Sixth Street Specialty Lending - Q1 2024

Transcript

Operator (participant)

Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker, Cami Van Horn, Head of Investor Relations. Please go ahead.

Cami Van Horn (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, 2024, and posted a presentation to the Investor Resources section of our website, www.sixthstreetspecialtylending.com.

The presentation should be reviewed in conjunction with our Form 10-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 31st, 2024. 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)

Good morning, everyone, and thank you for joining us. With us today are our 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 the call to Q&A. After the market closed yesterday, we reported first quarter adjusted net investment income of $0.58 per share or an annualized return on equity of 13.6%, an adjusted net income of $0.52 per share, or an annualized return on equity of 12.3%.

As presented in our financial statements, our Q1 net investment income and net income per share, inclusive of the unwind of the non-cash accrued capital gain incentive fee expense, were $0.01 per share higher. The difference between this quarter's net investment income and net income was driven by $0.09 per share of net unrealized gains from the impact of tighter credit spreads on the valuation of our investments, $0.14 per share on net unrealized losses from portfolio company-specific events, and $0.03 per share of unrealized losses from the reversal of prior period unrealized gains related to investment realizations, and $0.03 per share of realized gains from investment sales. With these results in mind, I'd like to start by circling back to two remarks I made on previous earnings calls in February.

First, the BDC sector is at peak earnings, and second, the tail within portfolios is getting longer. On the first comment, we reported another strong quarter from an earnings perspective as net investment income continued to benefit from higher interest rates. Q1 was the first time in eight quarters, or since the start of the rate hiking cycle, that we experienced a modest decline in the weighted average reference rate resets on our debt and income-producing securities of five basis points. That said, the strength of the recent economic data and the higher for longer shape of the forward interest rate curve continues to support net investment income. Since our last earnings call, the forward curve has shifted towards higher for longer, with year-end base rates estimated to be 4.9%, which is up from 4.2% as of our last earnings call in February.

We anticipate the current environment will likely drive a dispersion between operating and GAAP earnings, as higher base interest rates may ultimately lead to credit deterioration and potential for losses, as we previously talked about. On my second comment, we're adding a nuance to the view that this quarter, which is that the tail is growing on the margin. While we're seeing evidence of idiosyncratic credit issues arising from across the private credit sector, we remain optimistic about the ability for private credit portfolios to withstand the headwinds of today's macroeconomic environment for a couple reasons. First and foremost, private credit managers underwrite investments with intent of holding that risk until maturity, given the largely illiquid nature of the asset class.

For us, this means extremely thorough due diligence and bottoms-up analysis on every credit we undertake, coupled with active portfolio management through the life of the investment. And second, private credit managers have the ability to be selective in terms of sector exposure. We have demonstrated selectivity in our portfolio by avoiding cyclical businesses, staying away from certain industries, and leaning into specific sector themes. This optionality differs from the public debt market, which are forced to hold a much broader range of sector exposures, including those that we have deliberately avoided. It is important to note that both of these benefits to private credit are not given and ultimately rely upon active management.

Having the ability to determine when to invest as well to what to invest is a feature of our business model and a core principle of operating our business with a capital allocation discipline. Turning to our portfolio specifically, the difference between this quarter's net investment income and net income highlights our point on the growing tail. Individual portfolio company specific events resulted in a $0.14 per share net unrealized loss, losses in Q1. A significant portion of this, or $0.11 per share, was related to the markdown in our investment in Astra Acquisition Corp. At quarter end, we added this investment to non-accrual status, driven by continued underperformance of the company.

While this is evidence that the tail is growing on the margin, we remain focused on the bigger picture, which is our ability to grow net asset value over the long-term. Despite idiosyncratic issues that have existed in our portfolio, we have steadily and consistently grown net asset value over the 12.5 years since we started this business, represented by a 3.5% annualized NAV growth before special and supplemental dividends since inception. We feel confident in our ability to continue this growth in the future, which we believe will result in outperformance relative to the sector. Turning now to the broader portfolio. Credit quality remains strong, with non-accruals limited to 1.1% of the portfolio by fair value. Revenue and EBITDA growth continued for another consecutive quarter.

Several of our portfolio companies have started to see cost-saving initiatives flow through the P&L, resulting in margin expansion and positive EBITDA trends. All things considered, our underlying portfolio companies have shown resilience, which we believe is reflective of our disciplined credit selection and effective portfolio management. Yesterday, our board approved a base quarterly dividend of $0.46 per share to shareholders of record as of June 14th, payable on June 28th. Our board also declared a supplemental dividend of $0.06 per share related to our Q1 earnings to shareholders of record as of May 31st, payable on June 20. Our net asset value per share pro forma for the impact of the supplemental dividend that was declared yesterday is $17.11, and we estimate that our spillover income per share is approximately $1.06.

Before passing it to Bo, I would like to note that on March 26th, Fitch Ratings published their annual review for the BDC sector, and we are pleased to note that Sixth Street Specialty Lending's rating of BBB- had its outlook revised from stable to positive. Of the 22 firms in their rated universe, TSLX is one of two BDCs to hold a rating with a positive outlook from Fitch. With that, I'll now pass it over to Bo to discuss this quarter's investment activity.

Bo Stanley (President)

Thanks, Josh. I'd like to start by sharing some observations on the broader market backdrop, in particular, the purpose and importance of direct lending in today's investing landscape. Through the first quarter of 2024, public and private debt markets welcomed an increase in demand for financing solutions after a historically low level of transaction volume in 2023. Access to the broadly syndicated market has improved, providing some borrowers with an option between public and private financing solutions. With both markets open for business, competition has generally increased compared to this time last year. However, we remain highly selective in where we transact to make certain we over earn our cost of capital. Our omni-channel sourcing capabilities has contributed to a robust and building pipeline of opportunities that rely upon the structures and features available only in the private credit markets.

We believe the current environment underscores the value proposition of private credit for borrowers looking for more than the cheapest cost of financing. Direct lending provides creative solutions, certainty in pricing, stability through market volatility, and structural flexibility, such as delayed draw features. All of these components differentiate the private credit markets from the BSL market and reinforce the importance of solutions we provide to the middle-market companies. Our investments in Equinox during the quarter highlights our differentiated capabilities as we stepped in to provide an alternative solution to a company with a complicated capital structure. As part of the transaction, Sixth Street led and agented a $1.2 billion first lien term loan, and to a lesser degree, participated in a $575 million second lien term loan.

TSLX committed $47.9 million and $2.1 million in these loans, respectively, in support of the company's refinancing of existing debt. This investment is also representative of the increase in opportunities we are seeing for companies with durable business models looking to restructure their balance sheets. In most cases, the complexity of these transactions require a direct lender that is willing and able to structure and underwrite a creative solution. Given our extensive experience and dedicated resources across the Sixth Street platform, we are well positioned to lead these opportunities. Additionally, the level of competition is lower for these investments compared to more traditional loan structures, which has contributed to our busy start to the year from an investment perspective, which I'll pivot to now.

In Q1, we provided total commitments of $264 million and total fundings of $163 million across 9 new portfolio companies and upsizes to 5 existing investments. We experienced $109 million of repayments from 3 full, 7 partial, and 18 structured credit investment realizations, resulting in $54 million of net funding activity. It was another strong quarter for originations, with 95% of total fundings of new investments, with 5% supporting upsizes to existing portfolio companies. This quarter's fundings contributed to our diversified exposure to select industries with 9 new investments across 8 different industries. Consistent with our long-term approach of investing at the top of the capital structure, 95% of fundings this quarter were in first lien loans, bringing our total first lien exposure to 92% across the entire portfolio.

We continue to benefit from the size and scale of Sixth Street's capital base as we participated in several cross-platform deals, including our largest new commitment during the quarter, which supported the take-private transaction of Alteryx. In March, Sixth Street agented and closed on a senior secured credit facility as part of the $4.4 billion acquisition of Alteryx by Clearlake Capital and Insight Partners. Our close relationship with both sponsors, combined with our ability to commit to the deal and size, were key to securing our leading role in the debt financing. Moving on to repayment activity, our two largest exits during the quarter, Avetta and Billhighway, were older vintage assets that were driven by refinancings. These investments generated a weighted average asset level gross IRR of 12.2% for TSLX shareholders.

Beyond refinancings, another notable area of repayment activity during the quarter was in our structured credit portfolio. As a reminder, we purchased approximately $54 million of CLO liabilities at a significant discount to par during the market volatility that occurred in Q2 and Q3 of 2022. Rather than holding excess capital or deploying capital into investments that do not exceed our cost of capital, we leveraged the experience across the Sixth Street platform to opportunistically invest in triple-B and double-B CLO liabilities that presented an efficient use of shareholder capital. Since then, we have watched our investment thesis play out as we've rotated out of approximately 85% of our CLO liability exposure to debt.

We purchased those securities at a weighted average price of 88.5, with a 3-year discount margin of approximately 880, and exited at a weighted average of 98.5, with a 3-year discount margin of approximately 535. For Q1, these exits resulted in approximately $0.02 per share of realized gains for TSLX shareholders. We expect to continue rotating out of the structured credit portfolio to crystallize the returns we've generated, and will opportunistically come back to this theme in moments where it presents an efficient use of capital based on the return profile. From a portfolio yield perspective, our weighted average yield on debt and income-producing securities at amortized cost decreased slightly quarter-over-quarter from 14.2%-14.0%.

This decline reflects a combination of 10 basis points of spread compression from lower spreads on new investments, and 5 basis points from the decline in reference rate resets. New investment spreads were lower in Q1, largely driven by roughly two-thirds of our fundings, including an upsize, falling into what we call our Lane One bucket. Lane One has historically been about 65% of our total investment activity and generally includes regular way financings to sponsor-backed companies. In Q1, this includes investments in high-quality companies such as Alteryx and Clario, which are scaled businesses with attractive financial profiles. The other third of our funding activity was in more complex Lane Two buckets, which typically includes higher-yielding assets represented by our investment in Equinox during the quarter.

As an illustration of the difference in yields, our new Q1 investments in Lane One had a weighted average yield of amortized cost of 11.3%, compared to 14.0% for our investments in Lane Two assets. On a consolidated basis, the weighted average yield of amortized cost of new investments, including upsizes for Q1, was 12.2%, compared to a yield of 14% on fully 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 conservative weighted average attach and detach points of 0.7x and 4.9x, respectively, and our weighted average interest coverage remains constant at 2.0x. As a reminder, interest coverage assumes we apply reference rates at the end of the quarter to steady-state borrower EBITDA.

As of Q1 2024, the weighted average revenue and EBITDA of our core portfolio companies was $275.5 million and $92.5 million, respectively. Finally, the performance rating of our portfolio continues to be strong, with a weighted average rating of 1.15 on a scale of 1 to 5, with one being the strongest, representing an improvement from last quarter's rating of 1.16, driven by growth in the portfolio from new investments. As Josh mentioned earlier, we added one new company, Astra Acquisition Corp, to non-accrual status at the end of the quarter, resulting in two portfolio companies on non-accrual across the entire portfolio. With that, I'd like to turn it over to my partner, 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 $0.58 and adjusted net income per share of $0.52. Total investments were $3.4 billion, up 3% from the prior quarter as a result of net funding activity. Total principal debt outstanding at quarter end was $1.9 billion, and net assets were $1.6 billion, or $17.17 per share, prior to the impact of the supplemental dividend that was declared yesterday. Since the start of the rate hiking cycle two years ago, we have successfully grown net asset value per share by 5.6% from a trough of $16.27 in Q2 of 2022 to $17.17 as of quarter-end.

Additionally, net asset value per share is now back above the pre-rate hike level of $16.88 as of March 31, 2022, and is a penny below our historical high of $17.18. It has been a very busy year-start to the year as we completed several capital markets transactions, including a bond offering, an equity raise, and a revolving credit facility extension. Starting off in early January, we improved our funding mix and liquidity profile through a $350 million long five-year bond offering. In March, we executed a small equity raise to take advantage of attractive new investment opportunities, while remaining below the top-end of our target leverage range of 1.25x debt to equity.

Consistent with the framework we've outlined in the past, we issued equity above net asset value and deployed the new capital raised into assets generating estimated returns that exceed our calculated cost of capital. We'll spend a moment to walk through this math, starting with the assumption that our cost of equity is 9%, which we sourced from Bloomberg. Based on this assumption, we can back into the required return on new assets by applying the cost structure of our business, including the marginal cost of leverage, fees, estimated credit losses, and other expenses to our unit economics model. This calculation results in a 10.6% return on assets, inclusive of credit losses, required to generate a 9% return on equity.

In our case, we deployed the new equity capital into investments with an average asset level yield of 12%-13.5%, depending on the assumed weighted average life, resulting in an estimated ROE range of approximately 11.5%-14% for the capital deployed, well above our estimated equity cost of capital. Shareholder returns continue to be our priority, and we strongly believe that our ability to access additional equity capital allows us to generate attractive risk-adjusted returns for our investors. Post quarter end, 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 $1.7 billion secured credit facility, including extending the final maturity on $1.5 billion of these commitments through April 2029.

We are pleased with this outcome of this transaction, as we successfully converted a legacy non-extending lender to extending status and accepted an incremental commitment from an existing lender. There were no new non-extending lenders as part of this amendment, and we maintained the existing pricing and terms on the facility. The combination of the January bond issuance and the closing of the amendment to our credit facility extended the weighted average maturity on our liabilities to 4 years, which compares to an average remaining life of investments funded by debt of approximately 2.5 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. All three of our capital markets transactions bolstered our balance sheet by enhancing our liquidity profile.

As of March 31, we had $1.1 billion of unfunded revolver capacity against $260 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 1.19x-1.14x. The decrease was driven by the equity raise in February, combined with repayment activity, which was partially offset by portfolio growth from new investments. As for upcoming maturities, we have reserved for the $347.5 million of 2024 notes due in November under our revolving credit facility.

After adjusting our unfunded revolver capacity as of quarter-end for the repayment of the 2024 notes, we continue to have ample liquidity of $764 million, representing 2.9x the amount of our unfunded commitments eligible to be drawn. Additionally, the repayment of 2024 notes will have an economic impact in 2025, as the implied funding mix shift will lower our weighted average cost of debt. Pivoting to our presentation materials, Slide 8 contains this quarter's NAV bridge. In addition to the items Josh walked through earlier, the equity raise resulted in $0.14 per share uplift to NAV in Q1.

Moving on to our operating results detailed on Slide 9, we generated $117.8 million of total investment income for the quarter, down 1.5% compared to $119.5 million in the prior quarter. Interest and dividend income was $112.1 million, down slightly from the prior quarter, driven by the marginal decline in interest rates off of peak levels experienced in Q4. Other fees, representing prepayment fees and accelerated amortization of upfront fees from unscheduled pay downs, were lower at $1.5 million compared to $3.5 million in Q4, driven by lower call protection from payoffs of older vintage assets during the quarter. Other income was $4.3 million, compared to $3.9 million in the prior quarter.

Net expenses, excluding the impact of a non-cash reversal related to unwind of capital gains incentive fees, were $65.4 million, up slightly from $65 million in the prior quarter. Our weighted average interest rate on average debt outstanding decreased from 7.8%-7.6%, driven by the marginal decline in reference rates. Before passing it back to Josh, I wanted to circle back to our ROE metrics. In Q1, we generated an annualized ROE based on adjusted net investment income of 13.6% and an annualized ROE based on adjusted net income of 12.3%.

This compares to our target return on equity on net investment income of 13.4%-14.2% for the full-year, as articulated during our Q4 earnings call, and we maintain this outlook heading into the rest of 2024. With that, I'll turn it back to Josh for concluding remarks.

Joshua Easterly (CEO)

Thank you, Ian. I'd like to close our prepared remarks here by encouraging our shareholders to participate and vote for our upcoming annual and special meetings on May 23rd. 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 seven years. We have no current plan to do so. We merely view this authorization as an important tool for value creation and financial flexibility in periods of market volatility. As evidenced by the last 10+ 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 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 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 them, this analysis in the Investor Resources section of our website. We hope you find the supplemental information helpful as a way of providing a clear rationale for providing the company this access to this important tool. As a final comment for today's call, I wanted to share my thoughts on the recent press focus on the perceived systemic risk in private credit.

I would suspect that this narrative largely comes from participants that have lost market share and the associated fee streams from the growth of private credit. Clearly, private credit has been a disruptive force to the incumbent business model in the non-investment grade corporate credit space, which is banks acting as an intermediary, which we have called the moving business, sitting between issuers and the ultimate holders of risk and collecting an economic rent. Private credit is no doubt disruptive to this model. The criticism of private credit is that it's taking more risk on the asset side. However, the historical data doesn't support this argument. According to Cliffwater Direct Lending Index, direct lending has had annualized losses in line with the JPM Leveraged Loan Index and significantly less than the high yield over the past one, five, 10, and 20 years.

In addition, any systemic risk must be in the context of business model of the business model, and we believe private credit has a superior business model. Unlike banks, where the business model is lending long and funding short, private credit is match funded. As students of all types of models and financial services, the tail risk typically comes from liquidity issues and, in its core, a poor asset liability matching model. This was apparent in the regional banking crisis. Furthermore, unlike banks, who have some protection through the FDIC program, a taxpayer put doesn't exist for private credit vehicles. And finally, we can't ignore the differences in capitalization. Risk-bearing capital inside banks is somewhere between 9%-12% versus private credit, between 25%-50%. That being said, we are sure there will be dispersion and results in private credit.

Dispersion, however, shouldn't be conflated with systemic risk. With that, thank you for the time today. Operator, please open up the line for questions.

Operator (participant)

Certainly. As a reminder, to ask a question, please press Star one, one on your telephone and wait for your name to be announced. To withdraw your question, please press Star one, one again. Please stand by while we compile the Q&A roster. Our first question will come from Brian McKenna of Citizens JMP. Your line is open.

Brian McKenna (Director of Equity Research)

Okay, thanks. Good morning, everyone. My first question is on the trajectory of adjusted NII. It stepped down $2.5 million sequentially in the quarter. So what was the biggest driver of that? I know you added one company to non-accrual status during the period. So did that contribute to the step down at all? And then how much did tighter spreads impact it on a per-share basis? And, you know, I'm just trying to get a sense of a good jumping off point for NII in Q2 and beyond.

Joshua Easterly (CEO)

Yeah, hi, great, thanks for the question. It's a good question. So the non-accrual was as of the end of the quarter, so had very little to no impact on NII. I think the drivers of NII, Ian laid it out, was a small impact on. That, I would call it three things. One is base rates were down 5 basis points, a small amount quarter-over-quarter. So the curve, although the curve is up and it's higher for longer, the curve is still downward sloping, so that's a piece of it. Spreads had a very small impact, as well. So yield and advertised investments went from, I think it was down to 20 basis, quarter-over-quarter, which 5 of that was base rates. Impact to base rates.

So, 15 basis points, and then the rest was just kind of episodic fees, which I think Ian laid out. So when we think about our business, I think we still feel very comfortable with our guidance on adjusted NII for the year, which was, Ian?

Ian Simmonds (CFO)

That was the $13.4-$14 NII.

Joshua Easterly (CEO)

Oh. Not ROE, NII.

Brian McKenna (Director of Equity Research)

Yep. Got it. Okay. Yeah, that's helpful.

Joshua Easterly (CEO)

Adjusted NII was $2.27. So I think we still feel very comfortable with that.

Brian McKenna (Director of Equity Research)

Yeah. Okay. Got it. Thanks. Then maybe just to follow up, so, you know, spreads have clearly tightened here over the past several months, and-

Joshua Easterly (CEO)

Yeah

Brian McKenna (Director of Equity Research)

If I look at new floating rate commitments in the quarter, spreads declined about 100 basis points on average from the fourth quarter. So, you know, I guess my question is bigger picture around originations and just with spreads where they are and more liquidity broadly in both public and private credit markets, you know, how are you making sure you're getting the right economics for the risk you're taking today, specifically as we move further into the current cycle?

Joshua Easterly (CEO)

Yeah, again, I think these are really good questions. I think the easiest way to see the economic value of what we're providing to shareholders is actually related to the, you can see it in the equity raise this quarter. So yields this quarter, I think we went through the math clearly, but yields this quarter were somewhere between yield average life of 11.5% and 14% on an average life basis with the swap curve. And that will bring ROEs similar into that range compared to our cost of equity of 9%. So even in this spread tightening environment, you've seen, I think, value to our shareholders vis-a-vis our cost of equity.

Look, we were clear, and I think the good news for SVB shareholders is we were one of the few, you know, public BDCs that had capital available to invest in the last vintage. And most definitely because of that, we're gonna have a portfolio that kind of overearns. But even in this most recent quarter's vintage, we have the ability to significantly outearn our cost of capital and provide value to our shareholders.

Brian McKenna (Director of Equity Research)

Yeah. Okay. I'll leave it there. Thanks, Josh.

Joshua Easterly (CEO)

Let me round out the point because I think it's helpful. Just because spreads have declined, doesn't mean that we're not providing significant value to our shareholders. You can clearly see that even in this quarter's vintage, given our cost of equity.

Brian McKenna (Director of Equity Research)

Yep. Got it. Thank you.

Operator (participant)

One moment for our next question. Our next question will be coming from Maxwell Fritscher of Truist. Your line is open, Maxwell.

Maxwell Fritscher (Equity Analyst)

Hi, good morning. I'm calling in for Mark Hughes. Kind of along the lines of Brian's question, with, with the higher competition, more capital being provided, are you seeing any companies becoming more comfortable with increasing their M&A activity? And if so, how do you see this shaking out throughout the year?

Joshua Easterly (CEO)

Yeah, look, I would say as the forward curve. I would expect activity levels generally to be up. So, you know, I don't think we saw. You know, we saw a little bit of that in Q1. When you look at Alteryx, for example, which was a take-private, you saw Truck-Lite, which was a M&A, which was a portfolio company, which was a strategic investor owned by a sponsor buying another strategic asset. So you saw a little bit of that this quarter. I think as volatility in the rates markets subside and as rates come down a little bit, I think you'll see more activity. I think that more activity will have two impacts on our business.

One is it will hopefully increase portfolio churn on the margin, which will drive additional economics that we haven't seen. It's kind of, you know, dried up. That's been a historical driver of our return on equity, but I think you'll, if you see activity levels, you'll see that portfolio churn, which will drive through economics to our business. And then there'll obviously be more activity on the front end of things to do. So, Bo, anything to add there?

Bo Stanley (President)

No, I expect to see M&A activity continue to strengthen after a pretty anemic couple years, both because of better financing costs, but also because, you know, equity valuations are coming in there's more parity between buyers and sellers as public equity markets have strengthened. And also a lot of businesses have grown into some of their valuations, so you're gonna see better assets come to market, over the next few quarters, and we're starting to see that, in our pipeline today.

Maxwell Fritscher (Equity Analyst)

Thanks. That's very helpful.

Joshua Easterly (CEO)

Thanks.

Maxwell Fritscher (Equity Analyst)

Josh, you mentioned last quarter, and correct me if I misunderstood, but you were hopeful for more opportunities in 2024 to strategically invest in good companies with bad balance sheets. Any developments on this front thus far?

Joshua Easterly (CEO)

Yeah. We didn't even ask you to ask that question. Not that we ask people to ask that question. But Equinox is a pretty good example of that. Equinox is a portfolio company of two strong sponsors, Related and Silver Lake Partners. It was a company that was obviously COVID impacted, but it's one of the, you know, premier companies in the fitness space. It really only has one competitor, and is a great company with a great brand and great unit economics. But obviously, COVID happened, and impacted that business, and their balance sheet got complicated.

And so we led a $1.2 billion two-year secured first lien facility in connection with the new second lien facility by the sponsor and others to refinance that, probably the existing loan capital structure. We held roughly half of the investment, and so we were the lead, but we partnered with Ares and HPS. And so that was a business opportunity that we were super excited about, and then it was complicated with our private equity due diligence and was kind of right in the middle of good company, bad balance sheet that needed, that was complicated. But we really liked, you know, both the sponsors in that business, who are very good stewards of that business and supportive, and the management team, including the CEO.

So, we're excited. We think we're gonna be, given the rate environment and the higher for longer narrative, there's going to be many of those same situations that I think go right in our wheelhouse, where we're gonna have to provide capital, where we have an opportunity to provide capital that generates strong risk-adjusted returns for our shareholders.

Maxwell Fritscher (Equity Analyst)

Great. Thank you.

Operator (participant)

One moment for our next question. Our next question will be coming from Finian O'Shea of WFS. Your line is open, Finian.

Finian O'Shea (Director)

Oh, hey, everyone. Good morning. Josh, on your, sort of segueing there, but on your opening comments on the affirming of the rate curve and the expected dispersion we'll see, is that, you know, happening in, in real time, say, in response to the rate curve? Are you seeing reorgs or LMEs and so forth, and on the, in private credit, and on the flip side, should that translate to a more abundant deployment opportunity?

Joshua Easterly (CEO)

Good to hear your, hear your work. Yeah, I think hopefully you're on the East Coast, we're on the West Coast, so we're kind of just waking up here, but I think that's a good question. So I think our theme has been that higher longer is a two kind of. There's two sides to that coin. The first side of that coin is companies are going, you know, some companies are going to have problems in that environment, both due to demand, stricter monetary policy might impact demand for their products or services. And the second is their balance sheet and that their cost, their costs have been increasing, most definitely their interest costs. And so there's most definitely going to be issues.

Hopefully, I think in general, those and that will cause dispersion between NII and net income and total economic return. Yeah, and we've seen that a little bit on that margin. Astra, you know, we put it on non-accrual. It was going so well for us, a fair value of 1.1%. Anthology, which is, we hold a small second lien position. We put it on accrual. We took a markdown. That is still paying cash, by the way. That will still pay cash, I think, to maturity. That will be the cash-on-cash returns are like in the 30s compared to fair value. That should be a tailwind in that asset value, as we're taking that into amortized cost. But there will be small tails that pop up.

We think those tails will be manageable for the industry. Given how much capital the industry holds, it shouldn't create any existential risk for the industry. On the flip side, that should provide great opportunity for those who can deploy capital into those companies and help facilitate those LMEs or those restructurings, like Equinox. So I think it's a double-edged sword. I think the Goldilocks is, you're good on credit, which we think we are, and you have capital to deploy either because the market trusts you to raise where you can raise more capital, which they historically have, or you have excess balance sheet.

Plus, you have the requisite skill set to actually execute on those transactions, which we most definitely have, which will create good deployment opportunities. And so that's the Goldilocks. We think we're in that. We think we have, you know, all those pieces of the Goldilocks, but we think it's gonna be a really interesting environment for the next couple of years, given the higher for longer and capital is misallocated, you know, in some ways, given low rates, that this will be a good opportunity to participate in that opportunity set. But I think you need capital, which a lot of the industry doesn't have, given more trades, you need the requisite skill set, and then you need a clean portfolio.

Finian O'Shea (Director)

Very good. Thanks. And, a follow-up, looks like the last mile leverage has been somewhat, declining, you know, last handful of quarters, at least. Seeing if this is market related or portfolio related, are you managing it down? And, if we should expect that to continue and, and what it means, for returns.

Joshua Easterly (CEO)

Yeah, look, what I would say is, we have we, we think on the margin, there are the opportunity set today is in larger companies, larger capital structures. And those companies, you know, given how big those credit facilities are, it's hard to club together somebody taking a first out revolver. And so by number, my guess is that's going down, given where we think the opportunity set is, but that will kind of go up and down. That's a combination of, I think, two things. One is the large capital structure, the second thing is banks are still capital constrained, and we see that with a lot of our bank partners on the margin.

So it doesn't have a huge drop impact- it hasn't had, it doesn't have a huge impact on economic returns, but it's really those two things, which is where we see the opportunity set is and, you know, how banks are positioned.

Finian O'Shea (Director)

Thank you.

Operator (participant)

One moment for our next question.

Joshua Easterly (CEO)

Go ahead.

Operator (participant)

Our next question will be coming from Robert Dodd of Raymond James. Your line is open.

Robert Dodd (Director)

Hi, everybody. I hope you, I hope you can hear me okay. On the comment, Josh, you made, you know, the tail's gonna get fatter. I mean, the longer rates stay up, obviously, you know, it's gonna get longer and fatter. I mean, but looking at your portfolio, PIK went up a little bit sequentially. Looks like that was mainly new investments, though. Your unfunded commitments ticked up again, looks like it's mainly new investments, but it's hard to tell. Can you give us any color on are you seeing incremental revolver draws more broadly? I mean, obviously, there's a couple of assets, right? You know, Astra, for example, you just put on a call that having some idiosyncratic issues.

But are there any emerging signs in the portfolio that this higher for longer is starting to create pressure in terms of liquidity and liquidity leaks?

Joshua Easterly (CEO)

No. Interest coverage has actually flattened out the increase. Earnings, I think, on a same-store basis, grew about 10% quarter-over-quarter. Revenues grew by about 5%. So the answer is no. I think some of the unfunded commitment increase quarter-over-quarter was Alteryx, I think, where they're going through a process to negotiate with the bondholders to call those bonds in. But no, broadly speaking, you know, we haven't seen that pressure. And then obviously from a ALM perspective, you know, we reserve for unfunded commitments and have close to 3x post our bond, our bond maturity of liquidity for unfunded commitments. So haven't seen stress, like broad-based stress.

Interest coverage has kind of, you know, bottomed out, it's on the rise given earnings growth, plus a combination of, the forward curve, although higher for longer, is still declining. So no.

Robert Dodd (Director)

Got it. Thank you. On the second one, if I can. On the other fee income, obviously, it was low again this quarter, not a huge surprise. But if we go higher for longer, if there's less activity there, do you think there's a risk that we're in for a relatively prolonged period of lower other fee income from the portfolio, given obviously the less activity, the older the assets get, the older they get, the less fee income they generate if they do anything anyway. So is there a little bit of a lull cycle here that could progress all the way through 2024, maybe even 2025, until the portfolio gets recycled? Or is it just transitory?

Joshua Easterly (CEO)

Yeah, it's a great question. Hard to model. What I would say is, I think there's us and the industry. First, historically, we've had more of this type of income.

Second, I think, so I think we can agree on that. So, but the question is, is it- how does that impact us? I think when you look at our portfolio, unlike the rest of the industry, we were actually able to deploy post rate hiking cycles, and so we have more vintage in 2022 and 2023. And so, you know, and that was in an absolute higher spread environment. So I think you're gonna, either one of two things will happen is, one is we'll hold those assets for longer, which should over earn, or those assets will churn because we can all agree spreads have come in a little bit, which will create income. So we have, you know, 43% of the portfolio was invested in the second half of 2022.

I think we were, you know, given how we've managed the business and how focused we've been on being good allocators of capital, the market has rewarded us with a, with a, the ability to give us more capital, which allowed us to, you know, in this vicious cycle, it allowed us to, invest in 2022, 2022, 2023 vintage in a higher spread environment, which my guess will at some point churn.

Robert Dodd (Director)

Got it.

Joshua Easterly (CEO)

So I think you have to, I think you have to like split it out between the industry and us, and we, we just have more 2022, 2023 vintage, and we can all agree spreads have come in.

Robert Dodd (Director)

Yeah. Understood. Thank you.

Operator (participant)

One moment for our next question. Our next question will be coming from Erik Zwick of Hovde Group. Your line is open.

Erik Zwick (Director of Equity Research)

Good morning, everyone. First question is maybe a two-part question. You know, Bo noted that competition, you guys have talked about it, you know, in subsequent answers, so the competition has increased since last year. And I'm curious if that is manifesting primarily just in compressed spreads and on the pricing side, or if you're seeing anything on the structure side as well? So that's the first question. And I guess the second would be, you know, on one of your slides, you note that the for your portfolio, the weighted average number of covenants per credit agreement is 1.8. I'm curious if that has changed over time or if that's been pretty consistent as well?

Joshua Easterly (CEO)

And it doesn't. It most definitely will leak on the margin into the document. The documents are still better than probably syndicated loan documents, but it doesn't just stop at the door of spreads. So, but we still feel comfortable with the overall package. And then I would say there is a little bit of a tale of two cities. We most definitely have seen the opportunity set upmarket. And, you know, on upmarket, there is those documents there, there might be a few less financial covenants. And so, but that is a. We're making a choice between the trade-off between credit quality, size of company, and protections. And we think the relative value is still very good there.

Just to size it up, you know, not everybody there's a handful of people who can write $500 million checks. There's a lot of people that can write $40 million-$50 million checks. And so in this moment in time, it always won't be that case. We've, we've moved upmarket. You can see that in our underlying EBITDA, average EBITDA, portfolio company, that's that defined metric. I think it's gone from 35 a couple of years ago to 90, Ian, what's the average now?

Ian Simmonds (CFO)

Yeah, it's over 90.

Joshua Easterly (CEO)

Over 90. So, anything to add there, Bo?

Bo Stanley (President)

No, the only thing I would add is, you know, we continue to only invest in situations, where we have control or influence on the documentation. And, you know, with competition, you're going to see looser documentation. But we still, you know, we still control that and, tend to only play in situations where we believe the document still has the protections that we, that we need as investors. So, we have seen, you know, loosening of terms certainly from 18-24 months ago when docs got really tight. But they're still adequate to protect our capital.

Erik Zwick (Director of Equity Research)

Thanks. I appreciate the, the detailed commentary there. And I guess just the, the only remaining question from me and, you know, you just noted the ability to, to write large checks. And if I, you know, look at Slide 6 and average investment size in your portfolio, if I look at it, you know, excluding the structured credit investments, it's actually down a little bit year-over-year. However, if we then include the structured credit, it's up year-over-year. So just curious about the kind of the divergence there and, and what's transpired on the, the structured credit side over the past year or so.

Joshua Easterly (CEO)

Yeah, the divergence is, you know, we've increased diversity in our portfolio for sure, over time, and our capital base is relatively fixed in SOFR. And so, it's participating in larger deals across the platform, but our capital base is relatively fixed in SOFR, and we've been focused on increasing diversity. So I hope I think I got that question.

Erik Zwick (Director of Equity Research)

Yes. Thank you. That's all for me. Appreciate the answers.

Joshua Easterly (CEO)

Thank you so much.

Bo Stanley (President)

Thanks.

Operator (participant)

One moment for our next question. Our next question will be coming from Melissa Wedel of JPMorgan. Your line is open.

Melissa Wedel (VP of U.S. Equities Research)

Good morning. Most of my questions have already been answered, but I wanted to follow up on your comment, Josh, about the opportunity set right now. You're seeing it really with the larger companies and bigger capital structures. You know, based on, on Ian's comments, it seems in very detailed analysis of what the return threshold is, for new investments and, and where you were able to source, what you were able to source in the first quarter. Certainly, it looks like you're, you're able to clear that threshold by a couple hundred basis points, at least in, in the first quarter. But as competition increases, I guess the question is: do you see the opportunity set evolving more in the more complex deals? And you talked about a couple of those, that you guys done in the first quarter.

Is that where the economics are? Is that where we should think about you being involved, primarily in the next few quarters?

Joshua Easterly (CEO)

Well, okay. Let me tell you the power. I think this is at the heart of our platform. I think this is in the heart of how we think about investing and how we build Sixth Street. So, I mean, I may go down a rabbit hole, and then you can pull me up for a second. So Sixth Street, I think people know $77 billion, so $75+ billion of assets under management, 600+ employees. We have people sitting across industries and verticals and focused on companies of all types in all parts of their life cycle. And that includes by sector, by size, and then by where they are in their life cycle from growth to restructuring. And the power of our platform is.

is that we can go between, on a relative value, go between all those vectors, from size of company to, where they are in their life cycle, to what sectors we think are interesting. And at some point, sectors are thrown out for no reason, and we think they're interesting, and we deploy capital there. Think of that as energy, which our returns have been very good. At one point, it was retail and consumer. And, and in software, we have a differentiated view. And so we're really a relative value buyer across a big top of the funnel. That is our business model. And so the answer is, I don't know.

The difficult part of capitalism, if capitalism is working, is when there's excess returns, the capital will flow, and so you kind of have to keep shucking and jiving through the opportunity set. That is the power of the business. And so, you know, it might be retail for six months or nine months, it might be software business services, it might be industrials, it might be energy, it might be small cap, it might be large cap. The power of the platform is that what we're delivering to investors is our ability to cross those opportunity sets where we have a culture of a platform where we can collaborate, where we can deliver that to people. And so that is what we've built for people. That's what we'll continue to lean on.

And so I, I know across environments, across opportunity sets, we're just not a monoline business, and that is where the durability of the returns comes from.

Melissa Wedel (VP of U.S. Equities Research)

Okay. I appreciate that overview and reviewing of, you know, the opportunistic nature of what you guys are able to do. Maybe I should have rephrased my question a little bit, just in terms of really sort of the pipeline on complicated investments and that idea of the good company, bad balance sheet in a higher for longer environment. Are you expecting more of that?

Joshua Easterly (CEO)

I would hope so. I mean, I look back, my macro view is it's difficult for the Fed to pivot. We've been saying this for a long time. The Fed hasn't pivoted, and that's gonna cause stress in capital structures. And so, my hope is that will be that, you know, like Equinox, that'll be interesting. We did a DIP in Q1, which is public for 99 Cents Only Stores, which is a, you know, a retail business. That liquidation is going very well. And so we like that opportunity. That is my hope. That is kind of right into the strength zone of the platform.

Melissa Wedel (VP of U.S. Equities Research)

Thanks, Josh.

Joshua Easterly (CEO)

You got me all excited about the what the platform delivers for a value add. So sorry, I had to, I had to go down the rabbit hole.

Melissa Wedel (VP of U.S. Equities Research)

Okay. All good.

Operator (participant)

One moment for our next question. Our next question will be coming from Bryce Rowe of B. Riley. Your line is open.

Bryce Rowe (Senir Equity Research Analyst)

Thanks. Good morning. Wanted to maybe just continue on this theme of churn within the portfolio and just churn generally within the industry. You all have clearly focused on, you know, putting money to work in 2022 and 2023 vintages, and addressing any kind of maturities that you have in 2024 and 2025, and those are now kind of more limited. So if you could kind of talk about or size up the opportunity from an origination perspective versus, you know, what we might see from a repayment perspective within the portfolio, and, you know, what that might mean for kind of net portfolio growth, you know, as we look forward. Thanks.

Joshua Easterly (CEO)

Look, I would on the margin, I would think net portfolio growth, and it's, again, it's hard because we're very kind of opportunity set driven. But I would say on the margin, payments will increase because of our, of our exit of our vintage of 2022 and 2023. And I would say, on the margin, I would expect our balance sheet to remain stable, you know, and not grow as significantly as it did in the last, you know, 18 months. That would be my guess. I mean, look, we wanna lean in in environments where there's really, really high risk-adjusted returns. We can agree that was 2022, 2023, and grow the balance sheet. And not everybody can do that given their access to capital.

We did that, and then, you know, which will mean that portfolio churn will increase in the growth basis. On that basis, the opportunity set is gonna be marginally less. And so I think that means that our balance sheet will be, you know, relatively stable, maybe slightly growing, but it's not gonna grow to the extent it did over the last 18 months.

Bryce Rowe (Senir Equity Research Analyst)

Okay. And then maybe one more for me on the capital structure. I mean, you, you've been opportunistic in terms of, you know, raising both debt and equity. You know, as you and you've talked about kind of having pre-funded the 2024 notes. Do you think about layering in, you know, another round of notes, given, you know, how open debt capital markets are today, just, you know, giving yourself that much more liquidity or available liquidity, you know, as we think about capital structure?

Joshua Easterly (CEO)

Yeah, it's. I think we talked about this a little, a little bit. I think it's a good question. I actually think on the margin, we hold too much liquidity today. So if you kind of think about... If you look at the post refi of the 2024 notes, we have about $750 million of liquidity.

And we can't, given our, the constraint is debt-to-equity, which our range is 0.9 to 1.25, we can't really use that liquidity, if you don't think we're growing the net asset value of the business through new equity raises. And so if we were to, our choices would be to give back unfunded commitments to banks, which I don't think we wanna do, because that's the lowest cost of capital, if we were to raise more bond, like, more bonds. I just don't see. We have, and that liquidity, I think, is very valuable and is really good insurance, but it's limited given the constraint of our 1.25 debt-to-equity and how much our capital looks today.

So I don't see us—and it has an economic cost to shareholders. So I don't see us doing a bond deal, unless we think we can grow gross assets, which would require us to grow, do an equity raise, because we just have a whole bunch of trapped liquidity. That has an economic cost to shareholders.

Bryce Rowe (Senir Equity Research Analyst)

Got it. Okay. Appreciate the color.

Operator (participant)

I'm showing no further questions. I would now like to turn the conference back to Josh for closing remarks.

Joshua Easterly (CEO)

Great. Thank you. Look, I appreciate the time. As people are heading into summer and the weather's turning, I hope people get to spend time with their families and enjoy their summer. We'll obviously be back in contact, if not before, in August. Please vote in our shareholder meeting. It's a democratic process. As we all know, democratic processes are really, really important. But thank you for your time, and we're always around to answer questions. And I thought today's questions were really, really good. So thanks for the analyst community for putting in the work.

Operator (participant)

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