Sixth Street Specialty Lending, Inc.

Good morning and welcome to Sixth Street Specialty Lending, Inc.'s fourth quarter and fiscal year ended December 31st, 2020 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 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 the 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, the company issued its earnings press release for the fourth quarter and fiscal year ended December 31, 2020, and posted a presentation to the Investor Resources section of its website, www.sixstreetspecialtylending.com. The presentation should be reviewed in conjunction with the company's form 10-K 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 fourth quarter and fiscal year, December 31, 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 Simmonds. I hope everyone and their loved ones are doing well. On our Q4 earnings call a year ago, none of us could have predicted that we were on the precipice of a global pandemic that would claim over 2 million lives, shutter entire sectors of the global economy, and drastically alter the cadence of our everyday lives. In the context of a year that was fraught with complexity and uncertainty, our Q4 and full-year results are a testament to both the groundwork we've laid over the years to address the constraints of our sector's business model as well as the commitment of our people at all levels of our organization. After close yesterday, we reported fourth quarter and fiscal year financial results, which were consistent with the preliminary figures we provided on January 25th. Our Q4 net investment income and net income per share were 48 cents and 79 cents respectively. This resulted in a full year net investment income per share of 219, a return on equity of 13%, and a full year net income per share of 265, a return on equity of 15.8%, our highest annual return since inception. Both our 2020 ROE on net income and our ROE on net investment income were above their respective average annual results since our IPO. Despite ongoing earnings headwinds from LIBOR for most of our sector, Our strong Q4 net investment income was supported by the liable floors on our assets in connection with the lower cost of funding given our 100% floating rate liability structure. It was also supported by another quarter of robust fee income and portfolio activity. The difference between this quarter's net investment income and net income were primarily driven by overall net gains, including net realized and unrealized gains from portfolio company-specific events and net unrealized gains from the impact of tightening credit spreads on the valuation of our debt investments. As shared in our pre-release, our Q4 figures include approximately two cents per share of capital gains incentive fees that were accrued but not paid or payable related to cumulative unrealized capital gains in excess of cumulative net realized capital gains, less any cumulative unrealized losses in capital gains incentive fees paid inception to date. including the impact of the accrued capital gains incentive fee expenses. Our net investment income per share and net income per share for the quarter ended December 31st, 2020 was 50 cents and 81 cents respectively. Since capital gains incentive fee accrual is a GAAP-related non-cash item, we believe the adjusted NII which excludes the impact of the accrual more accurately portrays the current core power of our business. Our Q4 capital gains incentive fee Accrual Existence is just another byproduct of our long-term focus on minimizing losses and steadily building net asset value and economic value for shareholders. Another way to see this is through the total economic returns we've generated for shareholders. That's calculated by the change in net asset value per share with the starting point adjusted for the impact of a supplemental and or special dividends plus cumulative dividends per share. In 2020, we generated total economic returns of 16 percent exceeding our average annual return rate since IPO of 12.2% through 2019. As seen on slide 10 of our earnings presentation, the primary drivers of our net asset value per share growth in 2020 to a new high of $17.16 a year end were the over-earning of our base dividend to net investment income, net unrealized market-to-market gains from interest rate swaps on our fixed rate liabilities, and unrealized and unrealized gains on investments. Yesterday, our Board approved a base quarterly dividend of 41 cents per share to shareholders of record as of March 15th, payable on April 15th. Our Board also declared a supplemental dividend of 5 cents per share related to our Q4 earnings to shareholders of record as of February 26th, payable on March 31st. The supplemental dividend this quarter is calculated using our adjusted net investment income, which excludes the impact of accrued Capital Gains Incentive Fee Expenses. Since there's no certainty to when or if these accrued expenses will be paid, we believe the adjusted NII as a more relevant figure to determine the over-earning that should be distributed to our shareholders. In the ongoing assessment of our unit economics, mitigating the earnings drag and caused by excess tax related to our spillover income has been top of mind. Since declaring our tax-driven special dividend last February, We've continued to accumulate spillover income as a result of over-earning and capital gains from our portfolio realizations. In order to reduce our excise tax, satisfy RIC distribution requirements, and enhance our capital efficiency, we, in consultation with our board, have declared a special cash dividend of $1.25 per share to shareholders of record as of March 25, payable on April 8. Through this special dividend, holding all of us equal, we should expect to reduce our full year excise tax from 10 cents to 4 cents per share. This combined with a slight increase in our financial leverage is expected to drive approximately 100 basis points of uplift in our ROE. Our year-end net asset value per share adjusted for the impact of the special supplemental dividend that was declared yesterday is 1586, and we estimate that our spillover income per share after the special dividends is approximately 54 cents. Again, we would like to reiterate that our special dividend is motivated by tax and RIC distribution consideration, and our goal of steadily building net asset value per share over time remains very much a part of our operating philosophy. To sum up, we believe our performance in 2020 was largely supported by how we were positioned pre-pandemic. The defensive nature of our portfolio, combined with our strong liquidity, funding, and capital positions, and our floating-rate liability structure, were the bedrock of our outperformance this year. Having this foundation as we entered the uncertain period in March allowed us to better dedicate our energy and efforts to support our portfolio companies and management teams and tactically deploy capital in dislocated areas. I'll now let Bo and Ian each discuss how we're thinking about our positioning on the right-hand and left-hand sides of our balance sheet for the year ahead, as well as to review the Q4 and full-year activity in more detail. Bo, over to you.

Thanks, Josh. I'd like to quickly share our thoughts on the market environment and how it has informed our Originations activities over the course of this year. After the COVID-induced market shock in March, fiscal and monetary stimulus measures taken by the Fed and the U.S. government led to significant turnaround for risk assets. Strong investor demand for yield in a low-rate environment along with unprecedented fiscal stimulus to support COVID-impacted businesses and households drove down risk premiums in both the equity and credit markets, despite the prevailing uncertainty surrounding many parts of the U.S. economy. In the leveraged loan market, LCD first lien spreads ended the year only 30 basis points wider than where it started, and second lien spreads actually tightened 144 basis points year over year. On an absolute basis, taking into account movements in LIBOR, the benefit of floors, and the amortization of upfront fees, all in returns for new issue single B loans for the year ended 2020 were approximately 100 basis points tighter than where they were a year prior. While new issuance volumes gathered pace in the second half of the year fueled by opportunistic financings and the return of sponsor and M&A activity, strong investor demand still outpaced supply. By year end, we saw the return of looser underwriting standards similar to what we witnessed pre-COVID. Despite the theme of recovery and headlines for most risk assets, we believe the story of averages masked the diverging performance and credit quality for COVID-impacted borrowers this year. For example, total return for the Leveraged Loan Index in 2020 was 3.1%, but sectors like energy and retail underperformed with negative 7.3% and negative 2.0% returns, and sectors like healthcare, and tech generated over 5% returns. This dispersion was also evident in credit statistics. Despite a seemingly moderate reported median leverage of 5.5 times for public filers and the leverage loan index at year end, the percentage of filers with leverage greater than seven times doubled from a year ago, primarily led by EBITDA declines for borrowers most impacted by COVID. As we saw a return in competitive behavior in our own markets in the later half of the year, we were mindful of the unevenness and fragility of this recovery. We believe that much of the optimistic market sentiment we saw starting in the second half of 2020 hinged on continued accommodative Fed policy and timely global vaccine distribution, which to date has been fragmented and not without its challenges. In the near to medium term, we believe this could create windows of volatility and risk-off behavior in the broader markets, which would once again allow us to opportunistically deploy capital like we did in the spring and summer. In the meantime, however, we felt that it was prudent to focus our origination efforts on sectors and themes that have been the hallmark of our above-market returns and continue to reinforce the defensive nature of our portfolio. In Q4, we generated a record level of quarterly commitments and fundings, of $526 million and $450 million, respectively. This quarter's fundings were across 10 new and 10 existing portfolio companies. As sponsor M&A activity picked up, we were active in both bolt-on acquisitions for existing borrowers as well as new financings along the lanes of our expertise where we felt we could add incremental value to sponsors and management teams. Our activities this quarter tilted in favor of mission-critical software businesses with diverse, attractive revenue characteristics and high variable cost structures. We also blended our expertise on a hybrid recurring revenue software and asset-based financing for Follett, a provider of K-12 educational materials and technology solutions. Our ability to delve into and underwrite the company's software subsegment, as well as its working capital and other fixed asset collateral, allowed us to differentiate our capital and partner with an excellent family-owned business and management team. On the repayment side, we continued to have elevated activity in Q4, with 10 full and one partial portfolio repayment totaling $266 million. As a result, net fundings activities for the quarter was $184 million. A bulk of this quarter's repayments were M&A related, and in various cases, resulted in activity-related fees contributing to this quarter's income. For the full year, our commitment and funding levels closely track last year's record high figures, with $1.2 billion of commitments and $939 million of fundings. Total repayments for this year were $941 million, which meant the size of our portfolio remained relatively steady year over year. You may recall that in the first two quarters of the year, we had a cumulative $266 million of net repayment activity in our portfolio. This meant that our team worked incredibly hard to build a strong pipeline of opportunities to generate over $263 million of net portfolio growth in the second half of the year alone. As always, our priority is to source and structure consistent portfolio yields while partnering with high-quality companies and management teams. This philosophy is reflected in the stability of our weighted average yield on debt and income-producing securities at amortized cost, which can be seen on slide 15 of our earnings presentation. In Q4, the weighted average yield on debt and income-producing securities at amortized cost remained stable at 10.2%. There was a slight positive uplift from amendments during the quarter primarily related to M&A, which was offset by the impact of new versus exited debt investments. In Q4, the yielded amortized cost on new investments was 9.9% compared to an elevated yield of 12.9% on exited names as a result of upfront fees against the short contraction maturity on our investment in Centric Brands. Excluding Centric Brands, the yielded amortized cost on exited investments this quarter would have been 10.3%. Now I'll move on to the credit quality of our portfolio by first providing some updates on our prior quarter's non-accrual names. In December, we removed our pre-petition JCPenney's first lien term loan and notes from non-accrual status upon the company's emergence from Chapter 11. At emergence, our pre-petition debt and dip positions were converted to non-interest paying instruments, but with the rights to immediate and future distributions in cash and other instruments. Our immediate distributions were $2.3 million of cash 6.9 million of exited term loan in units in the PropCo and Earn Out Trust. The fair value marks of our JCPenney pre-petition debt and dip positions at December 31st reflected their respective level two prices. Overall, JCPenney's restructuring provided approximately five cents per share of uplift for our NAV this quarter. And at year end, the total realized and unrealized value of our pre-petitioned and Dip Positions exceeded the original cost basis. While this has been a complex process, we believe our involvement as pre-petition and dip lenders supported our ability to be one of four financing providers in the JCPenney's new $300 million ABL Filo Loan, which in our view offers very attractive risk-adjusted returns. At year-end, our retail and consumer exposure was 11.8%, down 13.9% in the prior quarter, and 75% of this existing exposure were asset-based loans. In December, we also removed our first lien loan in an EMP company, MD America, from non-accrual status following the company's emergence from Chapter 11. During Q4, our $13.6 million fair value loan was restructured into a $9 million first lien loan and a $3.9 million equity position. We believe the company's new capital structure is more appropriately suited for today's commodity price environment. At quarter end, our portfolio's total energy exposure was 1.7% at fair value. During the quarter, we added one new investment, our $21.6 million fair value loan and American achievement to non-accrual status. The company manufactures and supplies yearbooks, class rings, and graduation products, and as a result of COVID, underperformed for the 2020 sales season. We are currently working with the company on a potential restructuring to keep our term loan outstanding and to receive a majority of the equity in the business as a lender group. We expect to reach resolution on this in the near term. As a result of these activities, our non-accruals and remain stable from the prior quarter at 0.9% of the portfolio at fair value. Quarter over quarter, our portfolio's weighted average performance rating improved slightly from 1.21 to 1.18, and our terrorist names decreased from 8% to 2.5% on a fair value basis. As of Q4, our portfolio continued to be at the top of the capital structure with approximately 96% first lien loans. The percentage of business service portfolio companies increased during the year to nearly 80%, and we continued to have limited cyclical exposure, excluding our asset-based loans and retail of 4.5%. Note that the slight increase in our equity exposure from 3% to 4% year-over-year was primarily due to the increase in the fair value mark of our equity positions. Across our core borrowers, for whom these metrics are relevant, we continue to have conservative weighted average attachment and detachment points of 0.4x and 4.4x, respectively, and their weighted average interest coverage remains relatively stable at 3.1x. Year over year, the weighted average revenue in EBITDA of our core portfolio companies increased from $114 million to $117 million, and from $35 million to $41 million, respectively. We believe this reflects the resilient business model of our core portfolio companies, many of whom were able to execute on strategic acquisitions this year to drive continued growth. With that, I'd like to turn it over to Ian. Thanks, Bo.