Sixth Street Specialty Lending, Inc.

Good morning and welcome to Sixth Street Specialty Lending, Inc.' 's fourth quarter and fiscal year ended December 31st, 2020 for earnings conference call. At this time, all participants are in a listen-only mode. As a reminder, this conference is being recorded Friday, February 14th, 2025. I would now like to hand the conference over to Ms. Cammie Van Horn, Head of Investor Relations. Please go ahead.

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 fourth quarter and fiscal year ended December 31, 2024, and posted a presentation to the Investor Resources section of our website, www.6thStreetSpecialtyLending.com. The presentation should be reviewed in conjunction with our Form 10-K filed yesterday with the SEC. Sixth Street Specialty Lending, Inc.' 's earnings release is also available on our website under the Investor Resources section. Unless noted otherwise, all performance figures mentioned in today's prepared remarks are as of and for the fourth quarter and fiscal year ended December 31st, 2024. I will now turn the call over to Joshua Easterly, Chief Executive Officer of Sixth Street Specialty Lending, Inc.

Thank you, Kami. Good morning, everyone. Thank you for joining us. With us today is our President, Bo Stanley, and our CFO, Ian Simmons. For our call, I will review our full year and fourth quarter highlights and pass it over to Bo to discuss activity in the portfolio. Ian will review our financial performance in more detail, and I will conclude with final remarks before opening the call to Q&A. After the market closed yesterday, we reported strong fourth quarter results with adjusted net investment income of 61 cents per share, or an annualized operating return equity of 14.2%, an adjusted net income of 54 cents per share, or an annualized return equity of 12.5%. As presented in our financial statements, our Q4 net investment income and net income per share, inclusive of the unwind of the non-cash accrued capital gains incentive fee expense, were a penny per share higher than the adjusted figures. We earn 15 cents per share of activity-based fees, including dividend income, representing the highest amount in seven quarters. We continue to build net asset value per share from 1712 as of September 30th to $17.16 as of December 31st. Additionally, our base dividend remains well covered with adjusted net investment income of 61 cents per share, exceeding our base quarterly dividend by 15 cents per share, or 33%. For the full year 2024, we generated adjusted net investment income per share of $2.33, representing an operating return on equity of 13.8%, and full year adjusted net income per share of $1.97, or return on equity of 11.6%. As we've always said, return on equity on net income is a measure that matters. On that basis, we generated nearly 12% for 2024. This remains well above our estimated 9% cost of capital and significantly above the Q3 LPM average return on equity for the BDC sector of approximately 9.1%. Further, we delivered an increase of 70 basis points on net asset value per share from $17.04 as of December 31st, 2023, to $17.16 as of December 31, 2024. Looking back at 2024, all results were driven by a number of factors, including a shift in interest rates, additional activity-based fees, credit headwinds, and movement in new investment spreads. We'll highlight the impact from each of these components, starting with the tailwinds. First and most obvious, interest rates remained higher for longer, providing an earnings boost for the sector. Twelve months ago, the forward curve indicated interest rates of approximately 3.6% today. This compares a three-year SOFR swap rate today of approximately 4%, or 40 basis points difference. Higher base interest rates supported LTM operating ROEs for the sector through Q3 of 12.3% and 13.9% for TSOX, well above the long-term sector average of 8.9%. For TSOX, the rate environment in 2024 contributed approximately $0.03 per share of net investment income above our guidance. In addition to slightly uplift from rates, we earned $0.44 per share of growth activity-based fee income. including dividend and other income in 2024, representing the highest amount since 2021. A significant portion of the income came in the fourth quarter as we experienced a resurgence of repayment activity in our portfolio. This resulted in 15 cents per share of activity-based fee income for the quarter, above our trailing three-year historical average of nine cents per share. This fee income is a product of our in-depth underwriting and selective investment approach as we carefully structure investments to include call protection and other features that create value for shareholders. In 2024, activity-based income contributed approximately 15 cents per share of net invested income above our guidance. Now pivoting to the headwinds. Consistent with our message for the last couple years, we expected credit to weaken on the margin and tails to emerge. Over the last 12 months, we experienced idiosyncratic credit deterioration across two portfolio companies, Astra Acquisition Corp. and Lithium Technologies, both of which we added to non-accrual during the year. The lost interest income from these two investments after being placed on non-accrual status resulted in a $0.07 per share negative impact to net investment income in 2024 relative to our forecast. Even with the lower fair value on these investments, we continue to grow net asset value year-over-year by 70 basis points. This compares to a decline of approximately 160 basis points on average for the BDC peer group through Q3 2024 compared to Q4 2023. For the same period, net asset value per share for TSLF increased 50 basis points, representing roughly 210 basis points without performance. And finally, new investment spreads move tighter throughout the year, driven by the significant amount of capital raised in the direct lending space, combined with muted M&A volume. This is the supply and imbalance that we've talked about on several of our previous earnings calls. To illustrate the movement of spreads in 2024, we'll compare Q4 2023 to Q3 2024, given we are still early in the fourth quarter reporting cycle. As of Q4 2023, the weighted average spread on first lien performing assets in our portfolio and for public BDCs was 8.3% and 6.4% respectively. This compares to a weighted average spread as of Q3 2024 of 8% and 6.1% respectively, representing a decline of 30 basis points for TSOX and the public BDC sector. As the market moved tighter in 2024, the impact of tighter spreads on new deals lowered our net investment income by approximately 7 cents per share compared to our forecast for the year. That being said, we continue to put on new deals at wider spreads relative to the sector as evidence by our weighted average spread on new deals in Q3 2024 being approximately 150 basis points wider than the average for our public BDC peers. Although there were puts and takes, we met our guidance on an operating income basis for the year. Looking ahead to 2025, we believe the earnings potential for BDCs is largely tied to portfolio spreads. To put it simply, the deals you do today will ultimately be the driver of your returns in the future. As an illustrative example, we've calculated the estimated return on equity assuming our entire portfolio had a weighted average spread equal to the weighted average spread we earned on new investments in the fourth quarter of 6.4 percent. Based on our balance sheet as of year-end, the three-year SOFR swap rate of 4 percent, 1.5 percent OID over a three-year average life, and consistent with our union economics over the last year, a weighted average of 640 basis points implies a return on equity of 9 to 10 percent, assuming 0 to 50 basis points of credit losses on assets. We can compare this to earnings potential for the sector by using the weighted average spread on new first liens in the third quarter of 529 basis points for public BDCs. To simplify the analysis, we'll assume management, incentive fees, leverage, cost of funds, and operating expenses are all based on the Q3 LTM average for the sector. Using the three-month SOFR swap rate of 4%, 1.5% OID over a three-year average life, in the long-term annualized return net loss rates according to a clipwater direct lending index of 102 basis points. A weighted average portfolio spread of 529 basis points generates approximately 5% return equity for the sector. It is important to note that these return estimates assume a three-year swap rate of 4%. If base rates move lower, ROEs will move lower, Two, given the asset sensitivity and some liability sensitivity for the BDC space. As we've said in the past, today's front book is tomorrow's back book. This was the big theme we highlighted during our Q2 earnings call six months ago and remains top of mind when we make our investments. To be clear, the analysis is for illustrative purposes only. If our entire portfolio called away, our return on equity in the term would be loosely given the impact of embedded call protection and amortization of upfront fees. While it may feel like the value proposition for direct lending is eroding on the margin given spread levels in the market today, we set up our business with a differentiated sourcing channel to deliver a sustainable return profile for our shareholders. We continue over-earning our cost of capital, even in a more competitive, tighter spread environment, and believe this will be a key contributor to the dispersion of returns to the sector in the future. Yesterday our Board approved a base quarterly dividend of 46 cents per share to shareholders of record as of March 14th, payable on March 31st. Our Board also declared a supplemental dividend of 7 cents per share related to our Q4 earnings to shareholders of record as of February 28th, payable on March 20th. Our Euro net asset value per share adjusted for the impact of the supplemental dividend that was declared yesterday at $17.09, and we estimated that our spillover income is approximately $1.23 per share. With that, I'll now pass it over to Beau to discuss this quarter's investment activity. Thanks, Josh. I'd like to start by laying on some additional thoughts on the direct lending environment, and more specifically, how we are positioned for the opportunities that we are anticipating in 2025. 2024 was another year of lower M&A volumes as interest rates remained elevated and valuation gaps persisted between buyers and sellers in the market. While the setup for 2025 is not entirely different from that of 2024, we are optimistic about the higher activity levels this year for a few reasons. First, valuation gaps have narrowed after multiples reached a drop in 2023 from the peak prices paid for businesses in 2021. The reality is that if a buyer paid an excess multiple, a few years ago, and multiples have since contracted, that implies additional growth in the businesses required before they can earn back their money, let alone a reasonable return. Achieving that growth generally takes time, and companies have had yet another year to go back into earnings. Second, and a more stable macroeconomic backdrop. Compared to 2024, interest rates have stabilized to what we may now consider the new normal, while inflationary pressures have largely subsided at least for the time being. While still higher for longer, we believe that the normalization of rates will bring more buyers back into the market in 2025. Lastly, pressure has continued to build in the system with sponsors sitting on record amounts of dry powder. Each of these factors will take time to fully materialize, but they set a promising stage for increased activity levels this year. Amidst the slower M&A backdrop in 2024, we had an extremely productive year of putting capital to work in differentiated investment opportunities. In Q4, we provided total commitments of $479 million and total fundings of $324 million across nine new portfolio companies and upsized it to seven existing investments. In terms of commitments, Q4 was our busiest quarter in three years since Q4 of 2021. For the full year 2024, we provided $1.2 billion of commitments and closed on $839 million of fundings, representing an increase from the 2023 levels of $959 million and $808 million, respectively. In 2024, we stayed active in the market by leveraging our Armony channel sourcing capabilities across the Sixth Street platform, this including being a valuable solution provider in both the sponsor and non-sponsor channels. In the sponsored finance market, our thematic investment allows us to provide speed and certainty in the sectors we like and know well, thereby positioning us as a differentiated source of capital in what has become the most competitive segment of the direct lending market. As for the non-sponsored businesses, the breadth of Sixth Street's platform provides us with the ability to originate credits away from the regular way sponsored finance business. In 2024, 37% of total fundings were to non-sponsored businesses. It is generally in this less traveled scene of the market where we earn incremental spread while maintaining an appropriate risk return for our shareholders. Given our access to a wide top of the funnel across multiple origination channels, our investment pipeline is not solely linked to M&A volume, but rather stems from longstanding relationships, sector expertise, and flexible capital approach. To highlight a differentiated investment in Q4, also our largest funding for the quarter, we closed on a new investment to TRP Energy. This was structured as a new term loan facility that recapitalized the business in connection with a massive exchange. As part of the transaction, TRP refinanced its existing term loan, agented by Sixth Street, resulting in approximately $0.07 per share for the combination of prepayment fees and dividend income. This investment allowed us to stay invested alongside a trusted management team through a new deal with Call Protection. We believe this investment underscores the power of the Sixth Street platform in creating unique investment opportunities. To touch on another non-sponsored investment we made in 2024, Arrowhead Pharmaceuticals was in the press in Q4 announcing a large-scale global licensing and collaboration agreement with Therapeutics. After receiving HSR approval last week, the transaction will be effective in Q1, and we anticipate a repayment of a portion of our loan in accordance with agreed-upon prepayment terms. Based on these terms, we expect to earn 7 cents per share of estimated activity-based fees in Q1 of 2025. Similar to our investment in TRP Immunogy, this opportunity was the direct result of deep expertise across the Sixth Street platform. We have established a core competency in specific themes within the healthcare sector over a number of years, which has positively benefited our shareholders demonstrated by an asset level weighted average IRR and MLM of 14.7% and 1.4x on fully realized healthcare investments in the SLX portfolio. Both of these examples highlight the differentiated portfolio we have created. This is further demonstrated by examining the overlap of investments in the TSLX portfolio with other BDCs and comparing that to an investment overlap across the BDC sector. As of Q3 2024, TSLX had approximately 25% less portfolio overlap compared to the overlap on average for the sector. Pivoting to funding trends in Q4, 98% of our new investments were in first lien loans, reinforcing our long-term focus on investing at the top of the capital structure. All nine new investments were cross-platform deals where we leveraged the size of Sixth Street's capital base to lead and participate in transactions that presented attractive risk-adjusted return opportunities. This contributed to Sixth Street aging in 88% of the deals funded in TSLX in the fourth quarter. In today's crowded marketplace of direct lenders, we believe our scaled capital base serves as a competitive advantage as we are able to lead transactions, ultimately allowing us to drive shareholder return. Moving on to repayment activity, as Josh highlighted earlier, we experienced a significant pickup in payoffs during the fourth quarter to finish off the year. Total repayments in Q4 were $305 million. For the full year, repayments totaled $794 million, reflecting a 69% increase over 2023 and resulting in net funding activity of $45 million for 2024. To characterize the repayment activity we experienced during the fourth quarter, we saw a mix between payoffs related to M&A and refinancings. Two of our payoffs driven by M&A, TRP Energy and Kyriba, resulted in the repayment of our existing investment, followed by the opportunity to continue lending to the business through a new money term loan. In terms of repayments driven by refinancings, we continue to pass on deals getting done at spreads that do not present an appropriate return profile for our shareholders. From a portfolio yield perspective, our weighted average yield on debt and income-producing securities at amortized cost decreased quarter over quarter from 13.4% to 12.5%. Half of this decline, or 46 basis points, was from lower interest rates, and the rest was a mix between yields on new fundings and spread step-downs on an existing investment. In today's tighter spread environment, we have continued to participate in investment opportunities that we estimate will earn a return that is greater than our cost of capital. This is illustrated by only 5.1% of our portfolio by fair value in senior secured loans with spreads below 550 basis points. Further, less than 1% of our portfolio by fair value carries a spread below 500 basis points. We highlight this for the reasons we have outlined in the previous earnings call regarding the importance of earning your cost of capital. Moving on to the portfolio composition and credit stats. Across our core borrowers for whom these metrics are relevant, we continue to have conservative weighted average attach and detach points of 0.6 times and 5.1 times, respectively. And their weighted average interest coverage remains consistent at 2.1x. As a reminder, interest rate coverage assumes that we apply reference rates at the end of the quarter to run rate borrower EBITDA. As of Q4 2024, the weighted average revenue in EBITDA for our core portfolio companies was $336 million and $110 million, respectively. Median revenue in EBITDA was $147 million and $53 million. Finally, the performance weighting of our portfolio continues to be strong, with a weighted average rating of 1.10 on a scale of 1 to 5, with 1 being the strongest, representing an improvement from last quarter's rating of 1.14, driven by growth in the portfolio from new investments and the repayment of a two-rated investment during the quarter. Non-accruals represent 1.4% of the portfolio at fair value with no new investments added to non-accrual status in Q4. With that, I'd like to turn it over to my partner, Ian, to cover our financial performance in more detail.