically deploy capital in areas where our platform’s ability to underwrite and navigate complexity allows us to create excess returns across our portfolio. From a portfolio yield perspective, funding and repayment activity this quarter had a slight positive impact on the weighted average yield on debt and income-producing securities at amortized cost. Yields are up slightly to 10.3% from 10.2% quarter-over-quarter, and are up about 17 basis points from a year ago. The weighted average yield at amortized cost on new investments, including upsizes this quarter, was 10.6%, compared to a yield of 9.8% on exited investments. Moving on to the portfolio composition and credit stats, across our core borrowers for whom these metrics are relevant, we continue to have a conservative weighted average attach and detach points on our loans of 0.8 times and 4.5 times, respectively, and their weighted average interest coverage remains relatively stable at 2.9 times. As of Q1 2022, the weighted average revenue and EBITDA of our core portfolio companies were $117 million and $31 million, respectively. Finally, the performance rating of our portfolio continues to be strong with a weighted average rating of 1.13 on a scale of 1 to 5, with 1 being the strongest. We continue to have minimal non-accruals, less than 0.01% of the portfolio at fair value, with no changes from the prior quarter. With that, I’d like to turn it over to Ian to cover our financial performance in more detail.
Ian Simmonds, CFO
Thank you, Bo. For Q1, we generated adjusted net investment income per share of $0.49, and adjusted net income per share of $0.56. At quarter end, total investments were $2.5 billion, down slightly from the prior quarter as a result of net repayment activities. Total principal debt outstanding at quarter end was $1.2 billion and net assets were $1.3 billion or $16.88 per share prior to the impact of the supplemental dividend that was declared yesterday. Our average debt to equity ratio decreased slightly quarter-over-quarter from 0.99 times to 0.95 times, and our debt to equity ratio at March 31 was 0.91 times. We continue to have ample liquidity with $1.2 billion of unfunded revolver capacity at quarter end against $147 million of unfunded portfolio company commitments eligible to be drawn. Post-quarter end, we further enhanced our liquidity and debt maturity profile by closing an amendment to our revolving credit facility. With the ongoing support of our lending partners, we increased the commitment under the facility from $1.51 billion to $1.585 billion through an upsize from an existing lender and extended the final maturity on $1.51 billion of these commitments to April 2027. Pro forma for the revolver extension, our weighted average remaining life of debt funding is 4.1 years compared to a weighted average remaining life of investments funded by debt of only 2.1 years. At quarter end, our funding mix was represented by 76% unsecured debt in line with the prior quarter. I’d like to take a moment to circle back on Josh’s comments related to the upward movement in interest rates. During Q1, three-month LIBOR increased from 21 basis points to 96 basis points, and the average floor of our debt investments was approximately 1.1%. At the time of our last call, we expected to reach our average floors in May. However, this timeline accelerated as reference rates have been above our average floor since April. To quantify the impact on earnings, assuming our balance sheet and spreads remain constant as of quarter end, but every 25 basis points increase in rates above our average floors, we would expect to see approximately 20 basis points of ROE accretion or an incremental $0.03 per share of net income on an annual basis. We can further illustrate the potential impact by using the forward yield curve with the projected three-month term SOFR to 2.9% in one year from quarter end. Assuming all else equal as of the quarter ending Q1 ’22, an increase in base rates to 2.9% would imply 150 basis points of ROE accretion or an incremental $0.25 per share of net income annually. Moving on to our presentation materials, Slide 8 contains this quarter’s NAV bridge. Walking through the main drivers of NAV growth, we added $0.49 per share from adjusted net investment income against our base dividend of $0.41 per share. There was a $0.24 per share reduction to NAV, primarily from the reversal of net unrealized gains on our position in MD America, as we booked these gains as realized upon sale. The negative impact from widening credit spreads on the valuation of our portfolio was $0.05 per share. Also, there were minor negative impacts related to the mark-to-market on our outstanding swaps that are not designated as hedging instruments, which amounted to $0.04 per share. Finally, there was a $0.42 per share positive impact from other changes, primarily realized gains on investments of $0.18 per share and portfolio company specific events of $0.22 per share. Moving on to our operating results detailed on Slide 9. Total investment income for the quarter was $67.4 million compared to $78.3 million in the prior quarter. Walking through the components of income, interest and dividend income was $58.8 million, down slightly from the prior quarter driven by net repayment activity during Q1. Other fees, representing prepayment fees and accelerated amortization of upfront fees from unscheduled pay downs, were lower at $6.9 million, compared to $14 million in Q4, given the elevated portfolio activity we experienced in Q4. Other income was $1.8 million, compared to $2.6 million in the prior quarter. Net expenses, excluding the impact of the non-cash accrual related to capital gains incentive fees, were $29.9 million, down approximately 8% from the prior quarter. Despite the upward movement in reference rates, our weighted average interest rate on average debt outstanding remained relatively flat quarter-over-quarter, primarily due to the one-quarter timing lag on the reset date of our interest rate swaps. Before passing it over to Josh, I wanted to circle back on our ROE metrics. In Q1, we generated an annualized ROE based on adjusted net investment income of 11.6%, and an annualized ROE based on adjusted net income of 13.2%. This compares to our target return on equity of 11% to 11.5% for the year, as articulated during our Q4 earnings call, and we maintain this outlook heading into the rest of 2022. With that, I’d like to turn it back to Josh for concluding remarks.
Joshua Easterly, CEO
Thank you, Ian. I’d like to close our prepared remarks today by encouraging our shareholders of record for our upcoming Annual Special Meetings on May 26 to participate and vote. Consistent with the past five 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 the prior shareholder authorization granted to us over the past five years. We have no current plans to do so. We view the authorization as an important tool for value creation and financial flexibility in periods of market volatility. As evidenced by the last eight plus years since our initial public offering, our track record 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 this authorization to issue shares below net asset value if there are sufficiently high risk-adjusted return opportunities that would ultimately be accretive to our shareholders to over-earn 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 this analysis in the Investor Resources section of our website. As a final thought for today’s call, we are extremely optimistic about the road ahead. With current market conditions in mind, we believe the value proposition for our business has never been better for both our clients and shareholders. The declining purchasing power from the impacts of inflation have only underscored the value proposition of our franchise as a source of alternative returns for our shareholders, which we believe to be sustainable. As for our clients, we’re prepared to provide capital with speed and certainty through periods of volatility in public markets. As the credit cycle continues to evolve based on monetary policy implemented by the Fed, we believe our low leverage and significant liquidity profile positively positions us to play offense in the event of a market dislocation. These types of dislocations have been our greatest periods of outperformance in the past. Although we cannot predict what is ahead, we continue to build the robust business model that performs through cycles. In closing, I wanted to call out how refreshing it has been to receive feedback in the office and be able to interact face-to-face with friends, colleagues, clients and stakeholders. I know that collaborating in person will continue to provide new motivation and ideas as we push further into 2022. We especially look forward to resuming our annual tradition on the Sixth Street off-site, where we gather approximately 400 strong team members in Austin, Texas. To our stakeholders, thank you for your continued interest in Sixth Street Specialty Lending. With that, thank you for your time today. Operator, please open up the line for questions.
Operator, Operator
Thank you. Our first question comes from Mickey Schleien with Ladenburg. Please go ahead.
Mickey Schleien, Analyst
Yes. Good morning, everyone. Hope you’re doing well. Josh, I’m sure there’s a ton of questions on interest rates. But I’m going to start with one. On Page 13 of the investor presentation, that shows that the weighted average spread on your floating rate investments came down as LIBOR increased. But I suspect that was probably reflecting the lag in the repricing of the assets. And when I look at the interest rate risk table in the Q, as you mentioned in your prepared remarks, you would expect your net interest margin to expand with higher rates. But that assumes everything remains equal, which it never does, right. So, I’d like to ask what’s your view on how you think the private lending market will react to higher short-term rates in terms of maintaining spreads?
Joshua Easterly, CEO
Yes, hi Mickey. Can you repeat that last part of the question? What was the last part of the question?
Mickey Schleien, Analyst
The last part of the question is, you know we’re looking at a forward LIBOR curve or SOFR curve that’s very steep. So I’d like to ask what’s your view on how the private lending market will react to higher short-term interest rates in terms of maintaining spreads?
Joshua Easterly, CEO
Yeah, it’s a question top of mind for us. So first of all, I think one thing to note is that the ceiling of the LIBOR curve or SOFR curve are about the same when you think about credit spread adjustments, which has had an extremely positive impact on the business. If you were to look back at September of last year, we would have probably had to add around $0.09 to our investment income line, so not the net income line, but the investment income line, to get through our LIBOR floors. And you know, we estimate that to be only about $0.02 today. What tends to happen in our market, and hopefully people will be thoughtful about this, is that pricing is based on an IRR basis, and they don’t differentiate between spread and risk-free rate. So, you know, we were doing something at 10% or 11% IRR. And hey, we’re still doing 10% loans versus an IRR and therefore you know that the pricing with a reduced spread, not realizing or maybe realizing that a lot of that’s coming from risk-free. I hope the industry reacts differently. I think we have massive sensitivity in our book coming for sure, but how much the industry captures is a key question. And all things being equal, you want a spread and low return instead of risk-free SOFR or LIBOR. But, I think that the key question is, hopefully the industry does allow for a tradeoff between the return attribution between risk-free rates and spread.
Mickey Schleien, Analyst
Yeah, I understand. Thanks, Josh. A couple of housekeeping questions. What are your expectations for settling the convertible which is coming up? And also what is the level of undistributed taxable income?
Ian Simmonds, CFO
Yeah, sure. Hey, Mickey, it’s Ian. I’ll take that one. On the convert, we had to make an election in the six months prior to maturity. So that was actually on February 1. And we elected to settle the converts primarily in stock, and there is about $100 million principal amount of convertibles outstanding today. And that settlement is about, I think it’s basically all-in stock. Because there’s a de minimis amount of cash, about $2 million out of that $100 million in principal.
Joshua Easterly, CEO
I mean it’s slightly accretive to the net asset value, because those will be issued above NAV. And slightly, I would say, it’s could be dilutive on earnings although the least value of that is $0.61 of undistributed earnings. So $0.59 of undistributed earnings plus we expect some growth in undistributed earnings from expected realizations above the current marks. And so, I think you have – obviously, we expect to grow above and keep leverage steady or in our target leverage ratio. If we don’t, you’ll obviously can use special dividends to ensure you’re still capital efficient. We think we have enough spillover income plus kind of pipeline unrealized gains that allow us to have that flexibility.
Bo Stanley, President
And so maybe you should think of it the same way we addressed some early conversion in Q4 of last year, and then we had a special one, that’s a tool that we felt was an efficient way to achieve those goals.
Mickey Schleien, Analyst
I understand. What did you say the UTI balance was?
Bo Stanley, President
$0.59 per share.
Mickey Schleien, Analyst
5-9?
Bo Stanley, President
Yes.
Mickey Schleien, Analyst
5-9? Okay –
Bo Stanley, President
Correct.
Mickey Schleien, Analyst
That’s it for me this morning. Thank you for taking my questions.
Joshua Easterly, CEO
Thanks, Mickey.
Operator, Operator
Thank you. Our next question will come from Kevin Fultz with JMP Securities. Please go ahead.
Kevin Fultz, Analyst
Hi, good morning and thank you for taking my questions. My first question is similar to one of Mickey’s questions. Given that the economic outlook has shifted in the past few months, are you seeing less competition in the market from other lenders? Just curious if you’re beginning to see a shift to a more lender-friendly environment either in the form of improved documentation or widening loan spreads?
Joshua Easterly, CEO
Hey, Kevin. I don’t think we’ve seen it yet. I think there’s a couple of forces in the market. One is, typically private markets react slower to the public markets. The second thing that happens, I think is that there’s a decent amount of capital formation in the private credit market, which had somewhat of a muted impact on the pendulum shifting. I think that there’s a tailwind. So I think those are the two headwinds. The first headwind of the slow reaction kind of goes away over time. The capital formation is what it is. The tailwind is that the private markets are likely to expand, given that volatility in public markets allows for people to pay for certainty, which increases the total addressable market for private markets. With that increased total addressable market, I think that will be a tailwind. As we mentioned, the slowdown in M&A earlier this year has created a lot of supply out there that hasn’t been deployed earlier. So, that will keep tension in the market, I suppose.
Bo Stanley, President
I would also say, because the slowdown in M&A earlier this year has created a lot of supply out there that hasn’t been deployed earlier, that will keep tension in the market, I suppose.
Ian Simmonds, CFO
You know with both of those statements, we haven’t seen evidence of any tightening of spreads or better terms at this point, though as we’ve seen in my remarks, I noted this the top of the funnel start to fill off. I think there are going to be opportunities to pick our spots, especially as Josh mentioned in some of the opportunistic non-sponsor activities that we see as companies looking to shore up their balance sheets and play offense in a different valuation market.
Joshua Easterly, CEO
But the total addressable market is surely going to expand, given the volatility in public markets and issuers and sponsors looking for certainty, which should help capital flow from each issuer.
Kevin Fultz, Analyst
Okay, great. That’s all really helpful. And then just one on leverage. Your stated target leverage range is 0.9 to 1 this quarter. As of quarter end, you’re at the low end of that target. Are you still comfortable operating anywhere within that range? Or has your internal target changed a bit in the current environment?
Joshua Easterly, CEO
No, I look, I think, given the uncertainty in the world, I don’t think we’re going to operate at the top end of the range. I think how we think about our business and how we think about leverage is that you’ve got to burden both the capital and liquidity by unfunded commitments and changes in spreads given the mark-to-market piece on the asset side of our balance sheet. You also want to have a whole bunch of dry powder to invest in volatile moments, which quite frankly lead to the outperformance we’ve seen in 2020-2021. I think the industry had a return on equity for 2021 of about 10%. And we had a return on equity of about 35% or 36% over those two years. That was a function of us having enough capital, enough liquidity to make investments given the change in the economic environment. I don’t think we’re going to operate at the real top end of our leverage, given we think there’s volatility coming, which probably means there’s opportunity coming, which means that our capital, our liquidity represents a relatively high opportunity cost.
Kevin Fultz, Analyst
Okay, that makes sense, Josh. And I’ll leave it there. Congratulations on a really nice quarter.
Joshua Easterly, CEO
Thanks.
Operator, Operator
Thank you. Our next question will come from Finian O’Shea with Wells Fargo Securities. Please go ahead.
Finian O’Shea, Analyst
Sorry, it’s on mute. Hi, everyone. Good morning. Josh or Bo, last quarter you talked about the opportunity budding in growth equity, late-stage growth equity to provide junior preferred structures. We’ve heard some of that from your peers as well. Can you talk about how that is? We obviously didn’t see too much this quarter. But logically, we would have hoped to, given those assets have continued to lag in the market. Is this something that’s still around the corner? Or have these types of opportunities faded?
Joshua Easterly, CEO
So I think it’s most definitely an opportunity. The question is how appropriate it is going to be however given the structures and the nature of those opportunities for the Sixth Street Specialty Lending fund. Across our platform, for example, we will evolve into say that we think we can be value-add to portfolio companies and the value proposition of Sixth Street only grows. Such a product, you know, we’ve hired Mike Dryden, who we’ve known for a long time. We ran that business at Credit Suisse. We think there will be lending opportunities in that space that will come to the platform. There’s that good assets and bad assets, then you’ve got to be sensitive to, but we will look to find the right opportunities and we think that there will be continue to build a mosaic of skill sets in the organization, which we think only enhances the suggested returns for Sixth Street Specialty Lending. Bo want to discuss Northern Capital.
Bo Stanley, President
Now we are very excited to have brought on Jeff Stone as a four-time CEO of technology businesses to help us build out that effort. This will help our portfolio companies with a lot of common problems they experience in building and scaling businesses. So super happy to have him on and I think you’ll hear more from that group over the next couple of years.
Operator, Operator
Thank you. Our next question will come from Bryce Rowe with Hovde. Please go ahead.
Bryce Rowe, Analyst
Thanks. Thanks a lot. Good morning. Wanting to maybe start just on market activity. Bo, you mentioned some level of pickup in March. Maybe you could speak to is that more kind of seasonality of the business or what the source of the pickup would be? Any color around that would be helpful.
Bo Stanley, President
Yes, it’s a bit of both. There’s always a bit of a seasonal Q1 lag as Q4 is generally quite active from an M&A market. So that is pretty typical, I think what was a little bit unique in this quarter is we did have the valuations reset in the public markets. That sort of paused activity on buyers and sellers in the M&A market. So activity slowed as I mentioned in my remarks, and in addition to that, we saw spread widening, so opportunistic refinancings slowed down. You saw that begin to unthaw in the back half of the quarter as the top of our funnel pipeline really started to fill with more opportunistic M&A, involving both public to private, but also portfolio companies looking to be opportunistic in the valuation environment. Secondly, you saw a pickup in non-sponsor activity. As you know, the strongest companies in these periods will look to shore up their balance sheets, both to invest internally in growth but also opportunistically in M&A. So between what we have going through the pipeline that we’ve already committed to, we’re pretty bullish on the opportunity set.
Joshua Easterly, CEO
And Bo, you would say that unthaw kind of happened a lot sooner than we would have expected, you know usually takes a quarter or two? It was a little bit, especially given the move in tech valuations.
Bo Stanley, President
Exactly.
Joshua Easterly, CEO
So I think that’s I think you hit it, which is some seasonality, some market volatility, and market volatility in terms of flow both M&A and opportunistic refinancing feel like they’ve gotten a little bit quicker than I would have thought.
Bryce Rowe, Analyst
And do you guys feel like, you know, prepayment or repayment activity will slow here with the volatility and with higher rates? Or do you have pretty good line of sight into continued repayment activity and exit activity?
Joshua Easterly, CEO
Yeah, I would say so. Typically we’re unlike mortgages, we’re not sensitive to rates on prepayment speeds. We’re at spreads and so, and idiosyncratic events. I would say that you would expect that there’s, you know that the signs that we discussed a second ago will have some impact on our portfolios or portfolio companies that were up for sale. Now might trade that didn’t trade before. And so, you know there will be relatively outside of the energy books, given the commodity price environment in Q1, there was you know very little kind of repayment activity that was involved in the repayment activity. Given that commodity price environment, I would expect it to kind of get back to normalized levels to some extent.
Bryce Rowe, Analyst
Okay, all right. Maybe one more for me just on the right side of the balance sheet. And this may be a tough question to answer. But you’ve got unsecured note maturity early in ’23 just, you know curious how you’re thinking about how you might handle it today if it were today you know with spreads haven’t widened for unsecured debt in the BDC space?
Joshua Easterly, CEO
Yeah. So look, I think our unsecured spreads have less beta than others, especially given the upgrade and getting the quality of the franchise we built. The great news is we have about 1.1 billion to 1.3 billion growth of unfunded commitments available to draw building. You know, 1 billion to 1.2 billion of total liquidity burden for unfunded commitments. I think that maturity is like 150 million?
Ian Simmonds, CFO
150.
Joshua Easterly, CEO
- And so, I think we have a lot of optionality and flexibility in regards to doing it on our line today. Ian, correct me if I’m wrong. On a floored adjusted basis, what is that maturity? It’s like probably LIBOR 200 something like that?
Ian Simmonds, CFO
Yeah.
Joshua Easterly, CEO
At LIBOR 200. If you think about a marginal cost of capital on a revolver of, yeah I think it’s about LIBOR 150 because you offer value lien fee or the commitment fee. And so if we were to do it on a revolver, you know we have 1.1 billion, 1.2 billion for unfunded commitments, and that would actually be accretive to our cost of capital. And I think that 150 is actually LIBOR we got 200, 199. And so you actually pick up 50 basis points, you know interest saving $150 million on a net basis and a marginal basis if you were to do it online, we have a ton of liquidity.
Bryce Rowe, Analyst
Okay. All right. That’s helpful. Thanks, guys.
Joshua Easterly, CEO
Thank you.
Operator, Operator
Thank you. Our next question will come from Melissa Wedel with J.P. Morgan. Please go ahead.
Melissa Wedel, Analyst
Good morning, and thanks for taking my questions today. First of all, on your current stance about expressing repayment activities, normalize a bit, but it will make sense in the context of what’s happening with rates. We also recognized that the repayments that you guys have had over the years have driven a lot of sort of upsized fee income. So I’m curious how you’re thinking about sort of that line item and the potential for you know what the trajectory can be on the fee income as repayments normalize? Thank you.
Joshua Easterly, CEO
Yeah, I think it was really hard to hear. But what I think I heard is, what do you think about the impact of income on your income statement as prepayments normalize? I think it – was that the question?
Melissa Wedel, Analyst
Yes, that’s it, Josh. Thanks.
Joshua Easterly, CEO
Okay, great. Look I think typically fees, I’ll try to get you the exact data. This is a row kind of attribution quarter for us. So historically on average, we get the data between accelerated OID, prepayment fees and amendment fees that typically is around $0.47 to $0.52 per quarter per share basis divided by 4 is you know what $0.14 a quarter. I think this quarter was $0.07, $0.07 to $0.08?
Ian Simmonds, CFO
$0.09.
Joshua Easterly, CEO
So it was definitely low in this quarter. So you know I think that’s historically how we’ve operated. I think our worst year and yeah so I would say you know you could expect it to be kind of probably $0.03 to $0.07 more per quarter or something like that, given activity levels, but you know they’re surely lumpy quarter-to-quarter.
Melissa Wedel, Analyst
Understood, thank you.
Operator, Operator
Thank you. Our next question will come from Ryan Lynch with KBW. Please go ahead.
Ryan Lynch, Analyst
Hey, good morning. First question I had, if I understand your comments correctly, it sounds like the slowdown in Q1 was partially driven by, I think seasonality with kind of a very robust second half of 2021. Also in combination with, I think some economic uncertainties about what the rest of 2022 looks like. And Bo, you kind of said that your pipeline had now been growing kind of to end Q1 and into 2022. My question is, is a little bit confusing just because or a little bit surprising I guess, just because the economic uncertainty seems as high as they’ve ever been with rising inflation, labor issues, decreasing equity valuations, geopolitical things out there. And so I’m just curious of why is the pipeline seem to be building at the same time that the economic uncertainties are also on the rise?
Joshua Easterly, CEO
How do you square that rally around that square peg into question? I think the answer lies in the amount of private equity dry powder out there to be honest with you, which is most of the activity a lot of is private equity-driven. And you know there’s always this greed-fear thing, which is sometimes the best time to invest for long-term investors is when there’s volatility. And you know there is a ton of dry powder in the private equity. And you’re starting to see them put that to work. You know – a great example that’s not in the Sixth Street Specialty Lending portfolio, but like you’ve seen you know that company which is a publicly-traded company, and to say it was a private equity-backed company from insight ventures. And so you’re seeing sponsors you know in certain industries putting you know money to work given the uncertainty.
Kevin Fultz, Analyst
Okay. That has – because obviously those fears and uncertainties are all well known in the marketplace, everybody’s operating with all their eyes wide open at this point. So with that, has the quality of deal flow or the quality of companies that are transacting at least potentially transacting in the pipeline? Have they improved, you know to be higher quality companies that are potentially in good positions to weather these headwinds? You noticed any change?
Joshua Easterly, CEO
Yeah. These are really good questions. Look, I would say I think there’s one nuance, I think everybody sees the uncertainty. I think people have very divergent views on how the uncertainty is going to play out. Soft lending, maybe not soft landing; you know how do you deal with the employment gap? You typically, I think, maybe never seen a recession if you haven’t seen unemployment increase by 50 basis points. I know I can’t say worldwide unemployment increases by 50 basis points given the employment gap. That’s why I say I don’t think there’s going to be – that’s why I think there’s going to be far planning or not, so I think there’s clearly divergent views. But we mostly see the activity around businesses that have stronger models that are able to push through cost and have high gross margins and have operating leverage and still can grow earnings. And so I think, you know, I think there’s very divergent views, but the quality of the businesses are high. The valuations I think people have different views depending on the environment. I think we’re less impacted by that given where we’re invested in the capital structure.
Kenneth Lee, Analyst
Great, very helpful there. One follow-up if I may and just from a high level in terms of the ROE, looks like they’re maintaining your ROE targets, despite having you know 13% ROE in the quarter. One of you just talk a little bit about how you think about ROE over the near-term? What are some of the major puts and takes that can impact the ROE one way or the other? Thanks.
Joshua Easterly, CEO
Yeah, I mean that when you think about our business from a unit economics perspective, the things that impact ROE are yields, leverage, so capital efficiency, which is a function of net payoffs, plus how we manage or net portfolio growth in a negative positive. And then how do we manage our access capital? We’ve historically managed that through a combination of, you know growing our capital base to address and you know special dividends and credit losses. I feel pretty good about where we sit in credit losses. I actually think there were some you know, depending on how things play out, some upside in unrealized realized gains that exceed our current marks. And so, that will have a positive impact on ROE. So I don’t see any near-term credit losses. So ultimately, it is a function of yields and capital efficiency. We’ve done a pretty good job of managing both.
Matt Tjaden, Analyst
Hey, all, good morning. First question for me on the ABL product. You know given your ABL loans generally fund working capital and higher inflation tends to drive up both the cost of inventory and working capital needs. Do you think there’s any chance higher inflation might actually drive a higher demand in the market for your ABL type products?
Joshua Easterly, CEO
Yeah, I mean, the offsetting factors that the consumer has been in really good shape. And so when you look at gross margin, and EBITDA margin expansion across you know retail which we’ve done, you know quite frankly we’ve been involved in Neiman Marcus across the platform for a long time. The income statements are in really, really good shape, given the lack of discounting and given consumers post the pandemic. And so you’re right, that there’s a more working capital need, but you know income statements find working capital through strength of income statements and free cash flow and then you know the balance sheet either through operating cash flow, income statement or financing. And so I think that’s the offset. And retail has to be in really good shape at the moment. That could change on a dime for sure.
Matt Tjaden, Analyst
Got it. That’s helpful. Last one for me, maybe following up with you, Josh. Kind of more high level, what’s your outlook for the year-end 2022 private credit default environment and how much has that changed versus you know five months ago at the beginning of the year?
Joshua Easterly, CEO
I still think it’s pretty low. You know I think the trigger questions 23 and 24. But if you look at our book, I think it’s pretty low. If you think about the recent vintages of deals, those companies have had you know earnings growth and started off with good liquidity. The private credit has been slightly, I think that the software and tax. And so it feels like it’s pretty well, you know, not that much exposure of cyclicals or we don’t have much exposure to cyclicals. So I feel pretty constructive about the fall cycle for '22, especially private credit. I let Bo or Fishy do you have anything to add?
Michael Fishman, Analyst
I think, 23, 24 it’s an alternative question, but I think I would expect pretty low default rates across the sector.
Joshua Easterly, CEO
I can tell you, industries that are going to be hurt or where there are kind of low EBITDA margin businesses where they’re relatively competitive businesses where they’ve had commodity price inputs they cannot pass along to consumers, those industries are going to be hurt. So you know, paper, packaging, you know, non-specialty chemicals. And you know I think I’m not calling both of those titles, but any industries that have relatively low EBITDA margins and no pricing power and you know high commodity inputs to their cost structure. I think those are the industries that are you know have a higher chance of being hurt.
Matt Tjaden, Analyst
Got it. That’s helpful. I appreciate the time.
Operator, Operator
Thank you. And we do have a follow-up from Finian O’Shea with Wells Fargo Securities. Please go ahead.
Finian O’Shea, Analyst
Hey, thanks so much for the follow-up. Josh I was thinking a bit more from our dialogue on preferreds. And I appreciate your commentary and logic on avoiding too much pick. But is there a firm line there you’re drawing in the sand? Or is there somewhere on the curve of returns where you would take on these sorts of deals? And I asked because in today’s environment, the outlook could very well be that this type of company turns out to be the provider of a large structured rescue type opportunity that you’ve done really well on in the past, obviously. So yeah, question is, is this a hard line in being anti-pick? Or is it just not good enough today?
Joshua Easterly, CEO
No, I don’t think we have a hard line just to where we are as Mike Fishman filing. We are looking at our overall balance sheet, we got tons of liquidity. So you know we like to think about funding our dividends from operating areas and we have tons of liquidity, I think it’s a combination of bottom-up investors where so finding the right opportunities that fit right into our balance sheet. I don’t see us being a large provider of rescue financing in a junior capital division. Our strategy has historically events running rescue financing of the capital structure. We were not the full run. And we’re not taking process risk. So I think if you see us doing some of that type of investing as in companies we really, really like with clean capital structures, great prospects, secular growing and healthy businesses is the way I would generally characterize our strategy. And then like what I think the fundamental question is, does the risk return work, which I’ve said many times, you can’t eat IRR. So in an investment structure where you make you know – where you can get like you know 11% to 12% of preferred, but it’s callable. And so your yield – your enrollment or worst is like 1.2 times, but you’re deep down a capital structure and you’re going to lose a lot of your capital like that doesn’t work I think. You have to be thoughtful about the probability of returns, returns given a default or not being the fulcrum. So I think we’re bonds of investors and there’s no hardline but we like some of those opportunities we aren’t like others.
Operator, Operator
Thank you. I’m showing no further questions in the queue at this time. I would now like to turn the call back over to management for any closing remarks.
Joshua Easterly, CEO
Great. Look, we really appreciate people’s time. We’re actually on the West Coast today. So this is slightly painful for me getting up at 4:30 in the morning. But we really appreciate people’s time. You know, Mother’s Day is coming up, I think so in our tradition, we hope everybody takes the time to spend with their families and appreciate the people in their life and Happy Mother’s Day to everybody out there who’s listening, including our significant others. So I – we really love the dialogue. If you make your way to New York or San Francisco, feel free to stop in and we’re welcoming people back in our office, given the environment. Thanks, everybody.
Ian Simmonds, CFO
Thanks.
Operator, Operator
Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation. You may now disconnect.