Sixth Street Specialty Lending, Inc.

Good morning and welcome to Sixth Street Specialty Lending, Inc.'s June 30, 2020 quarterly earnings conference call. 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 risk 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 filing for the Securities and Exchange Commission. The company assumes no obligation to update any such forward-looking statements. Yesterday, after the market closed, the company issued its earnings press release for the second quarter ended June 30, 2020 and posted a presentation to the Investor Resources section of its website, www.sixthstreetspecialtylending.com. The presentation should be reviewed in conjunction with the company's form 10-Q filed yesterday with the SEC. Sixth Street Specialty Lending, Inc.'s earnings release is also available on the company's website under the Investor Resources section. Unless noted otherwise, all performance figures mentioned in today's prepared remarks are as of and for the second quarter ended June 30, 2020. As a reminder, this call is being recorded for replay purposes. I will now turn the call over to Joshua Easterly, Chief Executive Officer of Sixth Street Specialty Lending, Inc.

Thank you. Good morning, everyone, and thank you for joining us. With me today is my partner and our president, Bo Stanley, and our CFO, Ian Simmons. We and everyone here at Sixth Street hope you and your loved ones are able to stay safe and healthy in this uncertain environment. We spoke in May. Our hope has been that by August there would be more clarity on the path and timeline of a return to full business activity. However, the current health crisis continues to take a toll on human lives as well as the economic health of households and businesses around the world. While the Fed and U.S. government have provided rapid and extraordinary fiscal and monetary support, it remains to be seen how long a return to normalcy will take and what the long-term impact of COVID will ultimately be. As shared in our stakeholder letter less than two weeks ago, we've always believed that any business model, including the BDC model, has inherent constraints and risks. These risks make it fragile and particularly vulnerable to market shocks and uncertainty. That is why, over the last years, we've taken steps across our business not only to mitigate the undesired outcomes of the inherent fragility but also to allow us to create value in periods of volatility. These elements we've introduced into our business model include our focus on high-quality underwriting and cycle-appropriate portfolio construction, match funding the nature of our liabilities with our assets, proactively manage our liquidity and liability role risk, setting a financial policy that preserves our reinvestment option, and finding the optimal business model to provide both the benefits of scale and outside returns for our stakeholders. While still early in the unfolding of this COVID-induced downturn, we believe that the strength of our Q2 results is an early indication of the value we can create for our stakeholders in the period ahead. With that, let me turn this quarter's highlights, which are consistent with the preliminary earnings results we provided on July 23rd. After the market closed yesterday, we reported second quarter net investment income of $0.59 against our Q2 base dividend of $0.41. Net income per share of Q2 was $1.43. These results correspond to an annualized return of equity on net investment income and net income of 15.6% and 38% respectively. An annualized year-to-date return on equity on net investment income and net income of 13.1 and 7.6% respectively. Net investment income this quarter was supported by elevated prepayment and other fee activity in our portfolio, most notably our realized investment in feral gas. Our strong net income this quarter was primarily due to the unrealized gains related to the impact of market spread tightening during this quarter, as well as a robust net investment income. Over the course of Q2, LCD first lien and second lien spreads retraced 60 and 71% of the respective Q1 spread widening. Consistent with the broadly syndicated market, the impact of this on valuation of our portfolio this quarter resulted in a reversal of approximately 60% of our Q1 spread-related unrealized losses, which was reflected as an unrealized gain for Q2. Net Asset Value Per Share was $16.08, increasing by 6.7% from our pro forma March 31st Net Asset Value Per Share of $15.07, which accounts for the impact of the $0.50 aggregate special dividends per share that was paid during Q2. Ian will walk through the quarter's Net Asset Value Bridge in more detail. Taking a step back, our Net Asset Value Per Share quarter end If we were to add back our $0.50 per share of special dividends paid to shareholders in Q2 would be $16.58, which brings us almost entirely back to our starting level of $16.77 at the beginning of the year, even though our spread-related unrealized losses have only been reversed by 60%. This is because we've been able to rebuild net asset value in other ways, including through the over-earning of our base dividend, outperforming some of our small equity positions, and unrealized mark-to-market gains on our interest rate swaps. Yesterday, our Board declared a third quarter base dividend of 41 cents per share to shareholders of record as of September 15th, payable on October 15th. Consistent with what we said last quarter, based on a view of the core earnings power of our portfolio, we do not anticipate making any changes to our base dividend level in the near or medium term. There are no supplemental dividends declared relating to Q2 earnings as a result of the net asset value test in our framework, which specifies that no supplemental dividends are declared if pro forma net asset value per share adjusted for the impact of any supplemental dividends over the current and preceding quarter declines by more than 15 cents per share. Any downward impact of net asset value as a result of special dividends, not supplemental dividends, are added back for the purpose of the net asset value test. If we compare this quarter's net asset value per share, adding back our 50 cents per share of special dividends of 1658 against our Q4 2009 pro forma net asset value of 1677, there was 19 cents of NAV per share decline against a limiter of 15 cents. Therefore, we are four cents short of being able to declare a supplemental dividend of 50 cents of this quarter's over-earning. based on our current outlook and presuming no material declines for net asset value per share as a result of exogenous events like the market volatility we observed in March, we would expect to resume declaring supplemental dividends on over earnings in Q3 provided that our reported net asset value per share as September 30th is greater of 1492. With that, I'd like to turn the call over to Bo to walk through Thanks, Josh.

I'll begin with a quick overview of our market backdrop during the quarter. Amid economic uncertainty, M&A activity continued to be significantly muted as buyers and sellers struggled to agree on valuations. Meanwhile, in the second quarter, there was significant tightening of risk premiums in the broader credit markets. A disconnect emerged between asset prices and economic reality, which we believe was primarily fueled by extensive fed and government intervention driving investor demand back into risk assets. As a result, secondary prices across credit rose sharply in Q2, and there was an abundant liquidity in the investment grade and high yield markets for a broad variety of issuers, including those in sectors most impacted by COVID. In light of these market dynamics, and given our focus on maintaining strong risk-adjusted returns across our portfolio, Q2 originations activity was relatively light at $89 million of commitments and $77 million of fundings. These fundings were across six new and six existing portfolio companies. The majority of our fundings on a dollar basis this quarter was providing a new financing in connection with the recapitalization of Moran Foods, where we replaced our existing ABL loan with a new one at a higher spread and refreshed call protections. Other new investments included small, opportunistic purchases of BBB CLO liabilities in limited junior debt co-investments alongside our affiliated funds and growth businesses with attractive risk-adjusted returns. As a result, our portfolio's first mean exposure decreased slightly from 97% to 96% quarter-over-quarter on a fair value basis. Repayments during Q2 totaled $211 million across three full and two partial paydowns. Farrell Gas and Nectar, which were our two largest portfolio names at the end of Q1, were both fully repaid early in the quarter. As a result, net repayment activity for the quarter was $134 million. During the quarter, as M&A activity slowed and the immediate opportunity set for secondary market purchases and rescue financings became less actionable given Fed intervention, our team continued to work hard to build a pipeline of opportunities where we could create value through our core competencies of deep sector expertise and the ability to underwrite complexity. As we previewed in our letter on July 23rd, we've been active in capital employment post-quarter end. As of today, Q2 funding's total approximately $135 million, primarily led by two new investments. In broad strokes, our reputation as creative solution providers, particularly amongst participants within our sector themes, played an important role in the sourcing of these investments. Our deep diligence and underwriting capabilities, along with the scaled solutions we're able to offer as part of the $34 billion Sixth Street platform, allowed us to structure investments with attractive spreads, strong call protection, and other fees that enhances the overall risk-adjusted return profile of our portfolio. Today, we continue to have a robust pipeline, which we are constantly working to build through our direct sourcing channels. Looking ahead, we believe the competitive advantage of our human capital will become increasingly evident as the financing solutions sought by companies, management teams, and sponsors will only grow in complexity in this uncertain environment. As it relates to our portfolio at quarter end, the overall performance of our portfolio continues to be solid with approximately 98% rated 1 or 2 on a performance rating scale of 1 to 5 with 1 being the highest and minimum non-accruals at approximately 0.4% of the portfolio on a fair value basis. representing three investments. To revisit Josh's introductory remarks, we have long recognized the inherent fragility of the left-hand side of the balance sheet. Our assets are callable loans, which means that the investments where we are over-earning due to borrow-out performance are typically the ones that get called away, and in periods of volatility when credit spreads widen, the value of our assets tend to decline. In order to combat the fragile elements of the left side of our balance sheet, we've over the years focused on strong underwriting discipline in defense of portfolio construction, which includes sector, business model, and management team selection. We believe these efforts have played a role in the performance of our portfolio today. However, we'd be remiss not to highlight our portfolio company's high-quality management teams who took quick action at the onset of COVID to optimize cost structures and protect their liquidity positions. Albeit still early, our portfolio has performed above our expectations given the macro backdrop. The slight increase in this quarter's non-accruals from approximately 0.1% to 0.4% of the portfolio by fair value at quarter end was driven by our Neiman Marcus First Lean Term Loan, not our ABL Philo Term Loan, and the residual non-dip roll-up portions of our JCPenney First Lean Term Loan and Secured Notice. Given what we believe may be less than par recovery, we have applied the regularly scheduled cash interest payments we received during the quarter to the amortized cost of our positions, all of which were acquired at prices less than par. As we covered in our preliminary release in July, our retail ABL exposure at quarter end was stable from prior quarter at 9.4% of the portfolio at fair value. 99 Cent, Moran Foods, and Staples, businesses that were generally deemed essential during COVID shutdown, continue to benefit from tailwinds in the current environment, and together represent 44.5% of our retail ABL exposure at quarter end. Our largest retail ABL exposure is our FILO term loan in Neiman Marcus, which was 3.6% of our portfolio at fair value at quarter end. Our current expectation, based on the company's plan of reorganization and case milestones, will be refinanced upon Neiman Marcus' exit from bankruptcy, which is expected to occur in the fall of 2020. With Sixth Street as lenders of size in each of Neiman and JCPenney's pre-petition capital structures, we were able to have meaningful roles in driving the dip financing process and terms. As a result, we believe our $11.5 million par value dip loan for Neiman and our $6 million par value dip loan for JCPenney at quarter end offer attractive risk-adjusted returns given the structural protection of dip loans in combination with our contractual economics. Our portfolio's energy exposure at quarter-end was 3.9% at fair value, but has since fallen to 2.8% on a pro forma basis given partial paydowns on Verdad and Energy Alloys post-quarter-end. We expect to be fully repaid on Energy Alloys during Q4 2020 as the company competes and more. Our portfolio composition and credit stats for Q2 remain relatively stable from prior quarter. Top industry exposures continue to be business services at 22% of portfolio fair value, followed by financial services and healthcare at approximately 17% and 11% respectively. Based on the financial information through March 31st of our core portfolio companies, The average net attachment point at last dollar average was 0.4 times and 4.3 times compared to 0.3 times and 4.1 times, respectively. Our average interest cover ratio was 3.3 times compared to 3.2 times in the prior quarter. We would caveat that these figures, given the timing lag and trailing nature, do not fully reflect the impact of economic shutdown that persisted through most of Q2. Based on an ongoing engagement with borrowers, we do not expect a material deterioration of credit metrics across our portfolio in the near term. This quarter, out of our portfolio of 65 names, we had only one investment outside of the retail sector ones we discussed earlier complete an amendment with COVID cited as a direct cost. To the extent state reopenings are paused or reversed, We would expect that this figure to increase in order to provide our borrowers with additional flexibility on covenants. As of today, we do not expect any defaults on debt service obligations in the near term. Now on to our portfolio yields. The weighted average total yield on our debt and income-producing securities at amortized cost increased by approximately 10 basis points quarter over quarter to 10%. Breaking this down, there were 15 basis points of yield uplift from the impact of new and Exited Investments this quarter and 10 basis points uplift from the impact of amendments. These were partially offset by 15 basis points of downward yield impact from the movement in LIBOR prior to it reaching our average floors of 115 basis points across our floating rate assets. Quarter over quarter, the weighted average spread over the three-month LIBOR of our floating rate investments increased by 100 basis points, almost entirely due to the benefit of our LIBOR floors. With that, I'd like to turn it over to Ian.