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spk01: Ladies and gentlemen, today's conference is scheduled to begin shortly. Please continue to stand by. Thank you. Thank you. Thank you. Thank you. Ladies and gentlemen, thank you for standing by And welcome to the Sixth Street Specialty Lending in Q1 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If we require any further assistance, please press star 0. I would now like to hand the conference over to your speaker, Ms. Cammie Van Horn. Head of Investor Relations. Please go ahead.
spk05: Thank you.
spk00: 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 6th Street Specialty Lending Inc.' 's filings with the Securities and Exchange Commission. The company assumes no obligation to update any such forward-looking statements. Yesterday, after the market closed, we issued our earnings press release for the first quarter ended March 31st, 2022, and posted a presentation to the investor resources section of our website, www.sixstreetspecialtylending.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 press release is also available on our website under the investor resources section. Unless noted otherwise, all performance figures mentioned in today's prepared remarks are as of and for the first quarter ended March 31st, 2022. As a reminder, this call is being recorded for replay purposes. I will now turn the call over to Joshua Easterly, Chief Executive Officer of 6th Street Specialty Lending, Inc.
spk12: Thank you. Good morning, everyone, and thank you for joining us. With us today is my partner and our president, Bo Stanley, and our CFO, Ian Simmons. For our call today, I will provide some highlights of this quarter's results and pass it over to Bo to discuss this quarter's origination activity and portfolio. He will review our quarterly financial results in more detail, and I will conclude with final remarks before opening the call in Q&A. After market closed yesterday, we reported first quarter financial results to just an investment income per share of 49 cents, corresponding to an annualized return on equity of 11.6%. An adjusted net income per share of $0.56, corresponding to an annualized return on equity of 13.2%. As discussed in previous quarters, at quarter end, we had approximately $0.21 per share of cumulative accrued capital gain incentive fees on the balance sheet. Approximately $0.13 per share of this amount would be payable in cash if our entire portfolio would be realized at the quarter end mark in the low course. The remainder of the accrued fees are tied to unrealized gains with evaluation of our debt investments, inclusive of call protection, which if prepaid would require recognition of fees and investment income and trigger a reversal of previously accrued capital gains instead of fees related to these investments. This non-cash expense, which was not paid or payable, was approximately two cents per share for Q1. From a reporting perspective, our Q1 net investment income and net income per share inclusive of these accrued capital gain into the fee expenses was 47 cents and 54 cents respectively. This quarter's net investment income reflects continued strength in our quarter's power of our portfolio above the guidance we provided in our last earnings call. Net investment income was supported by fee income from portfolio activity alongside interest and dividend income levels driven by sustained portfolio yields. The difference between this quarter's net investment income and net income was a result of net unrealized gains primarily from portfolio company-specific events. Looking ahead, we are facing an operating environment which has changed significantly over the last few months. Increase in inflation, rising interest rates, geopolitical factors, and lingering impacts from the global pandemic will certainly present a headwind for the U.S. and global economy. However, similar to our positioning heading into the uncertainty of COVID in early 2020, we have invested in high-quality durable businesses on the asset side to maintain a disciplined approach to building and maintain liquidity, inclusive of understanding of our unfunded commitments on the liability side. We further enhanced our liquidity profile during the quarter through an extension expansion of our existing revolving credit facility, which Ian will discuss in further detail later on the call. From a macroeconomic perspective, the impact of the interest rate environment is on top of mind. Although we saw meaningful upward movement in interest rates during Q1, we haven't seen the impact yet on our financial results for two primary reasons. On the asset side, the Floors on our Debt Investments Act is downside protection of falling rate environment, which we had seen up until recently. In a rising environment, as we experienced in Q1, our floors' mass impact of the increase in total reference rates rise above our average floor levels. Once through our floors, we are able to benefit from the asset sensitivity of our matched floating rate exposures. On the liability side, our weighted average cost of debt, outstanding. We remain relatively flat for this quarter given the mechanics of how the swap contracts or unsecured liabilities are reset at the end of the preceding quarter, resulting in a one-quarter lag of rising rate rates impacting our income statement. Given the speed for which interest rates have risen to date, the increase we expect to see in weighted average cost of debt will be offset from the asset side as reference rates rise further above our average force in 2022. Although we anticipate the rising interest rate environment to play out favorably as a lender positioned to benefit from the positive asset sensitivity of our balance sheets, We also are very cognizant of the potential impact on our borrowers. Today, interest coverage remains strong across our portfolio companies, and we are confident in the credit quality we have underwritten. As we've said in the past, we are focused on investing on top of the capital structure in high-quality businesses and the industries that we like and know well. At quarter end, net asset value per share was $16.88, up 15 cents per share, or 1% for performing net asset value at per share at year end of 1673. This growth was primarily driven by continued overriding of our base dividend and net unrealized gains from investments. Over the trailing two-year period, reported net asset value has increased by 8.4%, and a total of $5.94 of distributions have been distributed, resulting in total economic return on book value of over 46.5%. Yesterday, our Board approved a base quarterly dividend of 41 cents per share to shareholders of record as of June 15th, payable on July 15th. Our Board also declared a supplemental dividend of four cents per share relating to our Q1 earnings to shareholders of record as of May 31st, payable June 30th. Our Q1-22 net asset value per share pro forma for the impact of the supplemental dividend is $1,684. We estimate our spillover income per share is approximately 59 cents. Before I pass it over to Beau, I wanted to note on April 8th, Fitch Rating Agencies published their annual review of BDC sectors. The BDC sector, we are pleased to share a six-week specialty where we received a one-notch ratings upgrade from BBB- to BBB- with a stable hour. Of the 16 firms in the rating universe, TSOX was the only firm to receive such an upgrade There's only one or two BDCs to hold the ratings from Fitch. As Fitch reported, the upgraded firms are decades' worth of strong and consistent performance, and it's supported by our sector-leading returns. With that, I'll now pass it over to Beau to discuss his quarterly investment activities. Thanks, Josh. I'd like to start by sharing some observations on the broader market backdrop, in particular, the inflationary environment and upward movement in rates since our last earnings call in February. These macroeconomic factors, coupled with Russia's invasion of Ukraine, led to heightened volatility and uncertainty in the financial markets during the quarter. Public markets reacted quickly, with equities and high yields ending the quarter down 4.5% for the S&P 500 and 4.6% for the U.S. High Yield Index, representing their worst quarter since Q1 of 2020. These fluctuations in the public markets ultimately led to a period of price discovery for private buyers and sellers, resulting in a slowdown in M&A activity in Q1. As we'd expected, decline in M&A activity was matched with muted leveraged loan volume relative to historical periods. These trends carried across the middle markets, where new issue loan volumes were down 51% from a year ago. Loan volumes were also driven by issuers taking time to reconsider the immediacy of their capital needs, reflecting the widening of first lien and second lien spreads by a peak of 47 and 124 basis points, respectively, through mid-March. By quarter end, there was some reversion of spread movement with first lien and second lien spreads 31 and five basis points tighter than their wides, respectively. With more volatility likely ahead, we expect to see boroughs look into the private markets as an alternative to traditional capital markets, leading to opportunities where we can provide our differentiated capital solutions and expertise. Pivoting now to the inflationary environment, if we take a step back and look at what is driving the price increases, much of this can be explained by the scarcity of certain goods, raw materials, and commodities. Over the last six to 12 months, we've seen the impact across several sectors such as real estate, automotive, and energy, as demand has exceeded supply in these industries, driving up prices for the consumer. Given we have low exposure to these industries and are heavily weighted towards software and business services, we generally haven't seen margin depressions or supply chain issues thus far impacting our portfolio companies. Demand has also been strong as the consumer sector has benefited from high wage growth and prior fiscal transfers from government support provided throughout COVID. Household wealth has soared on the back of strong house price increases and prior equity gains. With rent growth and demand for services increasing post-COVID, the longevity of higher inflation will be key to the outlook. We continue to monitor and construct our portfolio with inflationary pressures in mind. Turning to portfolio activity, our commitments and funding slowed in Q1 after a busy 2021, totaling $79.3 million and $52.8 million, respectively. This was distributed across two new and eight upsides into existing portfolio companies. Our new investments this quarter were both first lien loans in the software services space and businesses providing value-added technology and solutions. We were also active during the quarter by supporting our existing portfolio companies on their strategic growth and capital needs. Including our new investments in Lose It Works, 71 percent of this quarter's funding served our existing borrowers. In terms of new borrowers, we closed $130 million senior secured financing alongside 6G's European Direct Lending Fund to support the acquisition of Unilei by CDC Growth. Unilei is a provider of employee experience software with a strong recurring revenue base and low historical churn that has a large addressable market. We believe that our expertise and experience in this sector allow us to move quickly and provide certainty to borrowers amidst strong competition with direct lending space. On the repayment side, there are 144.4 million of pay downs across five full and three partial investment realizations. Two of our realizations were upstream E&P companies in the energy sector, Verdad Resources and MD America, which made up 26 percent of payout activity during the quarter. We'll briefly highlight these two investments as an example of our capabilities in the Sixth Street platform. Our investment in Verdad was in the form of a $225 million term loan facility that we sole led and sourced by our energy team and reflects our opportunistic investment approach, providing first lien reserve-based loans to upstream companies that provide a strong risk-return profile. Since our investment in 2019, the company's credit profile improved materially due to the attractive development returns and an improved commodity price environment, ultimately allowing the company to refinance through the bank market at a lower cost of capital. As a refresher on MD America, we made an initial investment led by our energy team in November of 2018, where we closed on a $200 million first lean term loan, of which Sixth Street Platform held 40% of the deal. Since our initial investment, there's been a series of amendments ultimately resulting in the company filing for Chapter 11 in October 2020. Our asset management capabilities along with our flexible capital base allowed us to be a value-added partner, resulting in a successful emergence from bankruptcy in December of 2020, with the lenders receiving 100% of the post-reward equity. During Q1, we completed the sale of MD America to Wildfire Energy, representing a full exit for Sixth Street's 40% ownership interest in the company. At the time of our investment in 2018, we underwrote to a 12.8% IRR and a 1.30X MOM and ultimately generated a 24% IRR and 1.82X MOM, further demonstrating our ability to create value for our shareholders in complex situations. After these two repayments, our energy exposure decreased to 1.7% of the portfolio at fair value. One other notable exit during the quarter was our investment in designer brands, which is one of our ABL retail portfolio companies. We made our initial investment in designer brands back in August of 2020 when the retail sector was suffering from the shutdowns brought on by the global pandemic. Because of our strong balance sheet positioning, we were able to play offense during this time by providing capital borrowers in need in several COVID-impacted industries. During the quarter, the company retained the outstanding balance of its term loan credit facility, and we received a 3% prepayment premium on the outstanding balance. Since inception, and inclusive of this quarter's design and brand exit, we've generated an average gross unlevered IRR of 20.1% across our fully realized ABL investments. On activity levels generally, we saw a pickup beginning in March, and we are optimistic about our originations and funding pipelines heading into the rest of 2022. The direct lending landscape remains competitive. We continue to pick our spots and remain selective in our opportunity set, which is expanding alongside the growth of the Sixth Street platform. As demonstrated by the returns generated during this quarter from our EMP and retail ABL names, we will look to opportunistically deploy capital in areas where our platform's ability to underrate and navigate complexity allows us to create excess returns across our portfolio. From a portfolio yield perspective, funding and repayment activity this quarter had a slight positive impact for a weighted average yield on debt and income-producing securities at amortized cost. Yields were up slightly to 10.3 percent from 10.2 percent quarter-over-quarter and are up about 17 basis points from a year ago. The weighted average yield at amortized cost on new investments, including upsizes of this quarter, was 10.6 percent compared to a yield of 9.8 percent on exited investments. Moving on to the portfolio composition and credit stats, across our core borrowers for whom these metrics are relevant, we continue to have a conservative weighted attached and de-attached points on our loans at 0.8 times and 4.5 times, respectively. And their weighted average interest coverage remained relatively stable at 2.9 times. As of Q1 2022, the weighted average revenue in EBITDA of our core portfolio companies was $117 million and $31 million, respectively. Finally, the performance rating in our portfolio continues to be strong, with the weighted average rating at 1.13 on a scale of 1 to 5, with 1 being the strongest. We continue to have minimal non-accruals at less than 0.01 percent of the portfolio at fair value, with no changes from the prior quarter.
spk09: With that, I'd like to turn it over to Ian to cover our financial performance in more detail. Thank you, Bo. For Q1, we generated adjusted net investment income per share of 49 cents and adjusted net income per share of 56 cents. At quarter end, total investments were $2.5 billion, down slightly from the prior quarter as a result of net repayment activities. Total principal debt outstanding at quarter end was $1.2 billion, and net assets were $1.3 billion, or $16.88 per share, prior to the impact of the supplemental dividend that was declared yesterday. Our average debt-to-equity ratio decreased slightly quarter over quarter from 0.99 times to 0.95 times and our debt to equity ratio at March 31 was 0.91 times. We continue to have ample liquidity with 1.2 billion of unfunded revolver capacity at quarter end against 147 million of unfunded portfolio company commitments eligible to be drawn. Post quarter end, we further enhanced our liquidity and debt maturity profile by closing an amendment to our revolving credit facility With the ongoing support of our lending partners, we increased the commitments under the facility from $1.51 billion to $1.585 billion through an upsize from an existing lender and extended the final maturity on $1.51 billion of these commitments to April 2027. Pro forma for the revolver extension, our weighted average remaining life of debt funding is 4.1 years compared to a weighted average remaining life of investments funded by debt of only 2.1 years. At quarter end, our funding mix was represented by 76% unsecured debt in line with the prior quarter. I'd like to take a moment to circle back on Josh's comments related to the upward movement in interest rates. During Q1, three-month LIBOR increased from 21 basis points to 96 basis points, and the average floor on our debt investments was approximately 1.1%. At the time of our last call, we expected to reach our average floors in May, and this timeline accelerated as reference rates have been above our average floors since April. To quantify the impact on earnings, assuming our balance sheet and spreads remain constant as of quarter end, for every 25 basis points increase in rates above our average floors, we would expect to see approximately 20 basis points of ROE accretion or an incremental $0.03 per share of net income on an annual basis. We can further illustrate the potential impact by using the forward yield curve, which projects three-month term SOFR to be 2.9% in one year from quarter end. Assuming all else equal, as of the quarter-ending Q1-22, an increase in base rates to 2.9% would imply 150 basis points of ROE accretion, or an incremental $0.25 per share of net income annually. Moving on to our presentation materials, slide eight contains this quarter's NAD bridge. Walking through the main drivers of NAD growth, we added 49 cents per share from adjusted net investment income against our base dividend of 41 cents per share. There was a $0.24 per share reduction to NAV, primarily from the reversal of net unrealized gains on our position in MD America, as we booked these gains as realized upon sale. The negative impact from widening credit spreads on the valuation of our portfolio was $0.05 per share, and there were minor negative impacts related to the mark-to-mark on our outstanding swaps that are not designated as hedging instruments, which amounted to $0.04 per share. Finally, there was a 42 cents per share positive impact from other changes, primarily realized gains on investments of 18 cents per share and portfolio company specific events of 22 cents per share. Moving on to our operating results detail on slide nine. Total investment income for the quarter was 67.4 million compared to 78.3 million in the prior quarter. Walking through the components of income, interest and dividend income was $58.8 million, down slightly from the prior quarter, driven by net repayment activity during Q1. Other fees representing prepayment fees and accelerated amortization of upfront fees from unscheduled paydowns were lower at $6.9 million compared to $14 million in Q4, given the elevated portfolio activity we experienced in Q4. Other income was $1.8 million compared to $2.6 million in the prior quarter. Net expenses, excluding the impact of the non-cash accrual related to capital gains incentive fees, were $29.9 million, down approximately 8% from prior quarter. Despite the upward movement in reference rates, our weighted average interest rate on average debt outstanding remained relatively flat quarter over quarter, primarily from the one-quarter timing lag on the reference rate reset date on our interest rate swaps. Before passing it over to Josh, I wanted to circle back on our ROE metrics. In Q1, we generated an annualized ROE based on adjusted net investment income of 11.6% and an annualized ROE based on adjusted net income of 13.2%. This compares to our target return on equity of 11 to 11.5% for the year as articulated during our Q4 earnings call, and we maintain this outlook heading into the rest of 2022. With that, I'd like to turn it back to Josh for concluding remarks.
spk12: Thank you, Ian. I'd like to close our prepared remarks today by encouraging our shareholders of record for upcoming annual and special meetings on May 26th to participate in both. Consistent with the past five years, we are 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 five years. We have no current plan to do so. We merely view the authorization as an important tool for value creation, financial flexibility, and periods of market volatility. As evidenced by the last eight-plus 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 issue below net asset value if there are sufficiently high-risk adjusted return opportunities that would ultimately be accretive to our shareholders through overrunning our cost of capital and any associated dilution. If anyone has questions on this topic, please don't hesitate to reach out to us. We have also provided a presentation which walks through this analysis in the investor resources section of our website. As a final thought for today's call, we are extremely optimistic about the road ahead. With current market conditions in mind, we believe the value proposition for our business has never been better for both our clients, and shareholders. The decline in purchasing power from the impacts of inflation have only underscored the value proposition of our franchise as a source of alternative real returns for our shareholders, which we believe to be sustainable. As for our clients, we're prepared to provide capital with speed and certainty through periods of volatility in public markets. As the credit cycle continues to evolve based on tiny monetary policy implemented by the Fed, we believe our low leverage and significant liquidity profile positively positions us to play offense in the event of a market dislocation. These times of dislocation have been our greatest periods of outperformance in the past. Though we cannot predict what is ahead, we feel that we build a robust business model that performs through the cycles. In closing, I wanted to call out how refreshing it has been to be back in the office and be able to interact face-to-face with friends and colleagues and clients and stakeholders. I know the ability to collaborate in person will continue to provide new motivation and ideas as we push further into 2022. We especially look forward to resuming our annual tradition of the Sixth Street Offsite when we gather our approximately 400-strong team in Austin, Texas. Stakeholders, thank you for your continued interest in 6.3 Specialty Living. With that, thank you for your time today. Operator, please open up the line for questions.
spk01: Thank you. As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from Mickey Schleen with Lattenberg. Please go ahead.
spk06: Yes, good morning, everyone. Hope you're doing well. Josh, I'm sure there's a ton of questions on interest rates, but I'm going to start with one. On page 13 of the investor presentation, it shows that the weighted average spread on your floating rate investments came down as LIBOR increased, but I suspect that was probably reflecting the lag in the repricing of the assets. And when I look at the interest rate risk table in the queue, as you mentioned in your prepared remarks, you would expect your net interest margin to expand with higher rates. But that assumes everything remains equal, which it never does, right? So I'd like to ask, what's your view on how you think the private lending market will react to higher short-term rates in terms of maintaining spreads?
spk12: Can you repeat that last part of the question? What was the last part of the question?
spk06: The last part of the question is, you know, we're looking at a a forward LIBOR curve or SOFR curve that's very steep. So I'd like to ask, what's your view on how the private lending market will react to higher short-term interest rates in terms of maintaining spreads?
spk12: Yeah, it's a question top of mind for us. So first of all, I think one thing to note is that the steepening of the LIBOR curve or SOFR curve, and they're about the same when you think about credit spread adjustments, has had a extremely positive impact on the business. If you would have looked back at September of last year, we would have probably had a $0.09 drag on investment income line. So not net income line, but investment income line to get through our LIBOR flows. And we estimate that to be only about $0.02 today. What tends to happen in our market, and hopefully people will be thoughtful about this. They tend to price things on an IRR basis, and they don't differentiate between spread and risk-free. And so, you know, hey, we were doing stuff in a 10% to 11% IRR, and, hey, we're still doing a 10% to 11% IRR. And therefore, they price things with a reduced spread, not realizing or maybe realizing that a lot of that's coming from risk-free. So I hope the industry reacts differently. I think we have some massive sensitivity in our book coming. For sure, how much the industry captures is, I think, a key question. And all things being equal, you want you want it to spread in low return instead of risk-free, or so for LIBOR. But, you know, I think that's a key question, and hopefully the industry doesn't allow one-for-one tradeoff between the return attribution between risk-free and spread.
spk06: Yeah, I understand. Thanks, Josh. A couple of housekeeping questions. What are your expectations for LIBOR? settling the convertible, which is coming up, and also what is the level of undistributed taxable income?
spk09: Sure. Mickey, you see, and I'll take that one. On the convert, we had to make an election six months prior to maturity, so that was actually on February 1, and we elected to settle and convert primarily in stocks. And there's about $100 million of principal amount of converts outstanding today. And that settlement is about, I think it's basically all in stock. There's a minimum amount of cash.
spk12: Think of it as $2 million out of that $100 million in principal. And even slightly accrete of the net asset value. Because those will be issued above NAD. And slightly, I would say, slightly... you know, could be dilutive on earnings, although the least value of that is 61 cents of undistributable earnings, so 59 cents of undistributable earnings, plus we expect some growth in undistributable earnings from, you know, expected realizations above the current marks. And so, I think you have, obviously we expect to grow above, and keep leverage steady or in our target leverage ratio. If we don't, you obviously can use special dividends to make sure you're still capital efficient, and we think we have enough spillover income plus kind of pipeline of realized gains that allows us to give us that flexibility.
spk09: And so, Mickey, you should think of it the same way we addressed some early conversion in Q4 of last year, and then we saw a special... That's a tool that we felt was an efficient way to achieve those goals.
spk06: I understand. What did you say the UTI balance was?
spk09: 59 cents per share.
spk06: Five-nine?
spk09: Yes.
spk06: Five-nine? Okay. That's it for me this morning. Thank you for taking my questions.
spk12: Thanks, Mickey.
spk01: Thank you. Our next question will come from Kevin Fultz with JMP Securities. Please go ahead.
spk10: Hi, good morning, and thank you for taking my questions. My first question is similar to one of Mickey's questions. Given that the economic outlook has shifted in the past few months, are you seeing less competition in the market from other lenders? Just curious if you're beginning to see a shift to a more lender-friendly environment, either in the form of improved documentation or widening loan spreads?
spk12: I don't think we've seen it yet. I think there's a couple forces kind of in the market. One is typically private markets react slower to the public markets. The second thing that happens, I think, is that there's a decent amount of capital formation in the private credit market, which I think has somewhat of a needed impact on the pendulum shifting. I think that the kind of the tailwind, so I think those are the two headwinds. The first headwind of the slow to react kind of goes away over time. The capital formation is what it is. The tailwind, I think, is that clearly private, given that there's the TAM has expanded to private credit, which is the the volatility of public markets allow, you know, I don't want to say this, people willing to pay for certainty in the context of the volatility of public markets, which increases the TAM for private markets, I think with that increased TAM, I think that will be a tailwind maybe to that pendulum shift.
spk08: I'd also say because of the slowdown in M&A earlier this year, you know, it's created a lot of, I'd say, supply out there that hadn't been deployed earlier. So that will keep tension in the market, I suppose.
spk12: Well, anything to add? You know, I agree with both those statements. We haven't seen evidence of, you know, lines of spread. or better terms at this point. Though, as we've seen in my remarks, I noted this, the top of the funnel starts to fill up. I think there's gonna be opportunities to pick our spots, in particular, as Josh mentioned, in some of those opportunistic, non-sponsored activities that we see as companies looking to shore up their balance sheets and play offense in a different valuation and market. So. Yeah, but the TAM is surely gonna expand given volatility in public markets and issuers and sponsors and looking for certainty, which should help the capital formation issue.
spk10: Okay, great. That's all really helpful. And then just one on leverage. Your stated target leverage range is 0.9 to one and a quarter. As a quarter end, you're at the low end of that target. Are you still comfortable operating anywhere within that range, or has your internal target changed a bit in the current environment?
spk12: So, no, I think given the uncertainty in the world, I don't think we're going to operate at the top end of the range. I think, you know, how we think about our business and how we think about leverage is you've got to burden both our capital and liquidity by unfunded commitments and change of spreads given the mark-to-market piece on the asset side of our balance sheet. And you also want to have a whole bunch of dry powder to invest in volatile moments, which quite frankly led the seeds to the outperformance in 2020, 2021. I think the industry had a Q return on equity for 2021 of about 10%. And we had Q return on equity of about 35% or 36% over those two years. And that was a function of us having enough capital, enough liquidity to make investments. And given the change in the economic environment, I don't think we're going to operate at the real top end of our leverage given, you know, we think there's volatility coming, which means there's probably opportunity coming, which means that our capital has, you know, our capital equity has a relatively high opportunity cost.
spk10: Okay. That makes sense, Josh. I'll leave it there. Congratulations on a really nice quarter. Thanks.
spk01: Thank you. Our next question will come from Finn and O'Shea with Wells Fargo Securities. Please go ahead.
spk11: Hi, everyone. Good morning. Josh or Beau, last quarter you talked about the opportunity budding in growth equity, late stage growth equity to provide you know, junior preferred structures. We've heard some of that from your peers as well. Can you talk about how that, obviously we didn't see too much this quarter, but logically we would have hoped to given those, a lot of those assets have continued to lag in the market. Is this something that's still, you know, around the corner or have these types of opportunities faded?
spk12: I think it's most definitely an opportunity. The question is how appropriate it's going to be for getting the structures and the pick nature of those opportunities for the 6th Street Specialty Lending Fund. Across the platform, for example, we were involved in Kaseya, a data Kaseya transaction. We've been an investor in Kaseya, which we think is an amazing company. We think the CEO is amazing for a long time. And so I think those opportunities are coming. The question is, you know, we'll pick the right ones that fit into the balance sheet and how we position 6th Street Specialty Lending, given that we think about our dividend as a liability to the business. I think during the pandemic, people realized it was a liability to the business because you had to pay to keep your RIC status. You had to pay your dividend in cash and some flexibility in stock, but it's really people should think about their dividend as a cash liability. So the question is appropriateness and sizing, but I think there will be spots to pick, you know, over the next couple years, and we think that, you know, the right growth businesses that have the right, either in economics or return on capital, and the right TAM and addressable markets, there's still some opportunity there. But with that, I agree with all that. I think the opportunity set, though we'll pause for a bit with valuations and the private markets resetting, I think the opportunity set will be there and strong. I agree with everything Josh said with the appropriateness. We'll pick our spots, and it's a market that we're quite active on across the platform, and I think having a good brand recognition.
spk11: Sure, that's helpful. And then, Josh, on the platform level, we saw a couple new groups set up this quarter, the More Than Capital group, the Structured Products group. Anything you want to talk about there in terms of direct or ancillary benefits to the BDC platform?
spk12: Thanks for the commercial opportunity, my friend. I'll let Bo get more than capital, although generally more than capital. We have a great leader in that business and we think we can be value-added to portfolio companies and the value proposition on 6th Street only grows. On structured products, we've hired Mike Dryden who was known for a long, long, long time who ran that business at Credit Suisse. And we most definitely think there will be lending opportunities in that space that will come to the platform. You know, there's that good asset, bad asset thing you've got to be sensitive to. But we really think there's an opportunity. And, you know, Mike came in as a lateral partner that we've known for a long time and is super talented and has a big brand in that space. And so we think there most definitely will be You know, continuing to build the mosaic and skill set of the organization, we think only enhances the suggested returns for 6th Street Specialty Lending. More than capital? No, we are very excited to have brought on Jeff Stone as a four-time CEO of technology businesses to help us build out that effort. And this will help our portfolio companies with a lot of the common problems they experience in building and scaling businesses. So super happy to have him on, and I think you'll hear more from that group over the next couple of years.
spk11: Great. That's helpful. Thanks so much.
spk01: Thank you. Our next question will come from Bryce Rowe with Hovde. Please go ahead.
spk02: Thanks a lot. Good morning. I wanted to maybe start just on market activity. Bo, you mentioned some level of pickup in March. Maybe you could speak to is that more kind of seasonality of the business or the source of the pickup would be any color around that would be helpful.
spk12: Yeah, it's a bit of both. There's always a bit of a seasonal Q1 lag as Q4s are generally quite active from an M&A market. So that was pretty typical. I think what was a little bit unique in this quarter is we did have the valuations reset in the public markets. That put a pause generally on on, you know, buyers and seller activity in the M&A market. So, activity slowed, as I mentioned in my remarks. In addition to that, we saw spread widening. So, opportunistic refinancing slowed down. You saw that begin to unthaw in the back half of the quarter and the top of our funnel pipeline really starting to fill with more opportunistic M&A. You know, public to private, but also portfolio companies and looking to be opportunistic in the valuation environment. Secondly, you saw a pickup in non-sponsor activity. You know, the strongest companies in these periods will look to shore up their balance sheets. both to invest internally, but also opportunistically in M&A. So between, you know, what we have going through the pipeline that we've already committed to, we're pretty bullish on the opportunity set. And, Beau, you would say that unfollowing kind of happened a lot sooner than we would have expected? Yeah, it usually takes a quarter or two. It was a little bit, especially given the move in tech valuations. Exactly. So, you know, I think that's, I mean, you hit it, which is some seasonal, some market volatility, and market volatility tends to slow both M&A and opportunity financing, but it feels like it's thought a little bit quicker than typically, than I would have thought.
spk02: And do you guys feel like, you know, prepayment or repayment activity will will slow here with the volatility and with higher rates, or do you have a pretty good line of sight into continued repayment activity, exit activity?
spk12: I would say so. Typically, unlike mortgages, we're not sensitive to rates on prepayment speed. It's more spreads and idiosyncratic events. I would say that you would expect that there's, you know, that the sign that we discussed a second ago, that will have some impact on our portfolios, you know, portfolio companies that were up for sale now might trade that didn't trade before. And so, you know, there will be relatively, Outside of the energy book, given the commodity price environment in Q1, there was, you know, very little, you know, kind of repayment activity. That was a bulk of the repayment activity, given that commodity price environment. I would expect it to kind of get back to normalized levels to some extent.
spk02: Okay. All right. Maybe one more from me, just on the right side of the balance sheet. And this may be a tough question to answer. But you've got an unsecured note maturity early in 23. Just kind of curious how you're thinking about how you might handle it today, if it were today, with spreads having widened and rates having widened for unsecured debt in the BDC space.
spk12: Yeah. So, look, I think our unsecured spreads have less beta. The other is special given the upgrade and given the quality of the franchise we built. The great news is we have about a billion one, a billion three growth of unfunded commitments available to draw, a billion one to a billion two of total equity burden for unfunded commitments. I think that maturity is like 115 million. And so, I mean, we have a lot of optionality and flexibility. If we were to do it on our line today, and correct me if I'm wrong, what is that on a swap-adjusted basis? What is that maturity? Is that probably LIBOR 200 or something like that? Yes. That's LIBOR 200. If you think about a marginal cost of capital on a revolver, I think it's about LIBOR 150 because you offset down your line fee or the commitment fee. And so if we were doing a revolver, you know, we have a billion, you know, billion one, billion two for unfunded commitments, and it would actually be creative to our cost of capital. And I think that 150 is actually LIBOR, yeah, 200, 199. And so you actually pick up 50 basis points, you know, interest savings, 150 million bucks, on a net basis, on a marginal basis. If you were to do it online, we have a ton of liquidity.
spk02: Okay. All right. That's helpful. Thanks, guys. Thank you.
spk01: Thank you. Our next question will come from Melissa Waddell with J.P. Morgan. Please go ahead.
spk03: Good morning, and thanks for taking my questions today. Quick follow-up on your comments, Josh, about expecting repayment activity to normalize a bit. Does it make sense in the context of what's happening with rates We also recognize that the repayments that you guys have had over the years have driven a lot of sort of outside fee income. So I'm curious how you're thinking about sort of that line item and the potential for, you know, what the trajectory could be on fee income as repayments normalize. Thank you.
spk12: Yeah. I think it was really hard to hear, but what I think I heard, You can correct me if I heard this wrong. I think I heard, what do you think about the impact of income on your income statement as prepayments normalize? I think, was that the question?
spk03: Yes, that's it, Josh. Thanks.
spk12: Okay, great. Look, I think typically fees, hold on, I'll try to get you the exact data. This is a low kind of attribution quarter for us. So, historically, on average, let me get the exact data, between accelerated OID prepayment fees and amendment fees, that typically is, call it on an annualized basis, 47, 52 cents per quarter per share basis divided by four. is $0.14 a quarter. I think this quarter was $0.07, $0.08, $0.09. So it's most definitely lower this quarter. So I think that's historically how we've operated. I think our worst year. Yeah, so I would say, you know, you can expect it to be, you know, kind of probably three to seven cents more per quarter or something like that, given activity levels. But, you know, they are surely, you know, lumpy quarter to quarter.
spk03: Understood. Thanks.
spk01: Thank you. Our next question will come from Ryan Lynch with KBW. Please go ahead.
spk13: Hey, good morning. First question I had, if I understand your comments correctly, it sounds like the slowdown in Q1 was partially driven by, I think, seasonality with kind of a very robust second half of 2021, also in combination with, I think, some economic uncertainties about what the rest of 2022 looks like. And, Beau, you kind of said that your pipeline had now been growing. kind of to end Q1 and into Q2. My question is, it's a little bit confusing just because, or a little bit surprising, I guess, just because the economic uncertainties seem as high as they've ever been with rising inflation, labor issues, decreasing equity valuations, geopolitical things out there. And so I'm just curious of why the pipeline seemed to be building at the same time that the economic uncertainties are also on building.
spk12: How do you square that? I think the answer lies in the amount of private equity dry powder out there, to be honest with you, which is most of the activity, a lot of it is private equity driven. And, you know, there's always this greed-fear thing, which is sometimes the best time to invest as long-term investors is when there's volatility. And, you know, there is a ton of direct power in private equity, and you're starting to see them put that to work. You know, I just, you know, make a great example that's not, that was in the Sixth Street specialty lending portfolio, but like you've seen, you know, that Cassandria bought Datto, which is a publicly traded company, and Cassandria was a private equity-backed company from Insight Ventures. And so you are seeing, you know, sponsors, you know, in certain industries putting, you know, money towards giving the uncertainty.
spk13: Okay. Because obviously those fears and uncertainties are all well known in the marketplace. Everybody's operating with their eyes wide open at this point. So with that, has the quality of deal flow or the quality of companies that are transacting, at least potentially transacting in the pipeline, have they improved to be higher quality companies that are potentially in good positions to weather these headwinds? Have you noticed any change?
spk12: Yeah. Yeah, these are really good questions. Look, I would say, I think there's one nuance. I think everybody sees the uncertainty. I think people have very divergent views on how the uncertainty is going to play out. Soft landing, not soft landing. You know, how do you deal with the employment gap? You typically, I think, maybe never seen a recession if you haven't seen unemployment increase by 50 basis points. I don't I can't say worldwide employment increases by 50 basis points given the employment gap. By the way, that's not saying I think there's going to be soft landing or not. So I think there's clearly divergent views, but we mostly see the activity around businesses that have stronger business models that are able to push through costs and have high gross margins and have operating leverage and, you know, still can grow earnings. And so I think, you know, I think there's very divergent views, but the quality of the businesses are high. The valuations, I think, you know, people have different views given the environment. I think we're less impacted by that given where we're invested in the capital structure.
spk13: Okay. Understood. I appreciate the time today.
spk01: Thank you. Our next question comes from Kenneth Lee with RBC Capital Markets. Please go ahead.
spk04: Hi. Thanks for taking my question. Just one on the investment portfolio. It's pretty diversified across industries right now, but I'm wondering if you could just talk a little bit about How do you think about portfolio positioning, any marginal shifts across industries, just given the current backdrop and the near-term outlook? Thanks.
spk12: Yeah, I mean, that's a good question. I don't think there's any big marginal shifts. Look, I think energy is an interesting space. Look, we typically don't like to lend into higher commodity price environments But there's been a lot of capital outflows across the energy sector, both in the private and public side, given two big factors. One factor is ESE issues or concerns. And the second factor is that that sector historically has been a terrible allocator of capital, which is you have this correlation, which is, you know, as the prices are high, people put in more capital. That feels like it's been less, you know, that feels like it's been muted given energy companies focus on free cash flow versus that asset value growth and the ESG concerns. So, you know, I don't, our net energy exposure has gone down significantly. I think it's like 1.7% of the book today. I think there's room there, you know, but we'll be very, you know, thoughtful about how we do it. On retail, that's come down as a percentage of our portfolio historically as well. Retail is, I think today, is the exact amount is 10.7. I think it's been high as, you know, 20% or something like that. But, you know, you've had a backdrop of a strong consumer and strong earnings from retail and the world was over kind of retail and that kind of got flushed or got changed in the pandemic. And so as the consumer softens or discounting comes back in and there's more volatility in retail earnings, I think that might change. So I think on the margin, but I think it's in the bands of historically what our portfolio has been. But if you look at those two segments for sure, we're under-allocated given where we are in the cycle. You know, I expect there to be some versions of the mean flow. Fishy, anything to add? Sure.
spk04: Great. Very helpful there. One follow-up, if I may, and just from a high level, in terms of the ROE, it looks like you're maintaining your ROE targets despite having 13% ROE in the quarter. I wonder if you could just talk a little bit about how you think about ROE over the near term. What are some of the major puts and takes that can impact ROE one way or the other? Thanks.
spk12: Yeah, I mean, when you think about our business as a unit economic business, a unit economic perspective, The things that impact ROE is yields, leverage, so capital efficiency, which is a function of net payoffs plus how we manage, or net portfolio growth, either negative, positive, and then how we manage our excess capital. We've historically managed that through a combination of, you know, growing our capital base through the drip and, you know, special dividends, and credit losses. I felt pretty good about where we sit in credit losses. I actually think there is some, you know, depending on how things play out, some upside and less in the book on realized gains that exceed our current marks. And so that will have a positive impact. I don't see any going near-term credit losses. So ultimately it's a function of, you know, yields and capital efficiency, and we've done a pretty good job of managing both.
spk04: Great. Very helpful. Thanks again.
spk01: Thank you. Our next question will come from Matt Shaden with Raymond James. Please go ahead.
spk07: Hey, all. Morning. First question for me on the ABL product. Given your ABL loans, they generally fund working capital, and higher inflation tends to drive up both the cost of inventory and working capital needs. Do you think there's any chance higher inflation might actually drive a higher demand in the market for your ABL-type products?
spk12: Yeah, I mean, the offsetting factor is that the consumer has been in really good shape, and so when you look at gross margin and even a margin expansion across retail, which we've done. Quite frankly, we've been involved in even markets across the platform for a long time. The income statements are in really, really good shape given the lack of discounting and given consumers post the pandemic. you're right that there's a, you know, more working capital need, but, you know, income statements, you know, you fund working capital through, you know, strength of income statements and free cash flow and then, you know, the balance sheet, either operating cash flow, so income statement or financing. And so I think that's the offset. And retail tends to be in, you know,
spk07: really good shape at that moment that could change on the dime um for sure got it that's helpful last one for me maybe following up with you josh kind of more high level what's your outlook for the the year in 2022 private credit default environment and how much has that changed versus you know five months ago at the beginning of the year i still think it's pretty low um
spk12: I think the trickier question is 23 and 24, but if you look at our book, I think it's pretty low. If you think about the recent vintages of deals, those companies have had earnings growth and started off with good liquidity. The private credit's been slightly, I think, tilted. The software and tech. It feels like it's pretty low. Not that much... not that much exposure to cyclicals, or we don't have that much exposure to cyclicals. So I feel pretty constructive about the default cycle for 22 for general credit, especially with private credit. I don't know, Bo or Fish, do you have anything to add? I agree. I think 23, 24 is a much harder question, but pretty low default rates across the sector. I can tell you industries that are going to be hurt. Industries are going to be hurt where the kind of low even of margin businesses, where the relatively competitive businesses, where they've had commodity price inputs and they can't pass along to consumers, those industries are going to be hurt. So, you know, paper packaging, you know, non-specialty chemicals, you know, I think I'm not calling defaults in those cycles, but any industries that have relatively low EBITDA margins and no pricing power and, you know, high commodity inputs into their cost structure, I think those are the industries that are, you know, have a higher chance of being hurt.
spk07: Got it. That's helpful. I appreciate the time.
spk01: Thank you. And we do have a follow-up from Finn and O'Shea with Wells Fargo Securities. Please go ahead.
spk11: Hey, thanks so much for the follow-up. Josh, just thinking a bit more from our dialogue on preferreds, and I appreciate your commentary and logic on avoiding too much PICC. But is there a firm line there you're drawing in the sand, or is there somewhere on the curve of returns where you would take on these sorts of deals? And I ask because in today's environment, the outlook could very well be that this type of company turns out to be the provider of a large structured rescue type opportunity that you've done really well in the past, obviously. So, yeah, question is, is this a hard line in being anti-PIC or is it just not good enough today?
spk12: No, I don't think we have a hard line. We are, as Mike said, we are, when you look at our overall balance sheet, we got tons of liquidity. So, You know, we like to think about funding our dividend from operators, but we have tons of liquidity. I think it's a combination of we're bottoms-up investors. So it's finding the right opportunities that fit right into our balance sheet. I don't see us being a large provider of rescue financing in a junior capital position. Our strategy has historically been has been providing rescue financing of the capital structure where we're not the full growth and we're not taking process risk. So I think if you see us doing some of that type of investing, it's in companies we really, really like with clean capital structures, great prospects, secular growing, and healthy businesses. is the way I would, you know, generally characterize our strategy. And then, like, look, I think the fundamental question is, does the risk-return work, which is, I've said this many, many, many times, you can't eat IRR. And so, in an investment structure where you make, you know, where you can get, like, you know, 11% to 12% of preferred, but it's callable, and so you yield your MLM to worse at, like, 1.2 times, but you're deep down in capital structure, and you can lose a lot of your capital. Like, that doesn't really work, I think. And so you have to be thoughtful about the probability of returns and returns given a default or, you know, not being the fulcrum. So I think we're bonds of investors, and there's no hard line, but we like some of those opportunities. We don't like others.
spk01: Thank you. I'm showing no further questions in the queue at this time. I would now like to turn the call back over to management for any closing remarks.
spk12: Great. Look, we really appreciate people's time. We're actually on the West Coast today, so there's some been slightly painful for me, getting up at 4.30 in the morning, you know, to get going. But we really appreciate people's time. You know, Mother's Day is coming up. I think, so in our tradition, we hope everybody takes the time to spend with their families and appreciate the people in their life and happy Mother's Day to everybody out there who's listening, including you know, our significant others. So we really love the dialogue. If you make your way to New York or San Francisco, feel free to stop in, and, you know, we'll welcome any people back in our office, given the environment. Thanks, everybody. Thanks.
spk01: Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.
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