Sixth Street Specialty Lending Inc (TSLX) 2015 Q1 法說會逐字稿

Good morning, and welcome to TPG Specialty Lending, Inc.'s March 31, 2015 quarterly earnings conference call.

Before we begin today's call, I would like to remind our listeners that remarks made during the call may contain forward-looking statements. Statements other than statements of historical fact made during this call may constitute forward-looking statements and are not guarantees of future performance or results, and involve a number of risks and uncertainties.

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 TPG Specialty Lending Inc.'s filings with the Securities and Exchange Commission. The Company assumes no obligation to update any such forward-looking statements.

Yesterday after the market closed, the Company issued its quarterly earnings press release for the first quarter ended March 31, 2015, and posted a supplemental earnings slide presentation to the Investor Resources section of its website, www.tpgspecialtylending.com. The earnings presentation should be reviewed in conjunction with the Company's Form 10-Q filed yesterday with the SEC. TPG Specialty Lending Inc.'s earnings release is also available on the Company's website, under the Investor Resources section.

As a reminder, this conference call is being recorded for replay purposes.

I will now turn the call over to Joshua Easterly, Co-Chief Executive Officer and Chairman of the Board of TPG Specialty Lending. Please go ahead, sir.

Thank you, Ashley. Good morning everyone, and thank you for joining us this morning. I'll begin today with a brief overview of our quarterly highlights, and then will turn the call over to my partner, Mike Fishman, to discuss our originations and portfolio metrics for the first quarter 2015. Alan Kirshenbaum, our CFO, will then discuss our quarterly financial results in more detail, and I will conclude with final remarks and our outlook for market conditions before opening the call to Q&A.

I'm pleased to report solid originations and financial results for the first quarter. Net investment income per share was $0.39 for the first quarter of 2015, as compared to $0.57 per share for the fourth quarter of 2014. This quarter-over-quarter variance in net investment income per share of $0.18 was largely driven by an elevated level of revenues during the previous quarter, related to investment pay-downs, which we discussed. During the first quarter of 2015, we generated net investment income plus realized gains of $0.42 per share, and net income of $0.45 per share, as compared to $0.26 per share for the fourth quarter of 2014.

Net asset value per share as of March 31st was $15.60 as compared to $15.53 as of December 31st. Alan will walk you through these quarter-over-quarter differences in greater detail, but at a high level, these variances were largely driven by unrealized gains on investments, primarily attributable to the tightening of spreads in the first lien liquid credit market during the first quarter.

Though the vast majority of our portfolio is classified as level 3, illiquid investments, our illiquid portfolio is not isolated from broader changes in risk premiums. Changes in credit spreads impact our portfolio valuations, and may indirectly impact loan repayment activity.

Turning now to our dividend. As announced on last quarter's call, our board of directors declared a first quarter 2015 dividend of $0.39 per share, payable to shareholders of record as of March 31st, which we paid on April 30th. Our board has also declared a second quarter dividend of $0.39 per share payable to shareholders as of record of June 30th, on or about July 31st.

Our board has established a dividend policy reflective of the high quality earnings power of our business over the immediate term, at a level that we believe can be consistently earned, and which maximizes cash dividends to our shareholders. During the first quarter of 2015, we earned our dividend on a net investment income per share basis, and over-earned our dividend on a net investment income plus realized gains basis. And as discussed on last quarter's call, we have over-earned our dividend for each of the previous three years.

With those highlights, I would like to turn it over to Mike, who will walk you through our quarterly originations and portfolio metrics in more detail.

Thanks, Josh. Q1 was another solid originations quarter for us, with gross originations of approximately $268 million, of which we syndicated $130 million, resulting in new investment commitments of approximately $138 million. These investments were distributed across three new portfolio companies and three upsizings of existing portfolio companies. Of the $138 million of new investment commitments made during the quarter, approximately $130 million was funded. Over the last four quarters, we have generated average quarterly fundings of approximately $165 million, or approximately $660 million on a full year basis.

During the first quarter, we exited commitments totaling $61 million due to the full paydowns of two level 3 investments, and the full sale of one of our liquid level 2 investments. And as Alan will discuss in greater detail, during the first quarter we generated economics as a result of these full paydowns, albeit to a lesser extent than in the prior quarter, as we retained a greater share of earning assets.

Approximately 94% of our debt investments have the benefit of call protection, which serves to mitigate reinvestment risk, and results in additional economics when loans are repaid. The level of repayments experienced during the first quarter was below our average quarterly repayments over the past four quarters of approximately $120 million. Our payoffs were skewed toward the first part of the quarter, while our net portfolio growth was concentrated in the last few days of the quarter. Our net funded activity for the first quarter was approximately $70 million, as compared to our average quarterly net funded activity of approximately $45 million, based upon the past four quarters, or approximately $180 million of net funded activity on a full-year basis, a level of growth that we continue to feel is prudent.

Since inception through March 31st, we've generated a gross unlevered IRR of 16.3% on fully exited investments totaling over $900 million of cash invested.

We continue to believe that our ability to provide flexible, fully-underwritten financing solutions and to hold significant positions is a key competitive advantage benefiting both our borrowers and our shareholders. Through our direct originations efforts, approximately 91% of our current portfolio was originated through non-intermediated channels. This enables us to control the documentation and investment structuring process, and to maintain effective voting control in approximately 82% of our debt investments.

Throughout our investment history, and including the recent periods of market volatility and opportunity, we have remained steadfast in our approach to selecting and structuring those investments with the highest risk-adjusted returns, not simply the highest absolute returns. Of the more than 3,900 opportunities we've screened since inception, we've closed less than 2% of these investments.

As of March 31st, our portfolio totaled $1.33 billion at fair value, compared to $1.26 billion at December 31st, and $1.20 billion at March 31, 2014. At quarter end, 90% of our investments by fair value were first lien, and 98% of our investments by fair value were secured. At this point in the cycle, we are primarily focused on investing on investing at the top of the capital structure. And in keeping with our focus over the past year, during the first quarter of 2015, we further reduced our second lien exposure. 93% of our new investment commitments made during the quarter were first lien securities.

The portfolio is broadly distributed across 35 portfolio companies and 19 industries. Our average investment size is approximately $38 million, and our largest position accounts for 5.2% of the portfolio at fair value. At this later point in the economic cycle, we are focused on industries with low exposure to cyclicality, and the ability to perform throughout credit cycles. Our largest industry exposures by fair value were to healthcare and pharmaceuticals, primarily healthcare information technology with no direct reimbursement risk, which accounted for 16.2% of the portfolio at fair value, and business services, which accounted for 10.5% of the portfolio at fair value.

The weighted average total yield on our debt and other income producing securities at amortized cost at March 31st was 10.3%, versus 10.3% at December 31st and 10.4% at March 31, 2014. The weighted average yield on new investment in new portfolio companies made during the first quarter was 11.6% at amortized cost. This yield will vary quarter-to-quarter, as originations in any single quarter are idiosyncratic, given our direct originations model.

Our investment process is predicated on mitigating both credit and noncredit risks. We seek to mitigate credit risk by investing in companies that are scaled and relevant to their supply chain. At March 31st, our core portfolio companies had weighted average annual revenues of $126 million, and weighted average annual EBITDA of $32 million. Our target borrower profile has inherent downside protection features that may include a high degree of contractual recurring revenues and/or hard asset value, depending on the borrower's industry and our investment thesis. Whenever possible, we seek to avoid credit risks that are asymmetrical to the downside.

Non-credit risks that we seek to mitigate include interest rate, foreign currency, and reinvestment risk, the latter of which is mitigated by call protection. We mitigate interest rate and foreign currency risk by match-funding our assets and liabilities. Approximately 97% of our income-producing securities are floating rate, typically subject to interest rate floors. And because we've swapped the interest rate on our convertible notes from fixed to floating, 100% of our liabilities are floating rate. And when we fund investments in currencies other than US dollars, we borrow on our credit facilities in local currency, as this provides a natural hedge against foreign currency fluctuations.

Consistent with the last quarter, as of March 31st, we had no investments on nonaccrual status. At quarter-end, 100% of our investments were meeting all payment requirements, and 94% of our investments were meeting all covenant requirements.

As was highlighted on the last quarter's call, during the first quarter the mark on our equity investment in Mississippi Resources was positively impacted by the contribution of an additional producing well. However, the incremental value of this producing well was muted by the decline in the oil spot price from approximately $53 per barrel as of December 31, 2014, to approximately $48 per barrel as of March 31st. As of May 7th, the oil spot (corrected by company after the call) price has recovered to approximately $59 per barrel. With that, I'd like to turn it over to Alan to discuss our quarterly results in more detail.

Thank you, Mike. Good morning, everyone. We ended the first quarter of 2015 with total portfolio investments of $1.33 billion, outstanding debt of $485 million, and net assets of $842 million. Our net investment income was $0.39 per share, and NII plus net realized gains was $0.42 per share. Our average debt to equity ratio for the three months ended March 31st was 0.50x, as compared to 0.44x for the previous quarter. At quarter-end March 31st, our debt to equity ratio was 0.59x pro forma for unsettled trades, as compared to 0.51x at December 31st. We have made considerable progress towards our target debt to equity ratio, which is 0.65x to 0.75x. Although the current regulatory limitations are 1 to 1 debt to equity, we believe there are structural limitations of operating at or near that level, which include our practice of reserving for our unfunded commitments and reserving for our forward pipeline.

As it relates to the right side of our balance sheet, in the first quarter of 2015, as we noted on our last call, we drew down on the remaining commitment from our SPV asset facility prior to the reinvestment period ending in January. As for other initiatives we're focused on, we continue to evaluate additional ways to diversify our funding sources. We have significant liquidity at March 31st, with over $525 million of undrawn commitments, and we believe we remain match-funded from an interest rate and duration perspective, and have little to no funding risk in our business.

As you can see on slide 8, during the three months ended March 31st, we had a number of factors impacting our net asset value per share. In February, our DRIP issuance had a small positive impact on NAV, as shares issued under this program were at a price above our net asset value per share. We added $0.39 per share to net asset value from net investment income. Our dividend was $0.39 per share, reducing net asset value, and we had $0.03 per share from the reversal of unrealized gains from the three investments that we sold or were paid down in full this quarter.

There were two other factors impacting net asset value in the first quarter. $0.12 per share can be attributed to unrealized gains resulting from a tightening in first lien credit spreads experienced during the first quarter, and $0.02 per share can be attributed to other unrealized and realized gains and losses during the quarter.

Moving onto the income statement on the next slide, total investment income for the quarter ended March 31st was $37.7 million. This is down $8 million from the previous quarter, or just over 17%. This decrease was driven primarily by the significant "Other Fees" earned during the fourth quarter, as Josh discussed. Also, our PIK income remains low at less than 3% of total investment income year to date.

On the next slide, slide 10, you will find a more detailed breakout of our revenues. Our "Interest from Investments-Interest Income" was $32.3 million for the quarter ended March 31st. This is up $0.7 million from the previous quarter, or approximately 2%. As you can see we continue to produce strong, consistent revenues on the top line, "Interest from Investments-Interest Income", as well as "Other Income". Our "Interest from Investments-Other Fees" was $2 million for the quarter ended March 31st. This is down from $11.5 million in the previous quarter.

To take a step back for a moment, we have discussed on prior earnings calls that our "Interest from Investments-Other Fees" revenue line will be uneven over time, which will generally be correlated to the movement in credit spreads and risk premiums. We can see that during 2014, we generally experienced strong levels of "Interest from Investments-Other Fees", which was in part was driven by the call protection embedded in our portfolio, and in part driven by the accelerated amortization of our upfront fees from full or partial paydowns. Also as noted on our last call, as we head into 2015, if we continue receive elevated levels of paydowns, we would expect to continue to see elevated levels of "Interest from Investments-Other Fees", but if we don't see similar levels of paydowns, then we would expect to more quickly lag back into our target debt to equity ratio, contributing more rapidly to our "Interest from Investments-Interest Income" line, either of which should continue to drive strong ROEs for the business. We quantify the former by looking at an important statistic in our business, our investments at amortized cost as a percentage of call protection, which is 93.5% as of March 31st. To sum all of this up, as was the case this quarter, we saw a reduced level of paydowns, and we were able to progress more towards our target debt to equity range, similar to what we saw in the third quarter of 2014.

As for expenses, net expenses for the quarter ended March 31st was $16.6 million. This is up from the previous quarter, primarily due to higher interest expense as a result of continuing to increase towards our target debt to equity range, and higher incentive fees as a result of unrealized gains booked during the quarter, which I noted as part of the NAV bridge.

On slide 15 and 16, we discuss our debt and funding profile. A few things to touch on here. We amended our SPV asset facility to reduce LIBOR pricing, and our lender syndicated a portion of the outstanding loan to two new lenders. As I noted earlier, we believe there is little to no funding risk in our business. As you can see on the bottom of slide 16, almost 60% of our earning assets are funded by permanent equity capital, which we expect will marginally decrease as we leg back into our target debt to equity ratio. Our remaining investment portfolio has a weighted average maturity of approximately three years versus our debt financings, which have a weighted average maturity of approximately five years.

A few final points in closing. We had another solid quarter, earning our dividend on an NII per share basis, over-earning our dividend on an NII plus net realized basis, and continuing to make steady progress towards our target debt to equity range- at 0.59x, we're at our highest level since prior to our IPO. As of March 31st, we have an estimated $0.60 per share in undistributed distributions on a tax basis. We continue to generate strong consistent earnings, driven by a high quality of income from embedded economics in our portfolio.

Josh, back to you.

Thanks, Kirsh. During the first quarter of 2015, the broader liquid market experienced a "flight to quality", with investors favoring first lien over more junior securities. LCD first lien spreads tightened by 28 basis points, while conversely LCD second lien spreads widened by 30 basis points. This was the third consecutive quarter in which LCD second lien spreads widened appreciably.

As we have previously discussed, at this later point in the economic cycle we remain primarily focused on investments at the top of the capital structure, in industries we believe will perform well throughout cycles. During the quarter, we further reduced our second lien exposure, and since the first quarter of 2014, our second lien exposure has declined from 17% to 8% as of March 31, 2015. During the first quarter, our primarily first lien portfolio experienced a $0.12 per share appreciation in value, largely driven by the decline of first lien leverage loan spreads, partially offset by an increase in second lien loan spreads. This appreciation, in conjunction with earning our dividend from an net investment income plus realized gains per share basis, resulted in solid financial results for the second quarter, and $0.07 per share of net asset value growth.

Turning now to the broader market, as was announced publicly last month, GE Capital, the largest non-bank lender in the US middle market, has announced its intention to sell nearly all of its non-captive finance assets. We believe that the exit of the largest middle market player will create ample opportunity for the remaining non-bank lenders. We believe the opportunities are particularly beneficial to BDCs that have scale and ample liquidity, providing them with the ability to originate and hold sizable positions. Further, it is our belief that our established originations platform, supported by the recent approval of our application for Exemptive Relief, and our significant liquidity, positions TSLX particularly well in light of this decreased market competition.

The first quarter of 2015 marked the one-year anniversary of TSLX as a publicly listed company. As we progress beyond the milestone, we remain committed to the sound investment principles, investment process, and financial policies that are the foundation of our business, and which we believe positions the Company well for the long-term.

This includes our investment strategy, which is predicated on mitigating credit and noncredit risk. Despite our late-cycle sector and capital structure perspectives, from time to time, particularly during later- cycle investment period, certain of our portfolio investments will underperform our expectations. While it is our strategy to seek to mitigate these outcomes by remaining highly selective and particularly focused on avoiding situations where asymmetrical downside risks exist, the risk of principal and interest loss is an inherent aspect of our business. We believe that our steadfast portfolio construction disciplines and focus on downside protection are mitigants to the inherent investment risk, and the drivers of our high-quality risk-adjusted returns.

Our long-term focus is the driving principle behind our dividend policy, capital raising philosophy, and capital allocation decisions, and the alignment of interest we foster with our investors. This long-term perspective is the motivation behind our practice of match-funding our assets and liabilities, as well as our stock buyback programs, a topic front and center, front of mind for many BDC stakeholders. It is our belief that in managing our Company with a long-term perspective, we are acting in the best interest of all of our stakeholders.

A few final points in closing. As of quarter end March 31st, no non-affiliated shares remain under lockup. As previously stated, we believe that return on equity, coupled with the quality and risk profile of our portfolio, is the appropriate measure of our ability to generate high-quality risk-adjusted returns over the long-term. For the three months ended March 31st, we generated an annualized ROE based on net investment income of 9.9%, and an annualized ROE based on net investment income plus realized gains of 10.9%.

Based on our current asset level yields, and as we continue to leg into our target leverage ratio, supported by our pipeline of new investment opportunities, our target return on equity is 10.5% to 11.5% over the intermediate term. This corresponds to $1.63 to $1.79 per share on net investment income basis, which compares to an annualized dividend of $1.56 per share.

On behalf of myself, Mike, and Alan, and our Investor Relations team, thank you for your continued interest in TSLX, and for your time today. Ashley, would you open up the line for questions?

(Operator Instructions)

Looks like we have a question from Mitchell Penn from Janney. Your line is open.

Yeah, hi guys. How's your business impacted if we go through a period of extended rising interest rates? And the follow-up, is what strategic changes would you make to your business if that occurred?

Great, so hey, Mitchell. It's Josh Easterly. Nice to talk to you, thanks for the question. So I think we'll talk about credit quality, and then we'll talk about -- we'll talk about kind of the impact to the income statement. And then we'll tackle your second question.

From the credit quality standpoint, I think the question is why are rates rising? If rates are rising, because there's growth in the US economy, and the fundamentals of the US economy are good, typically our portfolio companies would participate in that and typically they have operating leverage. And so, there should be no negative impact on the credit quality of our portfolio.

In the event that rates are rising for other reasons, i.e. rates were below fair value and subsidized by monetary policies by governments across the world, and there isn't fundamental growth, I think what you'll have is credit quality generally deteriorating. But we think our portfolio is well-positioned given it's a first lien portfolio, with 2.7x interest coverage.

So I think generally, the people under scenario B who would be taking that pain are obviously equity investors in those portfolio companies and junior security holders, given that the interest costs of the borrowers would be rising, although we have a ton of coverage where -- because of where we invest in the capital structure. But it would be tough on junior security holders. So, sorry, it's not quite as simple an answer, as what happens, it's what happens depending on why it's happening.

The second question, as it relates to what happens to the economics of our business, there are -- the best page to look is page 56, in the most recent filing. We do have some embedded floors, but because of our book -- the way to think about it is 60% funded with fixed capital. We do have some embedded floors, but because of our book, the way to think about it is 60% funded with fixed capital.

We do have -- we are asset sensitive. To get past those floors, it takes about, probably a little less than 100 basis points, about 100 basis points increase in interest rates, which will cost us about $0.04. And then, we start participating appreciably.

So on the strategic side, I think the answer is - I think we've already shifted our business with it. If you believe rates are going to rise, independent of the reason, or at least if there's some risk to rates rising under scenario B, which is rates are rising because they're below fundamental fair value, not because of growth, what we've done is we've shifted our portfolio into first lien securities. And so, we've basically cut our second lien or junior securities by half year-over-year, given what we believe, although a tail risk, to be a risk. Is that helpful, Mitchell?

Yes, and one of the things I am wondering about is, do you look at -- because under that strategy, my guess is your dividend remains fairly constant. But the rates are rising around you, so on a relative basis, you might be losing. And the question is, do you have to think about some portion of your funding as fixed, to give yourself the ability to grow the dividend in a rate-rising environment?

Yes, so again, so good question. Let me take a step back. I think people have heard me talk about this. We don't believe we have an edge in macroeconomics, right? If people want a macro manager, there are great macro managers.

But we think generally making those "bets" are very difficult, given that we don't know -- that finding the edge in very liquid, public securities that are based on individual idiosyncratic government issues is very, very challenging. So we're not a macro manager. So our objective is to be match-funded and be rate agnostic, right?

We have asset sensitivity in our book. What I would tell you is, how I would think it plays out, and not to talk about the competition, but we have a floating rate book of 97%. We have asset sensitivity given that 60% of our balance sheet that funds those assets, is basically fixed equity. So we will be able to grow the dividend as rates increase.

Will we be able to grow it as quick? The answer is, if we had an entire fixed rate liability structure, the answer is, of course not, but I don't have an edge in determining interest rates. The other piece I would tell you is, the sector has a higher proportion of their book in fixed rate securities. So as rates are rising, they are losing NAV, or should be losing NAV if they mark their books on the asset side, because those fixed rate securities are worth less.

So I think you're asking a more philosophical, fundamental question, about how we think about our business and where do we think our edge is? And our edge is originating middle market, illiquid, private credit, and not as a macro manager. And so, our financial policies are based on that.

You could have theoretically, and a lot of people did, made the same argument 18 months ago, about pending rising interest rates, and effectively set up their balance sheet to be short rates, and they would have been giving up intermediate ROEs to investors -- intermediate-term ROEs to investors. Is that helpful?

Yea, no, very helpful. Thanks.

We appreciate the question.

Thank you. Our next question comes from Terry Ma of Barclays. Your line is open.

Hey guys, I wanted to see if we could get some color on the lending environment right now, quarter to date? And also your view on the credit cycle? I think in the past, Josh, you've mentioned a middle-to-later innings of the credit cycle. And more recently, a couple of BDCs have said, they think the credit cycle is going to be extended by years. So I just wanted to get your view, to see if it's consistent?

Yes, Look, I think it's -- I'll turn it over to Mike to answer your first question. Let me answer the second one, first on the credit cycle. Look, are we in the -- when you look at cycles, cycles last, business cycles last between seven and nine years. And we're -- 2009 was -- May 2009 was the end of the last cycle, so we're six years into the cycle.

The challenge with timing the credit cycle, and going deeper down in the capital structure is, the nature of our business is we make illiquid investments where you write basically a -- we provide financing on somewhere between a four to six-year basis. So I think our weighted average commitment is for probably five years, might have been under five years.

So the idea that the cycle extends a year is not that helpful when you write a call -- when the nature of your business is writing a call option to borrowers on the capital you provide them. So I can't tell you if we're in the bottom of the 7th, bottom of the 8th, bottom of the 9th. I don't think it actually matters for our business, if it's -- because we're not in a trading business, if you're wrong by an inning. Is that helpful, Terry, given the nature of our business?

Yes, I think that's very helpful.

So you have to start shifting your portfolio earlier than later, given that you're writing call options and term financings to your borrowers. So when -- if the cycle extends, what happens is, and credit spread tighten, your borrowers will exercise that call option. Now that call option is out of the money for us, given that we have call protection, but they'll exercise that call option.

And if the credit cycle doesn't extend, and you have portfolio issues, you risk - you've effectively written a put on the valuation of the Company, and it's going to get put to you. So they have that five-year option, so it's not like you can make the call at the last moment. Fish, you want to talk about the current lending environment?

Yes, and also to add to what Josh was saying, we're still seeing pretty good risk/returns in the first lien investments that we are making, certainly relative to what we see in the current second lien investment opportunities that we're looking at.

So number one, we think it's the right time to continue to move up the capital structure. And number two, on a relative basis, we view those investments as relative to what else we're seeing in the market as better risk/return investments.

Here's the conundrum, Terry. And this is a -- this is a-- I think owned by the sector, and I'm getting a little edgy here, as people are looking at me oddly. But I'm getting a little edgy.

I think that the conundrum is, until investors start pricing and differentiating on a wide basis dividend yields, what happens is, the mantra in the sector is all based on what's happening in the yields, not yields per unit of risk. And so, when people aren't earning their cost of capital, that they're praised for increasing portfolio yields. And so, hopefully the sector over time starts evolving where they start differentiating cost of equity based on risk. And -- but what happens is people get rewarded now for -- I read people's equity research analyst reports. And what happens is when people increase the underlying portfolio yields independent of what risks they're taking on, the headlines are "good quarter, yields increased". So you have this cycle that happens in our industry. And I think that will change over time, hopefully. And I think it's gotten better where the industry and sectors start differentiating portfolios through their cost of capital. And this is not only investors who participate in the industry on the equity side, but also rating agencies and access to longer term funding, and differentiating that longer term funding cost based on the portfolio.

Yes, and as far as the current lending environment, the current competitive environment, I probably said this a year ago, six months ago, it was competitive then, I think it remains competitive. But maybe we have the luxury, we look at a lot of -- many opportunities every quarter. We tend -- we continue to be very, very selective, and typically find three to five new opportunities that seem interesting to us that we close each quarter.

So given -- and I think I've mentioned the numbers, that less than 2% of what we look at we actually fund. And from that perspective, we're still able to find interesting opportunities. But that being said, I think the market certainly continues to be competitive. There's a fair amount of capital that's been raised. I think if you take a forward view, given what's going on in the BDC sector, and certainly with GE, we see that environment should continue to improve, and that there should be continued opportunities in the middle market for us.

That's very helpful color, thanks a lot.

(Operator Instructions)

Our next question comes from Greg Nelson of Wells Fargo. Your line is open.

Actually it's Jonathan Bock from Wells Fargo, and always happy to pinch hit for the great Greg Nelson.

So Josh, a quick question for you, and it relates to available capital. You made some opportunistic investments, both you and Mike, and it worked very well, whether it was Toys R Us, or others in the credit dislocation. And so, given that loan prices have effectively reflated, and that opportunistic trade has paid off, how do you see those as a source of liquidity to acquit a pipeline of special sits and interesting originations versus the need for new equity capital?

Yes, that's a good question. So look, our view is when things are cheap, you want to buy when you have liquidity. When things are expensive, you want to sell. So independent of what other investment opportunities you have at that moment in time, because you're giving up the opportunity of that capital in the future.

So let's take for example, we did sell a level 2 asset -- Vivint -- in the quarter, which was, we bought two securities, one was a first lien bond, and one was an unsecured bond. I think we bought the first liens at 94-95. We sold those at par in the quarter. And so look, we obviously had excess liquidity in the quarter. And so, it wasn't a decision of, hey, we want that liquidity to go put it in more interesting things. Quite frankly, we just thought it was at fair value. So we sold that. And so, I think generally in time when, we will rotate the portfolio and be opportunistic, our capital and the opportunity cost of our capital and using that capital, given most of the stuff we do is illiquid, is very in its nature, is illiquid, the opportunity of the cost of that capital is very, very high. So we think about it, and we run our business that way. And we'll continue to try to optimize the portfolio, not only based on what opportunities exist in that moment in time, but also do our more liquid portfolio, do we think it's "cheap", or do we think it's expensive? If it's cheap, we're going to continue to hold it. If it's expensive, we're going to move it.

I appreciate that. And now, maybe another question. Just as leverage grows, because to Alan's point, as you experience repayments, leverage obviously falls, but earnings benefit from the call premium that you bring in. And if repayments slow, you leverage, and that actually benefits earnings, as well.

The question is, what happens as you start to get into more leverage and effectively, or prudently, lever the balance sheet at the 0.75x level over time? At that level, there really is no availability to further draw up leverage, unless you want to raise equity, which that case, dependent on costs of capital, et cetera can be an NAV or excuse me, an NOI push, as we've seen for some BDCs.

So the leverage rate is still working, and working well. Just a question of what happens when you are at a prudent level of leverage that you might not want to exceed, and prepayments still aren't coming in, what happens?

Prepayments-there will always be a constant level of prepayments in our business, right?

But away from that, I think the point is you try to optimize the portfolio, and then you make a decision on raising capital. And for us to raise capital, what we've told people is, and nine out of ten times, it needs to be accretive on a book value basis. Otherwise, we should be using our capital to reduce our equity base. And it needs to be accretive on an earning basis, based on the opportunities that we see.

So as you know, last year we traded above -- I think our stock closed above book value every day of the year. So we always had the opportunity to raise capital, it would have been accretive on a book value basis. But we didn't because it wouldn't have been accretive on an earnings basis, given that we were below our target leverage ratio, and we would have been creating drag, an earnings drag in our business.

So both of those things have to exist, for to us raise capital, nine out of ten times. There is an argument to be made, when you're in a 2009, and there's a lot of great investment opportunities, where raising capital that's slightly below (corrected by company after the call) book value, and there's ways to do so that is really accretive -- is really accretive. But we're surely not at that moment in time, and have to make a decision now. Nor do we expect we would have to make that decision in the future. But again, nine out of ten times, it needs to be accretive on an earnings basis, and it needs to be accretive on a book value basis, and both those things have to exist.

Appreciate that note. Last question, Josh and Mike.

You only get two questions, Jon (multiple speakers). I'm joking.

Thank you, thank you. Well, now that you said that, I'm going to make this one really tough then.

So Mike, Josh, looking at one loan that, Saba Software, which is obviously one of the larger deals done in the quarter, can you talk about how effectively this was sourced? Just in light, there were a few accounting issues early on. I'm just trying to understand how you became the solution provider here?

And how you expect -- not how you expect the loan to perform over time, obviously you wouldn't have made an investment if it doesn't perform well. But what gives you the added layer of comfort, when you step in, we'll say, somewhat complex situations, in order to earn outsized return for your investors while not risking principal?

I'll take a shot at it, and then Mike will take a shot. The reality is that there is -- we make money because of illiquidity and complexity. So we like complex situations. This business is very well-capitalized. I think we're less than half of the capital structure, Mike; is that right?

Yes. (multiple speakers)

Less than half of the capital structure. So on a purchase price basis, we're 50% loan to value, although we don't actually think about the world that way. We do private equity-style due diligence, we're involved in scoping and looking at quality of earnings reports, and really getting comfortable with the earnings power of the business, and the fundamentals of the business. And so, this is a business with a lot of recurring revenue that's in a space that we know well, that we've actually made investments previously in the space, and in the sector.

So we know that switching costs for customers, we know the return on -- the ROI proposition for customers. And so generally, we think there's a lot of downside protection in the business, where is it 1.7x on a recurring revenue basis. And we look at the DCF of the future recurring revenue streams and the margin, and we've gotten very, very comfortable with the future cost structure of the business.

And so we think we've created a very good risk reward. And not suggesting this is indicative at all. But this was an opportunity where we were able to underwrite a transaction. We ended up syndicating that transaction, and we ended up syndicating, creating a whole bunch of syndication income from that transaction. So that market generally thought we created a transaction that was very well priced.

I'll add to that. We worked on this transaction many months during the process, a number of sponsors looked at it. We know the current sponsor that owns it; had a longstanding relationship with them, conducted similar private equity-style due-diligence alongside of them, and really had a significant understanding of the business model, the business plan, and took comfort in it, for a lot of the reasons that Josh outlined.

But the great thing about having an originations structure, as well as -- although we do keep up walls and deal team walls and treat our sponsors' information. We do institutionally have knowledge of where cover bids are, and how many people are involved in the process, and where people thought the asset was worth. And that is not an indicative data point, but that is a data point that is helpful to us.

Great. And then last question.

So what would you estimate the all-in IRR return to be on this investment, on a go-forward basis? Understand it's first lien, but looking beyond the coupon, I'm just curious where that net return to you might be?

I think Jonathan, we look at unlevered returns in many, many different ways, right? And so, obviously we don't go name by name, but I would say this was a 12% to 15% yield to worst security.

Okay. Thank you for taking my questions.

Thank you. I'm not showing any further questions in queue. I would like to turn the call back over to management for any further remarks.

Great. Well, look, we appreciate everybody's participation. Please don't hesitate to give us a call, if you have any questions offline.

I wanted to take a second, in tradition and wish all the moms on our team a happy Mother's Day, and thanks for your efforts. And I hope people enjoy their weekend with their family. Hey, and Ashley, I think there was one call that just popped up.

It looks like we do have a question from Derek Hewett of Bank of America. Your line is open.

Good morning, everyone, and sorry for the delay in the -- dialing into the Q&A session. But origination activity has been strong, compared to peers this earnings season. And since GE is going to be exiting the middle market, should we expect to see more syndication revenue going forward? Maybe as an offset to some of the episodic lift to earnings from the strong prepayment activity that you experienced last year?

I think the GE thing has to, Derek good question --has to play out. I don't know how much it's going to play out. Surely them going through a process to sell that business, and given how they were positioned, will create uncertainty on the margin for that franchise. If I know the bankers involved, which I do, and I know GE, they are going to try to do everything they possibly can to minimize that uncertainty, and get that franchise back on its footing and in somebody else's hands.

But I think generally, that capital and their resources will need to be absorbed by the market, which I think could create some opportunity. The GE announcement is pretty new. I don't think it's flowed through at this moment in time.

But when we -- when there is opportunity to underwrite and provide certainty to borrowers, based on our conviction, our private equity-style due-diligence, we'll take advantage of that, and pass that along to our shareholders. And so, we'll continue to use that as a competitive advantage. The GE thing doesn't hurt. I think it's too early to tell you what the actual -- if it's a neutral impact or directionally positive. But it surely doesn't hurt.

Okay, great, thank you very much.

Great, well, again, I appreciate it. Please everybody enjoy their Mother's Day with their families over the weekend. Thanks for getting up early on the west coast. If you have any questions, please call myself, Mike Fishman, or Alan Kirshenbaum. And again, appreciate people's time. Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a wonderful day.