Q4 2021 Sixth Street Specialty Lending Inc Earnings Call
Okay.
Good morning, and welcome to sixth Street Specialty lending, Inc. 's fourth quarter and fiscal year ended December 31, 2021 earnings conference call.
At this time all participants are in a listen only mode.
As a reminder, this conference is being recorded on Friday February 18th 2022.
I'll now turn the call over to MS. Suzanne Horne 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 materially from those in the forward looking statements as a result of a number of factors, including those described from time to time in <unk> specialty lending Inc filings with the with the Securities and exchange can.
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, 2021, and posted a presentation to the Investor resources section of our website Www Dot sixth Street specialty lending dot com.
The presentation should be reviewed in conjunction with our Form 10-K filed yesterday with the SEC fixed rate specialty lending Inc. 's earnings release is also available on our website under the Investor resources section unless noted otherwise all performance figures figures mentioned in today's prepared remarks are as of and for the fourth quarter and fiscal year ended December 30 <unk>.
<unk> 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 <unk> good morning, everyone and thank you for joining us with US today is my partner and our President Bo Stanley and our CFO , Ian Simmonds for our call today.
I will review, our full year and fourth quarter highlights and pass it over to Bo to discuss our origination originations activity and portfolio metrics.
We'll review our financial performance in more detail and I will conclude with final remarks before opening up the call to Q&A. After the market closed yesterday, we reported fourth quarter adjusted net investment income and adjusted net income per share of <unk> 57.
Respectively. This resulted in a full year adjusted net investment income per share of $2 16, or a return on equity of 13, 6% and our full year adjusted net income per share of $3 12, 312, or a return on equity of 19, 7%. These results were primarily driven by record levels of both.
Fundings and repayments, which helps us operate within target leverage levels throughout the year. We will also experience for me.
Previously meaningful activity driven income.
Quarter end, we had approximately <unk> 20 per share cumulative accrued capital gains incentive fees on the balance sheet and approximately 11 cents per share will be payable in cash for our entire portfolio.
Would it be realized after quarter end, Mark and normal course, the rest of the accrued fees are tied to unrealized gains from valuation of our debt investments inclusive of call protection, which if prepaid would require recognition of fees and investment income and.
And trigger a reversal of previously accrued capital gains incentive fees related to these investments in Q4, the impact of such reversals was <unk> <unk> per share. This was offset by a similar amount from realized and unrealized gains that are above our prior quarter valuation marks resulting in the reversal of less than one cents per share.
Accrued capital gains incentive fees on the balance sheet.
As we discussed in previous quarters throughout 2021, we've excluded accrued capital gains incentive fees at Mt amounts in the presentation of adjusted results on the basis that the expense accrual requirement for that and create some noise around the fundamental earnings power of our business.
As of December 31, 2021, the amount of capital gains incentive fees due to the advisor.
And cash was zero because of gains driving the fee accrual were unrealized.
Throughout 2021, we continue to focus on capital efficiency by distributing a record level of $3 59.
<unk> per share during the calendar year through a combination of our base supplemental and special dividends over that period, we've generated a total economic return to shareholders as measured by the change in net asset value per share plus dividends per share of 19, 1% exceeding our annual.
Our average annual economic return rates since IPO of 12, 9% through 2020.
These returns were primarily driven by the overhang of our base dividend through net investment income accretive capital market transactions and realized and unrealized gains on investments.
Yesterday, our board approved a base our base quarterly dividend of 40 <unk> per share to shareholders of record as of March 15 payable on April 18th Our board also declared a supplemental dividend of <unk> 11 per share related to our Q4 earnings to shareholders of record as of February 28 payable on March 31.
Our year end net asset value per share pro forma for the impact of the supplemental dividend that was declared yesterday is $16 73, and we estimate that our spillover income per share was approximately 42.
We would like to reiterate that our supplemental dividend policy is motivated in part by tax indirect distribution considerations and a goal of steadily building net asset value per share over time remains very much part of our philosophy.
The distribution of the special and supplemental dividend. This past year have significantly reduced our excise tax obligations generating an estimated annual savings of eight cents per share relative relative to retaining that capital with that I'll now pass it over to Bo to discuss this quarter's record investment activity.
Thanks, Josh I'd like to start by sharing some perspectives on the broader credit markets.
The record levels of activities, we experience through Q4.
The leveraged loan markets LCD first lien spreads ended the year 2009 basis points tighter than where they started the year.
Second lien spreads actually tightened to 197 basis points.
In Q4 first lien spreads saw widening of 12 basis points.
While second lien spreads tightened by 11 basis points.
In 2021, new leveraged loan issuance volumes reached a record level of 797 billion fueled.
Fueled by a new high of sponsor back middle market M&A volume.
55 billion in Q4 alone.
And gentlemen, general corporate M&A activity in part of product uncertainty from proposed tax changes.
That likely accelerated strategic plans on the part of business owners, given the robust valuation environment.
2021 side continued recovery seen play out for most risk assets.
Total return for the leveraged loan index in 2021 was up 5.5.
Five 2% up from three 1% in 2020.
Although 2021 return to robust the range of outcomes by sector. Once again divergent with cyclicals, such as energy responding most significantly.
In industries with high exposure to negative secular trends, such as radio and television weighing down the index.
Other sectors, such as equipment leasing.
Food services and products and drugs also experienced returns below index average given the impact of supply chain issues.
And staffing cost pressures that have been a hallmark of the inflationary environment.
Despite this default rates for leveraged credit generally are at historic lows.
These impacts meaning these impacts meaningfully <unk>, our approach to origination opportunities and reinforce our selective approach to teams and sectors.
Understanding the unit economics and cost structures are borrowers remains a core component in our ability to appropriately position our portfolio to be resilient through economic cycles.
Turning now to our investment activity as Josh mentioned earlier, we generated record levels of commitments and fundings and experienced a record level of repayment activity in Q4 2021.
As noted in our Q3 dollars 21 earnings release much.
Much of our investment activity was weighted towards the back half of 2021, and this continued with $835 million of commitments and $656 million of fundings during the final quarter.
Our deal volume in the fourth quarter spanned across 15, new and four existing portfolio companies.
We continue to invest across several themes, including software and services.
They're attractive revenue characteristics and high variable cost structures.
For the full year.
Commitment and funding levels exceeded our previous record high figures with $1 4 billion of commitments and $1 $1 billion of fundings.
Total repayments for the year were just over $1 billion.
Which meant the net portfolio growth of $113 million for the year.
To dive into further detail on our Q4 activity, we continue to focus on our specialized sector sub teams, including software and business services.
As we briefly mentioned last quarter, we agent hit a $975 million first lien loan to booming.
With a $379 million commitment and Opportunistically contributed $150 million equity co invest both parts of the capital structure of being alongside affiliated sixth Street funds.
<unk> high quality scaled recurring revenue base.
With attractive retention characteristics.
Follows our thematic approach to investing in industries, where we have deep understanding and expertise.
Other investments in this space during the quarter included information clearinghouse.
Several of our upsize as two existing portfolio companies, including higher logic require quest and panel software.
Outside of software and services, our dedicated team of resources provides us the opportunity to diversify our portfolio by investing in other core areas of expertise.
We expanded our retail ABL exposure during the quarter through $300 million first lien term loan to price chopper supermarket.
To facilitate a merger with tops markets, which closed in October .
As agent, we committed $200 million across sixth street, including $75 million through TSA lax and syndicated a portion to a third party generating a syndication fee of more than <unk> <unk> per share.
We also leveraged the sixth street platform by working alongside our dedicated energy team to originate a direct to issuer $275 million first lien term loan to TRP energy during the quarter.
While we remain opportunistic to our exposure in the energy sector.
This investment presented an attractive risk adjusted return at the top of the capital structure.
And an opportunity to deploy capital in the most actively developed basin in the U S with low breakeven drilling inventory.
At year end, our exposure to the energy sector represented three 7% of our portfolio at fair value.
In addition to macroeconomic factors, we attribute a meaningful portion of our elevated deal activity during the quarter to relationships with borrowers and sponsors that we've built over the years.
During the quarter, we leveraged our existing relationship through our commitment to pay job <unk> was an existing portfolio company before our investment in Q4 and were able to benefit from the relationship to agent $190 million senior secured credit facility with speed and certainty of execution.
Excluding upsize is 28% of aggregate commitments during the course of the.
Quarter resulted from previous or existing portfolio companies.
Turning to the repayment side, we had a record activity in Q4 with 10, 4% and five partial portfolio repayments totaling $528 million.
Net portfolio growth for the quarter was $129 million.
This robust level of repayment activity driven largely by M&A transactions during the fourth quarter resulted in a combination to net investment income from activity related fees of <unk> 19 per share.
The <unk> 19 per share 11 was.
It was driven by accelerated OID in <unk> was driven by prepayment fees.
To highlight one of our largest.
Payoffs during the quarter Jcpenney repaid the outstanding balance on its $300 million asset based FILO term loan with call protection, resulting in a 14, 5% IRR.
We believe our retail ABL strategy continues to be a core strength of ours as we've now generated a gross IRR of 24% on fully realized retail ABL investments.
In addition to the ABL FILO Jcpenney also repaid the outstanding balance of its $519 million exit term loan during the quarter.
As a reminder, in connection with Jcpenney emergence from bankruptcy in December of 2020.
Our pre petition term loan and notes were converted to non interest paying instruments with rights to immediate and future distributions and cash and other instruments, including the term loan as.
As well as the earn out co and propco interests.
From the ABL FILO, we have generated a 32, 6% IRR and a 1.36 X MLM from the combined impact of our Jcpenney Securities.
As of December 31, 2021 investments in our retail ABL strategy comprise approximately seven 2% our investment portfolio at fair value.
Consistent with our investment philosophy in prior quarters, we have been selectively making equity co investments alongside our debt positions such as our investment improvement Boomy as previously mentioned.
During the quarter, we generated $22 $4 million of realized gains.
On our equity investments, primarily in <unk> modus risk connect in the EMS links these.
These positions generated an average MLM of approximately five <unk> based on our capital invested.
From a portfolio yield perspective funding and repayment activity. This quarter had a slight positive impact to our weighted average yield on debt and income producing securities at amortized cost.
Yield remained flat at 10, 2% quarter over quarter.
And is on par with what it was a year ago.
The weighted average yield at amortized cost on new investments, including upsides as this quarter was nine 8% compared to a yield of nine 6% on exited investments.
Our ability to maintain these yield metrics reflects our continued selectivity and origination approach across teams and sectors.
Moving onto the portfolio of composition and credit staff this quarter, our portfolio equity concentration came down slightly to 6% on a fair value basis from 7% in Q3.
About two percentage points from a year ago.
The year over year increase is primarily driven by the increase in fair value of our existing equity positions given net new fundings in equity positions during the year were relatively flat.
Across our core borrower from whom these metrics are irrelevant, we continue to have conservative weighted average attach and detach points.
Of 1.0 times at four five times, respectively with a weighted average interest coverage remained relatively stable at 3.0 times.
As of Q4 2021, the weighted average revenue and EBIT of our core portfolio companies was $114 million and $32 million respectively.
Finally, the performance waiting of our portfolio continues to be strong with a weighted average rating of 113 on a scale of one to five with one being the strongest.
Continue to have minimal non accruals that less than 0.0% to 1% of the portfolio at fair value across two portfolio of companies.
With that I'd like to turn it over to Ian to cover our financial performance in more detail.
Thank you Bo as Josh and Bo mentioned, we finished the year with a strong quarter from an earnings and investment activity perspective in Q4, we generated net investment income per share of <unk> 63, resulting in full year net investment income per share of $1 97.
Q4, net income per share was <unk> 57.
<unk> in full year net income per share of $2 93.
As Josh noted, we accrued <unk> 19 per share of capital gains incentive fees in 2021. However, none of this amount was payable at year end.
Excluding the <unk> 19 per share that was accrued this year, our adjusted net investment income and adjusted net income per share for the year with $2 16, and $3 12, respectively.
At year end, we had total investments of $2 5 billion total debt outstanding of $1 2 billion and net assets of $1 3 billion or $16 84 per share which is prior to the impact of the supplemental dividend that was declared yesterday.
Following this quarter's net funding activity, our ending debt to equity ratio was <unk> 95 times up from <unk> nine times in the prior quarter.
However, due to the quarter end timing on a number of fundings our average debt to equity ratio decreased slightly from 1.01 times to <unk> 99 times quarter over quarter.
For full year 2021, our average debt to equity ratio was one times up from <unk> 91 times in 2020 and well within our previously.
<unk> target range of <unk> nine to 125 times.
Our liquidity position remains robust with $1 2 billion of unfunded revolver capacity at year end against the $156 million of unfunded portfolio company commitments eligible to be drawn.
Year end funding mix was represented by 74% unsecured debt and our weighted average remaining life of that funding with three six years compared to a weighted average remaining lots of investments funded by debt of only two four years.
System with our historical cadence, we expect to amend our existing credit facility in early 2022.
Looking across our debt maturities, we have approximately $100 million remaining principal value of 2022 convertible notes that will mature in August of this year.
Similar to our approach on the Italy conversion on a portion of these notes last year in accordance with the requirements under the indenture, we announced the holders earlier this year that we will be settling our 2022 converts with primarily stock and a small portion of cash creating an equity issuance in Q3 22 related to the remaining principal outstanding.
Ending.
We would expect the conversion to be marginally accretive to NAV per share at the time of conversion. We will continue to assess the impact of the settlement of the convert on our leverage and return profile and look for ways to optimize Roe.
Through the same tools, we've used in the past, including through the use of special dividends.
Given the interest rates are clearly top of mind for many of our constituents I would like to hit on the Feds latest guidance specifically the expectation for the forward yield curve.
At the time of our Q3 'twenty one earnings call in November last year.
Didn't expect reference rates to reach the average flow levels of our debt investments until Q4 of 2023.
We now expect reference rates to return to our average floor level of 1.08% during Q2 of this year.
Given that 98, 9% of our debt investments are floating rate in nature and 53% of our portfolio is funded with equity.
Rising rate environment provides an earnings tailwind for our business once we retail average floors to.
To give an illustrative example of the impact once we reach out flows assuming our balance sheet remains constant as of Q4 'twenty one.
For every 100 basis points increase in rates, we would expect approximately <unk> 14 per share of uplift to annual net interest income.
Again in a rising rate environment, the sooner rates rise through our flaws. The sooner we will benefit from this positive asset sensitivity of our matched floating rate exposures.
To the extent expected rate rises take longer to reach our floors, we anticipate a potential negative impact to net interest income.
Moving to our presentation materials Slide 10 contains this quarter's AAV bridge.
Walking through the main drivers of NAV growth, we added 63 per share from net investment income against a base dividend of <unk> 41 per share.
There was a 40 <unk> per share reduction to AAV, primarily from the reversal of net unrealized gains on our equity positions as we book these gains as realized upon sale.
There were minor impacts from changes in credit spreads on the valuation of our portfolio and there was a positive <unk> <unk> per share impact from the early conversion of a portion of our convertible notes and the impact from our dividend reinvestment plan.
And finally.
There was a 39 per share positive impact from other changes primarily realized gains on investments of 31 per share.
A large portion of this was driven by our investments in NIM text modus risk connect and EMS link as Billy mentioned earlier.
Slide 11 contains an NAV bridge for full year 2021 for your further reference.
Moving onto our operating results detailed on slide 12 total investment income for the quarter was $78 3 million up 10% compared to $71 2 million in the prior quarter walking through the components of income interest and dividend income was $61 8 million up slightly from the prior quarter other fees representing prepaid.
<unk> fees and accelerated amortization of upfront fees from unscheduled paydowns were $14 million up from $10 million in the prior quarter due to higher portfolio repayment activity.
Other income was $2 6 million up from $1 8 million in the prior quarter.
Net expenses, excluding the impact of the noncash accrual related to capital gains incentive fees with $32 5 million up slightly from $31 2 million in the prior quarter. This was primarily due to higher incentive fees from this quarter's over earning there.
There was no waiver of management fees during Q4 given.
Quarter was below the one times threshold.
As Josh mentioned during the year, we've generated a return on equity on adjusted net investment income of $13, 6% per year of record fundings that were met with heavy repayment activity. We managed to increase our average financial leverage year over year to one times and we exceeded our full year 2021, beginning year.
ROE on adjusted net investment income target of 12% or $1 19 per share.
Further net realized and unrealized gains on our investments contributed to our record high ROE on adjusted net income of 19, 7% for 2021 compared to 15, 9% in 2020.
As we look ahead to 2022 based on our expectation for net asset level yields the movement in reference rates cost of funds and financial leverage we expect to target a return on equity of 11% to 11, 5% using our year end book value per share of $16 73, which is adjusted to.
To include the impact of our Q4 supplemental dividend. This corresponds to a range of $1 84 to $1 92 for full year 2022, adjusted net investment income per share.
With that I'd like to turn it back to Josh for concluding remarks.
Before we conclude I'd like to reflect on the performance of the business beginning with the onset of the global pandemic almost two years ago from today clearly the pandemic imposed on all of us and environment that we had not previously experienced creating for a period in time when the most challenging test of our business.
<unk> of our business have seen to date, the immediate and uncertain economic downturn beginning in Q1, 'twenty 'twenty was a true test for the resilience of our business and the principles for which we operate under.
In 2020, we sought to communicate our framework of managing an inherently fragile asset base by building a business model and developing principles to mitigate volatility and uncertainty. These elements included investing in high quality sectors with a selective approach to financial sponsors and management teams building anti fragility.
On the right hand side of our balance sheet by swapping our fixed rate liabilities into floating rate pain for the auction on liquidity and maintaining our leverage level well below regulatory limits.
Our goal through any market dislocation.
Vision ourselves such that we not only survived the volatility uncertainty, but grow and create value looking back. We believe we accomplished this goal, allowing us to play offense in a time of dislocation.
Over the past two years, we have experienced.
We're extremely proud to note that we have generated an average annual economic return for our shareholders of 17, 5% well above industry level returns above our average annual economic return to shareholders since IPO prior to that time period of 12, 2%. We believe our performance highlights the successful application of our.
Our framework and principles.
For avid readers of our presentation, we added a new page to our earnings presentation for today's call, which highlighted the consistency and resilience of our returns since we completed our IPO almost eight years ago.
Slide five presents key return metrics measured on both a return on equity basis that is using adjusted net income that's a numerator as well as on an economic perspective, which calculates move in net asset value per share plus dividends.
I've already highlighted our performance, but also wanted to emphasize how strong our returns were during that period with calendar year.
Adjusted return on equity of 15, 9% and 19, 7% for 2020 one respectively.
And while our BDC peers have reported to date.
That have reported date generally appear to have provided solid returns for the calendar year 2021 that is it is coming off a particularly weak prior year, where the average return on equity for our peer set was less than 1%.
The ability to manage our business through the course of an economic cycle remains a key differentiator of how we deliver returns to our shareholders.
<unk> already provided guidance on expectations for financial performance in 2022, but to add some more color to his comments, we remain constructive on the opportunity set ahead of US we continue to experience limited yield compression in our assets and we expect credit losses to remain low given our investment selection.
Discipline, and the health of our existing portfolio and while we begin the year with significantly.
We began the year with significant liquidity and capacity to drive incremental return on equity through financial leverage given with the low end of our target leverage ratio.
In closing I wanted to call out how excited we are at the prospect of returned to a more normalized post COVID-19 environment as we head deeper into 2022 from a work environment perspective, the fifth Street team officially returned to the office earlier this year and in the case of New York New York.
The case of our New York Office and new premise.
And it's extremely motivating for me to see everyone again in person to my colleagues and our partners and our business internal external we look forward to enjoying 2022 together in person with that thank you for your time to time today operator. Please open the line for questions.
Operator.
Thank you.
I'll ask a question you will need to press star one of your telephone to withdraw your question press the pound key please standby, while we compile the Q&A roster.
Our first question comes from Finian O'shea with Wells Fargo Securities. Your line is open.
Hi, everyone. Good morning.
Ed.
Josh on the on the outlook for earnings.
You touched on higher.
Higher average leverage by helping you more recently this year and such.
Can you talk about the outlook too to keep running at these levels. If your origination footprint has grown or if it's the overall.
Private market activity lifting things up here.
Hey, thanks.
Regardless of the questions people can hop in.
Efficient and Ian Bruce look our outlook on earnings just to hit it.
When you look back historically I think.
I recently did this our outlook on earnings on a return on equity basis, or basically the same outlook, which would be kind of year end and year out since we went public in 2015 years, something which has ranged between 10 and a half.
11, 5% to 12% so I think our outlook on earnings.
The same.
Two cross wind I would say is one is that a little bit higher leverage than historically, but obviously, a very low much lower base rate interest rate environment. So on a kind of a risk adjusted basis.
Compared to risk free were actually earning a higher return on equity.
We have.
As it relates to the prospects of a little bit of higher leverage.
Our origination footprint trip ethics. She is most definitely increased.
Significantly.
And you saw that with this was I think our highest origination year ever with over $1 billion origination.
With rate increasing by a little bit my guesses activity will be a low less than portfolio turnover will be a little less so.
And the final comment that Phil.
Constructive on the <unk>.
<unk>, given we have a whole bunch of excess capital we have excess liquidity, we can lag and the leverage the investment environment.
We have a little bit less portfolio turnover.
And given that we don't drive our economics to originate new origination activities.
But I think there'll be a little bit more.
<unk> to hold leverage in.
We will be able to drive returns that way with less portfolio leverage given the environment Bo or fish when do you have anything to add or Ian.
Yes.
But we remain constructive on the opportunity set I agree with Josh we'd expect last.
Last year was a very robust M&A environment, we expect it to be fairly robust this year, but probably not on par given the interest rate environment, but we remain constructive on the opportunity set the deals that we're seeing.
Yes.
Okay. Thanks, that's helpful and as a follow up.
Is there any change in the cadence on on front end front and leverage and can you remind us I think historically, that's that's employed on about half of the portfolio names.
Yeah, I'll give you the exact number of what percentage our attachment point that you look at our attachment point, which will really matter.
Really havent change has gone from I think.
Shortly to range between 0.5 on an EBITDA basis as an attachment point. The one I think we're in that range of <unk> five to one.
Closer to one now, but I think our attachment point, we really havent changed.
And we will come back on the percentage, but I think it's relatively similar.
Which is.
What percent of our portfolio has some leverage but on a risk basis, our attachment points really haven't changed.
Okay. Thanks, so much.
Thanks, Tony.
Thank you. Our next question comes from Kevin unfolds with JMP. Your line is open.
Hi, good morning, and thank you for taking my questions.
The portfolio weighted average EBITDA was $32 million this quarter, which has been trending down in recent quarters. Just curious if that's driven by finding more attractive opportunities are smaller borrowers or if it's being driven by something else that you could possibly shuttle item.
Yeah, Hey, Kevin I think good question I think it's it depends on.
I think last quarter. It was $37 million. If you look back in 2019 and was $33 million in 2018 and was $31 million in 2017 of the $25 million. So I think it's kind of in the range.
It also depends on what's in that.
Core number.
And the core numbers, usually typically I think Ian between 75, and 85% of the portfolio.
For example, we did one second lien this quarter, which which at a much larger EBITDA that wasn't included in that so it kind of it kind of moves around quarter to quarter, but I think it's quite frankly.
Have not changed your strategy one bit.
Quality same sized companies for the most part.
<unk>.
Same margin profile.
So the underwriting really hasnt changed.
I want to get caught up in the quarter to quarter stuff. It because it's a function of what's in the core number without the core number.
And it's kind of been in the historical range.
Okay. Thanks, Josh that's helpful. And then just one follow up to 2021 was clearly a incredibly strong year for deployment and portfolio growth can you talk about your expectation for the pace of investment portfolio growth in 2022.
Sure I think what we've modeled is it's interesting when you think about the economics around our business.
Well, if we add.
Yes.
If we add asset.
We generate higher return on equity because of financial leverage.
We have more port portfolio turnover.
And we don't are not unable to grow assets, we generate more economic from activity based fees such as accelerated OID given that we all have our OID or original issue discount is.
Not taking upfront, but it's deferred.
Prepayments and some prepayments fees.
So how.
How we've modeled it we don't really know what environment. We're in how we think about the world is probably a couple hundred million dollars of net portfolio growth.
We've modeled but again.
The confidence level of the returns or are pretty tight because.
Unless we have a environment like we did this past year, where you have kind of origination activities.
And eight kind of.
Repayments and so you've kind of got the benefit of both you've got the benefit of a little bit of higher leverage and the benefit of activity level fees Thats, what causes breakout years, but I think we're pretty confident in our level of returns this quarter. This year.
Great. That's helpful color and then I'll leave it there congratulations on a really nice quarter.
Thanks.
Our next question comes from Melissa Wedel with Jpmorgan. Your line is open.
Good morning, everyone. I appreciate you taking my questions today.
Many of them have actually been asked already so hoping that we could turn to a couple of new investment.
And it looks like in the human resources space. There were a few new holdings with bad I'm looking at this right employment Youre holding compliant payroll media.
I was hoping we could walk through those briefly and maybe you could talk about the opportunity there.
The resilience of those businesses.
Yes, I'll turn it over to Bo just one caveat.
Thanks for that question.
They are typically software businesses that are better.
Support human resources activities on the <unk> basis. So Bo you can you can you can get into it I think.
My guess is it employment hero is one and my guess is it's page up is another.
Yes.
I think thats exactly right prompt pay would be tangential, so thats a sector that we've been quite active in over the past decade, obviously.
Businesses continue to digitalize and manage their businesses HRS, an important function for back offices of these businesses, including employment hero.
Which is an Australian based company, who really help.
Really help with the Onboarding and the hiring and tracking of employees through the system with a very tight labor market.
Imperative at this.
Companies do this.
Sure.
And in a fashion that is.
More constructive in the past.
So again, the fact that we really like.
It relates to employment hero.
Low Levered security with high high return on invested capital.
And.
And really good retention rates. So that's really where we're focused on these it really become mission critical functions.
For the human resources Department, and again highlighted in an environment, where a tight labor market is really important for people to be agile with.
With their technology solution, so that was across all of those investments.
That we made this quarter.
Okay, Thanks for that and as a follow up.
Just get an update on American achievement.
It looks like maybe that was had a little bit of a mark down further in the fourth quarter. Thank you yes. Thanks.
I think American cheap, it's a relatively small position for us.
The Covid impact the name I think it's like 18 million Bucks I think thats right.
Somebody will correct me if I'm wrong.
In the yearbook classroom Catherine gallons business, obviously the method they missed the selling season.
In 2020.
2021 should be better.
The good news is the industry structure is pretty good there is a couple of players.
So.
Our expectation and hope.
It would rebound.
Around pre Covid numbers.
But it's obviously been a.
Covid impacted mean.
As with.
With the seasonal overlays.
A challenge, but a relatively small position for us.
Thanks, Josh.
Thank you. Our next question comes from Kenneth Lee with RBC capital markets. Your line is open.
Hi, good morning, and thanks for taking my question I.
I'm wondering if you could just share with us any updated thoughts around opportunities for more junior capital structure investment.
Based upon equity co investments in the prepared remarks, just wanted to see what the opportunities are over the near term. Thanks.
Yes, we've always said, we're going to be opportunistic and down the capital structure of investments we've made.
Probably a pure second lien investment a long time.
This past quarter.
Software name once we were very well that came along with an equity co invest.
We've had a great track record on our equity co invest.
The program I think Paul mentioned I think realized investments this quarter was like five times, our money unrealized equity co invest so we will continue to be opportunistic.
The environment is quite frankly, obviously.
And interest environment, which is.
Valuations have come off people might think thats, an opportunity people might think that the risk.
On high quality businesses, we probably I think that's an opportunity.
And.
The interest rate environment. So, we'll keep focused on what we do which is invest in high quality businesses that can pass along.
<unk>.
To pass on pricing to their customers.
But we'll be opportunistic up though any comments.
The only thing I would say that if you look at the equity co invest levels over time that it really hasnt changed we've always kind of picked our spots.
And made investments, particularly in areas that we had strong kind of thematic views.
No.
We thought could be supplementary to our returns on the debt piece, but.
That level of activity really has not changed over time, we will continue to be opportunistic and again focus on those opportunities where they are available to us.
Sector themes that we've been following and feel like we have a real view on.
Great that's very helpful.
Just one follow up if I may.
Okay.
On the liability side, especially.
Text of potentially rising rate environment I'm wondering if you could talk about.
How you see the funding mix or position and whether there could be any potential changes around that over the near term. Thanks.
Yes.
Starting to need to pick up but we've always had this view we have.
We matched under assets with our liabilities.
Which is in a rising rate environment, our portfolio generates more income.
Half our book is funded effectively with fixed rate liabilities in the form of equity they have a fixed rate dividend profile the payout ratio should increase on that but.
But we don't we don't make a real directional calling rates outside of that outside of how we're positioned given the nature of our book on the equity side and so.
We've always swapped our liabilities.
We will continue to probably will continue most definitely swap our liabilities that's because of the down in the down case. What you saw in 2020, we actually had net interest margin expansion at the time that we had the whole industry has some risk of increasing credit cost and so you don't.
I want to have a fixed rate liability profile, where.
Sure.
In an economic downturn rates go to zero you have less income off of your book.
Net interest margin basis, less credit cost is even worse.
So we will probably keep our profile exactly the same and there is obviously asset sensitivity and the nature of our book given.
The floating rate nature of our assets.
You can add there no. The only thing I would add is we've committed to the investment grade market and we've done a pretty deliberate job moving our funding profile and the funding mix more towards the unsecured.
Todd.
The opportunities there over the last four years.
And we like that market and I think we can be efficient and issuing into that but we still have the flexibility of having capacity.
In our existing revolver and that's why we highlight the capacity that we built up over the last two years, but it's still going to be a mix, but I think the mix that you see today of about 75% unsecured is pretty good guidance.
Yes.
The only thing I will the last thing I'll add is look at what we do well.
Underwriting idiosyncratic credits and making investments in corporates and capital structure, and obviously macro is a little piece of do with that but mostly we think of ourselves as kind of on a.
It's a chronic basis.
Picking.
Being a directional call rate is something that we really don't do.
So it doesn't.
And our deep core set.
I think.
Historically competing against central governments.
Hum.
And policymakers I think it's a tough business.
Got you great. That's very helpful. Thanks again.
Yes.
Thank you. Our next question comes from Ryan Lynch with <unk>. Your line is open.
Hey, good morning, Josh.
Congrats on the nice quarter and really nice 2021.
I wanted to touch on some of your commentary around market activity and kind of outlook of pipeline for originations.
Just because in 2021 that was such a robust year sort of won on all sides from our portfolio.
Activity standpoint for you and the overall market, but as we turn into 2022. It will take a lot of those tailwind can pent up demand, it's probably somewhat diminish and then you have that coupled with rising rates, which could pressure valuations for some of the sponsor backed business, which I think would make.
Less willing to transact at your business.
You guys.
Have a little bit more of a specialty lending business you do some other things, but I am just curious from.
From a pipeline standpoint, what are you guys seeing as far as outlook as far as the pipeline and potential to grow the portfolio in 2022.
Thanks, Brian .
Most of that I think it.
It depends on what line of business you are talking about quite frankly so.
When you think about we have multiple lines of businesses, we have kind of the sponsor business. The non sponsor business. We obviously do some things that are I call in late two and three which are <unk>.
Or more kind of opportunistic lending with good companies and bad balance sheets are bad companies in that business model is a good asset, but good assets our ABL.
If we have a pretty well rounded breadth and what we do.
My guess is given the valuation environment companies that used to raise equity high valuation for example, we're probably not going to raise equity.
It's about to fund their business. So that's probably the lower valuation environment, probably probably pretty bullish for activity.
I think I just saw an article right now where there's large players in the later stage growth business.
On the equity side, who kind of.
Taking a step back and so I think that.
It's helpful to our business I think the buyout and kind of.
M&A.
It's probably going to be actually is going to be less.
But overall I think we have a pretty broad base originations platform and what I would say is our.
Ability to grow.
Can't look at gross originations you have to look on a net basis because of net.
Plenty to what drives economics.
I would also think one of the actual tailwind we have in our business is probably going to be less portfolio turnover and so I feel pretty comfortable about.
The broad range of our skills across different kind of kinds of deals and what that means.
That you don't have the tailwind it'd probably such a robust M&A activity, but you probably don't have the amount of turnover in your portfolio. So.
Most definitely feels like we'll be able to.
Grow the book on a net basis and we're seeing interesting things in this quarter for sure. So yeah. We've got a handful of interesting things that we're working on a kind of a normal environment. In Q1, we are rebuilding the pipeline from an M&A perspective, I agree with everything Josh had which is if you look at historically over time, we've generally had.
Two thirds.
One third ratio of sponsored non sponsored deals as we have other core sectors.
Such as retail and pharma royalty energy.
Go direct the company quite often having that diversified.
Diversified stream of pipeline opportunities has helped us over time go through cycles, where there is less M&A.
Would agree with you we were probably going to see less M&A. This year. That's that's what we're forecasting. However, I think we do have a large portfolio that are still going to do add ons, you'll have the ability to grow the existing portfolio from there and then adjustments and lastly kind of a late stage asset growth businesses, we have raised equity.
Any capital Thats been very cheap over the last couple of years, that's going to become more difficult and they're going to have to look to other solutions such as private solutions to continue to their fund their businesses, which still have a pretty robust unit economics in this environment.
Okay, that's really helpful color.
Kind of on that point, you guys as you kind of look throughout the year.
You guys have a pretty meaningful deleveraging event coming along in the third quarter as you guys mentioned.
The exact math, probably hasn't been decided ITG combination of cash and stock that probably mostly stock with the convert.
I guess is it the intention to try to grow leverage kind of indicate that a bad debt deleveraging event and does you guys co investment policy would that allow you to potentially pull more at <unk>.
Versus some of the other funds or a bigger allocation then you would maybe normally taken knowing that that abandoned kind of on the horizon.
Yes, great question.
It's a great question. So you are talking about the the equity steadily convert with the $100 million roughly I don't know if that's outstanding that's right. So what I would say is yes, obviously, we're not talking about raising equity going forward.
We plan to we have the ability.
On a run.
Average higher.
What I would say on the co investment side, the first stop for kind of middle market specialty and lending has always been <unk> and so we don't have we determined.
Sure.
Our position sizing by risk tolerance, and what's needed and what needs. The needs are for the business and so that's definitely a lever. We also lever, which we've used historically is we still have 42 or something like that spillover income and so we can effectively manage economic.
The leverage in the business and the economics through through special dividends.
And so either we're going to grow the book.
And we're going to be in our target leverage ratio, we're taking on the additional $100 million of equity or.
Theres, obviously a valve.
Create leverage or economic leverage in the book.
Through return of capital.
Which was historically a return on capital that we just have been flushed out.
Okay.
Understood makes sense I appreciate the time this morning.
Thanks, Brian .
Okay.
Thank you as a reminder, if you wish to ask a question at this time. Please press Star then one on your Touchstone telephone.
Our next question comes from Robert Dodd with Raymond James Your line is open.
Hi, everyone. Congratulations on the quarter on 2021, and frankly on having a six year track record with the lowest style that we have generated an 11, 6%, which kind of brings me to my question. So how much should.
Should we have.
In your guidance of 11% to 11 in the past when the only time it hasn't been that low.
2014, 2015, when you are.
Under Levered in that onetime expenses. So can you walk us through a little bit what are the assumptions.
That lead to the lowest expected although we.
<unk> is for the business.
It's a great question Robert I think we've had the exact same guidance every year.
Thank you.
Yeah.
And why what you want on that but we've had the exact same guidance.
Obviously, the 11% 11, five rovs are harder in a lower interest rate environment.
Actually provided.
A more significant value proposition to our shareholders given.
The rate environment, what I would say is when you look at activity level income. So we can model our business and those are with very low activity.
The activity level of income.
So I'm going to I'll talk about last year's guidance.
And.
And what we had modeled and people do correct me if I'm wrong last year, we modeled only about <unk> 18 per share.
So if you look at back.
ROE is last year. It was in that same range of 11% to 12%.
And that and that was about <unk> <unk> per share and accelerated OID and prepayment fees.
And another 10 cents and amendment fees and other income.
Relatively call it 2008.
Per share.
Non pure interest income okay.
How the year ended up and I'm doing this math in my roughly.
Yeah.
At $58 ended up about 58 per share.
And those categories and so.
So when you historically look back just to put it out there I think our lowest year with those levels.
Sure.
In 2016, which was their team and business line.
Maybe 26.
For sure. So we tend to model very conservative levels.
Attribution from noninterest income, which is which is why we.
Which is why we've always said given our ROA range, where it is and which is all we beat it so the way the way I kind of think about it by the way. This is what's created the spillover income which is when you model the business with credit losses, when you set the ball very low.
And.
There's multiple levers to exceed the bar.
You turned up you can that be more often than not and so that's kind of how philosophically. We think we have thought about the business among the business, which was modeled conservatively.
Credit credit loss or credit cost perspective from an activity level perspective, and then.
Communicate that and that's what's historically driven the beads.
Got it got it I appreciate that.
You do intend to let's see the guidance Scott.
One on the just.
The other topic structuring.
All structures available in the market right now I mean, you have tended to focus on ensuring that you have call protection in your structures. It certainly look it's a very competitive market out there.
Nope.
Yes, it certainly looks.
The figures on page five of the presentation that you're still.
Right.
Able to structure those deals kind of at the same way with a lot of.
Potential call protection still in them.
Do you expect that to.
To change in terms of if the market remains competitive.
So, let's see disruption with that kind of potential embedded fee income.
Going to persist or do you think that's going to win.
Next year.
Look obviously environments that are more competitive I mean, I think we do a pretty good job. When you look at I think about 90% of our book has.
Yes.
Alright, I think 90% of our book.
We have some call protection.
I'll come back on the exact number of call protection.
On the book, but we still have a significant amount of call protection in the book. So what I would say is we focus on areas, where we can add value to clients.
Where we were in industries that we know where we tend to get the last look.
Some of the first some of what we sell off revolvers and some.
First I'll start with <unk>.
<unk> two we most definitely that helps on the how efficient our capitals and what call protection. We can what we can track about 85% of our book has corporate section today 85, 2% I think that's consistent with historically.
It's just when you look at the corollary or the analogy, which is portfolio yields I think portfolio yields.
In a relatively competitive environment.
Up.
On a vintage by vintage basis so.
<unk>.
Bo do you have anything to add now.
I'd say, it's been an intensely competitive environment over the last two to three years, we have not seen an acceleration of that over the last three to four quarters. It's remained intensely competitive we haven't seen you start changing and deal terms, our ability to get call protection and other features.
Such as covenants that protect us and our investors.
That has not changed we continue to pick our spots generally play an area that we're bringing more to the table than just capital have some expertise can provide certainty and that allows us to.
Be a value add and it gets to some.
Some of these call features that we think are important part.
Fixed income book, Yes, let me I'll point, you to one place in the earnings deck that I think that was helpful to quantify that which is on page eight of the earnings presentation, we lay out which is the fair value.
As a percentage of call price, so that kind of gives you.
An estimate of how much upside in the book if it gets called away I think the fair value of <unk> 95, 2% of the call price of our book. It was 96, 7% last quarter. So there's actually more kind of embedded economics in the book and that range from 94.
6% a year ago and this is.
95, 2% today so.
Kind of in the range.
Yes.
That was the number that's actually the thing till my paycheck to paycheck.
The point.
Key to this quarter versus last quarter, we had now in this competitive environment I mean.
Jim.
The mix issue because call protection is a declining asset until theres been portfolio turnover.
More new vintage stuff as a higher percentage of our book, which you would expect has more call protection so that.
That that's the benefit of that.
The kind of a mix issue.
Got it got it thank you.
Thank you and I'm currently further questions at this time I'd like to turn the call back over to Josh easterly for closing remarks, great.
Hey, I wanted to come back defense question, because since I had a question on the first out this range and first out last out makes its range between.
It's hover between 40 $60 $60 40 on either side and we're kind of exactly in that range. Today I think it's 43% from first pure personally is that 50% last outside.
<unk> been historically right in that mix. So I don't think Thats change I wanted to come back as we can.
Doug around and found the answer.
Yeah.
For me 2021 was a great year for <unk> and the direct lending business I actually think 2020 was a better year just to put it out there.
So.
Because we're able to generate significant returns across both cycle.
Both environments.
Very proud of the team.
Look forward to seeing people in the spring.
Hope people enjoy their presence day weekend.
This is the first time, we've had our earnings call before Presidents' day weekend, So I hope people enjoy the President's day weekend.
We will take full for the support and.
Ian can me and Mike and Bo we're available for follow up thanks, so much thanks everybody.
This concludes today's conference call. Thank you for participating you may now disconnect.
Yeah.
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Okay.
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