Sixth Street Specialty Lending - Earnings Call - Q4 2024

Executive Summary

• Q4 2024 delivered solid earnings power: Investment income rose to $123.7MM, adjusted NII was $0.61/sh (GAAP NII $0.62/sh), and adjusted NI was $0.54/sh (GAAP NI $0.55/sh); annualized ROE was 14.2% (adj. NII) and 12.5% (adj. NI). NAV/share increased to $17.16 from $17.12 QoQ, with adjusted NAV $17.09 after the supplemental dividend.
• Activity-based fees were a key upside driver: $0.15/sh in Q4 (highest in seven quarters) amid a resurgence of repayments; fundings of $323.5MM and repayments of $304.7MM supported fee income and portfolio rotation.
• The Board declared a Q1’25 base dividend of $0.46/sh and a Q4’24 supplemental dividend of $0.07/sh; adjusted NII covered the base by $0.15/sh (33%), reinforcing dividend sustainability.
• Outlook: 2025 adjusted NII guidance of $1.97–$2.14/sh (ROE 11.5%–12.5%) assumes current spread conditions and a conservative activity fee range; management expects to amend/extend the revolver with marginally lower drawn spread/undrawn fee in Q1’25.

What Went Well and What Went Wrong

• What Went Well

  • Strong earnings quality and coverage: “Adjusted NII of $0.61/sh exceeded our base quarterly dividend by $0.15/sh, or 33%,” while NAV/share edged up to $17.16.
  • Fee tailwinds resurfaced: “In Q4, we earned $0.15 per share of activity-based fees, including dividend income, representing the highest amount in 7 quarters,” aided by elevated repayments.
  • Balance sheet/liquidity positioning: $674MM undrawn revolver capacity against $205MM eligible unfunded commitments; management anticipates marginally lowering revolver spreads/fees upon amendment in Q1’25.

• What Went Wrong

  • Credit headwinds persisted in a few names: Two idiosyncratic credits (incl. Lithium Technologies) weighed on 2024, with non-accruals at 1.4% of FV in Q4 (no new additions in the quarter).
  • Spread compression: Tighter front-book spreads versus early-2024 reduced NII by ~$0.07/sh vs. forecast; management’s sector ROE math highlights risk to industry returns absent repricing.
  • Portfolio yield stepped down: Weighted avg yield at amortized cost declined to 12.5% (from 13.4% in Q3), driven by lower base rates and mix/spread adjustments on certain assets.

Transcript

Operator (participant)

Good morning and welcome to Sixth Street Specialty Lending, Inc.'s fourth quarter and fiscal year ended December 31st, 2024 earnings conference call. At this time, all participants are in a listen-only mode. As a reminder, this conference is being recorded Friday, February 14th, 2025. I would now like to hand the conference over to Cami, 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 fourth quarter and fiscal year ended December 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-K filed yesterday with the SEC. Sixth Street Specialty Lending, Inc.'s earnings release is also available on our website under the Investor Resources section. Unless noted otherwise, all performance figures mentioned in today's prepared remarks are as of and for the fourth quarter and fiscal year ended December 31st, 2024. I will now turn the call over to Joshua Easterly, Chief Executive Officer of Sixth Street Specialty Lending, Inc.

Joshua Easterly (CEO)

Thank you, Cami. Good morning, everyone. Thank you for joining us. With us today is our President, Bo Stanley, and our CFO, Ian Simmons. For our call, I will review our full year and fourth quarter highlights and pass it over to Bo to discuss activity in the portfolio. Ian will review our financial performance in more detail, and I will conclude with final remarks before opening the call to Q&A. After the market closed yesterday, we reported strong fourth quarter results with adjusted net investment income of $0.61 per share for an annualized operating return on equity of 14.2%, an adjusted net income of $0.54 per share for an annualized return on equity of 12.5%.

As presented in our financial statements, our Q4 net investment income and net income per share, inclusive of the unwind of the non-cash accrued capital gains and incentive fee expense, were $0.01 per share higher than the adjusted figures. In Q4, we earned $0.15 per share of activity-based fees, including dividend income, representing the highest amount in seven quarters.

We continue to build net asset value per share from $17.12 as of September 30th to $17.16 as of December 31st. Additionally, our base dividend remains well covered with adjusted net investment income of $0.61 per share, exceeding our base quarterly dividend by $0.15 per share, or 33%. For the full year 2024, we generated adjusted net investment income per share of $2.33, representing an operating return on equity of 13.8%, and full year adjusted net income per share of $1.97, or return on equity of 11.6%.

As we've always said, return on equity on net income is a measure that matters. On that basis, we generated nearly 12% for 2024. This remains well above our estimated 9% cost of capital and significantly above the Q3 LTM average return on equity for the BDC sector of approximately 9.1%. Further, we delivered an increase of 70 basis points on net asset value per share from $17.04 as of December 31st, 2023, to $17.16 as of December 31st, 2024.

Looking back at 2024, our results were driven by a number of factors, including a shift in interest rates, additional activity-based fees, credit headwinds, and movement in new investment spreads. We'll highlight the impact from each of these components, starting with the tailwinds. First and most obvious, interest rates remained higher for longer, providing an earnings boost for the sector.

Twelve months ago, the forward curve indicated interest rates of approximately 3.6% today. This compares to a three-year SOFR swap rate today of approximately 4%, or 40 basis points difference. Higher base interest rates supported LTM operating ROEs for the sector through Q3 of 12.3% and 13.9% for TSLX, well above the long-term sector average of 8.9%.

For TSLX, the rate environment in 2024 contributed approximately $0.03 per share of net investment income above our guidance. In addition to slight uplift from rates, we earned $0.44 per share of gross activity-based fee income, including dividend and other income in 2024, representing the highest amount since 2021. A significant portion of the income came in the fourth quarter as we experienced a resurgence of repayment activity in our portfolio.

This resulted in $0.15 per share of activity-based fee income for the quarter, above our trailing three-year historical average of $0.09 per share. This fee income is a product of our in-depth underwriting and selective investment approach, as we carefully structure our investments to include call protection and other features that create value for shareholders. In 2024, activity-based fee income contributed approximately $0.15 per share of net investment income above our guidance.

Now pivoting to the headwinds. Consistent with our message for the last couple of years, we expected credit to weaken on the margin and tailwinds to emerge. Over the last 12 months, we experienced idiosyncratic credit deterioration across two portfolio companies, Astra Acquisition Corp. and Lithium Technologies, both of which we added to non-accrual during the year.

The lost interest income from these two investments, after being placed on non-accrual status, resulted in a $0.07 per share negative impact to net investment income in 2024 relative to our forecast. Even with the lower fair value on these investments, we continue to grow net asset value year over year by 70 basis points. This compares to a decline of approximately 160 basis points on average for the BDC peer group through Q3 2024 compared to Q4 2023.

For the same period, net asset value per share for TSLX increased 50 basis points, representing roughly 210 basis points of outperformance. And finally, new investment spreads moved tighter throughout the year, driven by the significant amount of capital raised in the direct lending space, combined with muted M&A volume. This is the supply and imbalance that we've talked about on several of our previous earnings calls.

To illustrate the movement of spreads in 2024, we will compare Q4 2023 to Q3 2024, given we are still early in the fourth quarter reporting cycle. As of Q4 2023, the weighted average spread on first-lien performing assets in our portfolio and for public BDCs was 8.3% and 6.4%, respectively. This compares to a weighted average spread as of Q3 2024 of 8% and 6.1%, respectively, representing a decline of 30 basis points for TSLX and the public BDC sector. As the market moved tighter in 2024, the impact of tighter spreads on new deals lowered our net investment income by approximately $0.07 per share compared to our forecast for the year.

That being said, we continue to put on new deals at wider spreads relative to the sector, as evidenced by our weighted average spread on new deals in Q3 2024 being approximately 150 basis points wider than the average for our public BDC peers. Although there were puts and takes, we met our guidance on an operating income basis for the year. Looking ahead to 2025, we believe the earnings potential for BDCs is largely tied to portfolio spreads.

To put it simply, the deals you do today will ultimately be the driver of your returns in the future. As an illustrative example, we've calculated the estimated return on equity, assuming our entire portfolio had a weighted average spread equal to the weighted average spread we earned on new investments in the fourth quarter of 6.4%.

Based on our balance sheet as of year-end, the three-year SOFR swap rate of 4%, 1.5% OID over a three-year average life, and consistent with our unit economics over the last year, a weighted average of 640 basis points implies a return on equity of 9%-10%, assuming 0-50 basis points of credit losses on assets. We can compare this to earnings potential for the sector by using the weighted average spread on new first liens in the third quarter of 529 basis points for public BDCs. To simplify the analysis, we'll assume management incentive fees, leverage, cost of funds, and operating expenses are all based on the Q3 LTM average for the sector.

Using the three-month SOFR swap rate of 4%, 1.5% OID over a three-year average life, and the long-term annualized return net loss rates according to Cliffwater Direct Lending Index of 102 basis points, a weighted average portfolio spread of 529 basis points generates approximately 5% return on equity for the sector. It is important to note that these return estimates assume a three-year swap rate of 4%.

If base rates move lower, ROEs will move lower too, given the asset sensitivity and some liability sensitivity for the BDC space. As we've said in the past, today's front book is tomorrow's back book. This was the big theme we highlighted during our Q2 earnings call six months ago and remains top of mind when we make our investments. To be clear, the analysis is for illustrative purposes only.

If our entire portfolio were called away, our return on equity in return would be boosted given the impact of embedded call protection and amortization of upfront fees. While it may feel like the value proposition for direct lending is eroding on the margin given spread levels in the market today, we set up our business with a differentiated sourcing channel to deliver a sustainable return profile for our shareholders.

We continue over-earning our cost of capital, even in a more competitive, tighter spread environment, and believe this will be a key contributor to the dispersion of returns for the sector in the future. Yesterday, our board approved a base quarterly dividend of $0.46 per share to shareholders of record as of March 14th, payable on March 31st.

Our board also declared a supplemental dividend of $0.07 per share related to our Q4 earnings to shareholders of record as of February 28th, payable on March 20th. Our year-end net asset value per share adjusted for the impact of the supplemental dividend that was declared yesterday is $17.09, and we estimate that our spillover income is approximately $1.23 per share. 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 laying on some additional thoughts on the direct lending environment and, more specifically, how we are positioned for the opportunities that we are anticipating in 2025. 2024 was another year of lower M&A volumes as interest rates remained elevated and valuation gaps persisted between buyers and sellers in the market. While the setup for 2025 is not entirely different from that of 2024, we are optimistic about the higher activity levels this year for a few reasons.

First, valuation gaps have narrowed after multiples reached a trough in 2023 from the peak prices paid for businesses in 2021. The reality is that if a buyer paid an excess multiple a few years ago and multiples have since contracted, that implies additional growth in the businesses required before they can earn back their money, let alone a reasonable return.

Achieving that growth generally takes time, and companies have had yet another year to go back into earnings. Second, in a more stable macroeconomic backdrop, compared to 2024, interest rates have stabilized to what we may now consider the new normal, while inflationary pressures have largely subsided, at least for the time being. While still higher for longer, we believe that the normalization of rates, while still bringing more buyers back into the market in 2025.

Lastly, pressure has continued to build in the system, with sponsors sitting on record amounts of dry powder. Each of these factors will take time to fully materialize, but they set a promising stage for increased activity levels this year. Amidst the slower M&A backdrop in 2024, we had an extremely productive year of putting capital to work in differentiated investment opportunities.

In Q4, we provided total commitments of $479 million and total fundings of $324 million across nine new portfolio companies and upsized it to seven existing investments. In terms of commitments, Q4 was our busiest quarter in three years since Q4 of 2021. For the full year 2024, we provided $1.2 billion of commitments and closed on $839 million of fundings, representing an increase from the 2023 levels of $959 million and $808 million, respectively. In 2024, we stayed active in the market by leveraging our omni-channel sourcing capabilities across the Sixth Street platform, this including being a valuable solution provider in both the sponsor and non-sponsor channels.

In the sponsor finance market, our thematic investment allows us to provide speed and certainty in the sectors we like and know well, thereby positioning us as a differentiated source of capital in what has become the most competitive segment of the direct lending market. As for the non-sponsored businesses, the breadth of Sixth Street's platform provides us with the ability to originate credits away from the regular way sponsor finance business. In 2024, 37% of total fundings were to non-sponsored businesses.

It is generally in this less-traveled seam of the market where we earn incremental spread while maintaining an appropriate risk return for our shareholders. Given our access to a wide top-of-the-funnel across multiple origination channels, our investment pipeline is not solely linked to M&A volume, but rather stems from long-standing relationships, sector expertise, and flexible capital approach.

To highlight a differentiated investment in Q4, also our largest funding for the quarter, we closed on a new investment to TRP Energy. This was structured as a new term loan facility that recapitalized the business in connection with an asset exchange. As part of the transaction, TRP refinances existing term loan agented by Sixth Street, resulting in approximately $0.07 per share for the combination of prepayment fees and dividend income.

This investment allows us to stay invested alongside a trusted management team through a new deal with call protection. We believe this investment underscores the power of the Sixth Street platform in creating unique investment opportunities. To touch on another non-sponsored investment we made in 2024, Arrowhead Pharmaceuticals was in the press in Q4 announcing a large-scale global licensing and collaboration agreement with Sarepta Therapeutics.

After receiving HSR approval last week, the transaction will be effective in Q1, and we anticipate a repayment of a portion of our loan in accordance with agreed-upon prepayment terms. Based on these terms, we expect to earn $0.07 per share of estimated activity-based fees in Q1 of 2025. Similar to our investment in TRP Energy, this opportunity was the direct result of deep expertise across the Sixth Street platform.

We have an established and core competency in specific themes within the healthcare sector over a number of years, which has positively benefited our shareholders, demonstrated by an asset-level weighted average IRR and MOM of 14.7% and 1.4x on fully realized healthcare investments in the TSLX portfolio. Both of these examples highlight the differentiated portfolio we have created.

This is further demonstrated by examining the overlap of investments in the TSLX portfolio with other BDCs and comparing that to an investment overlap across the BDC sector. As of Q3 2024, TSLX had approximately 25% less portfolio overlap compared to the overlap on average for the sector. Pivoting to funding trends in Q4, 98% of our new investments were in first lien loans, reinforcing our long-term focus on investing at the top of the capital structure.

All nine new investments were across platform deals where we leveraged the size of Sixth Street's capital base to lead and participate in transactions that presented attractive risk-adjusted return opportunities. This contributed to Sixth Street agenting 88% of the deals funded in TSLX in the fourth quarter. In today's crowded marketplace of direct lenders, we believe our scaled capital base serves as a competitive advantage as we are able to lead transactions, ultimately allowing us to drive shareholder return. Moving on to repayment activity, as Josh highlighted earlier, we experienced a significant pickup in payoffs during the fourth quarter to finish off the year.

Total repayments in Q4 were $305 million. For the full year, repayments totaled $794 million, reflecting a 69% increase over 2023 and resulting in net funding activity of $45 million for 2024. To characterize the repayment activity we experienced during the fourth quarter, we saw a mix between payoffs related to M&A and refinancings. Two of our payoffs driven by M&A, TRP Energy, and Kyriba, resulted in the repayment of our existing investment, followed by the opportunity to continue lending to the business through a new money term loan.

In terms of repayments driven by refinancings, we continue to pass on deals getting debt at spreads that do not present an appropriate return profile for our shareholders. From a portfolio yield perspective, our weighted average yield on debt and income-producing securities at amortized cost decreased quarter over quarter from 13.4% to 12.5%.

Half of this decline, or 46 basis points, was from lower interest rates, and the rest was a mix between yields on new fundings and spread step-downs on an existing investment. In today's tighter spread environment, we have continued to participate in investment opportunities that we estimate will earn a return that is greater than our cost of capital. This is illustrated by only 5.1% of our portfolio by fair value in senior secured loans with spreads below 550 basis points.

Further, less than 1% of our portfolio by fair value carries a spread below 500 basis points. We highlight this for the reasons we have outlined in the previous earnings call regarding the importance of earning your cost of capital. 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 0.6 times and 5.1 times, respectively, and their weighted average interest covers remain consistent at 2.1x.

As a reminder, interest rate covers assume that we apply reference rates at the end of the quarter to run rate borrower EBITDA. As of Q4 2024, the weighted average revenue and EBITDA for our core portfolio companies was $336 million and $110 million, respectively. Median revenue and EBITDA was $147 million and $53 million.

Finally, the performance rating of our portfolio continues to be strong, with a weighted average rating of 1.10 on a scale of 1 to 5, with 1 being the strongest, representing an improvement from last quarter's rating of 1.14, driven by growth in the portfolio from new investments and the repayment of a two-rated investment during the quarter. Non-accruals represent 1.4% of the portfolio at fair value, with no new investments added to non-accrual status in Q4. 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. We finished the year with a strong quarter from an earnings and investment activity perspective. In Q4, we generated net investment income per share of $0.62, resulting in full-year net investment income per share of $2.39. Our Q4 net income per share was $0.55, resulting in full-year net income per share of $2.03. We experienced an unwind of $0.06 per share of capital gains incentive fees in 2024, resulting in adjusted net investment income and adjusted net income per share for the year of $2.33 and $1.97, respectively.

At year-end, we had total investments of $3.5 billion, total principal debt outstanding of $1.9 billion, and net assets of $1.6 billion, or $17.16 per share, which is prior to the impact of the supplemental dividend that was declared yesterday. Our ending debt-to-equity ratio was 1.22x, up slightly from 1.19x in the prior quarter, and our average debt-to-equity ratio also increased from 1.14x to 1.23x quarter over quarter. For full-year 2024, our average debt-to-equity ratio was 1.19x, down slightly from 1.2x in 2023.

In terms of our balance sheet positioning at year-end, we had $674 million of available revolver capacity against $205 million of unfunded portfolio company commitments eligible to be drawn. As discussed on last quarter's call, we satisfied the maturity of our 2024 unsecured notes during the fourth quarter through utilization of undrawn capacity on our revolving credit facility.

Following that repayment, our nearest maturity does not occur until August of 2026. Consistent with our ongoing messaging of being an annual issuer, we anticipate accessing the unsecured market in calendar year 2025 to extend our debt maturity ladder and maintain our target funding mix. Last month, we kicked off the annual process of amending and extending our revolving credit facility.

While the current maturity on the facility is not until 2029, we have historically extended the maturity on an annual basis, driven by our asset liability matching principle of maintaining a weighted average duration on our liabilities that meaningfully exceeds the weighted average life of the assets funded by debt. We anticipate marginally lowering the drawn spread and undrawn fee on the facility upon closing of the amendment in Q1. Moving to our presentation materials, slide 10 contains this quarter's NAV bridge.

Walking through the main drivers of NAV growth, we added $0.61 per share from adjusted net investment income against our base dividend of $0.46 per share. The impact of tightening credit spreads on the valuation of our portfolio had a positive $0.08 per share impact to net asset value. There was a $0.07 per share decline in NAV from net unrealized losses driven by portfolio company-specific events.

Other changes included $0.12 per share reduction to NAV as we reversed net unrealized gains on the balance sheet, primarily related to investment realizations in TRP Energy and Kyriba. And finally, there was a $0.05 per share uplift from net realized gains on investments, largely from our equity investment in Murchison Oil and Gas. Pivoting to our operating results detail on slide 12, we generated a record level of total investment income of $123.7 million, up 4% compared to $119.2 million in the prior quarter.

Walking through the components of income, interest and dividend income was $113.8 million, up from $110.9 million in the prior quarter, driven by net funding activity. Other fees, representing prepayment fees and accelerated amortization of upfront fees from unscheduled paydowns, were also higher at $5.1 million compared to $4.3 million in Q3, driven by the activity-based fees earned on repayments that Bo highlighted earlier.

Other income was $4.8 million, up from $4 million in the prior quarter. Net expenses, excluding the impact of the non-cash accrual related to capital gains incentive fees, were $65.9 million, up slightly from $65.8 million in the prior quarter. Our weighted average interest rate on average debt outstanding decreased approximately 70 basis points from 7.7% to 7%.

This was largely driven by the decline in reference rates coupled with a funding mix shift following the repayment of 2024 unsecured notes in the fourth quarter. As a reminder, our liability structure is entirely floating rate, which means our cost of debt will move in the same direction as interest rates. Before passing it back to Josh, I wanted to provide a framework for how we are thinking about guidance for this year.

We anticipate the key variables in 2025 to be similar to those in 2024, including the movement of interest rates and new issue investment spreads, which will impact the amount of interest income and activity-based fees we expect to earn. Based on our model, which incorporates the forward curve and assumes spreads on new deals and leverage remain consistent with the fourth quarter, we expect to target a return on equity on net investment income for 2025 of 11.5%-12.5%.

The lower end of this range reflects muted activity-based fees, while the upper end reflects a more normalized level of activity-based fees. Using our year-end book value per share of $17.09, which is adjusted to include the impact of our Q4 supplemental dividend, this corresponds to a range of $1.97-$2.14 for full-year 2025 adjusted net investment income per share. As a reminder, our base dividend is $1.84 per share on an annual basis, which we believe remains well protected. With that, I'll turn it back to Josh for concluding remarks.

Joshua Easterly (CEO)

Thank you, Ian. I started the call by sharing my thoughts on the unit economics of the sector and will wrap up today by closing the loop on that topic. Competition in the direct lending market is fierce, and spreads on new issue loans were at historical tights. Last year, the combination of interest rates and existing portfolio spreads on older investments contributed to above-average operating earnings for the sector.

As we anticipated, credit was a headwind to earnings in 2024 for the sector. This year, we expect largely to offset in terms of tailwinds and headwinds for the sector. As backbooks converted to frontbooks, we will see portfolio yields as a potential challenge to earnings. The math we illustrated earlier highlights that capital has been misallocated, at least as it relates to return on equity and where firms in the sector sit on the cost curve. We expect this to become evident in 2025 as weighted average portfolio spreads converge to prevailing spreads in the market today.

On a positive note, we believe the majority of credit issues to be known, and therefore we expect credit improves from here. We share these views because we care about maintaining the value proposition for the sector. Ultimately, we are aligned with the sector, and it's important that other direct lenders understand their cost of capital and price risk appropriately. We are dedicated to upholding our standards to ensure that our sector remains a desirable place for investors, both equity and debt investors. We look forward to working hard to deliver for all of our stakeholders throughout 2025 and beyond. With that, thank you for your time today. Operator, please open the line for questions.

Operator (participant)

Thank you. As a reminder, to ask a question, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. One moment while we compile our Q&A roster, and our first question is going to come from the line of Finian O'Shea with Wells Fargo Securities. Your line is open. Please go ahead.

Finian O’Shea (Analyst)

Hey, everyone. Good morning. I want to ask about the origination outlook sounds better and tie it to a name you mentioned. Couldn't find it. Maybe a new commitment, but to TRP Energy. It sounded like the type of capital solutions deal that delivers the first lien and recaps it. Correct me if I'm wrong there. But is that the source of a lot of the new opportunity you're feeling? And what kind of spreads or returns do you get from that opportunity? Thanks.

Joshua Easterly (CEO)

Hey, good morning. So TRP was not that type of transaction. TRP was a first lien financing, obviously in a space that we have expertise in and that is kind of, I would say, off the run in energy. On that, we feel really good about the risk-return. We are seeing the capital solution stuff. I think that will be prevalent in 2025 origination, but that was not TRP. I'm not sure there was any in, I guess, I don't think there's any in that book today.

I think we have a couple in our pipeline that would, or at least two that have closed, actually, in Q1 that are kind of continue to be more off the run capital solutions oriented. And those range from, obviously, in the top end of the range, somewhere between SOFR 600 up to SOFR 800, 850. But TRP was not one of them.

Finian O’Shea (Analyst)

Very good. Thanks. And a follow-up I wanted to ask about IRG. I think you've been working on that one for a while. It took a touch of a markdown this quarter. So yeah, any update you could give us on that? Thanks.

Joshua Easterly (CEO)

Yeah. We're working on getting those assets sold. They own super valuable, the portfolio company owns super valuable assets, we think, in land in Palm Beach or West Palm Beach. We hope to have a resolution there in the next quarter or two quarters on that.

Finian O’Shea (Analyst)

Okay. Thanks so much.

Operator (participant)

Thank you. And one moment as we move on to our next question. And our next question is going to come from the line of Brian McKenna with Citizens JMP. Your line is open. Please go ahead.

Brian McKenna (Equity Research Analyst)

Thanks. Good morning, everyone. So it's great to see such strong results in the quarter despite the 100 basis point decline in base rates into year-end. And then looking at page five of the deck, you've really delivered impressive results and strong ROEs in just about every kind of operating environment over the past decade. So the question is, why does your model work so well in any and all backdrops?

Joshua Easterly (CEO)

Yeah. Thanks, Brian. Thanks for the question. Yeah. I mean, look, we work really hard to be right on credit. And so when you look at our historical loss rates over time, they've been well, significantly below the sector loss rates and the asset returns in the industry. So that starts with loss rates. It starts with being an investor first.

Second is, I think we have a bigger top of the funnel, which is historically a lot of our competitors have focused purely on the sponsor model or sponsor origination channel. That origination channel is the most competitive where you have kind of the most whipsaw on spreads. And so I think it's a function of having a bigger top of the funnel where we're able to find off-the-run opportunities that offer better asset-level returns and then minimizing credit losses.

And so when you look at the unit economics of the space, you can see it historically on, let me find it, on, give me one second. So the unit economics of the space have historically been, I think our weighted average return on assets have been a couple of hundred basis points higher on the portfolio. And then credit losses have been, if you look at Cliffwater, it's been about 2.2% on equity, and we've been half that.

And so we've been, I guess, historically since our IPO, 280 basis points higher on all-in asset yields. Again, that's mostly because of a top of the funnel, wider aperture, and we've had significantly less credit losses since inception, since our IPO compared to the space. So those are the two big drivers of outperformance over time.

Brian McKenna (Equity Research Analyst)

Okay. That's super helpful. Thanks. And then just a bigger picture question here. I mean, there's clearly a lot of capital being raised and deployed in private credit today. And then obviously the public credit markets are also very active. So borrowers have a lot of different choices across the market. But from your seat, why do borrowers ultimately end up choosing Sixth Street as a lending partner?

Joshua Easterly (CEO)

Yeah. Great. So look, I think, A, again, we have top of the, I think on the sponsor side, it's because, and Bo should comment on this too, it's because we travel in the same industries. We can provide certainty and speed and some flexibility and size that is really important for a sponsor who kind of values speed and certainty and size. We're one of a handful of firms that can write $500 million plus checks across the platform. And then on the non-sponsor side, we tend to have deep industry expertise and can provide those same kind of values, which is speed, size, and certainty, but in less traffic areas.

Bo Stanley (President)

I think that's exactly right. Our thematic investing approach, especially in the sponsor universe, allows us to get up the curve quickly, provide speed and certainty. They have confidence that we can deliver. We have a lot of long-standing relationships outside of the sponsor community. We're really solutions providers for the sectors.

Brian McKenna (Equity Research Analyst)

Got it. Thank you, guys.

Operator (participant)

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

Yes. Good morning, everyone. Josh, you talked about the imbalance in the sponsored market, but we did finally see some stabilization of spreads, and I'm curious what your outlook is in terms of the ability for those spreads to remain stable over the next 12 months, or do you expect more pressure to redevelop?

Joshua Easterly (CEO)

Yeah. So Mickey, it's a right question. Look, I think what we tried to do at the beginning of our earnings call is to compare those spread levels and what those imply for return on equity for the space. And my hope is, and maybe this is a hope, my hope is that the market mechanism will work, which is the market will kind of wake up and say, "Oh my God, what does that mean for return on equity as your frontbook converts to your backbook?"

And that will be a mechanism to provide feedback for the space about how to price asset-level returns. And so I'm not sure, quite frankly, at the bottom level, not what we're investing, but the bottom-level spreads on the sponsor space, that it works given the cost curve and return on equity for the space.

I think our math says return on equity is going to be somewhere based on the cost curve, based on the SOFR swap rate, and based on losses, somewhere between 5% and 7% compared to a cost of equity between 9% and 10%, and so hopefully the market will kind of provide that feedback if capital is misallocated. Now, maybe the cost of equity is too high for the space, and that will adjust, but my hope is that there's a reinforcing market mechanism for the space that will at least provide some floor level to spreads.

Mickey Schleien (Analyst)

Oh, that's really interesting and quite helpful. Thank you for that. Just one follow-up question. The TSLX BDC is relatively small compared to your broad platform at Sixth Street. I'm curious whether you have interest in growing the BDC as the platform keeps expanding and growing on a relative basis.

Joshua Easterly (CEO)

Yeah. Look, it's a great question, Mickey. It's kind of an interesting way of how we built Sixth Street because I think it's, look, the goal of Sixth Street is we want to be investors, and we're an investor-first model, and so when you look at Sixth Street as a platform, we're about, I don't know, $100 billion of AUM, but that's across 8 to 10 strategies that we think we have raised constrained capital so we can invest across cycles just like we do in the direct lending market.

And so we'll grow our direct lending business, and as people know, we have Sixth Street Specialty Lending Partners, which focuses on the larger cap investments, but we'll grow a direct lending business as we see there's opportunity where we can both provide an efficacious solution to our sponsors and provide acceptable return on capital for our investors. But the model is kind of built to be investor-first because we believe as long as we can't really provide capital to sponsors or to issuers unless we're providing returns to our clients, and that flywheel only exists if we're doing a good job for the people who provide us the capital and trust capital to us.

Mickey Schleien (Analyst)

Got it. Thank you for that. Those are all my questions. Thanks for your time.

Joshua Easterly (CEO)

Thanks, Mickey. Have a good day.

Operator (participant)

Thank you. One moment as we move on to our next question, and our next question comes from the line of Ken Lee with RBC Capital Markets. Your line is open. Please go ahead.

Ken Lee (VP of Equity Research)

Hey, good morning. Thanks for taking my question. Really appreciate the commentary around the portfolio overlap. Just curious, would you attribute the less overlap mainly to the proportion of non-sponsored transactions that you have, or part of it's also due to the size of the portfolio company? Just curious in terms of the contribution there. Thanks.

Joshua Easterly (CEO)

Yeah. I think directionally, it's probably the non-sponsor side. I think on the sponsor side, for sure, there's a little bit of that. But directionally, I think it's the non-sponsor side that contributes mostly to the lack of portfolio overlap compared to the rest of the space, if that's helpful.

Ken Lee (VP of Equity Research)

Yep. No, that's helpful. That's helpful. And just one follow-up. Talked a lot about spreads on new investments, but just curious in terms of what you're seeing now, are you seeing any changes in terms of documentation, in terms of loan terms? Just wanted to see whether those items have been impacted by the level of activity you're seeing there. Thanks.

Joshua Easterly (CEO)

No. I think typically, Bo can comment. I think typically the document and underwriting standards outside of spread have been pretty kind of consistent over the last 18 months or so.

Bo Stanley (President)

Probably 18 months, they've been pretty consistent. You'll see some idiosyncratic pop-up where you see lack of discipline and documentation on those ones will pass outright. But for the most part, you've seen stabilization there.

Ken Lee (VP of Equity Research)

Great. Very helpful there. Thanks again.

Operator (participant)

Thank you. One moment as we move on to our next question. Our next question comes from the line of Melissa Wedel with JPMorgan. Your line is open. Please go ahead.

Melissa Wedel (Equity Research Analyst)

Good morning. Thanks for taking my questions. Following up on something you mentioned earlier in the prepared remarks, you talked about some new deals being put on with call protections. I'm just curious, has anything changed in terms of the typical structure on call protection, and is that characteristic of sort of most of the new investments you're putting on the balance sheet?

Joshua Easterly (CEO)

No. No, actually, you kind of opened up something that I was just going to hit in closing remarks, but call protection as a percentage of fair value. So if you look at fair value divided by the call price, it's actually at its lowest level in the portfolio today, and that's a function of, I think, a combination of newer vintage investments plus that we've been able to retain call protection, so that's at 93.6%. So if our entire portfolio got called away, we would have a lot of embedded economics, and that's kind of at the embedded economics is at the highest level.

So call protection has been pretty stable. I would say we're able to generate more call protection on the more off-the-run investments and the more non-sponsored, so generally, I think call protection on the sponsor stuff has been pretty stable, and it does exist.

Melissa Wedel (Equity Research Analyst)

Okay. That's helpful. You also mentioned expertise and exposure in the healthcare space. Just curious, as you look across the portfolio, do you see any sort of reimbursement risk embedded in there? Thank you.

Joshua Easterly (CEO)

No. Yeah. So look, our healthcare exposure has been really healthcare tech, in fact, pharma. It has not been on the services side, which has been a difficult place for the space on the services side given wage inflation and on services. So I think there was always a reimbursement on pharma that was priced in the market a couple of years back. We don't expect more of that. But we have a pretty differentiated healthcare strategy and healthcare portfolio.

Melissa Wedel (Equity Research Analyst)

Thank you.

Operator (participant)

Thank you. One moment as we move on to our next question. Our next question is going to come from the line of Robert Dodd with Raymond James. Your line is open. Please go ahead.

Robert Dodd (Director)

Hi, everyone. Hi, Josh. Going back to the spread question, because obviously you pointed out, I mean, there's a supply-demand mismatch that has been for the last few years. But so what's the probability you think that spreads actually stay as tight if we see a rebound in activity? I mean, some of the spread compression arguably makes sense on a spread per unit of leverage because leverage came down on new deals as rates came up. But is that trend going to reverse if we see an increase in activity? Are we going to see the last couple of years there's been more A-grade companies in the mix? Do we see more B-grade and spreads move there?

I mean, I don't think spreads move just because investors want them to, but are there other dynamics if there is a somewhat meaningful rebound in activity in terms of quality of company mix, spread per unit of leverage, anything like that kind of push the needle one way or the other?

Joshua Easterly (CEO)

Yeah. Let me look. By the way, I wasn't suggesting that my hope can drive spreads. What I was suggesting was that ultimately spreads are a function of supply and demand and equilibrium, right? And so on the supply side, supply capital side, my hope is that when people wake up and see, and it's not hope, but how the market should work, is that as people's frontbook converts into their backbook and the market provides them a signaling function that it's no longer meeting the return on equity and it's a destroying shareholder value, that some of that supply at lower prices will be cut off.

That's what should happen, right? What should happen is that the market says, "No, no, no. Your cost of capital is a nine. You can't really allocate capital at 450 spreads," and no matter what you think about the risk-adjusted return, the stock should trade down or below book value, and that should be a signal to managers of the capital to cut supply off at lower levels, so supply hopefully comes out of the market as there's more transparency in that conversion of frontbook to backbook. On the demand side, so that's the supply side.

On the demand side, increased M&A and other demands for capital, but mostly probably given increased M&A, catches up to the supply of private credit. That should also move spreads up, so you have, and what's happened over the last 12 months is that you've had a lot of supply of capital move in the space. The incentives are for people to put capital to work.

There hasn't been a real transparent signaling function about if that capital is being allocated appropriately because that backbook hides it. And then on the demand side, you've had low M&A that hasn't caught up. So that's kind of the basic supply and demand equilibrium framework for spreads.

Robert Dodd (Director)

Understood. So presumably, you don't think that kind of imbalance can be corrected on any short-term given that the guidance assumes spreads stay where they are. Is that fair? You think it might be a longer-term phenomenon for the market to self-correct there?

Joshua Easterly (CEO)

I don't know. I mean, it should self-correct. I'm not sure. It's going to depend on how strong the market signals are and when M&A comes back. I mean, when you look at our specific guidance, and this has come up now twice, I think the guidance that AIM provided is a little bit of just us being conservative. We like to overdeliver on expectations. I guess that's kind of the credit mindset of the firm, which is do no harm, kind of overdeliver. To give you a little perspective, I think 10 out of 10 years, we've beat the low end of our guidance framework. 9 out of 10 years, we've been above the high end. And 7 out of 10 years, we've been above the high end, above the top level of guidance.

I think when you look at our guidance, it implies actually low levels of M&A. Portfolio turnover, I think, is in our guidance at somewhere between 15% and 20% versus 25% this year. So it implies low level of which drives activity-based fees. So I think our guidance is relatively conservative. I think what we did was say, "Hey, spreads, let's try to, again, with the framework of overdelivering. Let's assume spreads don't get better.

Let's assume portfolio turnover gets a little bit worse. What does that mean?" And that's what spit out in guidance. But again, we have a track record of overdelivering. So I would not do Robert, which I think you do because you're quick. That PhD makes you quick. But I think what you've done is you've kind of said, "Hey, I'm looking at their guidance.What does that mean for the environment? You got to put our guidance in the historical context of our relationship with the Street.

Robert Dodd (Director)

Understood. Thank you. And congrats on the quarter. Thanks a lot.

Joshua Easterly (CEO)

Thanks.

Operator (participant)

Thank you, and one moment as we move on to our next question, and our next question comes from the line of Maxwell Fritscher with Truist. Your line is open. Please go ahead.

Maxwell Fritscher (Equity Research Associate)

Yeah. Thank you. Good morning. I'm on for Mark Hughes. I just wanted to get your view on how do you expect the mix of incumbent borrowers versus new borrowers to trend over 2025?

Joshua Easterly (CEO)

I mean, we've historically put work in our existing portfolio and created new portfolio relationships. I think the number of portfolio relationships have increased significantly, but it's going to be a mix. I don't know if I have a specific view. We'll take what the—I mean, obviously, we like to put money and work in our existing portfolio company where we can. The portfolio company you know better than the portfolio company that's new to you. But it's going to be a mix of what the opportunity gives us, what the market gives us.

Maxwell Fritscher (Equity Research Associate)

Understood. And then the large sequential increase in the average new commitments in the new portfolio companies, what's driving that, I assume? Is that just TRP Energy?

Joshua Easterly (CEO)

Let me come back to you real quick. Let me just see if I understand your question. Your question was about 39 before I. Yeah, give me one second. I mean, TRP was $54 million. So it's not that big of an outlier. Most of them were between. The median was probably 40. So it's not that big.

Maxwell Fritscher (Equity Research Associate)

Yeah. Okay. Thank you.

Operator (participant)

Thank you. And as a reminder to ask a question, please press star 11 on your telephone. One moment for our next question. And our next question comes from the line of Paul Johnson with KBW. Your line is open. Please go ahead.

Paul Johnson (Equity Research Analyst)

Yeah. Good morning. Thanks for taking my questions. Sixth Street's made a few new partnership announcements over the course of the last few months, but the most recent one, the First Citizens Equipment Financing Partnership. I'm just curious, does this partnership or any other partnerships that you could, I guess, potentially enter, would this provide any deal flow that fits into TSLX's funnel?

Joshua Easterly (CEO)

Yeah. We don't expect the First Citizens Equipment Leasing. That's really an equipment leasing partnership with First Citizens. So we don't expect that to kind of fit into the corporate direct lending portfolio for TSLX. But there will be partnerships, and there will be cross-platform opportunities that, if they're appropriate for TSLX, will most definitely, they will get allocated appropriately.

Paul Johnson (Equity Research Analyst)

Got it. Thanks for that. And then just on the non-sponsor opportunities within the portfolio, I'm just curious, how frequently do you typically expand financing or provide add-on financing with existing borrowers in your portfolio that have come in through primarily the non-sponsored channel? Or are these kind of more shorter-term payoff opportunities?

Joshua Easterly (CEO)

Yeah. They're actually a mix. If you look at TRP, TRP was an existing portfolio company that entered into basically an asset swap. And so we were able to expand that relationship. But so that's on one side where we're able to expand those relationships and the amount of capital that we deploy. And then on the other side, there's some that's more transitory that our capital is a bridge or, for example, the retail ABL strategy. So it's really a mix of both. I would say on the margin, now there's exceptions to the rule like TRP, but on the margin, they tend to be more transitory because they're opportunistic in nature.

Bo Stanley (President)

That's right.

Joshua Easterly (CEO)

But we don't, our capital for that channel and that strategy is durable, and we want to be long-term investors.

Paul Johnson (Equity Research Analyst)

Got it. Thank you. That's very helpful. Then the last one is just, I would ask how you guys are feeling from a capital standpoint. Leverage has been pretty stable throughout last year. You guys are right at 1.2 times in the upper end of your target. The market seems to be signaling a pretty optimistic year for activity this year. How do you guys feel, and do you think this is an opportunistic time to potentially be raising more capital for shareholders, just given your valuation and the outlook for the year? Or how do you guys think about maybe a line of sight on prepayments?

Joshua Easterly (CEO)

Yeah. So look, I would say given where spreads are, and I don't expect us to grow significantly and issue new capital. Obviously, the puts and takes on issuing new capital have created issues for shareholders given the share price. But because that capital is permanent and you're not really going to return that capital unless you trade below book value, you have to believe you can invest that capital at attractive ROEs for a long period of time. And I don't see us jumping in at spread levels that don't ultimately work for what we think the cost of capital is for the space. And so that may change. And if that changes, we'll put capital to work. We'll raise capital and put capital to work.

But our first North Star is that investors have entrusted us with their capital, and there is an implied return on equity for that capital. And we're going to do everything we can to make sure we meet and beat those expectations as it relates to the return on equity on that capital.

Paul Johnson (Equity Research Analyst)

That makes sense. Thank you very much. Those are great answers. Thanks for taking my question.

Joshua Easterly (CEO)

Those are great answers, but there are answers. Look, for us to have a long-term sustainable platform to serve our issuers, we got to meet the return on equity and meet investor expectations, and that is deeply important to Sixth Street and deeply important to me personally.

Operator (participant)

Thank you. I would like to hand the conference back to Josh Easterly for his closing remarks.

Joshua Easterly (CEO)

Great. Well, first of all, I appreciate all the questions. I hope people enjoy their holiday weekend. We're always around. We're always available. But thank you from the team and the people. Again, I hope people enjoy their weekend.

Operator (participant)

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