Q2 2021 Sixth Street Specialty Lending Inc Earnings Call
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[music].
Good morning, and welcome to St Specialty lending, Inc. Second quarter ended June 30th 2021 earnings Conference call before we begin today's call.
I would like to remind our listeners that remarks made during the call may contain forward looking statements.
Statements other than statements of historical fact 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.
<unk> results may differ materially from those in the forward looking statements as a result of a number of factors.
Putting those described from time to time, when sixth Street specialty lending, Inc. 's filings with the Securities and Exchange Commission. The company assumes no obligation to update any such forward looking statements yes.
Yesterday after the market closed the company issued its earnings press release for the second quarter ended June 30th 2021 on posted a presentation to the Investor resources section of its website Www Dot sixth Street specialty lending dotcom the presentation should be reviewed.
In conjunction with the company's form 10-Q filed yesterday with the S E C.
3 specialty lending Inc. 's earnings release is also available on the company's website under the Investor Resources section unless noted otherwise all performance figures mentioned in today's prepared remarks are adds up for the second quarter ended June 30th 2021.
As a reminder, this call is being recorded for replay purposes, I will now turn the call over to Joshua easterly Chief Executive Officer of sixth Street specialty lending Inc.
Thank you good morning, everyone and thank you for joining us as usual with me today is my partner and our President Bo Stanley and our CFO incentives for our call today I will review this quarter's results and then pass over to Bo to discuss this quarter's originations originations activity in portfolio.
We will review our quarterly financial results in more detail and I will conclude with final remarks before opening up the call to Q&A.
After market closed yesterday, we reported second quarter adjusted net investment income per share of 46.
Exceeding our quarterly base dividend per share of 41.
This corresponds to an annualized return on equity of 11%.
Adjusted net income per share for the quarter was 88.
Which corresponds to an annualized return on equity of 21, 4%.
Year to date, our annualized return on equity on adjusted net investment income is 12, 4% ahead of our full year target of 11, 5% to 12% and return on equity on an adjusted net income was 22.2 per cent.
This quarter's net investment income reflects continued strength in our core earnings power of our portfolio and the difference between this quarter's net investment income and net income was due to significantly net realized and unrealized gains on our investments, which bill will cover.
Since these gains resulted in accrued capital gains incentive fees. We have adjusted this quarter's results exclude the impact of this noncash expense expense, which was approximately approximately 8 cents per share.
There's a few there's a few there are a few reasons to do this to start the accrual for capital gains incentive fee is a GAAP requirement in quarters, where our cumulative gains exceed cumulative losses less previously paid capital gains incentive fees.
The rationale is that when these games become realized.
They would be subject to capital gains incentive fees no. However.
That only a portion of our accumulative unrealized gains at quarter end with actual be subject to a capital gains incentive fee. If our entire portfolio will be realized in normal course at June 30th Mark.
The rest of the cumulative unrealized gains related to the valuation of our debt investments inclusive of call protection, which if prepaid we resulted in the recognition recognition of fees and investment income and trigger a reversal of previously accrued capital gain capital gains incentive fees related to these investments.
At quarter end, we had approximately 16 cents per share of cumulative accrued capital gains incentive fees on our balance sheet, but only 4 cents per share would actually payable in cash if our entire portfolio would be realized.
Their quarter end Mark in normal course.
A reminder, that the calculation of accrued capital gains incentive fees is actually payable to the advisor is done annually at quarter at calendar year end.
Capital gains incentive fees would only be payable to extent, our cumulative net realized gains exceed or exceed our cumulative net realized and unrealized losses on inception to date basis less any previously paid fees.
All cumulative unrealized gains are disregarded for this calculation since it gains must be realized in order for us to be eligible to receive fees. Therefore illustrative way. If we were if we were at year end today and calculating the capital gains incentive fees payable based on our Q2 financials now never cumulative accrued capital gains is set.
The fees would be actually payable gives.
Given the capital gains incentive fee accrual accrual.
Rates noise around the fundamental earnings power of our business, we've adjusted our results exclude define item.
Continuing with this quarter's results gains on investments drove strong net asset value per share growth of 2.7% quarter over quarter. The 16, 85 up 44 cents per share from Q1 pro forma net asset value per share of <unk> 16.41.
If we were to look at the growth in our net asset value since the onset of COVID-19 through today.
Which would require adjusting for the impact of special in supplemental dividends.
We've grown net asset value per share by 12, 2%.
Since year end 2019.
From a total economic return perspective, which would factor in the benefit of our quarterly base dividend as well we've generated a return of 26.8 per cent for our shareholders over this time.
We think the challenges of Covid are far from over we believe our strong lead falls to day demonstrate they were both robustness of our business model on our ability to create value across uncertain market environments.
Yesterday, our board approved a base quarterly dividend of 41 cents per share to shareholders of record as of September 15 payable on October 15th Our board also declared a supplemental dividend of <unk> per share based on our Q2 adjusted net investment income to shareholders of record as of August 31.
Payable on September 30th.
So from them for the impact of the Q2 supplemental dividend our quarterly net debt quarter net and net asset value per share was 16.83.
Reviewing our first half per progress, we continue to generate attractive risk adjusted returns by focusing on segments of the market, where we believe we have the highest value proposition for our portfolio companies management teams and sponsors.
After experiencing elevated portfolio turnover in 2020 and face with reinvestment headwinds from falling credit risk premiums in the broader loan market, we were able to grow our portfolio, while maintaining stable portfolio yields and portfolio credit metrics, which bill will cover in more detail.
By remaining disciplined to our specialty lending focus and drawing on the breadth and depth of <unk> platform, we're able to find opportunities, where our deep sector knowledge and structure and capabilities allowed us to generate our targeted levels of returns for our investors without I'll now pass over to Bo discussed our Q2 originations activity in <unk>.
Portfolio metrics.
Thanks, Josh we had a very active quarter supported by a robust deal making environment.
And against an improving macro backdrop transaction levels were elevated as sellers look to capitalize on attractive valuation environment and buyers look to accelerate growth through strategic acquisition.
Meanwhile, sponsors with record levels of dry powder continue to focus on buying and building portfolio companies.
With a busy activity levels for the first half of this year, a thematic approach in scale and resource benefits of being part of the $50 billion plus sixth Street platform continued to serve as important competitive advantage.
Our thematic playbook all on our team to efficiently focus on transactions, where we have the expertise on the capital base to provide financing solutions that few other competitors could replicate.
In addition, the market insights and resources across the 6 free platform, which allow us to provide value beyond capital became an important consideration for our management teams and sponsors looking to successfully navigate todays complex and evolving market dynamics.
In addition to the strong originations activity. We had in Q2, we also have a strong backlog for the second half of this year, including agent Rolls on 3 large financings that total over $1.5 billion in facility size.
As you can expect we are partnering with our affiliated funds and other maintenance is on these transactions, which provides us the flexibility to determine the optimal final hold sizes for T. S. L Ax.
This quarter, we had $303 million on commitments and 265 million of fundings across 7 new investments and upsize is 2.8 existing portfolio companies.
As an illustration of the power of the platform. The majority of our new investments were completed in collaboration with funds across the sixth Street platform.
Perhaps reflective.
A broader market trends all of our new investments this quarter, where financing to support acquisitions or growth in 6 of the 7 of these were backed by financial sponsors.
We continue to execute on our educational technology theme with new first lien term loan investments in iguana Phi and modern campus.
Given that we were 1 of the first lenders to market on this theme and have significant familiarity with a business model and market dynamics, we're able to provide speed of execution.
And our level of deal structure customization that set us apart from our competition.
As for our other new investments this quarter. They all had the hallmarks of our focus on well managed businesses with mission critical deeply embedded tech enabled solutions.
And they were all sourced through our proprietary origination channels.
On the repayment from activity continued to be relatively muted this quarter at $108 million across 2 full paydowns on 1 sell down.
Which partly reflects the more recent vintage of our portfolio as we began the year.
This resulted in net funding activity of $157 million for Q2.
To pay downs this quarter were both M&A driven.
On the sell down was our small neiman equity position at a price above our cost basis as mentioned on our last earnings call on May.
During the quarter a few of our portfolio companies were in the press falling certain milestone events.
All of which I'll touch upon here.
May curious completed a growth equity round at nearly $8 billion post money valuation led by sets sixth streets health care and life Sciences team.
Since 2018 T. S. L. Ax has made relatively small investment in the Companys capital structure alongside our affiliated farms and received warrants as part of these transactions.
Based on the valuation of curious this latest financing round the fair value of our junior debt warrants and preferred equity positions increased significantly quarter over quarter contributing to this quarter's unrealized gain.
Sprinkler another 1 of our portfolio companies and a provider of customer experience management solutions completed its IPO on June 23rd.
We made a small investment in sprinklers convertible notes on sort of affiliated funds last may and upon completion of the IPO our notes automatically converted into common equity.
The quarter end fair value Mark of our equity position reflects a discount to the company's June 30th closing share price given the trading restrictions on our equity security, but still represents a 2.5 X M O M on our capital invested.
Driven primarily by the unrealized gains in the debt to equity conversion of certain investments upon milestone events. This quarter, our portfolio's equity concentration increased slightly from 4% to 6% on a fair value basis.
We continue to be focused on investing at the top of the capital structure and our portfolio remains predominantly first lien oriented with 94% first lien at quarter on.
As Jos alluded to the credit quality of our portfolio remains robust with minimal changes in our credit metrics compared to the prior quarter. The weighted average EBITDA on our core borrowers this quarter was steady at $41 million on.
On our portfolio's average attachment and detachment points remain stable at zero point, Forex and 4.2 X respectively.
The average interest cover zone on our core borrowers and push slightly from 3.2 extra 3 point forex quarter over quarter.
Our investments on non accrual status remain minimal at 0.02 per cent of the portfolio at fair value represented in our restructured sub notes in American achievement as discussed on our Karl and Matt.
Our portfolio's weighted average yield on debt and income producing securities at amortized costs continues to be steady.
This quarters yield was 10, 1% same as the prior quarter and approximately 10 basis points higher than what it was a year ago.
The yield impact on new vs exited investments this quarter was minimal the weighted average yield at amortized cost of new investments. This quarter was 10.0 per cent compared to a yield of 9.5% on exited investments with that I'd like to turn it over to you.
Thanks book.
Reviewing the headline results for Q2, we generated adjusted net investment income per share of 46 cents and adjusted net income per share of 88 cents.
What are the quarter total investments at fair value grew by approximately 8% to $2.6 billion driven by net funding activity and the positive impact of valuations on the fair value of our portfolio.
Principal debt outstanding at quarter end was $1.3 billion and net assets were $1.2 billion or $16.85 per share which is prior to the impact on the supplemental dividend that was declared yesterday.
This quarters average debt to equity ratio increased to 1.07 times compared to 0.93 times in the prior quarter as a result of net funding activity as well as the payment of Abdullah twenty-five per share special dividend in April.
Our debt to equity ratio at June 30 was 1.08 times.
We continue to have ample liquidity with $1.1 billion of unfunded revolver capacity against the 121 million of unfunded portfolio company commitments eligible to be drawn at quarter end. We remain match funded with full 0.1 years of weighted average remaining time to maturity on our debt liabilities against 2.4 years of.
Weighted average remaining life of investments funded by debt.
Our next debt maturity is approximately a year away in August 2022 on the $143 million remaining par value of convertible notes.
This quarter the average share price of desktop continued to exceed the adjusted conversion price on these notes.
As we've mentioned previously we have the flexibility under the indenture to settle the aggregate value of these notes any of the cash stock or a combination thereof.
The triggers for early conversion had not been met and we will make a determination on the most efficient settlement method. When the time comes based on al Ben balance sheet leverage and investment opportunity set so that we can manage the impact on NAV per share and ROE vs.
A reminder, that per our early adoption of ASU 2000, Twenty's Dash zero 6 last quarter the diluted EPS in our financial statements uses the if converted method, which shows the maximum dilution effect of our convertible notes to common stockholders, regardless of how the conversion can actually occur.
Moving back to our presentation materials.
<unk> 8 contains these quarters and a V bridge.
Walking through the notable drivers of NAV growth, we added 46 cents per share from adjusted net investment income against a base dividend of 41 cents per share.
As Josh mentioned, they were 8 cents per share of accrued capital gains incentive fees related to this quarters net realized and unrealized gains.
The impact of tightening credit spreads on the valuation of our portfolio had a positive <unk> <unk> per share impact and there was a positive 51 cents per share impact from other changes primarily net unrealized gains on investments of 43 cents per share due to portfolio company specific events, which bode provided some examples of Elliot.
Moving on to our operating results detailed on slide 9 total investment income for the quarter was $62.8 million compared to $66.2 million in the prior quarter.
Walking through the components of income interest and dividend income was $59.4 million up $3.5 million from the prior quarter, primarily as a result of an increase in the average size of that portfolio.
Other fees, representing prepayment fees and accelerated amortization of upfront fees from unscheduled paydowns with $2.2 million compared to 8 million in the prior quarter.
Other income was $1.1 million compared to $2.3 million in the prior quarter.
In summary, the slowdown in portfolio turnover this quarter and net portfolio growth allowed us to generate a higher quality of earnings from interest income.
For reference 95% of this quarters total investment income was generated through interest and dividend income compared to 79% across 2020 and 88% across 2019.
Net expenses, excluding the impact of the noncash accrual related to capital gains incentive fees were $29.7 million up slightly from 29 million in the prior quarter. This was primarily due to higher interest expense from an increase in our average debt outstanding at.
Our weighted average interest rate on debt outstanding decreased slightly quarter over quarter by 4 basis points to 2.26% as a result of a funding mix shift to greater usage of our secured revolver.
Lastly on expenses, you'll notice that we applied for the first time a fee waiver on base management fees related to this quarters portion of average gross assets financed with greater than 1 times leverage above that leverage level base management fees are reduced to an annualized level of 1%.
This is the first time since all stockholders approve the application of a 150% minimum asset coverage ratio in 2018 that we have reached the threshold.
For the year to date period, we've generated an annualized return on equity on adjusted net investment income of $12.4 per cent.
And on adjusted net income of 22, 2%.
On net income has benefited from both net realized and unrealized gains on investments from company specific events as well as the positive valuation impact of Titan, Inc. Risk premiums across asset classes.
As portfolio repayments moderated in the first half of the year, we've been able to generate greater interest income from investments, while increasing our balance sheet leverage to support our roe's.
In the second half, we expect some rebound in portfolio repayment activity, which would drive a more normalized level of activity related fees for our business.
Based on where we stand today, we believe we are on track to meet the high end or exceed our previously stated guidance range of $1.82 to $1.90 of adjusted NII per share for full year, 2021, which corresponds to a return on equity of 11, 5% to 12 per se.
With that I'd like to turn it back to Josh for concluding remarks.
Thank you Ian and the per.
First half of the year the broader market sentiment has been mostly positive given the vaccine rollout economic reopening and the promise of continued a continued accommodative fed.
Given the health of the consumer and health or financials on the eighth.
A form mentioned accommodative fed we remain constructive on the U S economy, Although we do believe there's a myriad of factors, including the impact of the Delta variant the debate around transitory versus non transitory inflation that could create periods of volatility.
As always we positioned our balance sheet on in liquidity, such that we stand ready to operate across various varying market environments as of 2020 as shown in periods of uncertainty. We are a proven source of stability of capital for new and existing clients.
While being a provider of strong risk adjusted returns for our investors.
To ensure that sixth street platform continues to be a leading solutions provider and deliver superior results for shareholders and L. PS, we're working hard to expand our capabilities over the past year and a half 6 years focus on growing our capabilities in health care.
Growth in energy among other business verticals and have grown our team by approximately 80 people, including 30 investment professionals across sectors and disciplines.
Today 6 years more than 320 team members, including over 145 investment professionals operating across 9 collaborative investment platforms from 9 locate locations around the world. We believe that the scale and resources of our platform business, we well position and nimble across doesn't cycles and market.
[noise] environments, which is ultimately, which ultimately benefits the T. S O shareholder with that thank you for time today operator, Please open up the line for questions.
Thank you.
If you have a question at this time. Please press Star then 1 on your Touchtone telephone.
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Our first question comes from the line of Devin Ryan with JMP Securities. Your line is open. Please go ahead.
Okay, great good morning, everyone.
Good morning Devin.
Our first question here, just given the strong economic backdrop and elevated transaction activity coupled with meaningful.
Available liquidity, just curious how youre thinking about leverage your current leverage on point no wait times do you see an opportunity to take that higher in the current environment.
How should we think about the trajectory there if anything you can share. Thanks.
Yeah, Great. That's a good question look I think.
This quarter was a quarter, where it was very showed up in our P&L very low kind of activity related fees.
That being said on NOG.
To your question I think this is our highest quarter on a per share basis by a long shot on.
Interest income.
On that and that was primarily driven by a slug it into our balance sheet leverage so put in perspective I think on average.
True interest income per share has ranged about 81 since this quarter was 89 cents with activity fees, where no typically tense tents, where 3 since this quarter or so and that was all driven by balance by a financial leverage I would expect that we continue to leg into our financial leverage we're kind of in a low in.
In a low ish the middle of our financial leverage range.
I would expect activity levels to you know.
Activity level fees, and some portfolio turnover and in in the second half of the year and so we're going to work hard to continue to stay you know kind of in a 1 plus range and will given the economic backdrop I think we'll want to take it out.
1.15, a 1.25.
On a in this environment.
So.
I Hope I hope I answered your question, but we most definitely given the economic backdrop and the activity levels.
Well will most definitely continue we think there's.
Our path to put out our capital, but theres going to be more activity in our portfolio I think in the second half of the year on the repayment side.
Okay.
That's perfect. Thank you.
And then just a follow up Josh.
The environment for capital.
Allocation.
How would you compare today versus other periods of your career, what you've seen and clearly there's a lot of deal flow right now and so that's good.
Do you think that might evolve if deal flow.
Flows from here.
Yeah, So look I think on.
I'd frame. It this way I think this is probably 1 of the most competitive environments we've seen.
And there's many that the space has been gentrified for sure there's capital flow into the space both in the in a fund format.
The BDC format in the I would call in a gray market for Bdcs. So most definitely this is probably 1 of the most competitive markets that being said.
From a risk adjusted return perspective, it's a pretty it's a pretty good environment to put capital out I would expect default rates to be low going forward corporates were in pretty pretty good shape.
And so you know although its competitor of.
Overall risk adjusted returns given where we are on the economic cycle, which feels like it got reset where in the first or second inning. There theres. Some small corner cases, but it felt like we're in the first or second inning.
Do you feel like default rates.
On our end and losses given defaults.
<unk> will be pretty high this environment. So I think there's a there's a continues to be a path to generate strong risk adjusted returns for shareholders.
In this environment.
Anything to add.
The only thing I would add is that while competition is intense it is stable. It is not you know it's been stable. The last couple of orders and it doesn't seem to be intensifying.
And I think the risk adjusted return to Joshua's point.
You know is compelling given the economic backdrop.
Okay, great very helpful. Thank you guys I'll leave it there.
Thank you and our next question. Our next question comes from the line of Finian O'shea with Wells Fargo. Your line is open. Please go ahead.
Hi, everyone. Good morning.
First question in the line of.
The competition discussion as well, but more toward venture which.
It looks like you've.
And on the back then.
Doing it.
Growing cadence.
Of over time can you.
Kind of explain the perhaps pros and cons of.
Let's say say dabbling in an adventure.
Where that that market seems to be typically reserved for the dedicated crowd.
Just give us a feel of how.
How what the challenges in getting good good quality deals win when youre not full time in that market.
Yeah, Hey, Hey fan. So I. Appreciate your question I know this has been a little bit of a theme for you this quarter.
I would argue with your premise, we don't do venture debt and so when I think about venture and I think and on the spectrum.
You know and kind of investment strategies venture is typically investing in companies that have.
Unknown or how he speculative business models that are either pre revenue or not scaled businesses.
That we do zero and I'll say it again, we do zero of that.
On occasion, which we've been a leader in and we've done for 'twenty.
20 years, we've financed companies with known business models known unit economics, very diverse customer base that are growing that are reinvesting in their business and so I would juxtapose that against.
The venture debt model, where there is a you know unknown.
On a known business model, a large tam, but unknown business model unknown unit economics.
Or.
If it's if it's post revenue there is highly concentrated revenue and so we do we do zero of the what you would think of or with the market would think of venture debt I don't know Bo or fish would you have anything to add there.
No I was just you know I was just going to reiterate that the late stage growth market that we play in which is characterized by with companies that have underwritten.
Our business models that you can underwrite.
Downside protection secondary forms repayment, we've been doing that for 20 plus years and you know.
Now is that theme expanding over time as you're seeing the digitization of the economy and more businesses fall into that late stage market. Yes, I think that is that debt is a fair statement, but we've never done venture in the late stage growth lending something we've been doing for 20 plus years and you even the earlier stage.
<unk> recurring revenue deals we do are tied directly to very high gross margin recurring revenues that throw off cash flow at the Marshall either just reinvesting those.
Those cash flows easily scaled businesses with revenue low customer concentration. So I would I would I would argue that premise now there might be on the case of passport, which is a company that as you know went from a a venture debt provider to accompany that.
It's now grown up and has real diversified contracts with municipalities.
And then on the payments business.
And for municipalities and in parking lot owners that that is that that as transitioned as a as a credit and as a business model, but that that's how I'd frame it for you.
Yes.
Very helpful and.
Then.
I guess this is sort of a related question.
On <unk>.
I think Ian you mentioned, there's an impact of yields coming down from the competition and such.
There is.
Obviously not.
On a large pool of.
On a rescue or or special sit or oriented deals right now.
Do you have any.
Any like.
Strategy 2 <unk>.
Let's say like increase your equity co invest or engage in.
I'll just leave it at that anything to.
You know how it helps sustain just the baseline yield you've been getting I know you'll get some pick up you said from a.
Normalized activity, but you know if this environment is protracted.
What do you think on on on that matter.
So I'll hand, it over here I, just want to again frame it up a little bit which is yield.
Look at our yields if you look at June 30th Twenty-twenty, our yields and amortized costs are up 10 basis points year over year. So I you know I'm not I'm not sure. We said anywhere that yields are coming down just a debt.
Uh huh to frame it I think our Q.
<unk> to 2021 yields on new investments, we're basically at our average yield and so on.
And I think that exceeded.
Loans slightly that paid off so I think again, a little bit of a that the maybe this is a theme theme in this space but.
We haven't really seen yield compression in our book.
We actually picked up net interest margin when LIBOR went from you know whatever 2 and a half down the 20 basis points. We picked up net interest margin and yields have been flat to stable to slightly increasing actually year over year and in yields on new investments equal yield on a total book. So I don't think I think that's a.
A little bit of the benefit of being small nimble, having the benefit of the 6 free platform, having a you.
150 people.
You know getting up and thinking about you know among other things that direct lending and how to solve.
M a N a.
On issuers problem and being nimble across sectors.
To a lesser degree does a lessor.
Lessors are lesser.
On extent our geographies.
And.
So I like that given that I think the premise.
As is maybe something if the medically happiness space I don't think it's <unk>.
Happy to eat a fixed or specialty lending.
Ian do you have anything to add no was the second part of your question Fin also getting to whether where we're seeing more opportunity on equity co invest is that is that where you are going to debt.
Yes, and your plans to engage on it as well I suppose.
We've always been opportunistic about or equity co invest program I think over time, we've invested just to put it in perspective, we've invested.
I'm trying.
Yeah.
We've invested.
I'll give you the math, we've invested about $160 million of equity overtime and.
And.
We're currently at like 1.7 times M O M and I guess I will grow because we have a whole bunch of stuff on the book still and so it's been a a decent source of returns I think the average return on fully realize.
It has been in the.
And that 40% range. So we'll continue to take our shots I would say that it's a it's a very specific so we're not asking for our equity co invest program is not asking for equity co invests in every deal we have a we have a we have a if it fits into our sector and we have a you know.
<unk> deep fundamental view of that of the business and think they are you know the prospects are good on the valuation is good we'll ask for it but it's more rifled than a shock on it's more I would say actively managed versus kind of a you know a passive.
On strategy of equity co invest and taking kind of private equity returns across the cycle, where we're pretty specific and thoughtful what we do given the capabilities of the platform.
Got it thanks, so much.
Thanks fin.
Thank you on our next question comes from the line of Robert Dodd with Raymond James Your line is open. Please go ahead.
Hi, guys. Firstly, a follow up to Devins question. Obviously, you gave kind of an indication that you may be able to get towards the higher end of your leverage range by year end maybe.
If that path.
Kind of kind of plays out and there's a lot of value bolts understood would would that change your you'll bias.
On on what to do with the convert in terms of how much cash how much debt how much equity.
You know as we got into next year I mean is that is that the.
The <unk>.
Strategy, a function of where leverage ends up at the end of the.
Yeah, Robert your debt up first of all I just want to be clear like I think we have given the converge.
And our ability to federal debt, an all equity.
<unk>.
We are most definitely willing I'm not sure we.
We'll be able to or willing to run quote quote unquote hotter on debt to equity.
That will give us flexibility and that is most definitely a consideration and the convert so.
I think that theres going to be you know I think the market environment.
And Ah is 1 consideration, which we're very constructive on the U S economy, which allows you to be you know b.
You know us lean into your financial leverage a little bit more and that we have you know effective we can settle the convert with equity allows us flexibility as well and that's most definitely in consideration.
Got it got it. Thank you and then 1 more if I got on you.
You mentioned adjusted in the prepared remarks, I think adding expertise I think book.
The pivot and the manager obviously and.
Obviously energy is a.
It's everything from oil and gas E&P to.
Solar panels could you give us.
2 parts, 1 way, you're adding the expertise, but more on the point should we expect energy exposure to go up at the BDC and if so could you maybe narrow down what kind of energy verticals you plan to attract.
Yeah. So it's a great question.
So we've got expertise both on what I would call infrastructure and distributed energy.
So.
Solar wind et cetera on the platform well you know people on notice I think we're 1 of the largest.
Owners of solar and some of our private funds.
And I've also weighted versus the wind et cetera, and then on and then typically on traditional we've been you know.
Really everywhere from.
Far upstream to midstream, we've done stuff and made investments historically are so I think it's I think it's wide open.
We haven't really seen a ton of opportunities I would say in and the energy space.
For winding maybe.
Maybe that changes, but we most definitely have the expertise that we've added to that expertise we had been.
Relatively act of AR in the in the non Alt space.
Hum.
For example, we bought a group of probably by a group of RBS.
<unk> loans.
On.
With a partner that.
That was exiting the business obviously, we have.
We have on ESG framework and committed to day ESG framework.
But I would expect us to be active across a complex.
And be opportunistic in that I think the Max exposure was in our energy in the BDC was about 10%.
And most of that was in the form of a reserve base lending on hedged proven collateral.
I'm not sure we ever get back up to 10%, but we most definitely when we see opportunities will be on you know.
Moving to address there and be opportunistic, but it has to fit into the portfolio construction and it has to be assets. We like that are low on the cost curve, where theres not development risk and where we are where they're they're they're hedging the commodity price.
We've done a actually a pretty good job I think over time in that space we have.
Positive P now.
Mississippi was he.
The 1 mistake and it was you know.
I would say relatively small.
But you know across you know are the investments we've done a pretty good job on.
So we'll still be active in it.
Got it thank you.
Thank you and our next question comes from the line of Kenneth Lee with RBC capital markets. Your line is open. Please go ahead.
Hi, Thanks for taking my question just 1 on the sixth Street platform on.
The broader level I'm wondering if you could expand upon your expectations for the platform its potential contribution to originations.
For the near term thanks.
Yes.
We've talked we've touched on this a couple of times, but look we sorry. It is a question the contribution of our originations for the platform.
Or is it just where we're adding expertise sorry.
Just the first part just contribution to a potential originations.
Uh huh.
I don't know if we track it specifically because we kind of have we kind of go out as a 1 team.
Mentality.
And it ebbs and flows so for example, just to call out.
Tactically the healthcare team doesn't fit inside the direct lending platform, but my guess is like 50 per cent of their activities or direct lending related and so they really own all of our activities and biotech land and you know that so and that that for example in that space I think we've invested.
No.
A couple of hundred million dollars, if not more than maybe a half a billion dollars of half yard.
So, but I don't think we give.
Given the culture of the platform, which is really.
Now on 145, 150 investment professionals getting up every day and thinking about how to be a solution provider.
For our clients and how to be you know and protect our or our investors capital I don't think we track it but it's ebbed and flowed and though the 1 thing that Pops out to me is on the health care. The technically it's not within the direct lending team, but has contributed a decent amount too.
The success for our shareholders.
Got you very helpful.
And just 1 follow up if I may.
And this is.
And related to the previous question about equity co investments I'm wondering if you could just refine your comments would it be fair to say that the philosophy around equity co investments is more around potential upside.
Vs mitigating potential losses.
Over the cycle.
Yes.
Yeah look so if the question is.
As our equity co investment program.
Secondly, the way to mitigate credit losses over the cycle versus in the answers.
No in the sense that we're trying to if you look at historically, where in a obviously you can see the suit with the accrued capital gains fee. We're in that we basically have had positive.
Net gains across the book and and haven't really experienced massive credits any real credit significant credit losses over over a long period of time, Inc. Is the 1 in Mississippi, but it's been offset by a whole bunch of other stuff. So.
For us as that.
Say, it's a more offensive strategy.
On where companies.
And where we can partner with people, where we have the expertise to make a an educated investment decision.
And in incomplete and educated underwriting versus taking a portfolio approach and China offset.
Long.
Pivot capital Slash private equity data to offset losses in the credit book.
That is not on our approach our approach is.
Be specific be a good partner.
Have a thesis be able to underwrite and B office of when we think Theres an opportunity.
Based on our sector a company our management team.
And our value evaluation, we like.
Well anything either.
It's pretty simple.
Great. That's very helpful. Thank you.
Thank you and our next question comes from the line of Ryan Lynch with K B W. Your line is open. Please go ahead.
Hey, good morning, Thanks for taking my questions.
You guys have always been a big investor into the software space.
It feels like over the last several years and really after and really in the last several quarters kind of post COVID-19. It feels like everybody all the direct lenders youre really piling into the software space as that sector performed fantastic overall during COVID-19.
So I'm just wondering you know as we sit here today and as you guys evaluate new opportunities what are the biggest risks that you all see today in the software lending spaces at elevated multiples is it risky end markets, you know technology risk and really how are you guys navigating that sector, given the amount of capital flowing into it and.
Given the focus you guys have had in the past.
As part of your portfolio.
Yeah. It's a great question I'll I'll start then I'll turn it on a Boe.
First of all I think the debt most definitely there is a greater focus on on the software space that being said the that the day the.
There's a there's a larger universe as well software over the last.
10 years.
You know that the quote somebody smarter than all of us or at least me. Okay. It's kind of in the world and so the base that the digitization or the worst software isn't a life in both companies and consumers is very large and and theirs.
The opportunity set as grown along with the capital.
Along with the capital is looking at so it's not like.
Is that I'm not deeply concerned in the sense that the opportunities that as has stayed the same we've got smaller and there's a whole bunch more eyeballs on it.
<unk> had a step function together, so I just want to level set there.
Sure.
That being said you know we do think we have a unique lens in expertise in.
And can.
Can bring the 6 free platform to think about now end markets, but technology.
On any technology risk.
Your trends and in technology.
But in a world, where we have a pretty good from where we are from what we like where we're already thinking about where we will focus on companies that are highly embedded that are super capital efficient.
And we have a framework on how in how to determine how capital efficient they are.
That's been around for 20 years.
Adjusted it but.
But I don't know if anything to add yeah look the 1 thing I'd add is.
We don't think of software as an industry. Its ubiquitous we get very nuanced within within technology itself and have sub teams that we focus on and I think part of your question was like with everybody piling into that sector.
As our concerns about you know certain business models et cetera, I think that's right I think all business models within software are not created equally all businesses aren't created equally and you have to be very nuanced and your underwrite I think the 20 years of pattern recognition that we have along the sector and see.
It evolved has allowed us to get very nuanced.
To attack Subsectors, what we think return on invested capital is going to remain strong and the durability of those business models Rus range remained strong.
So that's how we combat it we'd be well.
We're very nuanced.
Very thematic focused.
<unk> continued to see very interesting.
Opportunities in the sector, but without a doubt as is it more crowded for sure and but I do think there are.
Folks that are being indiscriminate on how they look at businesses.
They've put on.
On point on an indiscriminate look not every dollar of quote on quote recurring revenue is created equal.
And.
And not every dollar of marketing spend is as efficient and so depending.
Depending on customer life gross margin, how embedded do they control the customer.
How stable the end markets you, we continue to be very discriminating as the investments we make in this space and then we always.
Same underwriting.
That's really helpful color until you understand.
Not every software deals is created equal.
The other question that I had was obviously the direct lending space and the borrowers have been growing significantly over the last several years and I was just curious you know you guys have on slide number 6 you guys showed near the average loan commitment that you guys are making in over the last several.
Quarter since Investor day kind of $40 million committed range at Chiasso ask I'm just curious.
What what would you say that the average commitment you know if you guys are holding $30 million to $40 million at <unk>. What is the average commitment that you guys are making.
On kind of across the sixth Street platform, and where where would you guys still kind of on on a max level feel comfortable committing because today, you're seeing multibillion dollar direct lending deal that are that are clubbed up but still I'm, just trying to get a sense of where your guidance could kind of.
Clay on the upper end.
In the direct lending market today, given the growth of your platform.
I looked at that.
Yes.
You pointed out and I appreciate it I would not conflate with.
P S O hold side.
With our ability to scale, our scale, our capital and so they're being part of fixed rate allows us.
The Exemptive order allows us to move up market I think Bob mentioned in the prepared remarks.
3 deals were ages on on that total over what's going on $5 on capital and so I think those range from like 3 per.
100 <unk>.
950 million so.
No.
We most definitely we'll pick our spots on market.
On.
It kind of the district, 6.3 way, which is where we can.
We can move fast and be a value partner too.
Sure.
The sponsor or the issuer.
And so I will come back to you on the exact commitment sizes across the platform and have those changed over time.
I would say my my intuition is that they've got bigger although we've continued to keep.
Portfolio size is pretty granular in T. F. L X. So that we can continue the.
Where our shareholders can get the value of some diversification.
We're not always going to be right and so.
I don't know if that's helpful but.
Look at the back half pipeline.
We're an agent on a 900 military on a million dollar deal where an agent on.
Couple of 250 million dollar deals.
So we're continuing to you know.
Move up market, where our capital can be value add in that.
Again, we are where bdcs generally sit on the cost curve you Gotta do you have to you have to you have to provide.
You have to understand where he isn't on the cost curve and your cost of capital to make sure you're providing value by finding that place where there's overlap we're providing value to your clients and value to your shareholders. You can't just be a substitute to the high yield market.
Leverage on market and have fees that are.
For 4 to 6 times higher just doesn't it doesn't work as an enduring book business model.
Hmm.
Okay.
Understood. That's helpful. I appreciate the time this morning.
Thanks, Brian.
Thank you and our next question comes from the line of MS. Melissa Wedel with.
J P. Morgan Your line is open. Please go ahead.
Thank you good morning.
With that Michael.
Yes.
I'll follow up.
Okay.
Okay.
Sorry, Melissa.
Got you.
Oh, sorry.
Youre breaking up.
Sure.
Okay.
Yeah, we can't hear you want to try to get into a better zone.
Obviously, we want everybody to get the benefit of your question have you already answered your question, but we can't we can't hear you at the moment.
Our next question is going to be from the line of Mickey Schlein with Ladenburg. Your line is open. Please go ahead.
Good morning, everyone hope you're well.
Josh you haven't been historically very successful using.
<unk> investment thesis in your portfolio management, and if we look back at 2020 and this year I would like to ask how has the pandemic affected the themes that you're pursuing if theres been any change.
Yeah look I would say.
Thank you Mike Yeah by the way I think it's as is.
I appreciate the attribution that Josh, but it's really the platforms and the people around the platform, but I think most definitely themes come in and out of Vogue.
I will say 1 thing that's coming out of Vogue for US is is retail on the margin.
You know kind of the pandemic washed out.
Our.
Generally I think Kaplan capitalism does a lot of the heavy lifting for society. So typically you have an economic downturn.
It gets rid of all the zombie companies that are high on the cost curve that are inefficient use of resources and I'm not sure the pandemic did that except for the retail.
And so you surely have that done on retail and that was happening before with.
Amazon directly.
Direct to consumer and so people, who didn't have a real omni channel model, we are going away.
That being said I think the pandemic accelerated that cleansing of retail now the retail it's laughed overlaid with a really really healthy.
Consumer.
Is is in is is I would say is in really good shape and now probably you know peak ish earnings across the sector are going to be pikachu earnings across the sector.
So I think we're probably less bullish about in the short term that the.
Given that the health of the U S. Consumer there was I think 1.7 joined dollars of excess savings across the U S economy that the retail has left has a a better value proposition and so I think that's clearly 1 thing that's come out of Vogue for us.
Payments continue to be invoked for us and so passport.
Fits into that into the into the <unk>.
Software kind of where it meets payment ecosystem.
And so on constantly changes.
On parts of healthcare, we think are.
Really interesting.
On and others not and so we continue this is the thing as a platform. We continue always talk about.
And spend our time as a group and the partners talking about Bo or fish anything that.
Oh.
What I would add is for direct lending Theres generally 15 to 20 themes we're actively.
Pursuing at any 1 time, that's constantly rotating we spent a lot of time.
Meetings, you know talking about thematic research and testing ideas and pressure testing certain themes and constantly rotating that's been our practice since we started will continue to do that.
In periods of dislocation in at the beginning or end of cycles, we see.
That rotation generally speed up so to your point I think we've had a pretty healthy rotation of the themes that we're pursuing post post COVID-19.
But that that will continue as long as you know as long as long as we're here Murray managing money.
We also look at.
On software recurring revenue the <unk>.
Sub themes would be the end markets that they're related to so we spent a lot of time thinking about that.
And as we said before not every a recurring revenue deal or software deals the same and those that focus on <unk>.
Specific sectors themselves, we have to look at that.
As a effectively a sub sector of <unk>.
Our theme.
Josh on the back of that then.
I haven't done the math, but.
If you were to look at the IRR is on some of your distressed retail deals.
Were pretty exceptional if I'm not mistaken.
Is there a new theme that can sort of replace debt or when you on the board think about sort of target Roe.
Do you are you are you considering a lower ROE target going forward. If there is no theme that can replace that distressed retail opportunity.
Obviously, that's been a theme for us.
The other things will pop up.
I would I would we've been pretty clear portfolio yields have remained pretty constant.
And I think ROE, our ROE are going to be.
At the high end of our <unk>.
When you think about the exceptional value proposition for <unk> shareholder.
I think what we said today was our average ROE vs a bit about.
Over time, I think about 12%, it's going to be it's going to be about 12, we think it's going to be 12% plus this year.
On a net investment income basis, obviously, there has been a.
<unk> uplift on a net income basis and on it.
Rate environment, that's 200 basis points less than what we've lived and we think there is that's it.
On a risk adjusted basis, we're actually doing more for.
For our shareholders and I don't think ROA target that move down I think we're doing more for our shareholders, that's a little bit of financial leverage but that's.
You know us being able to hold portfolio yields and so I think that.
This has been 1 of our and we will continue to be 1 of our best years, given the interest rate environment.
Great to provide value for our shareholders.
And you see that across not only the net investment income line, but the net income line and.
And how capital efficient we are.
I appreciate that Josh just 1 sort of more.
Housekeeping question I realize it's a small portion of the portfolio.
Could you review why you've invested in CLO debt instead of CLO equity given that CLO equity estimated yields are so much higher and their cash flows have been really exceptional.
Pretty much since the second half of last year.
Yeah.
I would say first of all CLO equity.
We invested in CLO debt I think in the middle of the of Covid, where there was.
Sure.
As you know, we don't try to lose capital, where there was a decent amount of uncertainty on defaults and recoveries and it wasn't clear that CLO equity is going to make the other side, we haven't added any new CLO debt positions in the book.
I think debt to your point that CLO equities.
Decent you know.
It has a decent value proposition at the moment.
Although is highly volatile and I would say as you know you've lived through.
And we've seen across the space. There is a significant difference between cash on cash returns and ultimate of ours and so current cash on cash returns and fill in is not only.
Our net interest margin, but if a if a return.
Not only return on capital return on capital when you look at a entire kind of life life 3 out of the CLO investment and so you know.
I wouldn't disagree that.
It's war.
At the time, where we made investments in infrastructure.
Structured credit Lan was and we haven't made it since COVID-19.
It was in a very different time with a whole bunch of especially around defaults and losses and given the nature of CLO equity is massively levered.
We didn't think it was appropriate for the for the for the BDC.
Okay I understand thats. It from me. This morning I appreciate your time. Thank you.
Yes.
Thank you and I'm showing no further questions at this time on I would like to turn the conference back over to Josh easterly for any further remarks.
Great. Thank you so much.
For People's interest in time, we look forward to chatting in the fall I hope people have easy and healthy.
Our rest of the summer and enjoy your labor day.
This concludes today's conference call. Thank you for participating you may now disconnect everyone have a great day.
Okay.
[music].
True.