Sixth Street Specialty Lending Inc. Q1 2023 Earnings Call
Yeah.
Okay.
Yeah.
Good morning, and welcome to the sixth Street Specialty lending Inc. First quarter ended March 31st 2023 earnings Conference call. At this time, all participants are in a listen only mode.
As a reminder, this conference is being recorded on Tuesday May nine 2023, I will now turn the call over to MS can be van Horne head of Investor Relations.
Thank you before we begin today's call I would like to remind our listeners that remarks made during the call may contain forward looking statements statements other than statements of historical facts made during this call may constitute forward looking statements and are not guarantees of future performance or results and involve a number of risks and uncertainties actual results may differ materially from those.
The forward looking statements as a result of a number of factors, including those described from time to time and sixth Street specialty lending Inc. Filings with the Securities and Exchange Commission. The company assumes no obligation to update any such forward looking statements yesterday. After the market closed we issued our earnings press release for the first quarter ended March 31, 2023 and posted a presentation.
Patients to the Investor resources section of our website Www Dot fixed street specialty lending dot com. The presentation should be reviewed in conjunction with our Form 10-Q filed yesterday with the SEC fixed Street specialty lending Inc. 's earnings release is also available on our website under the Investor resources section unless noted otherwise all performance fee.
As mentioned in today's prepared remarks are as of and for the first quarter ended March 31 2023.
A reminder, this call is being recorded for replay purposes, I will now turn the call over to Joshua easterly Chief Executive Officer of sixth Street specialty lending Inc.
Thank you Jamie good morning, everyone and thank you for joining us with US today is my partner and our president both favorably and our CFO incentives for our call. Today are provide highlights for this quarter's results and then pass over to Bo to discuss activity levels in the portfolio.
Ian will review, our quarterly financial results in 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 with adjusted net investment income per share of <unk> 55, corresponding to an annualized return on equity of 13, 3% and adjusted net income per share of <unk> 67.
Corresponding to an annualized return on equity of 16, 3% from a reporting perspective, our Q1 net investment income and net income per share inclusive of accrued capital gains incentive fee expenses was 53, and <unk> 65, respectively.
As a reminder, the <unk> per share is a noncash expense, which was not paid or payable is related to accrued fees on unrealized gains from the evaluation of our investments.
This quarter's net investment income reflects the continued strength in the core earnings power of our portfolio and the annualized return on equity metrics are above the guidance. We provided on our last earnings call net investment income was largely the result of elevated portfolio yields driven by higher underlying reference rates actor.
Activity based fees represented only three 6% of total investment income for the quarter.
Year over year total investment income has increased 43% largely driven by asset sensitivity from higher interest rates.
Putting rate investments, we expect that the interest rate environment will continue to support core earnings without the impact of any activity related income based on our base dividend level.
Further we believe there is potential upside relative to this quarter's $13 three annualized return on equity while adjusted net investment income as we generate incremental earnings from pay offs and other activity based fees.
The difference between this quarter's net investment income and net income was predominantly a result of unrealized gains from tightening credit market spreads on the fair value of our portfolio and realized gains from certain portfolio companies specific events.
Macroeconomic perspective say 2023 is after an eventful start as earlier stated.
Through the first quarter of the year, we've experienced financial contagion fears following the regional banking issues persistent inflation.
<unk> rising interest rates and ongoing geopolitical factors just to name a few.
As part of our commitment to transparency and our communications with our stakeholders. During March we published a letter outlining the positioning of our business as it relates to the most recent developments of the banking sector. We encourage you to read our perspective and welcome any feedback but for today's call. We will keep it simple by saying we don't believe there are any material impacts.
So our business from these developments.
If we take a step back and consider all of the opportunities and challenges presented by today's macro landscape. We believe that <unk> is well positioned we have built a defensive to.
Through the cycle business characterized by investors on top of the capital structure with low exposure to cyclical businesses.
Although our portfolio construction is bottoms up in nature, we continue to be mindful of the impact of certain macroeconomic indicators that can influence both the performance of our existing portfolio and the opportunity set ahead of us.
At quarter end net asset value per share was $16 59 up 25 per share or $1.
From adjusted net asset value per share at year end of $60 39.
This growth was primarily driven by continued over earning of our base dividend and net unrealized and realized gains from investors.
Yesterday, our board approved a second quarter base quarterly dividend of <unk> 46 cents per share to shareholders of record as of June 15 payable on June 30, Our board also declared a supplemental dividend of <unk> <unk> per share related to our Q1 earnings to shareholders of record as of May 31.
Payable on June 28, our Q1, 'twenty three net asset value per share adjusted for the impact of the supplemental dividend of $16 55.
We estimate that our spillover income per share at quarter end is approximately 87 as part of our focus on capital efficiency in conjunction with our board. We will review the level of undistributed income as the year progresses to ensure we minimize potential return on equity drag for the resulting excess tax.
At some level this will likely require the payment of additional distributions for our shareholders similar to how we address this in 2020 in 2021 with that now.
I'll now pass it over to Bo to discuss this quarter's investment activity.
Yeah.
Thanks, Jos I'd like to start by sharing some observation on the broader market backdrop in particular, the secular shift towards private credit that has been a persistent theme over the last few quarters.
We believe the opportunity set for our businesses agreements.
<unk> history.
Since the global financial crisis.
<unk> in the financial sector has further increased market share for direct lenders as banks are tightening credit.
In public markets remain unreliable in light of heightened economic uncertainty.
As a result, nearly every financing opportunity coming from the private credit market due.
Due to the flexibility and execution certainty that direct lenders with capital are able to provide.
This shift has been a positive for our business as we continue to build a robust pipeline while remaining selective.
Broadly speaking M&A and LBO activity.
As meaningfully slowed.
Scale and quality of company refinancing has generally improved given the shift towards private credit.
We remained active during the quarter with commitments and fundings totaling $176 million and $139 million respectively.
This was distributed across seven new and five outside of the existing portfolio of companies on.
On the repayment side higher interest rates and the lack of more traditional capital market financing alternatives.
I've led to a slowdown in refinancing activity, resulting in less portfolio turnover over the last couple of quarters.
We had one four and three partial investment realizations totaling $51 million in Q1, Consequently activity based fee income remains.
Our full pay off during this quarter was our investment in white orbit, which is a provider of television and radio traffic management software.
As a reminder, we made our initial investment in July of 2020.
Covid driven market dislocation.
Our ability to play offense. During this time not only benefited the company and its need for refinancing.
But also allowed us to structure the transaction with favorable terms for shareholders, including potential upside through ownership of warrants.
In February the company was acquired by the aluminum group, which included the repayment of the outstanding balance on our credit facility and proceeds.
Warrant holders.
Tfl Act received $5 2 million in proceeds from the sale of our warrants, resulting in a realized gain of $4 8 million or <unk> <unk> per share and generated a blended IRR and <unk> AUM on our total investment of approximately 17% and one forex respectively.
To touch on investments during the first quarter sponsor activity in the upper middle market remain active given the uptick in public to private transactions more broadly across the middle market.
Acuity levels were generally slower in Q1, but for the deals that we're getting done.
Scarcity.
<unk> proven the opportunity for our business with a substantial pool of capital costs.
That form.
One example that highlights the theme with our investment to support Thoma Bravo take private of Cooper Holdings.
With a total transaction value of $8 billion.
Since we play an important role in providing financing given the size of our capital base and knowledge in the software space.
Both of these Differentiators in addition to our relationship with the sponsor a lot of the structure of the underwriting profit.
In addition to making new investments remained very focused on active portfolio management, including monitoring the health of our existing portfolio of companies.
Elevated interest rates and sustained depletion of creating a more challenging operating environment, especially for those with high fixed cost obligations.
82% of our portfolio by fair value was characterized by software and business services companies as of quarter end.
We favor the durability in these sectors in particular.
Given the variable cost structure provides us the flexibility to implement more immediate cost savings.
In the event bookings, our topline growth slows in environment of broader economic slowdown.
Today, the performance of our portfolio companies remained solid demonstrated by quarter over quarter revenue and EBITDA growth of 9% and 17% respectively.
As Jos mentioned, we've constructed our portfolio to withstand all types of operating environments and we feel good about the overall health of our current portfolio.
I'd like to take a moment to provide an update on one of our existing investments bed Bath and beyond.
As publicly disclosed on April 20 <unk>.
Bed Bath and beyond announced that it would be volatility finally for bankruptcy to implement an orderly wind down of its business, while conducting a limited marketing process.
So what's the interest in one.
Or more sales of some or all of its assets.
This filing and the voluntary nature of it as a positive development for our investment.
Instead of the company potentially attempting to fund continued losses.
We believe the shorter time period, optimizes recoveries on our collateral and for creditors in general.
The company also announced that <unk> and.
<unk> of <unk>.
<unk> 500 lenders would be contributing $240 million in debtor in possession financing to provide liquidity for operations through the chapter 11 process.
This is comprised of $40 million of new fundings of which $5 $9 million with funded by <unk>.
With the rest being a rollover from previously funded commitments amongst the lender group.
Including our positioning of the dip Tfl assets funded $76 million related to the bed Bath and beyond to date since our initial investment in September of 2022.
At this moment, we feel confident about the recovery of our investment at fair value.
We would also note that there is potential upside above fair value as our total claim amount includes previously capitalized make whole amounts, which could positively impact earnings in the range of zero to $10 five per share net of incentive fees.
When we made our initial investment it was to provide liquidity and to support the turnaround of an iconic brand, which we felt had real potential to rebound is the right strategy was put in place.
Unfortunately that hasnt happened.
50% drop in same store sale during last years holiday season, and significant operating losses in Q1 were too much to overcome for the business to continue in its current form.
While liquidation with not the desired outcome. It was the base case from our underwriting approach and as we have demonstrated before we have core competency in these situations.
Since we began investing in <unk> in 2011, we've executed over 25 transactions in our retail ABL team and.
And in each case, we underwrite with a liquidation scenario in mind.
We have taken nine of those 25 investments through the bankruptcy process.
These processes are always fluid with this one being no different when we continue to work diligently to maximize value for our investors.
Our recoveries will ultimately be based on the underlying liquidation value of the assets of the business, which we will have more refined view on overtime.
We anticipate the liquidation process it takes approximately 16% to 20 weeks.
Heading into the rest of 2023, we saw a pickup in activity beginning in March and we are optimistic about our originations and funding pipeline.
The fact that we're in a strong position from a capital liquidity perspective, as Ian will discuss provides us with meaningful competitive advantage in the current environment.
As for repayment activity, we generally expect less churn in our portfolio through the course of the year. However, we do anticipate opportunistic.
And credit events will drive payoffs.
Deal flow and repayment activity or largely a byproduct of macroeconomic factors at play.
But we continue to pick our spots to remain selective.
We will opportunistically deploy capital in areas, where our platform's 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.
Positive impacts of our weighted average yield on debt and income producing securities at amortized cost.
Yields were up to 13, 9% from 13, 4% quarter over quarter.
We're up about 360 basis points from a year ago.
The weighted average yield at amortized cost on new investments, including Upsizing. This quarter was 13, 8% compared to 13, 2% on exited investments.
Moving on to the portfolio composition and credit staff across our core borrowers. So these metrics are relevant we continue to have conservative weighted average attach and detach point on our loans up <unk> eight times at four four times, respectively, and a weighted average interest coverage remained stable at two two times.
As of Q1 2023, the weighted average revenue and EBITDA for our core portfolio companies with $165 million and $54 million respectively.
Finally, the performance rating of our portfolio continues to be strong with a weighted average rating of one six on a scale of one to five with one being the strongest.
We continue to have minimal non accruals at less than <unk>, 7% of the portfolio at fair value with no new portfolio companies added from prior quarter the.
The increase in the notional quoted value from the prior quarter reflects another tranche of our investment in American achievement being placed on non accrual during the quarter.
This was a COVID-19 impacted business.
That has had difficulty recovering after missing one on one selling seasons and the relatively weakening of their competitive position in our industry.
American achievement continues to be on the portfolio company on non accrual status.
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> 55, and adjusted net income per share of <unk> 67.
Total investments with $2 9 billion up from the prior quarter as a result of net funding activity total principal debt outstanding at quarter end was $1 6 billion and net assets were $1 4 billion or $16 59 per share prior to the impact of the supplemental dividend that was declared yesterday.
Our average debt to equity ratio increased slightly quarter over quarter from $1. One four times to 117 times and our debt to equity ratio at March 31 was one two times. The increase was driven by portfolio growth from new investments combined with minimal repayment activity.
After the recent announcements from bed Bath and beyond the Beau mentioned earlier, we now expect to $76 million in funded par outstanding to be paid down in the near term, thereby decreasing leverage and increasing our capacity for new investment opportunities.
We continue to have ample liquidity with $603 million of unfunded revolver capacity at quarter end against only a $119 million of unfunded portfolio company commitments eligible to be drawn.
As part of the letter to all stakeholders, we published in March in response to the failure and Silicon Valley Bank, we shed aspects of that philosophy towards managing risks in our business.
As we've witnessed through the last couple of months. It is not enough to nearly satisfy minimum regulatory requirements. It is in the corner cases, the shocks with our strength or weakness of the operating model is truly apparent.
And understanding of this concept has guided the way we have structured our balance sheet in terms of both capital and liquidity.
As it relates to capital we operate within our previously established target leverage range of <unk>, 9% to one five times well below the regulatory limit of two times largely as a way to preserve our reinvestment option to create high risk adjusted returns.
This has been purposeful as we noted that it is in periods of volatility and market dislocation. The great investment opportunities are created while capital generally becomes constrained.
Turning to liquidity, we think about our liquidity profile in terms of reserving.
<unk>, all near term maturities of which we have known.
To unfunded commitments eligible to be drawn and three future pipeline investment opportunities, both known and unknown.
As of March 31 liquidity represented three two times the amount of unfunded commitments eligible to be drawn.
Moving to our presentation materials slide eight contains this quarter's niv bridge walking through the main drivers of NAV growth. We added 55 per share from adjusted net investment income against the base dividend of <unk> 46 per share.
As Josh mentioned at the beginning of this call there was <unk> <unk> per share of accrued capital gains incentive fee expenses related to this quarter's net realized and unrealized gains there.
There was a 22 per share positive impact primarily.
Primarily from the effect of tightening credit market spreads on the fair value of our portfolio and finally other changes resulted in a <unk> <unk> per share decline in NAV.
Which primarily included <unk> <unk> per share from lower equity valuations offset by <unk> <unk> per share from realized gains.
A large portion of the realized gains were driven by the pay off in February of our investment in wide open.
Moving onto our operating results detailed on slide nine total investment income for the quarter was $96 5 million compared to $100 1 million in the prior quarter.
Looking through the components of income interest and dividend income was $92 2 million up from $85 8 million in the prior quarter driven by higher OLED yields and net funding activity other fees, representing prepayment fees and accelerated amortization of upfront fees from unscheduled pay downs were lower at <unk>.
One 6 million compared to $11 million in Q4, given the minimal repayment activity we experienced in Q1.
Other income was $2 8 million compared to $3 4 million in the prior quarter.
Net expenses, excluding the impact of the noncash accrual related to capital gains incentive fees were $51 4 million up from $47 5 million in the prior quarter.
This was primarily due to the upward movement in reference rates, which increased our weighted average interest rate on average debt outstanding from five 4% to six 7% coupled with marginally higher average debt outstanding in Q1.
Before passing it over to Josh I wanted to circle back to our ROE metrics in Q1, we generated an annualized ROE based on adjusted net investment income of 13, 3% and an annualized ROE based on adjusted net income of 16, 3%. This compares to our target return on equity.
13% to 13, 2% for the full year as articulated during our Q4 earnings call and we maintain this outlook heading into the rest of 2023 with that I'll turn it back to Josh for concluding remarks.
Thank you and I'd like to close our prepared remarks, Dave I encourage you to our shareholders of record to participate and vote at our upcoming annual and special meeting is on May 25th consistent with previous years, we are seeking shareholder approval to issue shares below net asset value effective for the upcoming 12 months.
To be clear to date, we have never issued shares below net asset value.
Under prior shareholder authorization granted to us for each of the past six years.
We have no current plans to do so we merely view the authorization as an important tool for value creation and financial flexibility in periods of market volatility.
As evidenced by the last nine plus years since our initial public offering our bar for raising equity is high we've only raised equity when trading above net asset value on a very disciplined basis. So we would only exercise the authorization to issue shares below net asset value. If there are sufficiently high risk adjusted return opportunities that would ultimately be accrued.
To our shareholders through over earning our cost of capital and any associated dilution.
If anyone has questions on this topic. Please don't hesitate to reach out to US. We have also provided a presentation, which walks through this analysis and the investors resource section of our website. We hope you find the supplemental information are helpful. As a way of providing a clear rationale for providing the company with access to this important tool.
As a final thought for days call, we want to address all of the target.
There has been about the current environment being the Golden age for private credit.
While we believe there is a huge opportunity for private credit and direct lenders in today's marketplace. We also believe there will be meaningful dispersion in returns for shareholders.
To take advantage of the opportunities that requires a differentiated strategy, including the right human capital. It all starts with having the right team.
People with expertise across sectors and industries, who are positioned in the right fees to collaborate across our connected platform.
We just returned from our annual fixed street off site.
Nearly a 500 person strong team gathers to work together and build relationships. This tradition to continues to solidify the culture. We built is essential to the success of our business engineering differentiated returns for our shareholders with that thank you for your time today operator, Please open the line for questions.
Thank you as a reminder to ask a question. Please press star one one on your telephone and wait for your name to be announced to withdraw. Your question. Please press star one one again.
Please stand by while we compile the Q&A roster.
Our first question comes from the line of Kevin <unk> from JMP Securities.
Hi, Good morning, and thank you for taking my question.
The recent turmoil in the banking sector I was curious if you've seen any change over the past two months and your ability to negotiate better terms on the new deals that youre doing in the forms of more attractive spreads lower ltvs, possibly lower leverage or improved documentation just trying to get a sense of the deal making environment has become even more compelling.
Kevin Thanks for the question.
Say on the margin not I think the we've seen I think we haven't seen any step change from the regional bank failures.
And on the margin quite frankly to be honest, it's probably slightly more competitive over the last.
Two months versus the previous two months before that.
So I would say.
Yes.
<unk>.
Pretty similar to the environment, we've experienced over the last.
Seven eight months.
But theres been no kind of significant change on the margin given the regional banks most of those regional banks did not play significantly.
Excluding Silicon Valley Bank.
Signature does it play.
B didn't play.
And so on.
And we don't see we see superregional banks, but we don't see kind of the typical regional bank in our market in any event so on the margin.
I would say not any step changes.
That's nothing to add there I think.
On the margin, it's been slightly more competitive over the last couple of months, but still relatively attractive in historical terms.
But no step change since the regional banking crisis.
Okay that all makes sense and then just one more for me.
Curious if you saw an increase in amendment requests from borrowers in the first quarter. Then maybe also touching on what you are seeing quarter to date.
Yes, it's a great question. The answer is yes, but not mostly from LIBOR to sow for.
The amendment, obviously, there is a big push given the discontinuation of LIBOR to get everybody on the sofa.
I would say when we look at our amendment activity.
The vast preponderance of those were just so for LIBOR amendments.
And some upsizing.
There was no significant kind of amendments due to underperformance.
Okay. That's good to hear and congratulations on a really nice quarter I'll leave it there.
Great. Thanks, Thanks, Kevin.
Thank you one moment for our next question.
Yeah.
Our next question comes from the line of Mark Hughes from <unk> Securities.
Yes. Thank you good morning.
Did I hear it properly I think you said within the portfolio of the revenue growth was 9% EBITDA, 17% is that correct.
Yeah, Let me, let me take a chance to qualify for the way we think about what that is.
Portfolio quarter over quarter, if you think about it on a static or a same store basis is a little bit smaller than that year over year, 17%.
And year over year EBIT growth of about eight.
Okay, good topline growing a little faster than EBITDA. Good evening My question.
Yes, yes.
On a kind of a on a static basis.
Yes, understood and then any different industry mix in the pipeline I think you said it started to build again in March.
Any particular type of deal, it's more likely to come to market in this kind of environment.
Yes look I would say for sure on the margin our aperture as it relates to industries have opened.
Given the broad based dislocation.
For example, it's noted that were involved in an aerospace and defense take private.
For a company called <unk> technologies.
That is a new factor to us, but a very large company about $400 million plus of EBITDA.
Health care for sure is an active space.
With a lot of assets coming to market. So given the broad based dislocation.
Our sectors have opened up.
<unk>.
On the margin.
Is there any change in your ability to take kind of a leadership role where you got the effective control of these.
These.
The investments.
No I would say look the larger ones are more club deals with like minded investors, where we hold a significant piece of where typically the agent.
One of the agents are Rangers.
And so our access to diligence.
Is the same and I would say.
The larger deals are most definitely more publish.
Thank you.
Thanks for your questions.
One moment for our next question.
Our next question comes from the line of Jordan Watson from Wells Fargo Securities LLC.
Hi, good morning.
Couple of deals with the public markets.
Previously seeking private execution should we anticipate any.
Yes, Alex next quarter from those two deals.
Sorry say it again Jordan.
We anticipate any breakup fees from some of the.
So we're dealing with sell through that we're going to go private.
<unk>.
Great.
The BDC picked up any of the break fees.
Yes.
Great question, you guys I think there's only one I don't know if theres a couple but there's one that's emerson.
That that credit I think the public markets.
Have opened up a little bit for higher quality credits that ended up being a double b credit.
<unk>.
And a very large company and it will be credit.
And there is there will be a <unk>.
A transaction fee that rolls through.
Next quarter's income statement.
Okay, Great and then is there any.
Has there been any upward movement on floors or just 1%.
Default number in private credit.
I would say I would say I think.
Quarter over quarter was up slightly.
I'll give you the exact data, but I think our floors are.
Our average floor.
Yes.
1%, I think slightly up quarter over quarter are flat quarter over quarter.
But they range between 75 basis points and 2% for example on Laramie was 2%.
Okay understood. Thanks, so much.
Okay.
Thank you one moment for our next question.
Our next question comes from the line of Erik Zwick from Pulte group.
Good morning.
To start first and just thinking about the that yield in the portfolio and that trajectory of <unk>.
Investment income it seems likely that the fed is nearing the end of its hiking cycle.
Thank you also mentioned that spreads after widening for a while maybe starting to get tightened again, theres a little bit more.
Competition.
Your markets. There. So so just curious are we potentially nearing the peak of the portfolio yield offer this cycle or is there still opportunity.
As you are adding.
Older loans are.
Being repaid and Youre, adding new.
The relationships, where you can potentially get some some wider spreads and as you mentioned the floor just slightly coming up just trying to think about the kind of the puts and takes there and what that means for the trajectory of yield and then come going forward.
Yeah. So the way I would think about it is look the front end of the LIBOR curve I think is where the sulfur curve is still relatively high out of the fed funds rate.
And I think there is a large debate in the marketplace.
Where if the fad.
The near term.
I would take the.
I would take the under on a near term cuts.
That being said if there is a near term cut is because there are those financial stability issues or recession fears, which I think would drive spreads wider and that moment of time and recreate a good investment.
Opportunity, but the way our income statement.
Typically work.
The core areas of the business typically works.
That win and.
In an event, where we have a tightening spread environment.
We have much more activity based fees that provide.
Significant amount of near term earnings to the book.
And in an event where spreads were stable or.
Or wider obviously that is good for yields.
And.
Good for total investment.
The investment income line.
Portfolio leverage stays.
Flat to increasing which drives our ROE. So I think in the near term as you think about it.
We remain in.
A highly volatile environment, which either means.
On that.
That yields will remain stable or in the event that we are the fed is cutting that spreads will widen so I'm pretty bullish about the near term of kind of our business as it relates to the earnings profile and return on equity profile and the hedge again being activity based income.
If spreads to tighten.
That's helpful. I appreciate it and the second one for me just thinking about the funding profile of <unk>.
Good position now where you don't have any notes coming due until the end of 'twenty four and still have quite a bit of capacity on your revolver, but if we enter a period, where we do go into maybe a moderate or severe recession and it seems like the banks are pulling back a little bit on their funding and if investors become a little bit more skewed I was just curious how you think about funding.
Your funding needs in a tighter environment from that perspective.
Yes, I think so.
I'll speak to us on a relative basis, and an absolute basis on an absolute basis, you hit on it which we don't have any near term maturities until.
November of 2024, and the environment and the environment.
That environment, you called out spreads are much wider on non investment grade credit.
And although we might have to pay for.
We might our funding might get slightly more expensive.
I would say that spreads are going.
On our portfolio side, because it is non investment grade will be I think much better. So I think what we have left.
The left hand side of the balance sheet non investment grade.
Issuers will always selective enough type loss of Clos.
Right hand side of our balance sheet, we're investment grade issuer in the spread.
The spread kind of beta on spreads is much higher on the asset side, So I feel pretty good about our funding profile and absolute basis on a relative basis I think.
Much better position than the rest of the sector, which I think will benefit shareholders.
Do you have anything to add there no I think you've covered all of it Josh I think.
Mindful of keeping our options open and being opportunistic but.
We just keep a very careful eye on the market try to take advantage of windows when they present themselves.
Okay.
Excellent. Thank you for taking my questions today.
Thanks.
Thank you.
Our next question.
Our next question comes from the line of Robert Dodd from Raymond James.
Hi.
Congratulations on the quarter I'm, just trying to get a handle on.
The potential on prepay activity and this is this is a question whether its absolute ultra whether it's relative to Q1, which was obviously quite light, but I mean in your.
So that is a way forward Tom in your prepared remarks, you did mentioned prepay fees potentially and potentially.
Sites to that $13 to these in Boe.
<unk> mentioned, some expect some opportunistic and idiosyncratic payoffs.
And then also <unk>.
<unk> as a percentage coal prices ticked up this quarter. So is it fair to say you expect prepay activity to probably ramp in in the second half for the year and again. My question then is that ramp relative to Q1 or just.
Yes ramp in total obviously the buyback beyond question as well, but any color you can give me your thoughts.
Folks.
Yeah, Let me give you the unamortized OID on bed Bath <unk> beyond <unk>, So, let's start with bed Bath <unk> beyond bed Bath <unk> beyond.
We know for certainty is paying off.
Yeah. So.
We don't know the total net proceeds to us.
As we discussed in our prepared remarks.
We have that's why we don't have.
The call protection.
And in the income statement and there is a valuation analysis on our balance sheet, but we know that is paying off I think there are.
Three or four assets.
Three to four assets.
Yes.
<unk>.
In our portfolio that are out to market. Today, obviously those are predominantly private companies and so we have to respect their confidentiality. So we don't who knows if those trades are not traded I think one of the leases going to trade.
But the pull through on.
Activity based income is basically a function of what vintage they are in our first call protection on amortized OID I think on the unamortized OID for bed Bath <unk> beyond was $1 4 million.
$1 6 million and then there is about $10 8 million.
Call.
<unk>.
Of fees.
Capitalized yield maintenance fees that are above our par.
So it's I would say it is <unk>.
<unk> to be a low point on activity based.
Obviously in an environment where spreads have widened.
That is not shocking.
We have a pretty good handle on how the model works, which is in a widening spread environment activity fees go down yields go up leverage of a drive our ROE in a environment, where spreads tightened activity based fees go down.
Leverage it's harder to keep financial Leverages harder to keep.
Spreads may tighten.
But it is offset by the activity base. So.
There are some names out there and the obvious one is bed bath and beyond.
Got it I appreciate that color.
The follow up would be partly answered that already is how the.
The lack of embedded on how onerous if you've managed to make the call.
On new deals in the sense that hypothetically, if we don't have a bad recession.
If the fed stays up here for longer which I think that's a meaningful probability of that.
There's always the risk of <unk>.
Spreads coming down relatively quickly potentially.
Happened in previous cycle.
How what's the risk of.
Significant refinancing activity you get the fees from it clearly, but then the spreads compress.
<unk>.
Meaningful portion of that portfolio gets.
Okay.
Find out.
There is always to your point, there's a dynamic between fees and refinancing and how.
One of his comments.
Polio to refinance relative to where you think.
Something that.
Do you think it would meaningfully actually slowdown activity or could that happen quite quickly.
If spreads were to come down.
Some yes.
Yes.
A couple of different things of parts because I think.
One is I think we quote fair value as a percentage of call protection is that gives you some sense of how much embedded economics are in the book and there is a decent amount and better economics.
It's a function of.
How I mean.
The math for issuers as well.
What's the payback period compared to the call protection economic payback periods. So it's a function of.
How how spreads how much this website and so I think I did a little bit it doesn't probably increase now much that much refinancing if it.
It probably does that that being said I think there is a we have a long history. Now I think this is our 37 earnings call and I think I don't know I think I did that math last night in my head.
We have when you look at the.
Our team's ability to create a differentiated portfolio across environments and so it's pretty good and thats a function that we have a large platform with a that we get a large top of the funnel, where we don't only do on their own but we do offer on stuff.
So this idea of like how much reinvestment risk are you taking I think it is mitigated.
The scale of our platform as it relates to the capital, we manage and our ability to find interesting things across cycles for our shareholders.
And we've been through all this we've been through many cycles for the last 10 or 11 years with spreads widening and tightening and I think the average return on equity for the business is by 13% and we've always been able to have above average yields.
And above average total return on assets and above average return on equity, which is a function of book finding interesting assets and having lower credit cost and so I continue to be bullish across the environment and that's why we like the asset class that view that across environments.
Got it I appreciate that color. Thank you.
Thank you gentlemen, our next question.
Our next question comes from the line of Ryan Lynch from K B W.
Hey, good morning.
First question I had was.
Regarding just the potential for any sort of pullback and bank lending activity.
Not really sure how much it doesn't really seem like banks really compete with you all too much on kind of your.
Youre LVL.
Direct lending business, but I was just curious for the ABL portfolio.
For the deals you guys have historically done has that been a market that that banks have played in historically.
Obviously, you've won the deals where you're competing with banks in any of those deals in Q4 foresee any sort of pullback.
And that ABL sort of market from bank, yes.
This fall back.
Yeah. So it's a great. It's a great question.
<unk>.
Let's start with the pullback for banks I think thats. The most definitely happening I think theres been a realization.
That.
That.
Bank had.
Not completely understood their business model and their business model was linear along and borrowing short through deposits.
And those deposits.
They've been able to hold.
At very low cost and I think everybody is kind of woken up because of the kind of the.
The big systemic issues of bank failures.
And started moving the deposit beta is much higher than they thought they start moving things.
Consumers and businesses started moving thing for money market funds and in treasuries and moving things out of deposits I think banks are going to pull back on lending until they understand what their capacity Linda is given the balance sheet.
The right hand side of Pillsbury, probably unstable to them.
And that's what caused banks get get close either option. So I think your I think your general thesis is right and I think people are starting to talk about the credit Crunch, which I think is good for alternative lenders.
With our business models are distinct.
I think when you think about where are we competing with banks you're right on the LBO business.
Banks were not financing <unk> on our balance sheet directly there we're in the moving business not a storage business.
But indirectly they were financing <unk> and that they were buyers of triple A's.
<unk>.
And investment grades and Clo's and supported capital formation, and close which allow them to be that capital formation allows them to be in.
In the moving business. So I think CLO formation on the LBO side continues to be slow and slightly broken with banks not participating in buying those securities given what's happened on their balance sheet.
Are we competed directly with them on the on the storage business.
There is.
Small software companies for sure for sure on banks, which have cut capacity.
So we've seen.
Silicon Valley Bank, obviously out of that business and then there has been some one or two <unk> not to be named and a couple of regional banks that have most definitely cut capacity in that space and then on the ABL side, most definitely I would expect capacity to be kind of in that space as well and so I think that will.
Definitely create opportunity.
Or kind of are generally our specialty lending verticals.
Okay does that helpful. Ryan.
To do it in a linear way.
That's really helpful to just provide kind of an overall framework for where you guys kind of see the lending landscape for banks and how that affects you.
The other question I had was.
Yes.
Several different education software loans outstanding.
Just wanted to clarify I have looked at those businesses I believe most if not all of those businesses are kind of in the.
Kind of the management.
Administration of schools and school and software business.
Can you confirm that because obviously there has been some.
Actual software business that are providing education tools for students are those things that have come under a lot of stress in the public markets from from some concerns about artificial intelligence I would love to just talk about that.
There are all of our business.
Theyre all ERP light.
They all manage.
The back office of the schools themselves, we never got into the content part of that market that was always harder for us.
Okay got.
Got you.
I appreciate the time today. Thank you.
Thanks.
Thank you one moment for our next question.
Our next question comes from the line of Melissa Wedel from Jpmorgan.
Good morning, Thanks for taking my questions today, Alright, Josh.
The comment a couple of times today that youre pretty bullish about the environment right now and the opportunity for I think GSI last but also.
Private credit.
Generally given that you've taken leverage a bit higher this quarter as last quarter I'm curious.
Are you willing to take leverage portfolio of library to.
Start at the top end of your range.
Given the bullish outlook or does the incremental sort of tighter spreads slightly more competitive environment.
Diminish that.
Appetite at all.
So I think we're still finding things to deal with so we're still picky and choosy.
The range is the range and I think we will want to take it up to the top end of the range.
I would note that we slightly calculate our leverage.
On a conservative basis, which I think the market is net of cash and net of unamortized financing fees and so.
If you look at that way I think it was slightly lower than what we've said.
I think.
We're wanting to take it up.
In addition to that that.
Obviously bed Bath and beyond is coming off and then we have a level II portfolio of about $50 million.
That provides incremental capacity as.
As well.
And so there is there and Bob mentioned it a couple of days of market. So.
It sounds like we have capacity and it sounds like the opportunity set.
So pretty good for us.
Okay I appreciate that.
Also talked about potentially some health care assets and.
In the market.
Something that you guys would be looking at.
Can you provide any contacts within the health care sector, because that can be pretty diverse.
Which areas do you find most appealing.
Yes, I mean look we've always had a problem with services.
Given the cost structure and given the exposure to wage inflation and so the assets. We've looked at have not been in the services segment.
And obviously, we have a long history of doing.
Biotech.
But there's been a whole host of health care assets.
Most are actually not in the services space.
I've come to market.
Well I'll tell you there.
Thank you at this time I would now like to turn the conference back over to Josh easterly for closing remark.
Great well. Thank you Paul Thank you for participating.
Please remember to vote our shareholders.
The special meeting.
Obviously mother's day is coming up so.
Behind you all your mother's and most definitely appreciate my wife.
And so we will see in the summer.
On our Q2 earnings call. Thanks, everyone.
This concludes today's conference call. Thank you for participating you may now disconnect.
Okay.
[music].
Yes.
Yes.
Yes.
Okay.
[music].
Yes.
Yes.
[music].
[music].
[music].
[music].