Sixth Street Specialty Lending, Inc.

Good morning and welcome to 6th Street Specialty Lending, Inc.'s second quarter ended June 30, 2024 earnings conference call. At this time, all participants are in a listen-only mode. As a reminder, this conference is being recorded on Thursday, August 1, 2024. I'll now turn the call over to Ms. Cami Van Horn, head of investor relations.

Thank you. Before we begin today's call, I would like to remind our listeners that remarks made during the call may contain forward-looking statements. Statements other than statements of historical facts made during this call may constitute forward-looking statements and are not guarantees of future performance or results and involve a number of risks and uncertainties. Actual results may differ materially from those in the forward-looking statements as a result of a number of factors, including those described from time to time in 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 second quarter ended June 30, 2024 and posted a presentation to the investor resources section of our website, .6thstreetspecialtylending.com. The presentation should be reviewed in conjunction with our Form 10Q files yesterday with the SEC. 6th Street Specialty Lending, Inc.'s earnings release is also available on our website under the investor resources section. Unless noted otherwise, all performance figures mentioned in today's prepared remarks are as of and for the second quarter ended June 30, 2024. As a reminder, this call is being recorded for replay purposes. I will now turn the call over to Joshua Easterly, Chief Executive Officer, 6th Street Specialty Lending, Inc.

Thank you, Kamie. Good morning, everyone, and thank you for joining us.

With

us is our President, Bo Stanley, and our CFO, Ian Simmons. For the call today, I will provide highlights of this quarter's results and then pass it over to Bo to discuss activity in the portfolio. He will review our financial performance in more detail, and I will conclude with final remarks before opening the call to Q&A. After the market closed yesterday, we reported a second quarter adjusted net investment income of 58 cents per share or an annualized return on equity of 13.5 percent and adjusted net income of 50 cents per share or an annualized return on equity of 11.6 percent. As presented in our financial statements, our Q2 net investment income and net income per share, inclusive of the unwind of the non-cash accrued capital gains and cent to feed cents, were both a penny per share higher. At June 30, our net asset value per share reached a new all-time high of $17.19, representing an increase of 2.7 percent year over year, and an annualized growth of 3.4 percent since inception prior to the impact of special and supplemental dividends we distributed over that time. We don't want to sound like a broken record, but our outlook for the sector remains consistent with what we've said in our previous earnings calls. The -for-longer interest rate environment provides support for BDC operating earnings, but details within portfolios are growing on the margin. In June 30, our Q2 quarterly results reflected a continuation of these themes. Adjusted net investment income of Q2 exceeded our quarterly base dividend level by 26 percent. As we assess our projected dividend coverage over the long term, we look at the shape of the forward interest rate curve. As of today, the forward rate curve bottoms out at a terminal rate of approximately 3.5 percent. Based on this curve, we believe that our base dividend of 46 cents per share remains well supported by operating earnings in this interest rate environment. As we have said in our last two earnings calls, we expect to see dispersion between operating and gap earnings as a higher base rate interest rate may ultimately lead to credit deterioration, potential for credit losses. We started to see this play on Q1 results as net income ROE for our peer set were approximately 140 basis points below operating ROE. We slightly outperformed these results in Q1.

This

dispersion highlights the growing tails within portfolios that we've been talking about for several quarters. Before passing it to Bo, I'd like to take a big step back to emphasize what we're in the business of creating value for our shareholders. At a minimum, that means earning our cost of equity, but our goal has always been to exceed it. Given the rapid change in the spread environment in private credit, there's one key question operators should be asking themselves, which is, what does it require spread on investments to earn that cost of equity? This is a framework that guides us to maintain an investment selectivity and discipline in a competitive market environment. We are actively passing on deals, getting done at spreads that would generate an estimated return that is below the industry's cost of equity. We acknowledge that pricing floor exists in the BDC model, and capital should not be allocated to investments below a certain spread. We'll walk through this in detail now to clearly demonstrate that operating a successful BDC is about discipline and capital allocation. We'll start with the assumption that the average cost of equity for a publicly traded BDC is 9.4%. This is based on a data source from Bloomberg across our peer set, which incorporates a 10-year treasury rate. For simplicity, we'll assume management and incentive fees leverage cost of funds and operating costs are based on the LPM average for the sector. While management and incentive fee structures as well as leverage vary across industry, these minor differences do not result in a different conclusion. Using the current three-year SOFR swap rate of approximately 4%, .5% OID over a three-year average life, the required portfolio spread to earn a .4% cost of equity is approximately 620 basis points over SOFR. It is important to note that this output reflects leverage at the top end of the range indicated by rating agencies to be designated investment grade and is before the impact of credit losses. Historically, annual credit losses have averaged approximately 100 to 130 basis points on assets according to Cliffwater's Direct Lending Index. Including credit losses based on this data, the required spread applying our cost of equity assumption is 750 to 780 basis points. To explicitly show why we are passing on deals getting done at a spread of 450 basis points and the return on equity before credit losses is .3% and 3.4 to 4% after losses. At these spreads, the sector is not earning its current dividend yield, let alone its cost of equity. While we acknowledge this must be viewed on a portfolio basis, we outline the math to be illustrative yet instructive in the past to sharehold value creation. For us, specifically, our cost of equity is lower than the factor based on the Bloomberg data and we have had significantly lower credit losses in the long term industry average. Taking a look at our portfolio, the rate average spread on new investments this quarter was 6.6%. If we apply a spread of 660 basis points to our unit economics model including activity based fees on a three year assortable average, leverage at 1.2x and credit losses between 0 and 50 basis points, the output is 11 to 12% return on equity. Again, this math is based on the weighted average of one quarter's new investments, which compares the weighted average spread to the portfolio

at fair value of 8%.

This

clearly indicates that we are continuing to overrun our cost

of equity. Our track record of generating a .5% annualized hourly net income since our IPO in 2014 further demonstrates this consistency. Yesterday, our board approved the base quarterly dividend of 46 cents per share of shareholds of record as of September 16th payable on September 30th. Our board also declared a supplemental dividend of 6 cents per share related to our Q2 earnings to shareholds of record as of August 30th payable on September 20th. Our net asset value per share performed for the impact of the supplemental dividend that was declared yesterday at 17.13. We estimate that our spillover income per share is approximately $1.15. With that, I'll pass it over to Bo to discuss his scores

and investment

activity. Thanks, Josh. I'd like to start by sharing some observations on the broader macroeconomic environment and how that's impacting deal activity in the private credit markets. Over the last few weeks, the US economy has started to show signs of softness, evidenced by an increase in unemployment claims and reduced corporate pricing power. This data suggests there may be room for rate cuts on the horizon, which we anticipate will encourage a rebound in deal activity from the historically low levels experienced over the past two years. While not yet back to the pre-late rate hike levels, green shoots in the deal environment contribute to another busy quarter for our business in terms of deployment and repayment activity. In Q2, commitments and funding totaled $231 million and $164 million respectively across eight new and five existing portfolio companies. We continue to benefit from the size and scale of Sixth Street's capital base as we participate in several large cap transactions during the quarter. This underscores the power of the platform as we can toggle between small and large cap opportunities based on where the relative value and risk reward is appropriate for our shareholders. Further, we can maintain a steady deployment pace and further diversify the portfolio through periods of higher competition or lower deal activity. As a result of our wide originations funnel, we continue to source new investment opportunities this quarter with 83% of total funding in new portfolio companies. To highlight our largest funding this quarter, we agent and close on a senior secured credit facility to Merit Software Holdings. This investment is reflective of our core competency in the middle market where our direct relationship to this unit has welled to be a solutions provider for companies like Merit. Through our connectivity across the Sixth Street platform, we have multiple touch points with the company from inception of the business to when we executed on the transaction. Additionally, our expertise in niche markets allowed us to move quickly and with certainty to finance this company of -in-class SMB vertical market software businesses. On the repayment side, tightest threats triggered a long-awaited reemergence of payoff activity as borrowers took advantage of the opportunity to lower their cost of financing and address near-term refurities. We experienced $290 million of repayments from six full, four partial, and 20 structured credit investment realizations resulting in $127 million of net repayment activity for the quarter. Our repayment activity was largely driven by refinancing including a takeout by the high-yield market, two revives in the private credit market, and one refinancing to a bank loan. We also experienced a payoff in our retail ABA L3, which I'll discuss further in a moment, and opportunistically sold $25 million of our structured credit investments. The majority of our payoffs came from ultra-vintage assets with five of our six full payoffs being 2020 and 2021 investments and the other being from 2017. We earned $0.04 per share of activity-based fee income from these realizations representing an increase from last quarter but still below our long-term historical average as older investment realizations contain lower embedded economics compared to newer vintage names. Following this quarter's repayments, 58% of our portfolio is represented by investments made after the start of the rate hiking cycle. We believe our exposure to newer vintage assets positively differentiates our portfolio relative to the sector and creates the potential for incremental economics through our call protection, accelerated OID, and other activity-based fees should repayment activity persist in the second half of the year. Our two largest payoffs during the quarter, Reliacless and Homecare Software Solutions, were driven by refinancing in the private credit market. While both of these portfolio companies were successful investments for SLX, generating mid-teens IRRs on a gross unlevered basis, we passed on the refinancing transactions given the reasons Josh highlighted earlier related to the importance of disciplined capital allocation. Another payoff during the quarter that illustrates a specialized theme within our portfolio was our investment in 99 cents. We leveraged our expertise in the retail asset-based lending space to form our original underwriting thesis back in 2017. Over the .7-year hold period, we worked alongside the borrower through several amendments, maturity extensions, and restructurings, ultimately resolving a company filing for bankruptcy under Chapter 11 in April. To support the company during the case, SLX provided a DIP term loan that was funded in April and repaid in June. We generated an unlevered gross IRR of .7% for SLX shareholders on the total investment, including a .0% IRR on the original term loan and a .7% IRR on the DIP term loan.

While

this opportunity set as it flows, we've seen an increase more recently driven by shifts in consumer demand for goods and services and more specifically to experiences. Post-quarter end, we funded a new investment in this theme and expect to see this trend continue in the second half of the year. From a portfolio yield perspective, our weighted average yield on debt and income producing securities at amortized costs declined slightly quarter over quarter from .0% to 13.9%. The weighted average yield at amortized costs of new investments, including upsizes for Q2, was .5% compared to a yield of .1% on fully exited investments. To provide some color on investment portfolio today, credit quality remains strong with total non-cruel limit to .1% of the portfolio by fair value. Our internal risk rating improved quarter over quarter from 1.15 to 1.14, with 1 being the strongest. Overall, we are pleased with the performance of our portfolio companies and feel that the management teams of our borrowers have been generally successful in executing on cost-cutting initiatives and managing liquidity through a challenging operating environment. We have not experienced a material increase in amendment requests related to covenants or liquidity, which is another positive indicator of the health of the portfolio. On a weighted average basis across our core portfolio companies, continued top-line growth of approximately 4% quarter over quarter has contributed to de-leveraging and sufficient liquidity despite higher interest costs. While spread tightening has led to an increase in repricing requests, this has largely come from portfolio companies demonstrating stronger momentum and robust performance. Moving on to the portfolio composition and credit stats, across our core borrowers for whom these metrics are relevant, continue to have conservative weighted average attached and detached points 0.6 times and 5.0 times respectively. And their weighted average interest coverage increased slightly from 2.0x to 2.1x quarter over quarter. As a reminder, interest coverage assumes we apply reference rates at the end of the quarter to steady-state borrow EBITDA. As of Q2 2024, the weighted average revenue in EBITDA of our core portfolio companies was $310.4 million and $104.4 million respectively. There were no new investments added to non-cruel status store in the quarter. With that, I'd like to turn it over to my partner Ian to cover our financial performance in more detail.

Thank you, Bo.

For

Q1, we generated adjusted net investment income per share of $0.58 and adjusted net income per share of $0.50. Total investments were $3.3 billion, down .9% from the prior quarter as a result of net repayment activity. Total principal debt outstanding at quarter end was $1.8 billion and net efforts were $1.6 billion or $17.19 per share prior to the impact of the supplemental dividend that was declared yesterday. Turning now to our balance sheet positioning, our debt to equity ratio decreased from 1.19 times as of March 31 to 1.12 times as of June 30. And our weighted average debt to equity ratio for Q2 was 1.17 times. The decrease was primarily driven by our net repayment activity during the quarter. As mentioned on last quarter's call, we closed an amendment to our $1.7 billion revolving credit facility in April, including extending the final maturity of $1.5 billion of these commitments through April 2029. We continue to have ample liquidity with $1.2 billion of unfunded revolver capacity at quarter end against $250 million of unfunded portfolio company commitments eligible to be drawn. We are pleased with the strength of our funding profile heading into the second half of 2024. Moving on to the upcoming maturities, we have reserved for the $347.5 million of 2024 notes due in November under our revolving credit facility. After adjusting our unfunded revolver capacity as of quarter end for the repayment of those notes, we have liquidity of $862 million. To go a step further, if we assume we utilize undrawn revolver capacity to reach the top end of our target leverage range of 1.25 times debt to equity and further draw down for our eligible unfunded commitments, we continue to have $398 million of excess liquidity. Beyond the 2024 notes, our debt maturity profile is well-rounded with maturities in 26, 28 and 29 for our outstanding unsecured notes. As we said in the past, the unsecured market is our primary source of funding and we continue to have access to this form of financing at levels that have increased in attractiveness over the course of the year. We have been pleased to see the broader development of the unsecured market over the last few years and view it as a positive for TSLX and the sector. Fervently to our presentation materials, slide eight contains this quarter's NAV bridge. Walking through the main drivers of NAV growth, the over allotment shares issued in April related to our equity raise in February resulted in $0.02 per share upwifed to NAV in Q2. We had a $0.58 per share from adjusted net investment income against our base dividend of $0.46 per share. There was a $0.03 per share positive impact to NAV primarily from the effect of tightening credit market spreads on the fair value of our portfolio. Net unrealized losses from portfolio company-specific events resulted in $0.08 per share decline in NAV. This is primarily related to the markdown of our investment in lithium technologies from 91 spot 25 to 76 spot 75 quarter over quarter. The company has not performed as expected and our fair value mark reflects this assessment. At this stage, the company is in the middle of a strategic process and there is a range of possible outcomes. Other changes included $0.05 per share reduction to NAV as we reversed net unrealized gains on the balance sheet related to investment realizations and $0.02 per share upwifed from net realized gains on investments primarily from structured credit sales during the quarter. As for our operating results detail on slide nine, we generated a record $121.8 million of total investment income for the quarter, up 3% compared to $117.8 million in the prior quarter. Interest and dividend income was $112.2 million, slightly above prior quarter of $112.1 million. Other fees representing prepayment fees and accelerated amortization of upfront fees from unscheduled paydowns were higher at $4 million compared to $1.5 million in Q1, driven by increased activity-based fees from the elevated repayment activity experience during the quarter. Other income was $5.5 million compared to $4.3 million in the prior quarter. Net expenses excluding the impact of the non-cash reversal related to unwind capital gains incentive fees were $66.8 million, up slightly from the $65.4 million in the prior quarter, driven by expenses incurred during the quarter of the annual and special shareholder meetings that were held in May. Our weighted average interest rate on average debt outstanding increased slightly from .6% to 7.7%, driven by our funding mix shift towards unsecured financing, given net repayment activity led to lower outstandings on our lower cost revolver. Following the repayment of the 2024 notes in November, there will be a small positive economic impact of almost a penny per share quarterly in 2025, as the implied funding mix shift will lower our weighted average cost of debt. Before passing it back to Josh, I wanted to circle back to our ROE metrics. For the -to-date period, we generated annualized adjusted net investment income of $2.32 per share, corresponding to a return on equity of 13.7%. This compares to our previously stated target range for adjusted net investment income of $2.27 to $2.41, corresponding to a return on equity of .4% to .2% for the full year. We maintain this outlook heading into the second half of 2024. With that, I'll turn it back to Josh for concluding remarks.

Thank

you, Ian.

During this time of significant growth in the private credit market, it is no surprise that competition has increased and spreads have garnered tighter. As an investment manager, we view this time as an opportunity to further differentiate our business as being not only disciplined investors, but disciplined capital allocators. To us, that means having choices regarding what to invest in and when to invest. We create this optionality in our business in two ways. First, we size our capital base with the opportunities set. This means running a constrained balance sheet so that we can operate within a target leverage range without broader market participation deals that we do not think present appropriate risk-adjusted returns or meets our required return on equity. We accomplish this objective by taking a thoughtful approach to growth, regardless of our ongoing ability to raise capital. Second, investing in a platform that has a wide origination funnel. Despite the competitive drug lending backdrop that exists today, we remain active, yet selective, because of the benefits of the 6-Street platform. This wide range of deal flow allows us to make calls on relative value, toggle between large cap and middle market exposure, weighting the sector themes, and most importantly, pass on investments that do not meet the risk return and national return profiles in terms of our share. As disciplined investors, we make these choices with shareholder returns top of mind, which we believe leads to better credit selection and ultimately translates to a lower credit loss over the long-term and better shareholder experience. With that, thank you for your time

today. Operator, please open the line for questions.

Thank you. At this time, as mentioned, we'll now conduct the question and answer session. To ask a question, you'll need to press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, press star 1-1 again. Please stand by while we compile our question and answer roster. Our first question comes from the line of Finian O'Shea with WFS. Your line is now open.

Hey, everyone. Good morning. Taking some of the opening comments on the market, there's a rapid change in private credit you noted, assuming that references the amount of capital that's been raised and so forth. And then how you're passing on a lot of deals due to yield, the cost of capital. Would you say this relates to the deals you're passing on? Does it relate to market deterioration and credit underwriting? Or are there more firms out there that can do complexity at scale?

Hey, Finn. Good morning. So it's in the straight kind of sponsor stuff, so the vanilla stuff. I think I would flag two things. One is that our concern is it's not really credit deterioration or credit underwriting deterioration, even in those deals. It's just that the sector, BDC specifically, given where they borrow the amount of capital they have to hold, i.e. they can only be 1.25 times leverage, and fees and expenses, all that good stuff, puts them at a place in the cost curve where those assets at certain prices no longer create a return on equity that meets or exceeds the cost of equity of the space. So we find that in the sponsor stuff. If you look at our, we talked about our spreads for this quarter, which is predominantly sponsor stuff, which was, I think, above the sector and above our earning of cost of equity. If you look at what we funded quarter to date, it's 20 to 30 basis points wider than that. And if you look at what's in the pipeline, it's significantly wider than that because it has shifted from sponsor to non-sponsor stuff. And so, for example, in the pipeline is like 860 spread, and that's before fees, and that's predominantly non-sponsor stuff. So I think it's mostly in the sponsor stuff. And again, I think the relationship of how the size of your origination platform, your capabilities compared to the size of your capital are really, really important and being able to continue to create shareholder value.

It's very helpful. Thank you. And a follow up on Europe that that seemed to be most of your new deals this quarter. Can you remind us of the footprint you have there? Is there growth in that or was this more, you know, those were the best deals you saw this quarter in the market?

Yeah, yeah. So we're, I would say when you look at Europe, I think it's you're referring to by number, but probably not necessarily by dollar amount. So by dollar amount, I don't think that's a true statement. By number, that is a true statement. Under the exempt of relief, you know, our strategy is we want to make sure SOX has the ability to continue to invest in deals. And so it needs to take a position day one in those investments. And so a lot of those positions that you're referring to are small kind of toe hole positions. Our platform in Europe is growing, has been very successful. We've been in that market for a long time. And, you know, quite frankly, in the moment, the risk return better on the sponsor stuff is better in Europe than it is in the US. I think, Bo, you would agree with me on that. Yes, for sure. So, but again, I think it's by number, not by dollar, by dollar, predominantly US. Still, we like the risk return. For example, you know, one of the larger things we did was at event, which was a buyout of the kind of eBay auction assets in Europe. And, you know, that as a, you know, a nice spread compared to what you can find in the US.

Thanks so much.

Thanks,

and have

a good day.

Thank you. Our next question comes in line of Brian McKenna with citizens. JMP. Your line is now open.

All right, thanks. Good morning, everyone. So, you've talked a lot about the turnover with the within the portfolio since the fed started beginning raising rates. You've recycled a lot of capital over the past few years. Obviously, that's been good for the portfolio repositioning. But how should we think about the turnover from here and this continued rotation into new ventures alone? And then, I guess, what does all that mean for kind of the underlying performance of the portfolio from here?

Yeah, hey, Brian. So, I would frame it. So, just I would that I think the premise is slightly wrong, which is the portfolio, which is nice, which is mostly post great hiking cycle vintage was predominantly driven by that we were slightly below our target leverage going into the rate hiking cycle. Plus, we did we were able to raise that we had a convert and I think we did a two equity races. Three of the time. So, it's really that it wasn't the portfolio rotation with a portfolio composition changed, not because of turnover. Turnover has been light post great hiking cycle. You can see that in starting to pick up, but you can see that actually in the activity base fees. I think going forward, it's a set pivots, which is so that they set that up to pivot in September. Do activity picks up spreads coming spreads already started come in, but you activity picks up. My guess is there will be more natural kind of turnover in the portfolio, which will, you know, from an economic basis in the short term. So, actually, I was with benefit from because activity will pick up and you saw the activity base, please pick up. So, this is the first quarter. We had a little bit of, you know, we had a little net repayments and activity based fees picked up this quarter slightly in line with that.

Okay, helpful. Thanks. And then just a bigger question here, Josh, you know, will be great. Just get your thoughts on the broader macro. So, you're clearly there's a lot of puts and takes looking out over the next year. You know, long term rates have come in quite a bit recently. There's likely going to be several rate cuts into twenty five capital markets activities, accelerating public equity credit markets are performing well. But it does seem like the economy is slowing here. So, you know, how are you guys thinking about the macro over the next year? And, you know, what's the base case expectation for some of these moving pieces when you're underwriting new deals today?

So, it's a tricky it's a tricky environment. I actually am pretty bullish about the ventures of today. Those ventures are based on I are underwritten in a higher rate environment where where you haven't had the tailwind of the fact that any rate is in the stimulus of demand that comes with a rate cut. So, you got to be bullish on on on the last couple of years. Vintage is post-rate hiking cycle given value writing standards that improved. There was, you know, rate clarity and you were in a tightening cycle. So, I think that that I think is helpful. The recent vintage is will perform really, really well, but there's going to be tales and the tales are going to be in the previous vintage is you're most definitely started to see that we've talked about this for like three quarters, which is, you know, this idea of tales and the divergence between operating or which will be higher than. Get total economic or gap or we so the difference between and I and and I you see that a little bit. I think you'll see that continue a little bit. So, you know, I'm, you know, the economy is most definitely softening, which is allowing the Fed to pivot the Fed pivots, which should loosen financial conditions. Those should spur demand and get the economy going again at a stable level. So, I'm relatively constructive on the macro. There's most definitely going to be tales and there's most definitely be cohorts of like the consumer, especially the lower end that are that are that are that will be pinch points and pain points. And then I'm geopolitical, geopolitical. Who knows?

Yep, got it. All right. Great. Thanks. I'll leave it there. Appreciate it.

Thanks. Have a great day. Thank you.

Our next question comes to the line of Mark Hughes with Truist Securities. Your line is now open, Mark.

Yeah, thank you. Good morning. Your mark on a deal on the deal. So good morning. Has that changed materially over the last six months? Just that if you're having to be more selective on how is that working out in terms of your success rate? Yeah,

I would say look, I am you look at to I'll say generally our head rate probably is materially a little bit lower. Maybe I mean, I think what's changed is there's credits we like at prices we don't. But and, you know, we're very cognizant of, you know, driving shareholder return and return equity and and that the things we do today will generate the return on equity for 25 and 26. And even though that we have a back book with a higher yield, we want to be cognizant of making sure we earn a return equity. So I think our head rates similar, except that there are things that we like the credits. We just don't like the prices.

Yeah, the average commitment. This may be just an unfair snapshot, but the average commitment was a little lower in two cues, say compared to four cue. Are you seeing more opportunity at the smaller end of the market?

No, I mean, I know that that's a reflection of the co investment strategy where we're in European deals or large cap deals. You know, SLX or European deals is taking a smaller position. And so, you know, there's like a whole bunch of on the European deals, like five to six million dollars are dragging it down. But if you look at like the core positions like merit at event, you know, those are those are, you know, kind of 35, 40 million dollar commitments. So it's it's it's a little bit more that participation and how the co investment the new co investment order reads.

Yeah, I think you mentioned the more co holds and the final question, the. You're you described how spreads in the pipeline are looking better as you've shifted from the sponsor to non-sponsor. Is that the broader market helping support that or is that more intentionality on your part?

I mean, the great thing about being part of, you know, as people know, six weeks, eighty billion dollar platform and having this wide aperture that we get to toggle between things. So, you know, we did this quarter non-sponsor, we did a palace, which was a health spec pharma deal. We like that space. We like I think there's probably more to come. We did a retail .B.L. financing that consumers weekend that they either capital again and that was done post quarter end, which is a non-sponsor deal. So we were, you know, we kind of the great news is having a big wide top of the funnel. We get to be picking choose the and making sure we're driving shareholder return.

OK, appreciate it. Thank you.

Thanks. Have a great day.

Thank you. Our next question comes to the line of Mickey Slain with Latin. Your line is now open.

Yes. Good morning, everyone. Josh, not not to beat a dead horse here, but I wanted to ask you a follow up question on spreads. Do you think it's just this issue of a massive supply of private debt capital that's overwhelming the potential for the Fed to cut rates that that's causing this spread tightening? Or do you think we're approaching some sort of a floor?

My sense is

a great question, Mickey. And by the way, it's good to hear from you. I don't think we heard from the last one or two rainfalls. So it's good to hear your voice. You always have very good questions. My my sense is that private credit, private capital, been institutionalized. There was a lot of allocators that had now understand the value proposition. So they've allocated capital. And so that's on the supply of capital on the demand for capital. Given that M&A environment, there wasn't that natural demand from M&A. And so my sense is that we'll get back in equilibrium here shortly with the Fed cutting and more M&A picking up. And so but we were kind of in this supply kind of outpaced demand early on. And we've you know, we can you know, we've always wanted to be very disciplined. And then, you know, the incentives for managers to put that to work and earn fees, et cetera. Those are real incentives. We've always tried to fight those and acknowledge those incentives and B fight those incentives and think about the long term of shareholder experience. So my hope is that with more demand coming from a loosening, a loosening environment that will drive M&A and will drive investment in catbacks and growth, that supply and demand kind of will get more imbalanced.

That's good to hear. And if I could follow up, Josh, with this sort of disintermediation of the commercial banks that's occurred over the last many years and the rise of private credit, do you think what do you think the probability is that, you know, we'll see more regulation of private credit? And do you think there's systemic risk developing that that will come to light down the road? Yeah,

look, the idea, I have a whole thing about this. The systemic risk point is a little bit silly. And I think that the first thing I would say is, is that unlike the banking system, the taxpayers haven't written a put for private credit. And systemic risk really causes, you know, comes from a little bit of that, some of that put obligation for taxpayers and that the Fed has effectively through the FDIC program backstopped asset choices for banks. The second thing is most systemic risk has come from an ALM issue, and which is that people are long assets and short liabilities. And that does not exist in private credit. And private credit is not funded. There's no ALM. You know, we talk about this often, but I think the average life of our assets funded with leverage is like two and a half years versus leverage is like four years. And so we actually have small reinvestment risk, let alone liquidity risk. And that's where most kind of systemic or or issues have come with financial institutions. The third thing I would say is BDC specifically in private credit as compared to banks hold, you know, somewhere between four, three and five times the amount of capital space. And so risk bearing capital on BDCs are about 45 to 50 percent. You think about one times leverage or one point one times leverage and banks they hold about 8 percent capital. And so the idea that there is real systemic risk or real risk of loss of shareholders given the higher capital and private credit shows off to me as well. I started this conversation with the idea of return equity, and I would do this analogy for people. If I would describe two business models for listeners, one business model is that you win long, you own 8 percent capital, you win long, you borrow short. The other business model is you hold 50 percent capital, you are totally match funded. And I would say academically, what would be the required return on equity of those two business models? My guess is you would say the required return on equity would be a lot lower for the latter business model, the private credit business model. That's actually not true. The private banks return equity requirement and private credit and BDCs are about the same, which is which the business model of private credit is a much more robust business model, given the amount of capital and the robustness of the ALM. Is that helpful, Mickey?

That's very helpful, and I appreciate your clarity on that. And my last question, Josh, just switching gears. Lithium Technologies, which I think is part of Coros, if I'm not mistaken, is a customer care, you know, software based customer care company. I realize that at any moment in time, credit can run into headwinds. I'm more curious whether there's something underlying the headwinds at lithium that would cause you concern over the sector in general, because that is a focus of yours and as well other other BDCs.

Yeah, lithium is purely idiosyncratic. So it probably been like the one thing I would be critical on the margin of us in the space is that when COVID hit, everybody thought about negative businesses that were negatively impacted by COVID. There were some businesses that were positively impacted by COVID. This was a software business that had, was levered engagement online and through social media platforms. That was probably a positive tailwind that's unwound, so it's purely idiosyncratic.

Okay, I appreciate that. That's all for me this morning. Thank you for taking my questions.

Thanks, Mickey.

Thank you. Our next question comes from the line of Kenneth Lee with RBC. Your line is now open.

Hey, good morning. Thanks for taking my question. Sounds like in terms of the new originations, new investments you're seeing, there might be a little bit of a spread tiny across the industry. I wonder if you could just comment about what you're seeing in terms of documentation and terms on some of these newer deals, seeing any changes more recently. Thanks.

Look, I would say

docs have been pretty stable. So I think underlying standards remain good in private credit. I mean, the question again is, is like, where we sit on the cost curve, what's the required spread to earn your cost of equity? And if I was critical in one place, it would be people not understanding where they sit in the cost curve or where they're leaning too much into their back book. But the things you do today are the ROEs in 25 and 26. But the weighted average financial covenants and all that stuff is basically the same. The docs are in pretty good shape.

That's right. Great. Very helpful there. And just one follow up, if I may, just more broadly, in terms of the more complex investment opportunities, is this something where we have to wait perhaps for a more of a macro slowdown before you start seeing more opportunities there? Or could we see a potential pickup in complex, more complex investment opportunities when M&A activity rebounds as well? Thanks.

Yeah, look, I think it's I think it's again, I think the complexity is I think there's two things. One is that tails. We live in an environment with low rates. Cal. Cal, Cal, Cal got allocated very poorly. The complexity is going to come from that pipeline of yesterday's mistakes, and that's going to be there no matter what. Then I think also tailwind is if M&A picks up, people will, you know, some of our competitors or a lot of our competitors, quite frankly, that stuff is easier to persecute with less people. And so they'll their eyes will go that way. And so I think you have two kinds of compounding effects, which is the tails are growing, which will provide opportunity for us and complexity. And as M&A picks up, you know, people's natural kind of glare will will will be focused on that. And so I think I'm pretty bullish about the next couple of years for our complexity theme.

Great, very helpful. Thanks again.

Thank you.

Our next question comes to the line of Paul Johnson with KBW. Your line is now open.

Good morning. Thanks for taking my questions. So just with the development of, you know, liability management exercises and development of recently, Pluralsight realizing, obviously, that's not in your portfolio. But I'm just wondering your thoughts on whether those type of events increase the risk of sponsor concentration issues where you have an adverse event with one of your common partnering sponsors and there's risk to the deal flow, as well as just kind of, you know, the calculus of working within lender groups as well.

Yeah, so, oh, I don't really have anything to add in Pluralsight. We're not we're not that involved. We were not involved. Not that we're not that involved. We weren't involved. So I can't add anything specific. I would say my understanding of that situation, that doc seemed like a it was a doc that was kind of not was slightly outside of the range of the existing docs, or at least the docs in our portfolio, as I understand it. And the good thing is, is that it wasn't done. There was no lender on lender violence that existed like you've seen the Brawley syndicated more low market where there's this prisoner's dilemma, which is, you know, I got to do it because if I don't do it, somebody else will do it. And that didn't exist. So and then you're also seeing so I think that I don't see that as a big I think that's a overblown concern and private credit on the sponsor concentration, which I'm not sure they're exactly related. You know, we don't really have, you know, sponsor concentration over. Historically, we've done about 55% sponsor stuff 35% non sponsor an existing book today. We have no sponsor above 10%. So it's and we have like 45 or 50 sponsors in a book. So I don't I'm not I don't see I don't see them related. But I think I answered your question. That's helpful.

Yeah, it's very helpful. I appreciate that. I mean, do you think that that, you know, an event like that is just a result of, you know, bad credit underlying, you know, bad bad documentation or something like that? Or is this, you know, lawyers that are basically a fault here?

I would never blame. I can't

really speak to I don't speak to I'm not I'm not involved. So I don't have the, you know, things are going to happen in our business. Things, you know, we've been very good on the credit side and stuff pops up still. So things are going to happen. You know, like part of part of our business is a little bit about a lot of our business. The only thing about a business is about figuring out what the future looks like and trying to use historical and industry structures as an analog for that. And so, you know, we're in underwriting the future because value is based on future cash flows and how the business performs future. And, you know, on the margins, sometimes you're going to get it wrong. And that's why I think that's important as well as the industry's selection and where you invest in the capital structure. But I can't speak to Pluralsight specifically.

I appreciate that. Yeah, I was just kind of asking a little bit more broadly on the on the space, but appreciate appreciate the answers.

Yeah,

thanks.

I would never I would never blame something on a service provider. So we're we're we're we're principles. We own we own our decisions. So, like, like lawyers have to blame on lawyers. You know, they're you know, they're service providers. We're principles. And so we are when there's a when there's a mistake,

I own it. We own it as a team.

Thank you.

Our next question comes to the line of Melissa Wedel with JP Morgan. Your line is now open.

Good morning. Thanks for taking my questions. Most of mine have actually been asked already. Quick clarification. When you talked about the pipeline, you know, kind of going forward, did you did I miss it? Or did you find that at all for us?

Yeah, yeah, so I'll hit it real quick. Like, look, the you missed it. It's probably like the near term stuff is a couple hundred million bucks like in the you know, that in this next kind of quarter, I think. If that's helpful on the growth side before repayment.

Yep, got it. I appreciate that. And then separately, kind of digging into the non-sponsor side a little bit when we hear non-sponsor, I tend to think those tend to be a little bit smaller companies. They tend to be a bit better on spread, as you specifically mentioned. But then I'm also curious, does that take longer for your team to sort of diligence and close? Or do those investments, is the timeline any different for you versus some of the larger, more maybe syndicated across a few hundred type deals, sponsored deals? Yeah,

yeah, so I would say the barrier to entry for why I think we see less competition is for the manager. It is a much more difficult, less profitable business. It takes longer. It takes more resources. It takes more time, both on the under right side on the asset management side. And so it is in the in the average life tends to be shorter. And so the return on capital for the management company is a lot lower. The return on capital for our shareholders is a lot higher. And so it's I think that's why historically it's you need specialized resources. It's people intensive. The example I give the people is on the ABL stuff, the ABL stuff. The average life is, you know, everybody knows, understands the fees in our business. But, you know, if you could earn X fees on something that has an average life of three years, and it's a lot easier to persecute than earning the same fees on something that has an average life of one and a half years, and it's a lot harder to persecute. It's not shocking what people do. But not smaller.

Actually sometimes bigger. A lot of times bigger. The only thing we add is that these are not necessarily smaller opportunities. These are large businesses generally.

Got it. And is the use of funds is what strategic M&A or other?

No, sometimes it's balance sheet restructuring. Sometimes it's exiting of a bankruptcy. Sometimes it's entering a bankruptcy in a dip. Sometimes it's a bridge to somewhere, but they don't know exactly where somewhere is. Because they have an over levered balance sheet like Feral Gas. They didn't really know when we did that deal where they had an over levered balance sheet. We were the senior secure. They don't know exactly where it was going. So a whole host of things. In our spec form it's R&D. It's R&D development or spec form.

Appreciate it. Thank you.

Thank you. Our next question comes in the line of Bryce Rowe with Bea Riley. Your line is now open.

Thanks a lot. Good morning. Maybe wanted to offer one follow up to Melissa's first question there. Helpful for you all to size up the portfolio in terms of the gross potential at least over the near term. And you certainly have talked about the potential for increased repayment activity. This year we saw a little bit of it in the second quarter. Kind of curious how you kind of balance or handicap the second half of the year from a net perspective. Do you think that you'll continue to see some of this repayment activity that will offset originations or possible to see some net growth?

Yeah, I think our base case is we're kind of net flattish, Ian. So gross originations will pick up as activity levels pick up. Repayments will, which will create economics in the book. But I think it's net flattish, which we think is good. I would like to have being kind of in our debt equity of where we are today, which will give us room, women's big opportunities to actually participate in them.

Yeah, okay.

Without having to think about putting.

That's helpful, Josh. I appreciate it. And maybe a question around, I think it was Bo that made the comment, but the comment around lower rates possibly driving more deal flow at some point in the future. Can you kind of expand on your thoughts around what kind of environment behind the lower rates we have in driving that, I guess, that type of deal flow? And I guess I'm getting at whether we actually get a real credit cycle for the first time in 15, 20 years and kind of what that might mean, at least on the onset of the lower rates and how deep those rates get. Yeah, I don't

see. I don't feel real like 2001, 2008 credit cycle. I just don't see that. But I do think you have elevated tails. You know, businesses has performed relatively well. The portfolio is growing. Is growing when you look at last quarter is growing you over year quarter over quarter. So I think that to the feds credit, they've done a reasonably good job of trying to kind of getting to the soft landing. So I don't see a real credit. But I do see that when you take a step back that capital, you know, pre COVID post COVID was misallocated. And, you know, which will which is created a tails where you have basically zero one zero to 1% interest rates for a long period of time. And so there has to be reckoning to some of that misallocation of capital. But I don't see a deep credit cycle, given that businesses have been able to kind of continue to earn. The consumer has been relatively strong. I think the feds actually found a pretty decent balance.

Great. I appreciate the

perspective. Everybody likes to be critical of the fed. But I think they've actually found a feels like they've found a pretty decent balance. Got it. Got it. Thank you.

Thank you. Our next question, which is our last question, comes to the line of Robert Dodd with Raymond James. Your line is now open.

Thank you. Morning. I'm Bryce. Actually, just ask the main question. So I'm about about growth. So kind of a little add on to that. I mean, if you kind of flat this year, should we expect that to be a result of a little bit of rotation? I mean, you talked about, you know, more non sponsored in the quarter coming up. Is that going to be a theme this year? Most of the non sponsored, maybe more complex deals, but then those turn faster. So what's the maybe not just this year, but do you expect that you'll see more of that? Then they'll turn faster in twenty five, twenty six. And then you really need the sponsor market pricing to become more acceptable over over some period of time in order to keep the portfolio at this time.

Yeah, it's a good question. I frost. It's it's really how is let me tell you philosophically how we set up our business, because the answer is, I don't know. And if I sit here telling you what I know exactly how it's going to play out, I it's kind of silly. Not the question, but just that I have the answer to the question. To me, we set up our business where we have created a whole bunch of options for shareholders on different strategies, non sponsored health care spec pharma retail sponsored energy. And we go to the top of the funnel and as allocators of capital, we get to say, where does it overlap with a really good risk return on an unlevered basis and where they provide significant shareholder value and meet the return equity requirements of our shareholders. And like, so I we really like that model because that model allows us to drive. You know, we've been a public company now for ten plus years and we've been over, I think it feels longer to be honest with you, that we've been able to drive shareholder value because that combination of constraint capital. Top of the funnel and the options of what we can pick and then the acknowledgement of where we send the cost curve and return equity. Like that to me is the formula. Now, do I know exactly what options are going to be in the money in the top of the funnel? I don't know.

Thank you. Awesome. It's good to hear your voice, Robert. Thanks.

Thank you. I'm showing no further questions at this time and would now like to turn the call back to Josh Easterly for closing remarks.

Great. Well, we really appreciate everybody's thoughtful and engaging questions. And I hope everybody has a great end of the summer with their families. And we'll talk in November and it's going to be a crazy November, my guess. So, thank you. We're always around. We love the engagement and we'll keep working hard for shareholders. Thanks.

Thank you. This does conclude the program and you may now disconnect.