Q3 2024 Sixth Street Specialty Lending Inc Earnings Call
The End
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Speaker Change: Good morning and welcome to sixth street specialty windy in X3, quarter in the September 30th, 2024, on his conference call. At this time, Albert Smith's finalist, Nullie Mode.
Speaker Change: As a reminder, this conference is May of recorded on Wednesday, November 6, 2024. I will now turn to call over to Miss Cami VanHorn, Head of Investor Relations.
Cami VanHorn: 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 in our not guarantees of future performance or results and involve a number of risks and uncertainties.
Cami VanHorn: 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 six-street specialty lending aims, filing with the Security's and Exchange Commission. The company assumes no obligation to update any such forward-looking statements.
Cami VanHorn: Yesterday after the market closed, we issued our earnings press release for the third quarter and is September 30, 2024, and posted a presentation to be in best to resource section of our website www.6thretspecialcylending.com.
Speaker Change: The presentation should be reviewed in conjunction with our warm 10Q file yesterday with the SEC.
Speaker Change: Sixth Street specialty lending angst earnings release is also available on our website under the investor resources section.
Speaker Change: I must note it otherwise all performance figures mentioned today's prepared remarks are as of in for the third quarter and is September 30, 2024. As I remind you this call is being recorded for replay purposes. I will now turn the call over to Joshua Easterly, Chief Executive Officer at 6th Street specialty lending.
Joshua Easterly: Thank you, Cam. Good morning, everyone, and thank you for joining us. With us is my partner and our President post Stanley and our CFO Ian Simmonds.
Joshua Easterly: For our call today, I will provide highlights of this quarter of results and path over the boat and discuss activity and the portfolio. Ian will review our quarterly financial results in detail, and I will conclude with finally marks before opening the call of the Q&A.
Speaker Change: After the market closed yesterday, we reported third quarter financial results with the Justin and that invested income per share of 57 cents.
Speaker Change: Corresponding to an annualized return of 13.2%, the Justin Netanycompares share of 41 cents, Corresponding to an annualized return of the equity of 9.6%.
Speaker Change: As presented our financial payments, our Q3 net investment income and net income per share, inclusive of the unwind of the non-cashicrewed capital gains in its unique spend, or 59 cents and 44 cents respectively.
Speaker Change: For net investment income in the score, it continues to reflect the impact from the higher interest rate environment combined the small increase in activity base fees. Adjust the net investment income of 57% per share exceeder a base quarterly dividend by 11% per share, or 23%.
Speaker Change: Fices for sure was a specifically related activity which is up from the average of four cents per share that we've experienced since we started the Titan cycle. Since we're a laugh.
Speaker Change: The shape of the Ford Interest rate curve has declined in the near term, blowing the rate cut in September, and now bonds out at a slightly higher terminal rate in 2020-26. Based on the latest curve, our base-divent level remains well supported through that terminal rate.
Speaker Change: As a reminder, our different policy based on our true cycle earnings power, inclusive of credit losses and the economy based field comes.
Speaker Change: Rounding out the earnings summary, the 15 cents per share difference between this quarter's net investment income and net income was due to net unrealized losses primarily from the markdown of our investment in lithium technologies.
Speaker Change: Consistent with our valuation policy, we have marked this name taking into account a range of outcomes. We believe the distribution of outcomes has skewed lower since last quarter, and our fair value mark as of 9.30 reflects the updated view.
Speaker Change: Given the continued underperformance of this name, we've also added it to non-equal status at the beginning of Q3.
Speaker Change: Thank you. Thank you. Thank you.
Speaker Change: As for the economic impact...
Speaker Change: The lithium technology position represents less than 1% of our total portfolio fair value. To illustrate the impact on earnings, we assume we were earning approximately 11% return on equity on the $30 million of unrealized losses we've recognized to date.
Speaker Change: This return on equity number is based on the cost of equity from Bloomberg of roughly 9% and our evaluation on book value 1.2 times.
Speaker Change: An 11% assumed return on equity on $30 million implies less than a penny per share of lost net income on a quarterly basis or 15 basis points annually of ROE.
Speaker Change: Credit losses are incorporated as part of our base case assumption in our unit economic model. To be clear, the capital we put to work will continue to earn in excess of our cost of equity, inclusive of the potential for losses.
Speaker Change: This requires discipline in our investment decisions despite the tighter spread environment that persists. According to data published by the LCD, the portion of BDC portfolios based on count was spread below 550 basis points, reached 24% as of Q2.
Speaker Change: 2024.
Speaker Change: This compares to 7% of our portfolio by count and less than 5% of our portfolio on a weighted average basis as of 930, which we view as a more meaningful way to analyze the data.
Speaker Change: We believe the drastically lower percentage of sub-550 deals in our portfolio underscores our disciplined capital allocation approach.
Speaker Change: We are confident that our asset selection will continue to drive best-in-class returns for our investors.
Speaker Change: Our quarter-end net asset value was $17.12, down $0.07 per share compared to $17.19 per share as of June 30th. Over the last 12 months, reported NAV per share has grown from $16.97 to $17.12. Ian will walk through the net asset bridge in more detail.
Speaker Change: Yesterday our board approved a base quarterly dividend of 46 cents per share to shareholders of record as of December 16th, payable on December 31st.
Speaker Change: Our board also declared a supplemental dividend of $0.05 per share related to our Q3 earnings. The shareholder is a record as of November 29th, payable on December 20th.
Speaker Change: Our Q3 2024 Net Asset Value Bush Year Adjustment for the Impact of the Supplemental Dividend is $1707. With that, I'll pass it over to Beau to discuss this quarter's investment activities.
Beau: Thanks Josh. I'd like to start by sharing some thoughts on the broader economic backdrop, followed by observations on the current deal environment.
Beau: As rates continue to decline based on the shape of the forward interest rate curve, we generally expect corporate credit and activity levels to benefit from the shift in economic policy.
Speaker Change: On corporate credit, a lower cost of capital should improve the cash flow profile of borrowers after a prolonged period of slower growth and higher interest rates.
Speaker Change: We've started to see this play out across our own portfolio as the weighted average interest coverage on our core portfolio of companies improved quarter over quarter.
Speaker Change: In terms of activity levels, we anticipate that rates unlocking will support a more active M&A environment, which we already started to see in Q3, as BSL volumes to finance LBOs reach the highest level in two and a half years.
Speaker Change: While it's encouraging to see this activity, we believe a more significant increase in deal flow will take time as today's valuations generally remain below the purchase prices paid in the low interest rate or free money era prior to 2022.
Speaker Change: Turning now to our investment activity. During the third quarter, we closed on $269 million of commitments across eight new investments and upsizes to four existing portfolio companies.
Speaker Change: Consistent with our long-term approach of investing at the top of the capital structure, 100% of our Q3 fundings were in first lien positions, contributing to our 93% first lien asset mix across the entire portfolio.
Speaker Change: As for industry exposures, our eight new investments were diversified across seven different end-user industries.
Speaker Change: Our top industry exposure continues to be software and business services. Cyclical exposure, excluding our asset-based loan and retail, remains limited at 4.4% of our portfolio.
Speaker Change: During Q3, we continued to lean in on our capabilities across the Sixth Street platform to differentiate our capital. This includes focusing on sector themes that coincide with our platform's underwriting expertise and leveraging our deep relationships to source unique investment opportunities.
Speaker Change: To highlight one of the sector themes where we were active during the quarter, 6th Street closed and funded a $400 million senior secure credit facility for Arrowhead Pharmaceuticals, which is a clinical stage biotech company focused on the development of drugs for a wide range of conditions.
Speaker Change: We worked alongside our healthcare sector team to provide the company with long-term capital to fund R&D and platform development. The combination of six-streets scale, expertise, and flexibility contributed to the sourcing and execution of this attractive investment opportunity for SLX shareholders.
Speaker Change: We also added to our retail ABL portfolio in Q3 through our investment in Belk, which is our largest funding for the quarter. Belk is a regional department store retailer with a strong collateral base. The transaction was part of a balance sheet restructuring, ultimately allowing the company to delever and improve its financial positioning.
Speaker Change: Long-time followers of our business know that the track record in this theme spans over a decade and has contributed to the above-market asset level yield profile for SLX.
Speaker Change: Our ability to create value for shareholders in this theme has been built over a number of years by investing in resources, team, and relationships, which cannot be replicated overnight.
Speaker Change: We've been increasingly active in the opportunistic and non-sponsored channel to drive shareholder returns.
Speaker Change: Both of the investments I highlighted, Arrowhead and Belk, represent non-sponsored transactions which comprise 43% of total new investments funded in Q3. The weighted average yield at fair value on these investments was 13.5% compared to 10.1% for other new investments during the quarter.
Speaker Change: Thank you for watching!
Speaker Change: On the repayment side, we had two full and five partial investment realizations totaling $90 million in Q3.
Speaker Change: Consistent with the increase in refinancing activity in the credit markets, our two largest repayments during the quarter, BestPast and IntelliPeer, were driven by refinancing.
Speaker Change: I'll spend a moment to highlight the exit of BestPast as this investment demonstrates a benefit to shareholders for our newer vintage portfolio, as well as our willingness to pass on new deals that do not present an appropriate risk return for our business.
Speaker Change: Over the short period of 1.2 years, we generated 20% unlevered IRR and 1.2x MOM, including two cents per share of activity-based fee income from the crystallization of call protection and the acceleration of amortization of upfront fees.
Speaker Change: Given our ability to deploy capital in the wider spread environment in 2022 and the first half of 2023, we expect to see an increase in activity fee-based income.
Speaker Change: Should our portfolio experience higher velocity in the declining interest rate environment?
Speaker Change: From a credit quality standpoint, the overall performance rating of our portfolio remains strong, with a weighted average rating of 1.14 on a scale of 1 to 5, with 1 being the strongest, representing no change from prior quarter. Non-accruals represent 1.9% of the portfolio at fair value, with one new investment added to non-accrual status in Q3.
Speaker Change: Moving on to portfolio composition. In Q3, our portfolio's weighted average yield on debt and income-producing securities at amortized costs decreased from 13.9% in the prior quarter to 13.4%.
Speaker Change: for our loans of 0.6 times and 5.0 times, respectively, and their weighted average interest cover increased from 2.1 to 2.2 times quarter over quarter.
Speaker Change: As of Q3 2024, the weighted average revenue in EBITDA for our core portfolio companies was $327 million and $111 million, respectively.
Speaker Change: Beginning this quarter, we also note going forward the median revenue and EBITDA for those same borrowers, which was $149 million and $52 million, respectively, for Q3. With that, I'd like to turn it over to Ian to cover our financial performance in more detail.
Ian Simmonds: Thank you, Beau. For Q3, we generated adjusted net investment income per share of $0.57 and adjusted net income per share of $0.41.
Speaker Change: Total investments were $3.4 billion, up 3.7% from $3.3 billion in the prior quarter, driven by net funding activity.
Speaker Change: Total principal debt outstanding at quarter end was $1.9 billion and net assets were $1.6 billion or $17.12 per share prior to the impact of the supplemental dividend that was declared yesterday.
Speaker Change: Our debt-to-equity ratio increased from 1.12 times as of June 30 to 1.19 times as of September 30, and our weighted average debt-to-equity ratio for Q3 was 1.14 times.
Speaker Change: We continue to have significant liquidity for the size of our balance sheet, with nearly $1.1 billion of unfunded revolver capacity at quarter end against $226 million of unfunded portfolio company commitments eligible to be drawn.
Speaker Change: As of September 30, our funding mix was represented by 68% unsecured debt.
Speaker Change: Post-quarter end, we satisfied the maturity of our 347.5 million November 1, 2024 unsecured notes through utilization of undrawn capacity on our revolving credit facility.
Speaker Change: The settlement had no impact on leverage and marginally decreases our prospective weighted average cost of debt, resulting in a positive economic impact of almost one penny per share quarterly in 2025.
Speaker Change: Pro forma for the maturity, our funding mix is represented by 50% unsecured debt.
Speaker Change: After satisfying this maturity, we continue to have approximately $743 million of unutilized revolver capacity, representing more than three times our unfunded portfolio company commitments eligible to be drawn.
Speaker Change: Thank you for watching!
Speaker Change: Moving to our presentation materials, slide 8 contains this quarter's NAV bridge. Walking through the main drivers of NAV movement, we added $0.57 per share from adjusted net investment income against our base dividend of $0.46 per share.
Speaker Change: As Josh mentioned, there was $0.02 per share unwind of non-cash-recruited capital gains incentive fee expenses. The reversal of net unrealized gains on the balance sheet related to investment realizations resulted in a $0.03 per share reduction to NAV.
Speaker Change: the impact of tightening credit spreads on the valuation of our portfolio, increased net asset value by three cents per share, and finally, there were net unrealized losses on investments amounting to 13 cents per share.
Speaker Change: Shifting to our operating results detail on slide 9, we generated total investment income for the third quarter of $119.2 million down slightly compared to $121.8 million in the prior quarter.
Speaker Change: Walking through the components of income, interest and dividend income was $110.9 million, down from $112.2 million in the prior quarter.
Speaker Change: Other fees, representing prepayment fees and accelerated amortization of upfront fees from unscheduled paydowns, were higher at $4.3 million compared to $4 million in Q2, given the slight increase in activity-based income we experienced this quarter.
Speaker Change: Other income was $4 million compared to $5.5 million in the prior quarter.
Speaker Change: Net expenses, excluding the impact of the non-cash accrual related to capital gains incentive fees, were $65.8 million, down from $66.8 million in the prior quarter.
Speaker Change: This was primarily due to seasonal expenses incurred last quarter for the Annual and Special Shareholder Meetings held in May.
Speaker Change: We did not see a decrease this quarter due to the roughly one-quarter lagged impact of falling interest rates on the weighted average interest rate on average debt outstanding.
Speaker Change: We estimate undistributed income of approximately $1.19 per share at quarter end.
Speaker Change: As always, we will continue to review the level of undistributed income as the tax year progresses.
Speaker Change: minimise potential return on equity dragged from the excise taxes and prioritise returns to our shareholders.
Speaker Change: Before turning it back to Josh, I'd like to briefly provide an update on our ROEs.
Speaker Change: At the beginning of this year, we communicated an annualized ROE target range of 13.4% to 14.2% based on our expectations over the intermediate term for our net asset level yields, cost of funds, and financial leverage.
Speaker Change: Year-to-date, we've generated an annualized ROE on adjusted net investment income of 13.6%, consistent with that target range.
Speaker Change: Based on our performance this year through Q3, we continue to expect adjusted NII per share for the full year to be within the range previously stated of $2.27 to $2.41. With that, I'll turn it back to Josh for concluding remarks.
Joshua Easterly: Thank you, Ian. I'd like to add on to your comments regarding ROEs. As many of you have heard me say in the past, shareholders can't eat net investment income.
Joshua Easterly: For that reason, we focus on earnings after net, unrealized and realized gains and losses, or net income. On an LTM basis, we've generated a net income return on equity of approximately 12%, inclusive of the unrealized losses we recognize this quarter.
Joshua Easterly: We learned the return for shareholders that significantly exceed our estimated cost of equity of 9%.
Joshua Easterly: This is all to invest in assets that generate a return greater than our cost of equity inclusive of credit losses that we assume in our base case model.
Joshua Easterly: In closing, I'd like to take a moment to focus on what's most important to us, which is the shareholder experience. We are an investor firm first and have built the architecture of the Sixth Street platform to deliver the best risk-adjusted returns for our shareholders.
Joshua Easterly: We have invested in the talent and resources, including with 250 investment professionals across sector and capabilities, including direct lending.
Joshua Easterly: For SOX, we have access to the scale, resources, and intellectual capital across the entire platform while operating a constrained balance sheet of roughly $3.5 billion of total assets.
Joshua Easterly: This allows us to remain highly selective given the wide range of investment opportunities that we evaluate relative to capital we have available to invest.
Joshua Easterly: We strongly believe that structuring our business in this way will allow us to continue to deliver top-tier results for our shareholders over the long term.
Joshua Easterly: With that, thank you for your time today. Operator, please open the line for questions.
Speaker Change: Thank you. To ask a question please press star 1 1 on your telephone and wait for your name to be announced.
Speaker Change: To withdraw your question, please press star 11 again.
Speaker Change: Our first question comes from the line of Brian McKenna with Citizens JMP. Your line is now open.
Brian McKenna: Okay, great. Thanks. Good morning everyone. So, a question on your non-sponsor business to start.
Speaker Change: It was great to see all the activity here during the quarter. I think it speaks to the broad capabilities of 6th Street.
Speaker Change: as well as your ability to pivot across different parts of the market to deliver the best returns for shareholders, but
Speaker Change: You know, it would be great just to get a little bit more detail on this business. You know, how big is the team? How do they collaborate with the rest of the Sixth Street platform?
Speaker Change: And then how do they cover the market from a sector and size perspective? And then just as we move forward here, you know, the incremental yield you're getting from these types of deals is quite notable. So should we continue to expect you'll lean into these non-sponsored transactions over the next couple of quarters?
Speaker Change: Yeah, hey Brian, thanks for the question, really appreciate it.
Speaker Change: I'm sure people had an interesting night last night.
Speaker Change: probably parked in front of the TV, so I appreciate you getting up early for Ernie's call.
Speaker Change: Just real quick, just to level set, on the sponsor side, historically our business has been 65% sponsored, 35% non-sponsor.
Speaker Change: This quarter, it was 50-50 approximately. I think two out of our three largest transactions this quarter were actually non-sponsored deals.
Speaker Change: out to a Belk in that category and Arrowhead which is a publicly traded spec pharma business.
Speaker Change: So the platform today, and by the way, even though our sponsored business is not the typical sponsored business, it's more thematic, tilted.
Speaker Change: which is we're not trying to do, you know, we're not trying to bid every sponsor deal based on a relationship. We focus on sponsors who have the same industry themes where we think we can add value and understand those business models with those industries.
Speaker Change: So even our sponsor business, I would say it's not a traditional kind of go-to-market sponsor business.
Speaker Change: We have approximately 250 investment professionals in our business.
Speaker Change: and they're grouped in both.
Speaker Change: for lack of a better word, kind of strategy team, so-called like direct lending, ABS.
Speaker Change: and then they're also grouped in industry teams as well and so health care, consumer, retail, energy is a big one for us.
Speaker Change: Bo, software, infrastructure, and so those...
Speaker Change: And in healthcare, for example, we have a big focus on staph forma.
Speaker Change: Those typically go direct-to-company, given that they're not sponsor-driven.
Speaker Change: And we like that model. We like the model of being able to toggle between risk return and allocating our capital in the most efficient way. And, you know, that's been a historical big driver of our of our shareholder returns.
Speaker Change: So hopefully that gives you a little flavor, but it is, and I think in a world quite frankly where there's probably more volatility, maybe there's higher rates.
Speaker Change: and there's going to be, in a world where you're going to have to navigate complexity and that opportunity is that we think the platform is built for that.
Speaker Change: Okay, that's great. Thanks, Josh. And then just to follow up on that a little bit in sponsor M&A, you know, there's clearly been a lot of focus on the election.
Speaker Change: and I think some sponsors have been waiting for clarity here before moving forward on transacting. So just looking across your network of sponsors as well as your deal pipelines, is there any way to quantify how many sponsors and related companies were in fact on the sidelines waiting until they had more clarity on the election? And I'm just trying to get a sense of the magnitude and the acceleration we could see in deal flow post-election here. Yeah. So I think it's tricky, to be honest with you, and I'll turn this over to Beau. What I would say is...
Speaker Change: The traditional thinking is...
Speaker Change: that as rates come down and they have visibility on rates
Speaker Change: By the way, which may not come down as much now, given kind of the change in administration, you know, the conventional wisdom is, I think that
Speaker Change: The economic policies of the new administration are probably slightly more inflationary, which might keep rates higher, although it's probably better for growth.
Speaker Change: and you see that in equity markets or at least equity market futures today. So I think it's hard to tell that the traditional thinking was that as rates come down
Speaker Change: The M&A pipeline gets unlocked. I would say you know what we what we've and I think you've seen a little bit of that I think the bigger issue is
Speaker Change: A lot of assets were purchased in a zero-rate environment at high valuations.
Speaker Change: that need time to work through and generate a return. And so those vintages are, you know, 2020 to middle of 2022.
Speaker Change: It's a large portion of the NAB sitting in private equity and the sponsor-to-sponsor transactions, they just need time because that's slower money given you got to work your way through high valuations.
Speaker Change: So I think...
Speaker Change: I think you'll see a little bit of it unlocked.
Speaker Change: I don't know if, you know, you'll see all but unlock given, you know, the change in valuations on the private side, given the rate environment, and the amount of leverage you can put on businesses, given the structural change in rates.
Speaker Change: Bo, do you have anything to add there? I think that's spot-on. It's really hard to calibrate.
Speaker Change: There was a cautious tone coming into an election cycle, which is typical of every election cycle. And what you generally see there, Q4 is the busiest time of year from an M&A.
Speaker Change: perspective, but in elections years that's a little bit more smoothed out in Q4 and Q1. I would expect that this year. Anecdotally, I think there's some folks that were waiting to see the results.
Speaker Change: but overall I think it's more it's going to be driven more by interest rates and the valuation on loss that Josh alluded to earlier.
Speaker Change: Yeah, I mean, the simple math is, if you bought something...
Speaker Change: You know for 14 or 15 times earnings that now the market's 10 times and there's limited free cash flow given that's going to creditors
Speaker Change: It's going to take you longer to kind of, you know, you're going to have to hold that asset longer. And I think that's the offsetting dynamic.
Speaker Change: All right, I'll leave it there. Thank you, guys.
Speaker Change: Thank you.
Speaker Change: Our next question comes from the line of Mark Hughes with Truist Securities. Your line is now open.
Mark Hughes: Yeah, thank you. Good morning. You mentioned that the interest coverage, I think it improved sequentially. I don't know if you gave those specific numbers, but any sense of how much improvement and then how much of that might have been just lower base rates or growth and even death?
Speaker Change: Yeah, so it went from 2.1 to 2.2 and I think it's both base rates which take a little bit
Speaker Change: longer to reset because if you're on 90 days so for election you don't get that benefit immediately. You obviously saw that in our cost of interest given the delay and then there was earnings growth in the in the portfolio.
Speaker Change: So I think it's mostly early growth with a little bit of help from rates.
Speaker Change: Joshua Easterly, Ian Simmonds, Robert Stanley, Ian Simmonds, Joshua Easterly, Ian Simmonds,
Speaker Change: Yeah. And then how about the amendment activity in the court or anything noteworthy there, and then just a broader comment on your credit outlook coming up?
Speaker Change: Yeah, cool. So, amendment activity is actually very, very, very low. Most of the amendments were positive credit amendments. I think there were eight total amendments.
Speaker Change: Seven upsides is all positive.
Speaker Change: Repricing slightly, some repricings.
Speaker Change: spread compression, but like they were all real positive credit amendments.
Speaker Change: So, the leading indicator...
Speaker Change: of credit activity in the book, the credit outlook is, you know, really amendment activity, and that, you know, I, you know, was at a kind of an all-time low. I think it was, you know, zero, one and a quarter. So, that should be a leading indicator in credit quality.
Speaker Change: On credit, generally what I would say is, you know, we've been talking about dispersion and tails.
Speaker Change: It feels like we've kind of worked through that.
Speaker Change: There's, you know, I think no
Speaker Change: Thank you. Bye-bye.
Speaker Change: credit names in our book below 90. I think the only thing below 90 that's not a non-accrual, the only thing below 90 is an equity name in our book or a small second lien at like 400 grand or something like that. So I think, you know, I think we're pretty constructive and positive on credit.
Speaker Change: And, you know, from my vantage point, you know, the fundamentals are, you know, intact on the business, like, you know, if you believe we're kind of through the, the, the, the tail names and dispersion, the, you know, core and I, X.
Speaker Change: and activity-based fees, at least from the spot interest rate curve, is probably like 50 cents.
Speaker Change: for $2 annualized. Then you have activity fees. This quarter, you know, I've got you kind of five plus other stuff. So I've got the 57 cents of NII, and so, and it feels pretty good on the fundamentals of the business.
Speaker Change: Yeah, appreciate that detail. One other question, if I'm seeing it properly, new investments in the quarter?
Speaker Change: 24% of those were fixed-rate. Is that a section of the mix? Sponsor, non-sponsor? What's driving that? That was just the one which was Arrowhead, which was a fixed-rate security.
Speaker Change: Okay, 50 feet out of the 180, I think.
Speaker Change: Yeah. Okay. Thank you very much.
Speaker Change: Thank you.
Speaker Change: As a reminder, to ask a question at this time, please press star 1-1 on your touchtone telephone. Our next question comes from the line of Robert Dodd with Raymond James. Your line is now open.
Robert Dodd: Hi guys. A couple of questions. On the interest coverage, obviously the 2.1 to 2.2, but as always for you and every other BDC, there's the caveat for BD, for companies where it's relevant, i.e. those underwritten or not.
Speaker Change: straight traditional cash flow basis. So could you give what percentage of the portfolio does that interest coverage metric actually apply to?
Speaker Change: Thank you for watching!
Speaker Change: Yeah, Robert, we might have to come back to you on that, but it's, I think, in...
Speaker Change: I think it's most of the portfolio, Robert. So I think, look, on the software names where there's a lot of growth, we calculate, we normalize.
Speaker Change: To normalize growth like we've talked about this before just to be Which is on software Software is the one of the only kind of on a gap basis. It's kind of one of the only industries where you don't
Speaker Change: capitalize your customer acquisition costs, you expense all of it, so the faster you grow, the worse the gap earnings, but on a steady state basis that the earnings are at cash flows if you were to capitalize your customer acquisition costs.
Speaker Change: And so that is the adjustment on some of the software names, but outside of that, I think it's all of them are based on that.
Speaker Change: Thank you. So going to the sponsor, non-sponsor mix. On the non-sponsor, I mean, it's supposed to be 35 percent.
Speaker Change: I mean, even that's not traditional non-sponsor, right? I mean, it's not necessarily just a cash flow loan to a company buyout with a sponsor behind them, things like Belk, right? So, how much of the non-sponsor mix is
Speaker Change: to, you know, what would pass for non-sponsoring kind of the rest of the industry, i.e. it's a cash flow loan, but there isn't a sponsor, versus it's something else.
Speaker Change: I think they're, well, this quarter they were all something else, like Belk is an ACLU.
Speaker Change: And Arrowhead is more or less maybe I'll deal too because
Speaker Change: The value of that is on the collateral of IP and on spec pharma portfolio.
Speaker Change: And so, I mean, what we, you know, it's all kind of off the run, you know, for this quarter there was no kind of traditional non-sponsored cash flow. It's all, you know, we're kind of, in my mind, asset-based.
Speaker Change: where there's a collateral that we can A, get to and that we can underwrite.
Speaker Change: The one thing I'd note is that Retail ABO is underwritten to collateral coverage, regardless of whether it's cash flowing or not.
Speaker Change: So, you know, that's how we underwrite it. We think about collateral coverage and liquidation values.
Speaker Change: for Asset Recoveries and, you know, oftentimes they're task-oriented.
Speaker Change: Robert Stanley, Joshua Easterly, Ian Simmonds, Robert Stanley, Joshua Easterly, Ian Simmonds,
Speaker Change: That was not your question, Robert, that was the question you asked. Right, that was Mark, yep. One last one, just kind of generally, I mean you talk, the election results are in now, there is an evaluation gap still.
Speaker Change: What's the risk if rates stay higher, like some of these non-accrual rents in the industry obviously for you and Lithium have been kind of...
Speaker Change: surprises, right? You know, it's a business that's been doing okay, sponsor has been supportive during a high-rate environment, and then pulled the plug. And it's not just Lithium, there's multiple others in that situation.
Speaker Change: What's the risk of more surprises that are hard to identify in advance, obviously, if rates stay higher for longer?
Speaker Change: Yeah, look, I think when you look at, it's a great question, so lithium, and you're right about that, the sponsor had been supportive, actually put in, you know, I don't know, $50 to $70 million.
Speaker Change: you know, a year ago, a month before,
Speaker Change: But I think
Speaker Change: Lithium, well...
Speaker Change: was, had really tough fundamentals and
Speaker Change: kind of negative revenue growth and earnings pressure and that was you know I think we've talked about this on previous phone calls if we've got one thing wrong
Speaker Change: It was, in COVID, we thought about names that were negatively impacted as an opportunity set, but there were also names that the fundamentals got improved, and lithium was one of them because it kind of sat in between social media, etc.
Speaker Change: And so, but lithium was, you know, fundamentally challenged or is fundamentally challenged. When you look at our book, I think we just went through this.
Speaker Change: The names that are fundamentally challenged, i.e. have like negative revenue growth, are I think basically have 100% overlap with the names that are not accrual.
Speaker Change: So, it doesn't feel like there are more fundamentally challenged names. Now, some are growing slower, some are growing faster, but, like, I think, you know, it feels like we're kind of through that.
Speaker Change: Got it. Thank you.
Speaker Change: Thank you. Our next question comes from the line of Bryce Rowe with B Raleigh. Your line is now open.
Bryce Rowe: I wanted to ask, I mean, you've made some comments here about portfolio velocity and what we might see post-COVID.
Bryce Rowe: post-election, and obviously there's some puts and takes, but Josh, how do you...
Speaker Change: How do you square that up with maybe your outlook from a net portfolio growth perspective? And I'm trying to think about the prospects for repayments relative to originations with spread, where they are today.
Speaker Change: Yeah, look, I think there are some really good, so I would say a couple things. One is we invested a lot in the book.
Speaker Change: And we were one of the few people in the industry that had capital, was able to invest capital post 22 rate hike cycle.
Speaker Change: And so 61% of that portfolio is invested past 331. My guess is some of that will turn just...
Speaker Change: by the nature of, you know, those were good investments and the markets got better, et cetera, and we'll have the option to keep them because, you know, incumbency usually provides you that option, but we'll decide what to do.
Speaker Change: It's hard to gauge.
Speaker Change: And then there's some idiosyncratic things in the book that, you know, I think are, you know, will come off because they performed really well when they're being sold. But it's really hard to gauge.
Speaker Change: You know, kind of the net portfolio or churn, it feels like we're at the bottom of our activity level fees.
Speaker Change: You saw a pickup of 20% on activity level fees quarter over quarter from 4 cents to 5 cents per share.
Speaker Change: Do I know that for sure? No, but it feels like, you know, on the margin, that's true because rates are coming, the curve's coming down, and as things get longer than a tooth, people have to start moving assets and selling stuff, and the velocity of money has to increase.
Speaker Change: But, you know, it's hard to, you know, tell for sure.
Speaker Change: So if, you know, do I have exact numbers? No.
Speaker Change: You know every day we get up trying to think about put good assets on
Speaker Change: you know, risk manage, get our underwriting right. I think we've done that through the lack of credit losses in the business.
Speaker Change: We probably set the bar slightly too high for ourselves on that front and you know everything else will take care of itself.
Speaker Change: I think the one other thing that we hit on the on that theme is like you got a price. We price new loans, not to perfection, but then include credit losses. And so, you know, we, we will continue to do that. But that's that's.
Speaker Change: It's hard to tell gauge velocity because that's often by the macro, which we don't control.
Speaker Change: Thank you. Thank you. Thank you.
Speaker Change: Yep, okay.
Speaker Change: One more for me, as we think about kind of the forward curve, and you noted,
Speaker Change: You know, the terminal rate might end up being a bit higher. That's certainly...
Speaker Change: A good thing, I think, from a dividend coverage perspective, at least for you all, if credit kind of continues to hold, you've had the base dividend set here at 46 cents for seven quarters, give or take, what gets you to the point where you can increase the base dividend again?
Speaker Change: Yeah, look, I think the way we think about the world is, where do we...
Speaker Change: By the way, we're aligned in that we want to get capital back to shareholders.
Speaker Change: We think that's valuable.
Speaker Change: for a lot of different reasons. The least obvious is that they have the option to reinvest that back in the business at a discount through the reinvestment plan. So that option is super valuable to people. But we wanna get capital back. We wanna make sure we continue to reduce the excise tax.
Speaker Change: But we want to set the base dividend, we think about the base dividend as a liability, which is, you know, post credit losses.
Speaker Change: post, you know, on the curve, low activity fees.
Speaker Change: Where do we feel comfortable that will always be covered?
Speaker Change: You know, and, you know, I think our view is...
Speaker Change: That's $0.46, and we have a really good mechanism to get capital back to shareholders through the supplemental, which is quarterly, which was $0.05 this quarter, which was half of the over-earning, and through specials, which we use really to reduce the excise tax, which is a real economic drag on the business.
Speaker Change: Thank you.
Speaker Change: All right, that's it for me. Appreciate it. Thanks.
Speaker Change: Thank you, and I'm currently showing no further questions at this time. I'd like to hand the call back over to Joshua Easterly for closing remarks.
Joshua Easterly: Great. Well, first of all, thank you for everybody's participation. We really appreciate it. We hope everybody has a great Thanksgiving, a great holiday season with their family. If we don't talk to you, we'll talk to you after our Q4 meetings.
Speaker Change: This concludes today's conference call. Thank you for your participation. You may now disconnect.
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