Q1 2022 Sixth Street Specialty Lending Inc Earnings Call

May 4, 2022

Ladies and gentlemen, todays conference is scheduled to begin shortly please continue to standby. Thank you for your patience.

[music].

Ladies and gentlemen, thank you for standing by and welcome to the sixth Street Specialty lending Inc. Q1, 2022 earnings conference call. At this time all participants are in a listen only mode. After the speaker presentation. There will be a question and answer session to ask a question. During the session you will need to press star one on your.

Your telephone please be advised that today's conference is being recorded.

Any further assistance. Please press star Zero I would now like to hand, the conference over to your Speaker Ms. <unk> Van Horne head of Investor Relations. Please go ahead.

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 guarantee.

The future performance or results and involve a number of risks and uncertainties actual results may differ materially from those in the forward looking statements as a result of a number of factors, including those described from time to time in fixed or specialty lending Inc. Filings with the Securities and Exchange Commission.

Company assumes no obligation to update any such forward looking statements.

Yesterday after the market closed we issued our earnings press release for the first quarter ended March 31, 2022, and posted a presentation to the Investor resources section of our website Www Dot fifth Street specialty lending dot com. The presentation should be reviewed in conjunction with our Form 10-Q filed yesterday with the SEC specialties.

Specialty lending Inc. 's earnings press release is also available on our website under the Investor Resources section unless noted otherwise all performance figures mentioned in today's prepared remarks are as of and for the first quarter ended March 31 2022.

As a reminder, this call is being recorded for replay purposes, I will now turn the call over to Joshua easterly Chief Executive Officer of Fifth Street Specialty lending Inc.

Thank you good morning, everyone and thank you for joining us with US today is my partner.

Kelly CFO .

For our call today I'll provide some highlights of this quarter's results.

We're about to discuss this quarter's origination activity and portfolio.

I'll review quarterly.

These results in more detail now final remarks before opening the call to Q&A.

After market closed yesterday, we reported first quarter financial results with adjusted net investment income per share for you guys.

Responding to the annualized return on equity of 11, 6% adjusted net income per share at <unk> 56.

Corresponded to an annualized return on equity of 13, 2%.

As discussed in previous quarters at quarter end, we had approximately 21 cents per share cumulative accrued capital gains incentive fees on our balance sheet and approximately <unk> <unk> per share of this amount will be payable in cash if our entire portfolio would be realized as of quarter end market Mark in normal course.

Remainder of the accrued fees are tied to unrealized gains the valuation of our debt is expenses inclusive of call protection, which would you prepay would recognize require recognition of fees and investment income and trigger a reversal of previously accrued capital gains incentive fees related to that.

Mrs.

This non cash expense, which was not paid or payable was approximately <unk> <unk> per share for Q1.

40 perspective, our Q1 net investment income and net income per share inclusive of accrued.

Accrued capital gains incentive fee expenses of 47% to 54% respectively.

This quarter's net investment income reflects continued strength in our core earnings power of our portfolio above the guidance.

We provided on our last earnings call net investment income was supported by fee income from portfolio activity.

Interest and dividend income levels driven by sustained portfolio.

The difference between this quarter's net investment income and net income was the result of net unrealized gains primarily from portfolio companies specific events.

Looking ahead, we are facing an operating environment, which has changed significantly over the last few months.

The increase in inflation interest rates geopolitical factors really impacts the global pandemic.

The headwinds in the U S in global economy. However.

However, similar to our positioning heading into that uncertainty of COVID-19 into early 2020.

<unk> invested in high quality businesses.

On the asset side, we maintained a disciplined approach to building and maintaining liquidity.

Understanding of our unfunded commitments on the liability side.

Further enhance our liquidity profile during the quarter to an extension and expansion of our existing revolving credit facility, which Ian will discuss in further detail later on the call.

From a macroeconomic perspective, the impact of the interest rate environment on top of mind, although we saw meaningful upward movement in interest rates. During Q1, we haven't seen the impact yet.

On our financial results for two primary reasons.

The asset side.

Further debt investments.

The downside protection of foreign rate falling rate environment, which we have seen up until recently.

As we experienced in Q1, our floors mask the impact of the increase in total reference rates rise above our average.

Once the work was variable and a benefit from enhanced asset sensitivity of our matched floating rate exposures.

Liability side, our weighted average cost of debt outstanding.

Relatively flat.

Given the mechanics of how the swap contracts unsecure.

Unsecured liabilities are reset at the end of the preceding quarter.

We are all being a one quarter lag a variety of ways.

Great impact.

Our income statement.

Given the speaker, which Andrew interest rates in Brazil to date.

We expect to see your weighted average cost of debt will be offset from the asset side as reference rates rise further above ground for us in 2000.

Although we anticipate the rising interest rate environment to play out favorably in the lender positioned to benefit from the positive asset sensitivity of our balance sheet. We also are very cognizant of the digital impact on our borders.

If this coverage remain strong across the portfolio across the portfolio.

And we are confident that the protocol we have underwritten.

<unk> said in the past we are focused on investing in top of the capital structure and high quality businesses.

Industries that we like.

At quarter end net asset value per share was <unk> 15 per share or 1% from pro forma net asset value per.

Per share at year end <unk> III. This growth was primarily driven by continued over each of our base and then in net unrealized and realized gain.

For these vessels.

Over the trailing.

Two year period.

Net asset value has increased by eight 4%.

The total of $5.94 of distributions have been distributed well getting full economic return on book value of about 46, 5%.

Yesterday, our board approved a base quarterly dividend <unk> 41 per share for shareholders of record as of June 15 payable on July 15.

Board also declared a supplemental dividend of <unk> <unk> per share related to our Q1 earnings.

Our Q1 earnings to shareholders of record as of May 31 payable June 30.

Our Q1, <unk> net asset value per share pro forma for the impact of the supplemental dividend of <unk> 84.

We estimate our spillover income per share approximately 15 minutes.

Before I pass it over to Bo I wanted to know on April 8th Fitch rating agencies published their annual review of BDC factors.

The BDC sector. We're pleased this year of fixed rate, especially when we received a one notch ratings upgrade from triple B minus ctrip will be flat with a stable outlook of the 15 firms with a range of users. So the only firm to receive such an upgrade is only one or two bdcs will hold the ratings from Fitch has since reported the upgraded.

Firms are decades worth of strong.

Performance is supported by our sector, leading returns with that.

I will now pass it over to discuss this quarter's investment activity.

Thanks, Josh I'd like to start by sharing some observations on the broader market backdrop in particular, the inflationary environment and upward movement in rates since our last earnings call in February .

These macroeconomic factors, coupled with Russia's invasion of Ukraine, but the heightened volatility and uncertainty in the financial markets during the quarter.

Public markets reacted quickly with equities and high yield ending the quarter down four 5% for the S&P 500.

Four 6% for the U S high yield index, representing their worst quarter since Q1 of 2020.

These fluctuations in the public market markets ultimately led to a period of price discovery from private buyers and sellers, resulting in a slowdown in M&A activity in Q1.

As we would expect a decline in M&A activity was masked with mutant leverage loan volume relative to historical periods. These trials carried across the middle market, where new issue loan volumes were down 51% from a year ago.

Volumes were also driven by issuers, taking time to reconsider the immediacy of the capital needs, reflecting the widening up first lien and second lien spreads by a peak of 47 and 124 basis points, respectively through mid March.

By quarter end, there were some reversion of spread movement with first lien second lien spreads 31, and five basis points tighter than their wives respectively.

With more volatility like we had we expect to see borrowers looking to the private market as an alternative to traditional capital markets, leading to opportunities, where we can provide our differentiated capital solutions and expertise.

Pivoting now to the inflationary environment, if we take a step back and what could what is driving the price increases most of this can be explained by the scarcity of certain goods raw materials and commodities.

Over the last six months to 12 months, we've seen the impact across several sectors, such as real estate automotive and energy as demand has exceeded supply in these industries driving up prices for the consumer.

Can we have low exposure to these industries are heavily weighted towards software and business services, we generally havent seen margin compressions or supply chain issues, thus far are impacting our portfolio companies.

Demand has also been strong and as a consumer sector has benefited from high wage growth and prior fiscal transfers from government support provided throughout covenant.

Household wealth of sort on the back of strong house price increases and prior equity gains.

With rent growth in demand for services, increasing post COVID-19 and longevity of higher inflation will be.

The higher inflation will be key to the outlook, we continue to monitor and construct our portfolio with inflationary pressures in mind.

Turning to portfolio activity, our commitments and funding slowed in Q1 after a busy 2021 totaling $79 3 million and $52 8 million respectively.

Distributed across two new upsized to two existing portfolio companies.

Our new investments this quarter were first lien loans and software services space and business is providing value added technology and solutions.

We were also active during the quarter by supporting our existing portfolio companies on their strategic growth and capital needs, including our new investments and lucid works 71 for some of this quarter fundings to our existing borrowers.

In terms of new borrowers, we closed $130 million senior secured financing alongside <unk> European direct lending fund.

To support the acquisition of Italy by CVC growth, we as a provider of employee experience software and a strong recurring revenue base and low historical churn that has a large addressable market. We believe that our expertise and experience in this sector will allow us to move quickly to provide certainty to borrowers and strong competition with direct lending.

Pace.

On the repayment side.

There were $144 $4 million of pay downs of cost by 4% and three partial investment realizations.

Two of our realizations were upstream E&P companies in the energy sector for that resources, and MD America, which made up 26% of pay off activity during the quarter.

I will briefly highlight these two investments as an example of our capabilities in the sixth Street platform our investment in <unk> that was in the form of a $225 million term loan facility that we saw that in Asia as an agent sources.

Sourced by our energy team and reflects our opportunistic investment approach, providing first lien reserve based loans to upstream companies that provide a strong risk return profile.

Since our investment in 2019, the company's credit profile improved materially due to the attractive development returns and an improved commodity price environment ultimately, allowing the company to refund advance through the bank market at a lower cost of capital.

As a refresher on MD America, we made initial investment led by our energy team in November of 2018, when we closed on a $200 million first lien term loan with sixth Street platform, 40% of the deal.

Since our initial investment there has been a series of amendments ultimately, resulting in the company filing for chapter 11 in October 2020.

Our asset management capabilities, along with our flexible capital base allows us to be a value added partner, resulting in a successful emergence from bankruptcy in December of 2020, where the lenders receiving 100% of the post reorder equity.

During Q1, we completed the sale of MD America to wildfire and energy.

Representing a full exit for sixth streets, 40% ownership interest in the company.

At the time of our investment in 2018, we underwrote to a 12, 8% IRR and a 130 X MLM and ultimately generated a 24% IRR and $1 eight X MLM further demonstrating our ability to create value for our shareholders and complex situations.

After these two repayments our energy exposure decreased to one 7% of the portfolio at fair value.

One other notable exit during the quarter was our investment in designer brands, which was one of our ABL retail portfolio companies.

We made our initial investment designer brands back in August of 2020 on the retail sector, we're suffering from a shutdowns.

Global pandemic.

Because of our strong balance sheet position, we were able to play offense. During this time by providing capital require hours and Needham and several COVID-19 impacted industries.

The cure the company repaid the outstanding balance of its term loan credit facility and we received a 3% prepayment premium on the outstanding balance since inception, and inclusive of this quarter's designer brand et cetera, we generated an average gross unlevered IRR of 21% across our fully realized ABL investments.

On activity levels generally we saw a pickup beginning of March and we are optimistic.

Our originations and funding pipelines heading into the rest of 2022, the direct lending landscape remains competitive we continue to pick our spots. We remained selective in our opportunity set which is expanding alongside the growth of the sixth Street platform as demonstrated by the returns generated during this quarter from our E&P and retailing beyond names.

We will look to opportunistically deploy capital in areas, where our platform and ability to underwrite and navigate complexity allows us to create excess returns across our portfolio.

From a portfolio yield perspective funding and repayment activity. This quarter had a slight positive impact to our weighted average yield on debt and income producing securities at amortized cost.

Yields were up slightly to 10, 3% from 10, 2% quarter over quarter about 17 basis points from a year ago. The weighted average yield at amortized cost on new investments, including upsizing of this quarter was 10, 6% compared to a yield of nine 8% on exited investments.

Moving on to the portfolio composition and credit stats across our core borrowers for whom these metrics are relevant we continue to have a conservative weighted attached and detached points on our loans at 0.8 times and four five times, respectively, and our weighted average interest coverage remained relatively stable at two nine times.

As of Q1 2022, the weighted average revenue and EBITDA from our core portfolio companies was $117 million and $31 million respectively.

Finally, the performance rating on our portfolio continues to be strong with a weighted average.

That $1 one three on a scale of one to five with one being the strongest we continue to have minimal non accruals at less than 0.1% of the portfolio at fair value with no changes from the prior quarter.

With that I'd like to turn it over to Ian to cover our financial performance in more detail.

Thank you both for Q1, we generated adjusted net investment income per share of <unk> 49.

And adjusted net income per share of <unk> 56 at quarter end total investments with $2 5 billion down slightly from the prior quarter as a result of net repayment activity.

Total principal debt outstanding at quarter end was $1 2 billion and net assets were $1 3 billion or $16 88 per shares prior to the impact of the supplemental dividend that was declared yesterday.

Our average debt to equity ratio decreased slightly quarter over quarter from <unk> 99 times to <unk> 95 times and our debt.

Debt to equity ratio at March 31 was <unk> 91 times, we continue to have ample liquidity with $1 2 billion.

On the revolver capacity at quarter end against the 147 million of unfunded portfolio company commitments eligible to be drawn.

Post quarter end, we further enhanced our liquidity and debt maturity profile by closing an amendment to our revolving credit facility with.

With the ongoing support of our lending partners, we increased the commitments under the facility from 151 billion to $1 $5 85 billion through an upsized from an existing lender and extended the final maturity of 151 billion of these commitments to April 2027.

Pro forma for the revolver extension, our weighted average remaining life of that funding is four one years compared to a weighted average remaining life of investments funded by debt of only two one years at.

At quarter end, our funding mix was represented by 76% unsecured debt in line with the prior quarter.

I'd like to take a moment to cycle back on Josh his comments related to the upward movement in interest rates.

During Q1, three month LIBOR increased from 21 basis points to 96 basis points and the average floor of our debt investments was approximately one 1% at.

At the time of our last call, we expect it to reach our average floors in may and this timeline accelerated as reference rates have been above average floor since April .

To quantify the impact on <unk>.

Assuming our balance sheet and spreads remain constant as of quarter end for every 25 basis points increase in rates above our average flows we would expect to see approximately 20 basis points of ROE accretion or an incremental <unk> <unk> per share of net income on an annual basis.

We can further illustrate the potential impact by using the forward yield curve, which project three months time.

Oh, sorry to the two 9% in one year from quarter end.

Assuming all else equal as of the quarter ending Q1 dollars 22, an increase in base rate to two 9% would imply a 150 basis points of barley accretion or an incremental 25 per share of net income annually.

Moving on to our presentation materials slide eight contains this quarter in a deep rich walking through the main drivers of growth. We added 49 per share from adjusted net investment income against a base dividend of <unk> 41 per share it.

There was a <unk> 24 per share reduction to NAV, primarily from the reversal of net unrealized gains on our positioning in <unk> America as we book these gains realized upon the sale.

The negative impact from widening credit spreads on the valuation of that portfolio was $5 <unk> per share and then what might have negative impacts related to the mark to market on our extend on our swaps that are not designated as hedging instruments, which amounted to four cents per share.

Finally, there was a 42 per share positive impact from other changes primarily realized gains on investments of <unk> 18 per share and portfolio company specific events of 22 cents per share.

Moving onto our operating results detailed on slide nine total investment income for the quarter was $67 4 million compared to $78 3 million in the prior quarter.

Walking through the components of income interest and dividend income was $58 8 million down slightly from the prior quarter driven by net repayment activity during Q1.

The fees, representing prepayment fees and accelerated amortization of upfront fees from unscheduled pay downs were lower at $6 9 million compared to $14 million in Q4, given the elevated portfolio activity, we experienced in Q4.

Other income was $1 8 million compared to $2 6 million in the prior quarter.

Net expenses, excluding the impact of the noncash accrual related to capital gains incentive fees were $29 9 million down approximately 8% from prior quarter.

The upward movement in reference rates, a weighted average interest rate on average debt outstanding remained relatively flat quarter over quarter, primarily from the one quarter timing lag on the reference rate reset date on our interest rate swaps.

Before passing it over to Josh I wanted to circle back on our ROIC metrics in Q1, we generated an annualized ROE based on adjusted net investment income of 11, 6% on an annualized ROE based on adjusted net income of 13, 2%.

This compares to our target return on equity of 11 to 11, 5% for the year as articulated during our Q4 earnings call and we maintain this outlook heading into the rest of 2022.

With that I'd like to turn it back to Josh for concluding remarks. Thank you Ian I'd like to close our prepared remarks, thereby encourage you or shareholders of record revenue.

Coming annual and special meeting on May 26 to participate but consistent with the past five years, we are seeking shareholder approval to issue shares below net asset value effective.

The upcoming 12 months to be clearer to date, we have never issued shares below net asset value of your prior shareholder authorization granted to us reaching the past five years, we have no current plans to do so we may only get us authorization as an important tool for value creation and financial flexibility in periods of market volatility.

As evidenced by the last eight plus years since our initial public offering our bar for raising equity is high.

<unk> raised equity trading above net asset value on a very discipline disciplined basis. So we would only exercise this authorization to issue shares below net asset value.

Efficient hospice is sufficiently high risk adjusted return opportunity that would ultimately be accretive to our shareholders to over earning our cost of capital and any associated dilution.

If anyone has questions on this topic. Please don't hesitate hesitate to reach out to US. We have also provided a presentation, which walks.

As in the Investor resources section of our website.

As a final thought for today's call.

Streaming optimistic about the road ahead with current market conditions in mind, we believe the value proposition for our business has never been better for both our clients.

And shareholders.

Okay.

Declining purchasing power from the impacts of inflation, but OE underscored the value proposition of our franchise as a source of alternative real returns for our shareholders, which we believe to be sustainable.

As for our clients, we're prepared to provide capital with speed and certainty through periods of volatility in public markets.

The credit cycle continues to evolve based on tiny monetary policy implemented by the time, we believe our low leverage and significant liquidity.

Profile positively because of this.

And for us to play offense in the event of a market dislocation.

Hasn't disclosed dislocation has been our greatest periods of outperformance in the past, while we cannot predict what is ahead before we built a robust business model that will perform through the cycle.

I wanted to call how refreshing it is refreshing that had been feedback in the office and be able to interact face to face with friends and colleagues and clients and stakeholders.

I know a ability to collaborate in person we will continue to provide new motivation ideas as we push further into 2022.

We especially look forward to resuming our annual tradition of the fifth Street Offsite, where we gather are approximately 400 strong team in Austin, Texas.

Stakeholders. Thank you for your continued interest in <unk>, especially with.

With that thank you for your time today operator, please open up for <unk>.

Questions.

Thank you as a reminder to ask a question you will need to press star one on your telephone to withdraw your question press the pound key please.

Please standby, while we compile the Q&A roster.

Our first question comes from Mickey Schlein with Ladenburg. Please go ahead.

Yes, good morning, everyone hope you're doing well.

Josh I'm sure, there's a ton of questions on interest rates, but.

I'm going to start with one on page 13 of the Investor presentation that shows that the weighted average spread on your floating rate investments came down as LIBOR increase, but I suspect that was probably reflecting the lag in the repricing of the assets and when I look at the interest rate risk table in the queue.

You mentioned in your prepared remarks, you would expect your net interest margin to expand with higher rates.

But that assumes everything remains equal, which it never does right. So I'd like to ask what's your view on how you think the private lending market will react to higher short term rates in terms of maintaining spreads.

Yes.

The last part of the question was the last part of the question.

The last part of the question is we're looking at a forward LIBOR curve were sofa curve thats, a very steep so I'd like to ask what's your view on how the private lending market will react to higher short term interest rates in terms of maintaining spreads yes.

Yes.

And top of mind for us. So first of all I think one thing to note is the steepening.

The LIBOR curve or social currently there are about the same when you think about credit spread adjustments has had a.

Extremely positive impact on the business. If you would've looked back at September of last year, we would've probably had 90% drag.

<unk> income line so.

Net income on the investment income line to get through.

LIBOR floors, and we estimate that to be only about two thirds today.

What tends to happen in our market and hopefully.

People will be thoughtful about this.

They tend to price things in IRR basis, and they don't differentiate between.

Brad in a risk free.

So.

We were doing something at 10% to 11% IRR and Hey, we're still 10%, 11% IRR and therefore.

The pricing with the reduced spread not willing not not realizing or maybe realizing that a lot of that's coming from risk free.

So I hope I hope the industry.

React differently.

We I think we have some asset sensitivity in our book coming in.

Sure how much the industry captures.

A key question.

And.

All things being equal.

One.

And spread.

And we'll return instead of risk free.

If we're a LIBOR.

But I think I think that's a key question.

Hopefully the industry rack.

It does it doesn't allow a one for one trade off between.

The return attribution between risk free and spread.

Yes, I understand thanks, Josh.

A housekeeping questions.

What are your expectations for.

Settling the convertible which is coming up.

And also what is the level of undistributed taxable income.

Yes, sure Nick you're seeing all types that one on the.

We had to make an election six months prior to maturity that was actually on February one and we elected to settle the convert is primarily in stock.

And there's about $100 million principal amount of the.

Outstanding today.

<unk>.

The settlement is about I think it is.

Basically holding stock de.

The minimum amount of cash.

None of that had been developed in principle and even to slightly accretive to net asset value because those will be issued.

Yeah.

Slightly I would say slightly.

It could be dilutive on earnings although the lease valve of that is 61 cents of undistributed lorean's.

So 59 cents of undistributed earnings plus we expect some growth in our distributable earnings.

Expected realizations above the current marks and so I think you have you have.

Obviously, we expect to grow above.

And keep leverage steady or in our target leverage ratio. If we doubled you obviously can use special dividends.

To make sure you're still capital efficient, we think we have enough spillover income plus kind of pipeline of realized gains.

Allows us to give us that flexibility and so you should think of the same way we address some early conversion in Q4 of last year, and then we can sort of specialty.

That's a tool that we felt was an efficient way to to achieve those goals.

I understand what did you say the UTI balance was.

<unk> 59 per share.

<unk> hundred nine.

Yes, the five nine.

Alright, that's it for me. This morning, Thank you for taking my questions.

Thanks Vicki.

Thank you. Our next question will come from Kevin false with JMP Securities. Please go ahead.

Hi, Good morning, and thank you for taking my questions. My first question is similar to one of Mickey's questions.

Given that the economic outlook has shifted in the past few months are you seeing less competition in the market from other lenders just curious if youre beginning to see a shift to a more lender friendly environment either in the form of improved documentation are widening spreads.

Hey, Kevin I don't think with TV, Yes, I think Theres a couple forces kind of in the market. One is typically private markets react slower.

The public markets.

The second thing that happens I think is is that there is a decent amount of capital formation in the private credit market.

Which.

I think had some somewhat of a muted impact on the.

The pendulum is shifting I think.

That kind of a tailwind so I think those are the two headwinds the first headwind.

The slow to react kind of goes away over time the capital formation is what it is that.

The tailwind I think of that.

Clearly given that there is.

<unk> has expanded for private credit which is the.

Volatility in public markets allow.

I don't want it.

People are willing to pay for certainty in the context of the volatility in public markets, which increases the Tam for private markets and I think with that increase Tam I think that will be a tailwind maybe the pendulum shifts I'd also say because of the slowdown in M&A earlier this year.

Created a lot of.

Okay.

Supply out there that have been.

Deployed earlier, so that will keep tension in the market I suppose.

Please go ahead.

Turning to both of those things we haven't seen evidence.

Widening of spreads or better terms at this point, though as we've seen.

My remarks, I noted us.

The funnel starts to fill out.

I think there's going to be opportunities to pick our spots in particular as Jos mentioned in some of those opportunistic non sponsor activities.

That we see as companies looking to shore up their balance sheets and play offense in a different valuation of market.

Yes.

The temperature we can expand.

Given volatility in public markets and issuers and sponsors.

Looking for certainty, which shipped which should help with the capital conditions here.

Okay, Great. That's all really helpful. And then just one on leverage your stated target leverage range is quite 90 to one last quarter as of quarter end Youre at the low end of that target are you still comfortable operating anywhere within that range or has your internal target changed a bit in the current environment.

So no I don't look I think given the given the uncertainty in the world I don't think we're going to operate at the top end of the range.

Thank you.

How do we think about our business and how we think about leverage as you got a burden.

Both our capital and liquidity by unfunded commitments and and change of spreads given the mark to market.

Piece on the on the outside of a balanced asset side of our balance sheet.

And you also want to have a whole bunch of dry powder to invest and volatile moments.

Which quite frankly led to feed to the outperformance.

In 2000, 22021, I think the industry had Q return on equity for 2021 of about 10%.

To return on equity of about 35%, 36% and over those two years.

That was a function of us having enough capital and less liquidity.

To make investment, but given the change in the economic environment I don't think were going to operate at the top end of our leverage given.

Think there's volatility coming which means there's probably opportunity coming which means that the our capital as well.

Relatively our capital, but he has a relatively high opportunity cost.

Okay that makes sense, Josh I'll leave it there congratulations on a really nice quarter.

Thanks.

Our next question will come from Finian O'shea with Wells Fargo Securities. Please go ahead.

Sorry, I was on mute.

Hello, and good morning.

Josh or Bo last quarter.

You talked about.

The opportunity budding and.

And in growth equity late stage growth equity to provide.

Junior preferred structures, we've heard some of that.

From your peers as well can you talk about how that is.

Obviously, we didn't see too much this quarter.

But logically we would have hoped to given those a lot of those assets have continued to lag in the market is this something thats still.

Around the corner or hubs have these types of opportunities.

No.

Most definitely an opportunity. The question is how appropriate it's going to be for given the structures and the fixed nature of those.

Those opportunities for the <unk> III specialty lending.

John .

Across the platform for example, we will involve in se.

Download statements transaction.

We've been an investor in <unk>, which we think is a amazing company with me the CEO of amazing for a long time.

And so I think those opportunities are coming.

The question is will pick the right ones that fit into the balance sheet and how we positioned fifth street specialty lending.

Given that we think about our dip.

Dividend as a liability to the business.

I think during the during the pandemic people realize it was a liability to the business.

Because you had to pay to keep your Ric status you had to pay.

The dividend in cash you have some flexibility in stock, but it's really people should think about there given the cash liabilities. So the question is appropriate in our society, but I think there will be fast impact.

Over the next couple of years, and we think that.

Yes.

The right growth businesses that have the right.

Given the economics and return on capital.

And the right.

Pam.

And addressable market is still there's still some opportunity there, but we are getting that.

With all that I think the opportunity set.

We'll pause for a bit.

Patients in the private markets resetting.

So it will be there and strong I agree with everything Josh it would be appropriate vessel, we'll pick our spots in the market.

We are quite active on the platform.

Brand recognition.

Sure that's helpful and then.

Josh on the platform level.

So a couple of new groups set up this quarter more than capital group the structured products group anything.

You want to talk about there in terms of.

Director or ancillary benefits to the.

The BDC platform.

Thanks for the commercial the commercial opportunity.

I'll, let Paul Morgan capital.

Although generally moving capital.

We have a great leader of that business and we think we can be value added to portfolio companies and the value the value proposition six feet only grows.

On structured products.

We've hired Mike driving who we've known for a long long long time.

When that business at credit Suisse.

And we most definitely you think youll be lending opportunities.

That space.

That will come.

To the platform.

Is that good asset bad asset thing you've got to be.

It's a bit too.

But we really think there is.

The opportunity in <unk>.

Catering to the lateral part of that we've known for a long time is super talented and has a big brand in that space and so we think they are most definitely we will be continuing to build that mosaic.

And skill set of the organization, we think only enhances the risk adjusted returns for 600 specialty lending.

<unk> just got more capital.

Very excited to have brought on just one as a first time CEO of technology businesses to help us build out that effort.

This will help our portfolio companies with a lot of common problems.

<unk> been building and scaling businesses so.

Super happy to have him on and I think you'll hear more from that group over the next couple of years.

Great. That's helpful. Thanks, so much.

Thank you. Our next question will come from Bryce Rowe with Husky. Please go ahead.

Thanks, Thanks, a lot good morning.

Wanted to maybe maybe start.

Just just on market activity, though you mentioned.

Some level of pickup in March.

Maybe you could speak to is that is that more kind of seasonality of the <unk>.

Business or.

The source of the pickup would be any color around that would be helpful.

Yes.

So there is always a bit of a.

Seasonal Q1 lag Q4s are generally quite active from an M&A market so that would predict.

Typical I think what was a little bit unique in this quarter is we did have valuations reset in the public markets.

Pause generally on.

On.

Buyers and seller activity in the M&A market.

So activity slowed as I mentioned in my remarks. In addition to that we saw spread widening so opportunistic refinancings slowed down you saw that begin to uninstall off in the back half of the quarter.

Tom.

Funnel pipeline really starting to fill more opportunistic M&A.

Public to privates, but also the portfolio companies.

And.

Looking to be opportunistic in the valuation environment. Secondly, you saw a pickup in non sponsor activity.

Yes.

Strongest companies in these periods will look to shore up their balance sheets, both for to invest internally in growth, but also opportunistically in M&A. So between what we have going through the pipeline that we've already committed to we're pretty bullish on the opportunity set.

You would say the following that kind of happened a lot sooner than we would've expected.

Takes a quarter or two it was a little bit.

Especially given the move in tech valuation exactly so.

I think thats right.

You hit it which is some seasonal some market volatility.

And market volatility tends to slow both M&A and the opportunistic refinancing.

It feels like it's got a little bit quicker.

And I would have thought.

And do you guys do you guys feel like prepayment or repayment activity.

We will slow here with the volatility.

And with higher rates or do you have pretty good line of sight into continued repayment activity exit activity.

I would say so.

Typically.

Mortgages were not a sensitive to rates on prepayments speeds.

It's widespread.

And so.

And idiosyncratic events.

I would say that you would expect.

You would expect that there is.

Yes.

The sign that we discussed a second ago that will have some impact on our portfolio portfolio.

Both companies that were up for sale and that might trade and administrative before and so there will be windows relatively.

Relatively outside of the energy book, given the commodity price environment. In Q1, there was very little kind of repayment activity that was the bulk of the repayment activity given the commodity price environment I would expect it to kind of get back to normalized levels.

Sure.

Okay Alright.

Maybe one more for me just on the on the right side of the balance sheet.

And this maybe a tough question to answer.

So you've got a you've got unsecured note maturity early in 'twenty three just just kind of curious how youre thinking about.

You might handle how you might handle it today if it were today.

With spreads, having having having widened and rates having widened for unsecured debt in the BDC space.

Yes, So look I think I think our unsecured spreads have less data and others, especially given the upgrade and given the quality of the franchise. We built the great News is we have about a billion one one.

Billing three growth on.

Unfunded commitments available to draw one billing.

One building too.

Total liquidity burden for unfunded commitments and I think that maturities like the $115 million 150, 150, and so I think we have a lot of optionality and flexibility.

And rewarded to do it on our wind today.

And correct me if I'm wrong.

Is that what is that.

On a swap adjusted basis what is that.

Maturity side.

Probably LIBOR 200 or something like that.

LIBOR 200.

If you think about our marginal cost of capital on our revolver.

It's about LIBOR 150, because you.

You also have the unused line fee and a commitment fee and so if we were to do it on a revolver.

We have $1 billion.

During one drilling too for unfunded commitments.

Actually be accretive to our cost of capital and I think that 150 is actually LIBOR, we got $299.

Accurate pick up 50 basis points.

Interest saving of about 150 million Bucks on a net basis on a marginal basis. If you were to do it online we have a ton of liquidity.

Okay, Alright, that's helpful. Thanks, guys.

Yes.

Thank you.

Thank you. Our next question will come from Melissa Wedel with Jpmorgan. Please go ahead.

Okay.

Good morning, and thanks for taking my questions.

Quick follow up.

And then Josh about special.

Our total portfolio.

Makes sense in the context of what's happening.

Great.

We also recognize Paul <unk> Paul.

Yes.

So.

So I'm curious, how you're thinking about sort of that top line.

The potential for what the trajectory can be long term.

Prepayments normalize.

Yes.

It was it was really hard to hear but I think I heard when you can say you could correct me if I if I heard this wrong I think I heard is why do you think about.

The impact of income on your income statement as.

As prepayments normalize.

I think it was that the question.

Yes, Josh.

Okay great.

<unk> typically fees.

I will try to give you the exact data.

Low kind of attribution quarter for us.

Historically on average.

We get the exact data between accelerated OID and prepayment fees.

And amendment fees that typically is call it on.

On an annualized basis.

752 pills per quarter per share basis divided by four.

The.

14th at the quarter I think this quarter it was 7%.

7% to 8%.

So it's definitely the order this quarter.

I think that historically.

How we've operated.

I think our.

Worse year.

Yes, so I would say you could expect it to be kind of <unk> three.

700, <unk> more per quarter or something like that.

Given activity levels, but.

They are just purely lumpy quarter to quarter.

Understood. Thanks.

Thank you. Our next question will come from Ryan Lynch with K B W. Please go ahead.

Hey, good morning.

First question I had if I understand your comments correctly it sounds like the slowdown in Q1 was partially driven by I think seasonality with kind of a very robust second half of 2021.

Also in combination with I think some economic uncertainties.

About what the rest of 2022 looks like and so you kind of said that your pipeline had now been growing.

And Q1 and into 'twenty into Q2. So my question is is it so it's a little bit confusing just because a little bit surprising I guess, just because the economic uncertainty <unk> seen as high as they've ever bandwidth.

Right Yeah inflation.

Labor issues decreasing equity valuations geopolitical things out there and so I'm just curious of why the pipeline seem to be building at the same time that the economic uncertainties are also on building yes.

How do you how do you square that value round that square peg a good question.

I think the answer lies in the amount of private equity dry powder out there to be honest with him which is most of the activity a lot of it is private equity driven.

And Theres always discreet fear thing, which is sometimes the best time to invest.

As long term investors is when there's volatility.

And there is a ton of dry powder.

In private equity and Youre, starting to see them put that to work.

Yes.

A great example, thats not that was in the fixed fee.

Especially lending portfolio, but like you've seen.

That's clear.

Clearly.

Data, which is a publicly traded company and curtail the private equity backed company some insight ventures and so you are seeing.

Sponsors.

And certain industries putting.

Money to work.

Given the uncertainty.

Yes.

Okay.

Because obviously those fears and uncertainties are all well known in the marketplace everybody's operate with our eyes wide open at this point so with that has the quality of deal flow or the quality of companies that are transacting at least a potential transaction and the pipeline has improved.

Rob.

To be higher quality companies that are potentially good.

Positioned to weather these headwinds we noticed any change yet.

Yes.

Really good question look I would say I think there is one nuance I think everybody sees the uncertainty I think people have very divergent views on how the uncertainty is going to play out.

Maybe not a soft landing.

How do you deal with the employment gap you typically I think maybe never recession.

If you haven't seen unemployment increased by 50 basis points.

I don't I cant give worldwide employment increased by 50 basis points, Kevin given the employment gap.

That's actually I don't think theres going to be.

Nothing I think theres going be soft landing or or not.

Clearly divergent views, but we mostly see the activity around businesses that have stronger business models.

That are able to push through cost.

And have high gross margins and.

<unk> operating leverage and still can grow earnings.

So I think I think.

Divergent views, but the quality of the business that they are high.

<unk> I think people have different views of our given the environment.

We are less impacted by that given where we are investing in the capital structure.

Okay.

Understood I appreciate the time today.

Thanks, Kevin. Thank you. Our next question comes from Kenneth Lee with RBC capital markets. Please go ahead.

Hi, Thanks for taking my question.

Just one on the investment portfolio, it's pretty diversified across industries right now, but I'm wondering if you can just talk a little bit about how you're thinking about portfolio positioning any marginal shifts within across industries, just given the current backdrop and the near term outlook.

Yeah, I mean, it's a good question I don't think Theres any big marginal shift.

Look I think energy is a interesting space.

Look we typically don't like to lend into higher commodity price environment.

There's been a lot of capital outflows across the energy sector, both on the private and public side given two big factors one factor is.

ESG issues are concerned in the second factor is that sector. Historically has been a terrible allocator of capital, which is you have this correlation which is as as.

Prices are high people put in more capital that feels like it's been less.

Like I said you that given.

Energy companies focus on free cash flow versus net asset value growth.

And the ESG concerns so.

We are net energy exposure has gone down significantly I think it's like one points.

One 7% of the book today, I think there's room there.

But we'll be very thoughtful about how we do it on a retail.

Thats come down as a percentage of our portfolio historically as well.

Retail.

<unk> is I think today is the exact amount is 10, seven and I think there has been high as.

20% or something like that.

But you have the backdrop of a strong strong consumer.

And strong earnings from retail in the world with over kind of retail.

And that kind of got flushed or has that changed in the <unk>.

And so as the consumer softens or discounting comes back and in this low volatility in retail earnings.

That might change.

On the margin, but I think it's in the bands of historically, where our portfolio has been but if you look at those two segments for sure. We're under allocated given where we are in the cycle.

I expect there would be some conversions the need for a fishing anything to add.

Yes.

Great very helpful. Then one follow up if I may and just from a high level in terms of the ROE.

It looks like you're maintaining your Roe targets.

Despite having 13% ROE in the quarter wondering if you could talk a little bit about how you think about RV over the near term what are some of the major puts and takes that can impact one way or the other thanks.

Yes.

When you think about our business from a unit economic business a unit economics perspective, the things that impact on ROE as yields.

Leverage so capital efficient team.

Which is a function of pay offs.

Plus how we manage that.

Net portfolio growth in the neck.

<unk> positive.

Then how do we manage our access capital we've historically manage that.

Through a combination of.

Growing our capital base through the drip and.

Special is special dividends.

And.

Credit losses, I felt pretty good about where we sit in credit losses actually think Jordan.

Sure.

Depending on how things play out some upside left in the book.

John .

Unrealized.

Realized gains exceed our current marks.

And so that will have a.

A positive impact to our ROE I don't see any near term credit losses.

So ultimately it's a function of.

Yields and capital efficiency, and we've done a pretty good job of managing both.

Great very helpful. Thanks again.

Thank you. Our next question will come from Matt Tjaden with Raymond James. Please go ahead.

Hey, Good morning first question for me on the ABL product.

Given your ABL loans, they generally fund working capital and higher inflation tends to drive up both the cost of inventory and working capital needs. Do you think there's any chance higher inflation might actually drive a higher demand in the market for your ABL type products.

Yes.

Offsetting the offsetting factor is that the consumer has been in really good shape and so when you look at gross margin and EBITDA margin expansion across retail, which we've done quite.

Quite frankly, we've been involved in even in markets across the platform for a long time.

Yes.

The income statement are really really good shape.

Given the lack of discounting given consumers post the pandemic.

So you are right that there was a more of a working capital need but.

Income statements.

You find your fun working capital through.

The strength of the income statement I think free cash flow and then.

The balance sheet.

<unk>.

Either operating cash flow, so pickup statement our financing.

And so I think that's the offset.

And retail tends to be in.

Really in good shape at the moment that could change on a dime.

For sure.

Got it that's helpful last one for me maybe following up with you Josh kind of more high level. What's your outlook for the year end 2022, private credit default environment and how much has that changed versus five months ago at the beginning of the year.

I still think it's pretty low.

I still LIFO.

I think the trigger questions 'twenty three 'twenty four but if you look at our book I think it's pretty pretty low if you. If you think about the recent vintages of deals.

Those companies have had earnings growth and it started off with good liquidity.

The private credit's been slightly I think it tilted the software are intact.

It feels like it's pretty pretty low.

Not that much.

Not that much exposure cyclicals.

We don't have that much exposure to cyclical so I feel pretty constructive about the default cycle.

For for 'twenty two.

Generally for general credit.

Especially in private credit I look Bo or fish, if you have anything to add.

Great.

324.

I'll turn your question, but.

I think.

We would expect pretty low default rates across the sector. I can tell you I can tell you the industry that are going to be heard industry, if theyre going to be hurt.

There are.

What are the kind of low EBITDA margin businesses, where the.

Relatively competitive businesses, where they have.

When they've had commodity price inputs that they can't pass along to consumers.

Those industries are going to be heard.

So.

Paper packaging.

Specialty chemicals.

I think I would not call it defaults to the cycles, but any industries that have relatively low EBITDA margins and no pricing power.

Hi.

Commodity inputs into there.

Cost structure I think those are the industries that are have a higher chance of being hurt.

Got it that's helpful. I appreciate the time.

Thank you and we do have a follow up from Finian O'shea with Wells Fargo Securities. Please go ahead.

Hey, thanks, so much for the follow up.

Josh just thinking a bit more.

From our dialogue on on Preferreds and.

I appreciate your commentary and logic on avoiding too much pik, but is there a firm.

Our wine there youre youre, drawing in the sand or or is there somewhere on the curve of returns where you would.

But take on these sorts of deals and I ask because.

In today's environment, the outlook could very well be that this type of company.

It turns out to be the provider of <unk>.

Large structured rescue type opportunity that that you've done really well in the past obviously.

So question is is this a hard line.

Being anti tick or is it just not good enough.

Hey.

No I don't think we have a hard line just to recall we are.

<unk> filing.

We are.

Look at our overall balance sheet, we've got tons of liquidity so.

We like to think about funding our dividend from operating areas, but we have tons of liquidity.

I think it's a combination of a bottoms up investors.

Sure.

So finding the right opportunities that fit right into our balance sheet.

I don't I don't see us being a large provider of rescue financing in a junior capital position. Our strategy historically has been providing rescue financing capital structure, where we're not the full growth.

And we're not taking process risk. So I think if you see us doing so.

All of that type of investing in companies and really worldwide with clean capital structure has great prospects secular growing.

And healthy businesses.

Is the way I would generally characterize our strategy.

And then I think the fundamental question is.

The risk return work, which is.

I've said this many many many times.

Can eat IRR.

And so any any any investment structure, where you can make.

Where you can get like 11% to 12% preferred is callable and so your yields your enrollment towards like one two times, but you are deep deep down the capital structure.

We've a lot of your capital like that that isn't going to work I think and so you have to be thoughtful about.

The probability of returns and returns given the given a default or.

I mean, not being the bulk of them and so I think we're bonds up investors and there is no hard line, but.

We like some of those opportunities we don't like the others.

Thank you I'm showing no further questions in the queue. At this time I would now like to turn the call back over to management for any closing remarks.

Great.

We really appreciate peoples time.

We're actually on the West coast today. So this has been slightly painful.

At 430 in the morning.

To get going but we really appreciate peoples time.

Mother's day is coming up I think.

And our tradition, we'd hope everybody takes the time.

Their families and appreciate the people in their life and happy mother's day.

Everybody out there.

Listening.

Pudding.

Our significant others so.

We really love the dialogue.

If you make your major way in New York, San Francisco feel free to stop and.

We will welcome any pullback in our office.

Given the environment.

Thanks, everybody.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation you may now disconnect.

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Ladies and gentlemen, thank you for standing by and welcome to the fifth Street Specialty lending Inc. Q1, 2022 earnings conference call. At this time all participants are in a listen only mode. After the speaker presentation. There will be a question and answer session to ask a question during the session.

We will need to press star one on your telephone please be advised that today's conference is being recorded if you require any further assistance. Please press star zero.

I would now like to hand, the conference over to your Speaker Ms. Tammy Van Horne head of Investor Relations. Please go ahead.

Thank you before we begin today's call I would like to remind our listeners that remarks made during the call may contain forward looking statements statements other than statements of historical facts made during this call may constitute forward looking statements and are not guarantees.

The future performance or results and involve a number of risks and uncertainties actual results may differ materially from those in the forward looking statements as a result of a number of factors, including those described from time to time in <unk> specialty lending, Inc filings with the Securities and Exchange Commission.

Company assumes no obligation to us.

Any such forward looking statements yesterday after the market closed we issued our earnings press release for the first quarter ended March 31, 2022, and posted a presentation to the Investor resources section of our website www dot fixed rate specialty lending dot com. The presentation should be reviewed in conjunction with our Form 10-Q filed yesterday with the <unk>.

Seven six days specialty lending Inc. 's earnings press release is also available on our website under the Investor resources section unless noted otherwise all performance figures mentioned in today's prepared remarks are as of <unk>.

For the first quarter ended March 31 2022.

As a reminder, this call is being recorded for replay purposes, I will now turn the call over to Joshua easterly Chief Executive officer at fixed rates specialty lending Inc.

Thank you good morning, everyone and thank you for joining us with US today is my partner and our President Bo Stanley and our CFO incentives for.

For our call today I'll provide some highlights of this quarter's results with passive about and discuss this quarter's origination activity and portfolio.

<unk> will review quarterly financial results in more detail and I will conclude with final remarks before opening the call to Q&A.

After market closed yesterday, we reported first quarter financial results. The adjusted net investment income per share for you guys.

Corresponding to the annualized return on equity of 11, 6%.

Adjusted net income per share at 56.

Corresponded to an annualized return on equity of 13, 2%.

As discussed in previous quarters at quarter end, we had approximately <unk> 21 per share a cumulative accrued capital gains incentive fees on our balance sheet and approximately <unk> <unk> per share of this amount will be payable in cash if our entire portfolio would be realized as of quarter end market Mark in normal course.

Under the accrued fees are tied to unrealized gains.

<unk> of our debt.

Inclusive of call protection, which is which are prepaid would recognize.

Require recognition of fees and investment income and trigger a reversal of previously accrued capital gains incentive fees related to these investments.

This non cash expense, which was not paid or payable was approximately $2 <unk> per share for Q1.

Reporting perspective, our Q1 net investment income and net income per share inclusive of these accrued capital gains incentive fee expense was 47% 54% respectively.

This quarter's net investment income reflects continued strength in our core earnings power of our portfolio above the guidance. We provided in our last earnings call. Net investment income was supported by fee income from portfolio activity alongside interest and dividend income levels driven by sustained portfolio yields.

The difference between this quarter's net investment income and net income was a result of net unrealized gains primarily from portfolio company specific events.

Looking ahead, we were facing an operating environment, which has changed significantly over the last few months.

Recent inflation rising interest rates geopolitical factors lingering impacts from the global pandemic will certainly present, a headwind for the U S and global economy.

However, similar to our positioning heading into that uncertainty of Covid into early 2020, we have invested in a high quality durable businesses on the asset side, we maintained a disciplined approach and an ability to maintain liquidity inclusive of understanding of our unfunded commitments and the liability side.

Further enhanced our liquidity profile during the quarter to an extension and expansion of our existing revolving credit facility, which Ian will discuss in further detail later on the call.

From a macroeconomic perspective, the impact of the interest rate environment on top of mind, although we saw meaningful upward movement in interest rates. During Q1, we haven't seen the impact yet.

On our financial results for two primary reasons on the asset side the fluids, our debt investors Act as downside protection of falling rates falling rate environment, which we had seen up until recently.

As we experienced in Q1, our Florida math impact of increase until reference rates rise above our average for levels.

Once the workforce, we were able to benefit from enhanced asset sensitivity of our matched floating rate exposures.

Liability side, our weighted average cost of debt outstanding.

<unk> remained relatively flat.

Further given the mechanics of how the swap contracts unsecure.

Unsecured liabilities are reset at the end of the preceding quarter.

We are already on a one quarter lag of graduation rates impact.

Alright, guys statement.

Given us vehicle, which.

Interest rates a rhythm to date the increase we expect to see weighted average cost of debt will be offset from the asset side as reference rates rise further above our average for us in 2022.

Although we anticipate the rising interest rate environment to play out favorably in the winter positioned to benefit from the positive asset sensitivity of our balance sheet. We also are very cognizant of the potential impact on our borrowers to do.

If its coverage remains strong across the portfolio across our portfolio of companies.

Confident in their credit card, we have underwritten.

In the past we are focused on investing in top of the capital structure of high quality businesses.

Industries that we like and Noel.

At quarter end net asset value per share was <unk> 15 per share or 1% for pro forma net asset value.

Per share at year end 16 Cemetery. This growth was primarily driven by continued over <unk> of our base and net unrealized and realized gains.

For the vessels.

Over the trailing.

Two year period.

Reported net asset value has increased by eight 4% and a total of $5.94 of distributions have been distributed as well given the total economic return on book value of over 46, 5%.

Yesterday, our board approved a base quarterly dividend <unk> 41 per share to shareholders of record as of June 15 payable on July 15.

Board also declared a supplemental dividend of <unk> <unk> per share related to our Q1 earnings release.

Our Q1 earnings to shareholders of record as of May 31 payable June 30.

Our Q1 'twenty to net asset value per share pro forma for the impact of the supplemental dividend of <unk> 84.

Estimated spillover income per share approximately 50 units.

Before I pass it over to Bo I wanted to note on April a Fitch rating agencies published their annual review of the BDC sector.

The BDC sector, we are pleased to share a fixed fee, especially when we received a one notch ratings upgrade from triple B minus to Triple B flat with a stable outlook of 16 further revenues <unk>. So the only firm to receive such an upgrade is only one two bdcs or hold the ratings with Fitch.

Fish reported the upgraded firms are decades worth of struggling.

Performance is supported by our sector, leading returns with that.

I'll now pass it over to Bob will discuss this quarter's investment activity.

These macroeconomic factors, coupled with Russia's invasion of Ukraine led to heightened volatility and uncertainty in the financial markets during the quarter.

Blick markets reacted quickly with equities and high yield ending the quarter down four 5% for the S&P 504, 6% for the U S high yield index, representing their worst quarter since Q1 of 2020.

These fluctuations in the public market markets ultimately led to a period of price discovery for private buyers and sellers, resulting in a slowdown in M&A activity in Q1.

As we would expect a decline in M&A activity was masked with mutant leverage loan volume relative to historical periods.

These trends have carried across the middle markets, where new issue loan volumes were down 51% from a year ago.

Loan volumes were also driven by issuers, taking time to reconsider the immediacy and the capital needs, reflecting the widening up first lien and second lien spreads by a peak of 47 and 124 basis points, respectively through mid March.

By quarter end, there were some reversion of spread movement with first lien second lien spreads 31, and five basis points tighter than their wives respectively.

With more volatility likely ahead, we expect to see borrowers looking to the private markets as an alternative to traditional capital markets, leading to opportunities, where we can provide our differentiated capital solutions and expertise.

Pivoting now to the inflationary environment.

Let's step back and what could what is driving the price increases much of this can be explained by the scarcity of certain raw materials and commodities.

Over the last six months to 12 months, we have seen the impact across several sectors, such as real estate automotive and energy as demand has exceeded supply in these industries driving up prices for the consumer.

Given we have low exposure to these industries are heavily weighted towards software and business services, we generally havent seen margin compressions or supply chain issues, thus far are impacting our portfolio companies.

Demand has also been strong as a consumer sector has benefited from high wage growth and prior fiscal transfers from government support provided throughout Covid how.

Household wealth of some work on the back of strong house price increases and prior equity gains.

With rent growth advance for services, increasing post COVID-19, the longevity of higher inflation will be.

Higher inflation will be key to the outlook, we continue to monitor and construct our portfolio with inflationary pressures in mind.

Turning to portfolio activity, our commitments and funding slowed in Q1 after a busy 2021 totaling $79 3 million and $52 8 million respectively.

This was distributed across two new upsize it to existing portfolio companies.

Our new investments this quarter were both first lien loans in the software services space and business is providing value added technology and solutions.

We are also active during the quarter by supporting our existing portfolio companies on their strategic growth and capital needs, including our new investments and lucid works, 71% of this quarter's funding served our existing borrowers.

In terms of new borrowers, we closed $130 million senior secured financing alongside <unk> European direct lending fund.

To support the acquisition of Italy by CVC growth generally is a provider of employee experience software and a strong recurring revenue base and low historical churn that has a large addressable market. We believe that our expertise and experience in this sector or allow us to move quickly to provide certainty to borrowers amid strong competition on the direct lending.

Space.

On the repayment side.

There were $144 $4 million of pay downs across five 4% and three partial investment realizations.

Two of our realizations were upstream E&P companies in the energy sector for that resources, and MD America, which made up 26% of pay off activity during the quarter.

We will briefly highlight these two investments as an example of our capabilities in the sixth Street platform, our investment and for that it was in the form of a $225 million term loan facility that we sold that in Asia as an agent sourced.

Sourced by our energy team and reflects our opportunistic investment approach, providing first lien reserve based loans to upstream companies that provide a strong risk return profile.

Since our investment in 2019, the company's credit profile improved materially due to the attractive development returns and an improved commodity price environment ultimately, allowing the company to recently announce through the bank market at a lower cost of capital.

As a refresher on MD America, we made initial investment led by our energy team in November of 2018, where we closed on a $200 million first lien term loan of with sixth Street platform helped 40% of the deal.

Since our initial investment there has been a series of amendments ultimately, resulting in the company filing for chapter 11 in October 2020.

Our asset management capabilities, along with our flexible capital base allowed us to be a value added partner, resulting in a successful emergence from bankruptcy in December of 2020, with the lenders receiving 100% of the post reorder activity.

During Q1, we completed the sale of MD America to wildfire and energy.

Representing a full exit for six weeks, 40% ownership interest in the company.

At the time of our investment in 2018, we underwrote to a 12, 8% IRR and a 130 X MLM and ultimately generated a 24% IRR and one eight X MLM further demonstrating our ability to create value for our shareholders and complex situations.

After these two repayments our energy exposure decreased to one 7% of the portfolio at fair value.

One other notable exit during the quarter was our investment in designer brands, which was one of our ABL retail portfolio of companies.

We made our initial investment designer brands back in August of 2020 on the retail sector is suffering from a shutdowns.

Global pandemic.

Because of our strong balance sheet position, we were able to play offense. During this time by providing capital required and needed in several COVID-19 impacted industries.

The cure the company repaid the outstanding balance on its term loan credit facility and we received a 3% prepayment premium on the outstanding balance since inception, and inclusive of this quarter's designer brand asset we generated an average gross unlevered IRR of 21% across our fully realized ABL investments.

On activity levels generally we saw pick up beginning of March and we are optimistic.

Our originations and funding pipeline heading into the rest of 2022, the direct lending landscape remains competitive we continue to pick our spots. We remained selective in our opportunity set which is expanding alongside the growth of the sixth Street platform as demonstrated by the returns generated during this quarter from our E&P and retailing beyond names.

We will look to opportunistically deploy capital in areas, where our platform and ability to underwrite and navigate complexity and allows us to create excess returns across our portfolio.

From a portfolio yield perspective funding and repayment activity. This quarter. It had a slight positive impact to our weighted average yield on debt and income producing securities at amortized cost.

Yields were up slightly to 10, 3% from 10, 2% quarter over quarter and are up about 17 basis points from a year ago. The weighted average yield at amortized cost on new investments, including Upsizing. This quarter was 10, 6% compared to a yield of nine 8% on exited investments.

As of Q1 2022, the weighted average revenue and EBITDA of our core portfolio companies was $117 million and $31 million respectively.

Finally, the performance rating on our portfolio continues to be strong with a weighted average.

Net 113 on a scale of one to five with one being the strongest we continue to have minimal non accruals at less than 0.1% of the portfolio at fair value with no changes from the prior quarter.

With that I'd like to turn it over to Ian to cover our financial performance in more detail.

Thank you both for Q1, we generated adjusted net investment income per share of <unk> 49.

And adjusted net income per share of <unk> 56, six at quarter end total investments with $2 5 billion down slightly from the prior quarter as a result of net repayment activity.

Total principal debt outstanding at quarter end was $1 2 billion and net assets were $1 3 billion or $16 88 per share prior to the impact of the supplemental dividend that was declared yesterday.

Our average debt to equity ratio decreased slightly quarter over quarter from <unk> 99 times to <unk> 95 times and our debt.

Debt to equity ratio at March 31 was <unk> 91 times, we continue to have ample liquidity with $1 2 billion of unfunded revolver capacity at quarter end against the 147 million of unfunded portfolio company commitments eligible to be drawn.

Post quarter end, we further enhanced our liquidity and debt maturity profile by closing an amendment to our revolving credit facility with.

Pro forma for the revolver extension, our weighted average remaining life of that funding is four one years.

Add to a weighted average remaining life of investments funded by debt of only two one years at quarter end. Our funding mix was represented by 76% unsecured debt in line with the prior quarter.

I'd like to take a moment to cycle back on Josh his comments related to the upward movement in interest rates. During Q1, three month LIBOR increased from 21 basis points to 96 basis points and the average Florida debt investments was approximately one 1%.

At the time of our last call we expect it to reach our average full of in May and this timeline accelerated as reference rates have been above average floor since April .

To quantify the impact on earnings assuming our balance sheet and spreads remain constant as of quarter end for every 25 basis points increase in rates above our average flows we would expect to see approximately 20 basis points of ROE accretion or an incremental <unk> <unk> per share of net income on an annual basis.

We can further illustrate the potential impact by using the forward yield curve, which project three months terms closer to the two 9% in one year from quarter end.

Assuming all else equal as of the quarter, ending Q1, 'twenty to an increase in base rates to two 9% would imply 150 basis points of barley accretion or an incremental 25 per share of net income annually.

Moving on to our presentation materials slide eight contains this quarter's niv bridge walking through the main drivers of Niv growth. We added 49 per share from adjusted net investment income against that base dividend of <unk> 41 per share.

<unk> 24 per share reduction to NAV.

Primarily from the reversal of net unrealized gains on our positioning MD America as we book these gains as realized upon sale.

The negative impact from widening credit spreads on the valuation of our portfolio with five ships and then were minor negative impacts related to the mark to market on our extend on our outstanding swaps that are not designated as hedging instruments, which amounted to four cents per share.

Finally, there was a 42 per share positive impact from other changes primarily realized gains on investments of <unk> 18 per share and portfolio company specific events of <unk> 22 per share.

Moving onto our operating results detailed on slide nine total investment income for the quarter was $67 4 million compared to $78 3 million in the prior quarter.

Walking through the components of income interest and dividend income was $58 8 million down slightly from the prior quarter driven by net repayment activity during Q1.

Other fees, representing prepayment fees and accelerated amortization of upfront fees from unscheduled pay downs were lower at $6 9 million compared to 14 million in Q4, given the elevated portfolio activity, we experienced in Q4.

Other income was $1 8 million compared to $2 6 million in the prior quarter.

Net expenses, excluding the impact of the noncash accrual related to capital gains incentive fees were $29 9 million down approximately 8% from prior quarter.

Before passing it over to Josh I wanted to circle back on our ROE metrics in Q1, we generated an annualized ROE based on adjusted net investment income of 11, 6% on an annualized ROE based on adjusted net income of 13, 2%.

This compares to our target return on equity of 11 to 11, 5% for the year as articulated during our Q4 earnings call and we maintain this outlook heading into the rest of 2022.

With that I'd like to turn it back to Josh for concluding remarks. Thank you Ian let me close our prepared remarks here, but I encourage you or shareholders of record roughly upcoming annual and special meeting on May 26 to participate in both consistent with the past five years, we are seeking shareholder approval to issue shares below net asset value the effect.

For the upcoming 12 months to be clear to date, we have never issued shares below net asset value of your prior shareholder authorization granted to us reaching the past five years, we have no current plans to do so we may only get us.

Authorization is an important tool for value creation and financial flexibility in periods of market volatility.

As evidenced by the last eight plus years since our initial public offering our bar for raising equity is high.

We raised equity trading above net asset value on a very discipline disciplined basis. So we would only exercise this authorization to issue shares below net asset value. If there are sufficient.

Sufficiently high risk adjusted return opportunities that would ultimately be accretive to our shareholders to over earning our cost of capital and any associated dilution.

If anyone has questions on this topic. Please don't hesitate hesitate to reach out to US. We have also provided a presentation, which will occur.

Yes.

Tester resources section of our website.

As a final thought for today's call. We are extremely optimistic about the road ahead with current market conditions in mind, we believe the value proposition for our business has never been better for both our clients.

And shareholders.

The.

Declining purchasing power from the impacts of inflation of OE underscored the value proposition of our franchise as a source of alternative real returns for our shareholders, which we believe to be sustainable.

As for our clients, we're prepared to provide capital with speed and certainty through periods of volatility in public markets.

The credit cycle continued vehicle based on tiny monetary policy implemented biotech, we believe our low leverage and significant liquidity.

Profile positive belief that positions us to play offense in the event of a market dislocation.

It has a disposal dislocation has been our greatest periods of outperformance in the past, while we cannot predict what is ahead before we built a robust business model that performs through the cycle.

I wanted to call out how refreshing it is refreshing that had been feedback in the office and be able to interact face to face with friends and colleagues.

Lions stakeholders.

I know a ability to collaborate in person we will continue to provide new motivation ideas as we push further into 2022.

We especially look forward to resuming our annual tradition of the fifth Street off site, where we gather.

Proximately 400 strong team in Austin, Texas.

Sure stakeholders. Thank you for your continued interest in <unk>, especially in Italy.

With that thank you for your time today operator, please open up.

Questions.

Thank you as a reminder to ask a question you will need to press star one on your telephone to withdraw your question press the pound please.

Please standby, while we compile the Q&A roster.

Our first question comes from Mickey Schlein with Ladenburg. Please go ahead.

Yes, good morning, everyone hope you're doing well.

Josh I'm sure, there's a ton of questions on interest rates, but.

You mentioned in your prepared remarks, you would expect our net interest margin to expand with higher rates, but that assumes everything remains equal which it never does right. So I'd like to ask what's your view on how you think the private lending market will react to higher short term rates in terms of maintaining spreads.

Yes.

The last part of the question was the last part of the question. The last part of the question is we're looking at a forward LIBOR curve were sofa curve thats, a very steep so I'd like to ask what's your view on how the private lending market will react to higher short term interest rates in terms of maintaining spreads.

It's a question top of mind for us. So first of all I think one thing to note is that the steepening.

The LIBOR curve ourselves with whoever they are about the same when you think about credit spread adjustment has had a extreme.

Extremely positive impact on the business. If you were to look back at September of last year, we would've probably had 90 <unk> drag.

Investment income line, so not not net income or investment income line to get through.

Our LIBOR floors, and we estimate that to be only about two thirds today.

What tends to happen in our market and hopefully.

People will be thoughtful about that.

They tend to price things in IRR basis, and they don't differentiate between spread and a risk free.

So.

Hey, we're doing stuff in it tend to 11% IRR and Hey, we're still doing it 10%, 11% IRR and therefore.

The pricing with the reduced spread not willing not not realizing or maybe realizing that allowed us coming for risk free.

So I hope I hope the industry.

React differently.

I think we have some asset sensitivity in our book coming for sure how much the industry captures.

I think a key question.

And all things being equal yes.

One.

And spread.

It will return instead of three or so.

For a LIBOR.

But I think I think that's a key question and hopefully the industry racks.

It does it doesn't allow one for one trade off between.

The return attribution between risk creating spread.

Yes, I understand thanks, Josh.

A housekeeping questions.

What are your expectations for <unk>.

Settling the convertible which is coming up.

And also what is the level of undistributed taxable income.

Yes sure.

I'll take that one on the on the converts we have to make an election six months prior to maturity that was actually on February one and we elected to settle those primarily in stock.

And there's about $100 million principal amount of outstanding.

Outstanding today.

Yes.

Settlement.

I think it is.

Basically all in stock.

The minimum amount of cash.

Out of that.

They've been development principle, and even to slightly accretive to net asset value because.

Those will be issued.

And slightly I would say slightly.

It could be dilutive on earnings although the lease valve of that is <unk> distributable earnings.

The United States of Undistributed earnings plus we expect some growth in distributable earnings.

Expected realizations above the current marks and so I think you have you have.

Obviously, we expect to grow above.

A key leverage steadier than our targeted leverage ratio if we double that you obviously can use special dividends.

To make sure you're still capital efficient and we think we have enough spillover income plus kind of pipeline of realized gains.

Allows us to give us that flexibility and so you should think of the same way we address some early conversion in Q4 of last year, and then we get sort of specialty.

That's a tool that we felt was an efficient way to achieve those goals.

I understand what did you say the UTI balance was.

<unk> 59 per share.

$5 9 million.

Yes, the $5 nine.

Alright Thats. It from me. This morning, Thank you for taking my questions.

Thanks Ricky.

Thank you. Our next question will come from Kevin false with JMP Securities. Please go ahead.

Hi, Good morning, and thank you for taking my questions. My first question is similar to one of Mickey's questions.

Given that the economic outlook has shifted in the past few months are you seeing less competition in the market from other lenders. Just curious if you are beginning to see a shift to a more lender friendly environment either in the form of improved documentation are widening spreads.

Hey, Kevin I don't think with TV, Yes, I think Theres a couple forces kind of in the market. One is typically private markets react slower.

The public markets.

The second thing that happens I think is is that there is a deep amount of capital formation in the private credit market.

Which.

I think had some somewhat of a muted impact on lipids.

The pendulum is shifting I think.

That kind.

Kind of a tailwind so I think those are the two headwinds.

The first headwind.

The slow to react kind of goes away over time the capital formation is what it is the fact that tailwind I think of that.

Clearly given that there is.

Tam has expanded for private credit which is the.

Volatility in public markets allow.

I don't want it.

People are willing to pay for certainty in the context of the volatility in public markets, which increases the Tam for private markets and I think what that increase Tam I think that will be a tailwind maybe to that pendulum shifts I'd also say because of the slowdown in M&A earlier this year.

Created a lot of.

I see.

Supply out there that have been.

Deployed earlier, so that will keep tension in the market I suppose.

Yes.

Turning to both of those things we haven't seen evidence.

Widening of spreads or better terms at this point, though as we've seen in my remarks I noted this.

The top of the funnel start to fill up.

I think there's going to be opportunities to pick our spots in particular as Jos mentioned some of those opportunistic non sponsor activities.

That we see as companies looking to shore up their balance sheets and play offense in a different valuation of market.

So the Tam is truly going to expand.

Volatility in public markets and issuers and sponsors.

Looking for certainty, which shipped which should help the capital provision issue.

Okay, Great that's all really helpful.

Then just one on leverage.

<unk> target leverage range is 90 to one last quarter as of quarter end Youre at the low end of that target are you still comfortable operating anywhere within that range or how is your internal target changed a bit in the current environment.

So no I look I think given the given the uncertainty in the world I don't think we're going to operate at the top end of the range I think how we think about our business and how we think about leverage as you got a burden.

Both our capital and liquidity by unfunded commitments and change of spreads given the mark to market.

Piece on the on the outside of our asset side of our balance sheet and you also want to have a whole bunch of dry powder to invest and volatile moments.

Which quite frankly led to see so the outperformance in Q.

In 2000, 22021, I think the industry had Q return on equity for 2021 of about 10% and we had to return on equity of about 35% to 36%.

And over those two years.

As a function of us having enough capital and that's liquidity.

To make investment, but given the change in the economic environment I don't think were going to operate at the top end of our leverage given we think there is volatility coming which means there's probably opportunity coming which means that the our capital adds.

Relatively our capital liquidity has a relatively high opportunity cost.

Okay that makes sense, Josh I'll leave it there congratulations on a really nice quarter.

Thanks.

Thank you. Our next question will come from Finian O'shea with Wells Fargo Securities. Please go ahead.

Okay.

Sorry was on mute hi, everyone. Good morning.

<unk>.

Josh for BOE last quarter.

You talked about the the opportunity butting in.

And growth equity late stage growth equity to provide.

Junior preferred structures.

We've heard some of that.

From your peers as well can you talk about how that is.

Obviously, we didn't see too much this quarter.

Logic.

We would have hoped to given those a lot of those assets have continued to lag in the market is this something thats still.

Around the corner or hubs have these types of opportunities.

No.

I think it's most definitely an opportunity. The question is how appropriate it's going to be for given the structures and the fixed nature of those.

Are those opportunities for further six years specialty lending fund.

Across the platform for example, we will involved in.

Data transaction.

We've been an investor in <unk>, which we think is a amazing company would be the CEO of the Navy and for a long time.

And so I think those opportunities are coming.

The question is will pick the right ones that fit into the balance sheet and how we positioned <unk> specialty lending given that we think about our dividend as a liability to the business.

During the during the pandemic people realize there was a liability to the business.

Because you had to pay to keep your Ric status you had to pay.

Your dividend a casualty had some flexibility to start but it's really people should think about there given the cash liability. So the question is appropriate in our society, but I think there will be fast impact.

Over the next couple of years, and we think that.

Yes.

The right growth businesses that have the right.

Given the economics that return on capital.

And the right.

Pam.

And addressable market. So there is still some opportunity there but anything that.

I agree with all of that I think the opportunity set.

We'll pause for a bit.

<unk> is in the private markets resetting.

The community will be there and strong I agree with everything Josh it would be appropriate vessel, we'll pick our spots in the market.

We are quite active on across the platform.

Excellent brand recognition.

Sure that's helpful and then and then.

Josh on the platform level.

So a couple of new groups set up this quarter the more than capital group the structured products group anything.

You want to talk about there in terms of.

Director or ancillary benefits to the <unk>.

The BDC platform.

Thanks to the commercial the commercial opportunity with your background.

I'll, let paul more than capital.

Generally most of the capital we have a great leader of that business and we think we can be value add to the portfolio companies and the value the value proposition six feet only grows on structured products.

We've hired Mike driving it was known for a long long long time.

Ran that business at credit Suisse.

Most definitely you think you'll be lending opportunities in that space.

That will come.

To the platform.

Is that good asset that asset.

<unk> said that too.

But we really think there is.

The opportunity in.

Mike came in as a lateral partner that we've known for a long time is.

Super talented and has a big brand in that space and so we think there most definitely will be continuing.

Continuing to build and mosaic.

And skill set of the organization, we think only enhances the risk adjusted returns for 600 specialty lending Poland will discuss more on the capital return.

Very excited to have brought on just one as a first time CEO technology businesses to help us to help that effort.

This will help our portfolio companies with a lot of common problems.

Experience.

In building and scaling businesses.

So super happy to have him on and I think you'll hear more from that group over the next couple of years.

Great. That's helpful. Thanks, so much.

Thank you. Our next question will come from Bryce Rowe with Husky. Please go ahead.

Thanks, Thanks, a lot good morning.

Wanted to maybe maybe start.

Just on market activity, though you mentioned.

Some level of pickup in March.

Maybe you could speak to is that is that more kind of seasonality.

Business or.

The source of the pickup would be any any color around that would be helpful.

Yes.

There is always a bit of a seasonal Q1 lag as Q4s are generally quite active from an M&A market. So that was a pretty typical I think what was up a little bit unique in this quarter is we did have valuations reset in the public markets. That's the pause that generally on.

On.

Buyers and seller activity in the M&A market.

Activity slowed as I mentioned in my remarks. In addition to that we saw spread widening so opportunistic refinancings slowed down you saw that begin to unfold in the back half of the quarter.

The top of our funnel pipeline really starting to fill with more opportunistic M&A.

Beautiful public to private but also portfolio companies.

Looking to be opportunistic in the valuation environment. Secondly, you saw a pickup in non sponsor activity.

Yes.

Strongest companies in these periods will look to shore up their balance sheets bolster to invest internally growth, but also opportunistically in M&A. So between what we have going through the pipeline that we've already committed to we're pretty bullish on the opportunity set.

And following that kind of happen a lot sooner than we would've expected.

Takes a quarter or two that was a little bit.

Especially given the move in tech valuation exactly so.

I think Thats I think you hit it which is some seasonal some market volatility.

And market volatility tends to slow both M&A and opportunistic refinancings and.

It feels like it's got a little bit quicker than typically than I would've thought.

And do you guys do you guys feel like prepayment or repayment activity will.

We will slow here with the volatility.

With higher rates or do you have pretty good line of sight into continued repayment activity exit activity.

Yes, I would say so.

Typically we're unlike mortgages were not a sensitive to rates on prepayments speed.

It's widespread.

So.

And idiosyncratic events.

I would say that you would if.

You would expect that there is.

That's the sign that we discussed a second ago that will have some impact on our portfolio portfolio portfolio companies that were up for sale and that might trade in and penetrate before and so there will be windows relatively outside of the energy book given the commodity prices.

<unk> in Q1, there was very little kind of repayment activity that was the bulk of the repayment activity given the commodity price environment I would expect it to kind of get back to normalized levels to some extent.

Okay Alright.

Maybe one more for me just on the on the right side of the balance sheet.

And this maybe a tough question to answer.

So you've got a you've got unsecured note maturity early in 'twenty three just just kind of curious how youre thinking about.

How you might handle how you might handle today if it were today.

With spreads, having having having widened and rates having widened for unsecured debt in the BDC space.

Yes, So look I think I think our unsecured spreads have less data there, especially given the upgrade and given the quality of the franchise. We built the great News is we have about a billion one one.

1 billion three growth of <unk>.

Unfunded commitments available to draw one billing.

One to one billing too.

Total liquidity burden for unfunded commitments and I think that maturities at the $115 million 151 ft, and so I think we have a lot of optionality and flexibility.

And rewarded do it on our line today.

Correct me, if I'm wrong that what does that what does that work on a swap adjusted basis, where does that.

Maturity side, probably LIBOR 200, or something like that.

<unk> 200.

If you think about our marginal cost of <unk>.

Capital on our revolver, yes, I think it's about LIBOR 150, because you.

You also have the unused line fee and a commitment fee and so if we were doing on our revolver.

We have $1 billion.

We're going to work for unfunded commitments.

It would be accretive to our cost of capital and I think that 150 is actually LIBOR at 299, and so you actually pick up 50 basis points.

Interest savings of about 150 million Bucks on a net basis on a marginal basis. If you were to do it online we have a ton of liquidity.

Okay, Alright, that's helpful. Thanks, guys.

Thank you.

Thank you. Our next question will come from Melissa Wedel with Jpmorgan. Please go ahead.

Good morning, and thanks for taking my questions today.

Yes current Josh about Stephane, Paul total smartphone.

That's in the context of what's happening.

We also recognize the points that you guys have had over the years.

Okay.

So im curious how youre thinking about sort of top line.

The potential for <unk>.

The trajectory can be.

As prepayments normalize thank you.

Yeah, I think it was.

It's really hard to hear but what I.

I think I heard you say you could correct me if I if I heard this wrong I think I heard is why do you think about.

The impact of income on your income statement as.

As prepayments normalize.

I think it was that the question.

Yes, Josh thanks.

Greg look I think tips.

Typically fees.

<unk>.

Well I'll try to give you the exact data this is a low kind of attribution quarter for us.

Historically on average.

We get the exact data between accelerated OID and prepayment fees.

And amendment fees that typically is call it.

On an annualized basis.

752 cents per quarter on a per share basis divided by four as well.

The 14th.

14th at the quarter I think this quarter was 7%.

7% to 8%.

So it looks definitely lower this quarter.

I think that historically.

How we've operated.

I think our.

Worse year.

Yes, so I would say you could expect it to be kind of probably three.

700, <unk> more per quarter or something like that.

<unk>.

Given activity levels, but that.

They are extremely lumpy quarter to quarter.

Understood. Thanks.

Thank you. Our next question will come from Ryan Lynch with BW. Please go ahead.

Hey, good morning.

First question I had if I understand your comments correctly it sounds like the slowdown in Q1 was partially driven by I think seasonality with kind of a very robust second half of 2021.

Also in combination with I think.

Economic uncertainties.

About what the rest of 2022 looks like and so you kind of said that your pipeline had now been growing kind.

And Q1 and into 'twenty.

Q2 My question is is.

It's a little bit confusing just because a little bit surprising I guess, just because the economic uncertainty scene.

As high as they've ever bandwidth right.

<unk> inflation.

How do you square that value round that square value for your question.

I think the answer lies in the.

The amount of private equity dry powder out there to be honest with you which is most of the activity a lot of it is private equity driven.

And there's always discreet fear thing, which is sometimes the best time to invest.

Long term investors is when there is volatility.

And there is a ton of dry powder.

In private equity and Youre, starting to see them put that to work.

Yes.

A great example of that is not that within the fixed fee.

Our specialty lending portfolio, but like you've seen.

Okay.

Sure.

<unk>, which is a publicly traded company and just say it was a private equity backed company southern debentures and so you are seeing.

Sponsors.

Sure.

And certainly the industry is putting.

Money to work.

Given the uncertainty.

Yes.

Okay.

Because obviously those fears uncertainties are all well known in the marketplace everybody's operated with our eyes wide open at this point so with that has the quality of deal flow or the quality of companies that are transacting at least a potential transaction and the pipeline has they improve.

<unk>.

To be higher quality companies that are potentially in good position to weather. These headwinds we noticed any change yet.

Yes.

Really good question look I would say I think the one nuance I think everybody sees the uncertainty I think people have very divergent views on how the uncertainty is going to play out.

Maybe not soft landing.

Or how do you deal with the employment gap you typically I think maybe never seen a recession.

If you haven't seen unemployment increased by 50 basis points.

I don't I can't give worldwide employment increased by 50 basis points, Kevin given the employment gap.

<unk>.

I don't think theres going to be.

Something I think is going to be soft landing or.

So I think it's.

Clearly divergent views, but we mostly see the activity around businesses that have stronger business models.

Better able to push through cost.

And have high gross margins and have operating leverage in silicon grow earnings.

So I think.

<unk>.

Very divergent views, but the quality of the businesses they are high.

Valuation.

People have different views of our given the environment I think we are.

Less impacted by that given where we are investing in the capital structure.

Okay.

I appreciate the time today.

Thank you. Our next question comes from Kenneth Lee with RBC capital markets. Please go ahead.

Hi, Thanks for taking my question.

Just one on the investment portfolio, it's pretty diversified across industries right now, but I'm wondering if you can just talk a little bit how you're thinking about portfolio positioning any marginal shifts within across industries, just given the current backdrop and the near term outlook.

Yeah, I mean, it's a good question I don't think Theres any big marginal shift.

Look I think energy is a interesting space.

What we typically don't like to lend into higher commodity price environment, but there's been a lot of capital outflows across the energy sector. Both on the private and public side given two big factors one factor is.

The FTE issues or concerns and the second factor is that sector. Historically has been a terrible allocator of capital, which is you have this correlation which is.

As far as the prices are high people put in more capital that that feels like it's been less that's until it gets muted given.

Energy companies focus on free cash flow versus net asset value growth.

And the FTC concerns.

So I don't we are net lease exposure has gone down significantly I think it's like one points.

One 7% of the book today, I think there's room there.

But we'll be very thoughtful about how we do it on a retail.

That's come down as a percentage of our portfolio historically as well.

Retail.

As I think today is the exact amount is 10, seven and I think there has been high as.

20% or something like that.

But you've had a backdrop of a strong strong consumer.

And strong earnings from retail and.

The World will go over kind of retail.

And that kind of got flushed or got changed in the pandemic and so as the consumer softens or discounting comes back and in this low volatility in retail earnings I think that might change. So I think on the margin, but I think it's in the bands of historically, where our portfolio has been but if you look at those two segments for sure we're under allocated.

Given where we are in the cycle.

I expect there would be some reversion to mean for fishing anything that we get it.

Sure.

Great very helpful. There.

One follow up if I may and just from a high level in terms of the ROE.

It looks like Youre, maintaining your Roe targets.

Despite having 13% ROE in the quarter Wonder if you just talk a little bit about how you think about RV over the near term what are some of the major puts and takes that could impact one way or the other thanks.

Yes.

When you think about our business from a unit economic business a unit economics perspective, the things that impact on ROE as yields.

Leverage so capital efficient team.

Which is a function of.

That pay offs.

Plus how we manage our.

Net portfolio growth and a negative positive.

And then how do we manage our access capital we've historically manage that.

A combination.

Growing our capital base through the drip.

Special dividends.

And.

Credit losses.

Pretty good about where we sit in credit losses actually think there is some.

Depending on how things play out some upside left in the book.

John .

Unrealized.

Realized gains that exceed our current marks.

And so that will have.

A positive impact to our ROE.

I don't see any one near term credit losses.

So ultimately it's a function of.

Yields and capital efficiency, and we've done a pretty good job of managing both.

Great very helpful. Thanks again.

Thank you. Our next question will come from Matt Tjaden with Raymond James. Please go ahead.

Hey, Good morning first question for me on the ABL product.

Yes.

Offsetting the offsetting factor is that the consumer has been really good shape and so when you look at gross margin and EBITDA margin expansion across retail, which we've done quite.

Quite frankly, we've been involved in the new markets across the platform for a long time.

Yeah.

The income statement are really really good shape.

Given the lack of discounting and giving consumers post the pandemic.

So youre right that there is a.

More of a working capital need but.

Income statements.

You found you're probably working capital through.

The strength of the income statement I think free cash flow and then.

The balance sheet.

<unk>.

Op, either operating cash flow, so pick ups, David R or financing.

And so I think thats the offset.

And retail has to be in.

Really in good shape at the moment that could change on a dime.

For sure.

I still think it's pretty low.

I felt LIFO.

I think the trigger questions 'twenty three 'twenty four but if you look at our book I think it's pretty pretty low if you. If you think about the recent vintages of deals.

Those companies have had earnings growth and it started off with good liquidity.

The private credit's been slightly I think until that the software intact and so it feels like it's pretty pretty low.

Not that much.

Not that much exposure cyclicals.

But we don't have that much exposure to cyclical so I feel pretty constructive about the pulp cycle.

For for 'twenty two.

Generally for general credit.

Especially in private credit I don't Bo or fish, if you have anything to add.

'twenty three 'twenty four.

Turner question, but I think.

We would expect pretty low default rates across the sector. I can tell you I can tell you the industry that are going to be heard industry, if theyre going to be heard are.

There are.

What are the kind of low EBITDA margin businesses, where.

They are relatively competitive businesses, where they have.

Where they've had commodity price inputs that they can't pass along to consumers.

Those industries are going to be heard.

So.

Paper packaging.

Specialty chemicals.

I think I would not call it defaults to those cycles, but any industries that have relatively low EBITDA margins and no pricing power.

By.

Commodity inputs into their cost.

Cost structure I think those are the industries that are have a higher chance of being hurt.

Got it that's helpful. I appreciate the time.

Thank you and we do have a follow up from Finian O'shea with Wells Fargo Securities. Please go ahead.

Yeah.

Hey, thanks, so much for the follow up.

Josh just thinking a bit more.

From our dialogue on on Preferreds and.

I appreciate your commentary and logic on avoiding too much pik, but is there a firm wide there youre youre drawing in the sand or or is there somewhere on the curve of returns where you would.

But take on these sorts of deals and I ask because.

In today's environment, the outlook could very well be that this type of company.

Turns out to be the provider of <unk>.

A large structured rescue type opportunity that that you've done really well in the past obviously.

So question is is this a hard line.

Being anti tick or is it just not good enough.

Hey.

No I don't think we have a hard line just to recall.

We are.

Mike just with colleagues.

We are when you look at our overall balance sheet, we've got tons of liquidity. So we.

We like to think about funding our dividend from operating areas, but we have tons of liquidity.

I think it's a combination of a bottoms up investors.

Sure.

So finding the right opportunities that fit right into our balance sheet.

I don't I don't see us being a large provider of rescue financing in a junior capital position. Our strategy historically has been providing rescue financings outside capital structure, where we're not the <unk>.

And we're not taking process risk. So I think if you see us doing some of that type of investing I think companies, we really really like with clean capital structure, great prospects secular growing.

And healthy businesses.

Is the way I would generally characterize our strategy.

And then I think the fundamental question is.

Does the risk return work, which is.

There's many many many times.

You can't eat IRR.

So in any any any investment structure, where you can make.

Where you can get like 11 or 12% of preferred is callable and so your yields on your enrollment towards is like one two times, but you are deep deep down the capital structure and you can lose a lot of the capital that isn't going to work I think so.

You have to be thoughtful about.

The probability.

Returns and returns given the given a default or.

Not being the bulk of them and so I think.

Where bonds are investors and there is no hard line, but.

We like some of those opportunities we don't like others.

Thank you I'm showing no further questions in the queue. At this time I would now like to turn the call back over to management for any closing remarks.

Great.

We really appreciate peoples time.

Actually on the West coast today. So this has been slightly painful for me to give you a bit.

In the morning.

Get go, but we really appreciate peoples time.

Mother's day is coming up I think.

And our tradition, we hope everybody takes the time.

Their families and appreciate the people in their lives and happy mother's day.

Everybody out there.

Listening in.

Pudding.

Our significant others so.

We really love the dialogue.

If you make here.

<unk>, New York, San Francisco feel free to stop and.

We will welcome any pullback in our office.

Given the environment.

Thanks, everybody.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation you may now disconnect.

Q1 2022 Sixth Street Specialty Lending Inc Earnings Call

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