Sixth Street Specialty Lending Inc (TSLX) 2015 Q4 法說會逐字稿

Good morning and welcome to TPG Specialty Lending, Inc.'s December 31, 2015, fiscal year-end 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 including with regard to TPG Specialty Lending Inc.'s proposal to acquire TICC Capital. 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 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 earnings press release for the fourth quarter and fiscal year ended December 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-K 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, Inc. Please go ahead, sir.

Thank you, Ashley. Good morning, everyone, and thank you for joining us. I will begin today with a brief overview of our quarterly and annual highlights and will then turn the call over to my partners, Mike Fishman and Bo Stanley, to discuss our origination and portfolio metrics for the fourth quarter and full year ended December 31, 2015.

I would like to introduce Ian Simmonds as TSLX's Chief Financial Officer. Ian will discuss our quarterly and annual financial results in more detail. And I will conclude with final remarks before opening the call to Q&A.

I am pleased to report solid financial results for the fourth quarter and full year 2015 with net investment income per share of $0.44 for the fourth quarter and $1.76 for the full year, the latter of which is on the upper end of our guidance of $1.63 to $1.79 per share. Net investment income exceeded both our fourth-quarter and full-year dividends of $0.39 per share and $1.56 per share, respectively, continuing our track record of over-earning our dividend on a net investment income plus net realized gains basis.

Net asset value per share as of the year-end was $15.15 as compared to $15.62 at the end of the third quarter and $15.53 at the end of 2014. Net asset value per share movement during the fourth quarter was largely driven by unrealized losses related to widening credit spreads in the broader markets and continued volatility in the energy sector, both of which negatively impacted our investment valuations.

The fourth quarter of 2015 saw continued widening of credit market spreads and risk premiums across asset classes due to concerns about global growth. LCD first-lien spreads widened by approximately 50 basis points and LCD's second-lien spreads widened by approximately 225 basis points during the fourth quarter. For the full year 2015, LCD first-lien spreads widened by approximately 80 basis points and LCD second-lien spreads widened by 400 basis points.

In light of this, and based on fair value accounting principles all BDCs are subject to, we would be surprised if net asset value across the sector had remained stable. From an asset price perspective, the headwinds in credit in 2015 would suggest a year-over-year unrealized decline of 10% to 20% in net asset value for leveraged loan-oriented BDCs, assuming a five-year average loan maturity and depending on portfolio leverage and tranche mix.

However, TSLX's net asset value per share only declined 2.5% year over year as a result of our first-lien-oriented and shorter duration portfolio. These qualities can be attributed to the private, illiquid nature of our loans, our control lender position, and our strong investor-friendly covenants.

As energy exposure continues to be a topic front of mind of many, I would like to take a minute to discuss our investments in the sector. At fourth quarter ended our oil and gas exposure was approximately 3.2% based on fair value. We did not add any oil and gas positions during the quarter and our exposure remains limited to two portfolio companies, Mississippi Resources and Key Energy Services.

Mississippi Resources, our largest oil and gas position, is an upstream E&P company in which we control 100% of the capital structure. We believe that our first-lien credit investment is supported by the company's proved, developed, producing reserves; low average cash lifting costs; and substantial hedges through early 2017, which will support cash flows for debt service.

Our other oil and gas position is a $10.5 million fair value investment that is currently dollar one risk and includes important protection features, including an asset coverage test on appraised collateral value. Since our inception we have viewed our dividend as a liability that must be financed with real cash earnings and, therefore, we generally avoid distress-for-control opportunities where we have lower certainty of receiving cash interest.

That said, as it relates to our investment strategy in the energy sector, we will opportunistically review situations where we can provide conforming first-lien reserve base loans. We expect to only focus on the upstream companies that have significant hedged collateral value at current price levels and are situated low on their respective cost curves. While the environment for energy has been challenging, it should be noted that we have generated a gross unlevered IRR of 39% on exited oil and gas investments to date and a gross unlevered IRR of 17% on exited and current investments across this sector.

Moving back to our portfolio overall, during the fourth quarter we fully exited our investment in Milagro upon the consummation of the company's prearranged plan of reorganization. Our implied loan-to-value exit was 49% and our gross unlevered IRR was approximately 32%.

We are also pleased to report that the A&P bankruptcy progressed as anticipated and that we were fully repaid on our investment during the fourth quarter. During the first quarter of 2016, we received a full repayment of one of our restructured securities related to IRG. This is denoted as the JL Secured Promissory Note in our schedule of investments. At the fourth-quarter ended, we had no loans on nonaccrual status.

As announced in our last quarter's call, our Board of Directors declared a fourth-quarter 2015 dividend of $0.39 per share payable to shareholders of record as of December 31, 2015, which was paid on January 29. Our Board has also declared a first-quarter 2016 dividend of $0.39 per share, payable to shareholders of record as of March 31 on or about April 29.

Now I would like to turn the call over to my partner Mike, who will walk you through our quarterly originations and portfolio metrics.

Thanks, Josh. I will give a quick overview of our fourth-quarter and full-year portfolio activity before passing it over to Bo Stanley to discuss our investment themes and originations outlook.

Q4 was our second-strongest originations quarter since inception with gross originations of approximately $399 million. We syndicated approximately $115 million of these originations, resulting in new investment commitments and fundings of approximately $284 million. These investments were distributed across six new portfolio companies and three add-ons to existing portfolio companies.

During the fourth quarter we had $154 million aggregate principal amount in repayments from four investment realizations, including the exit of our $60 million position in Milagro. Since inception through December 31, we have generated a gross unlevered IRR of 16.3% on exited investments, totaling approximately $1.2 billion of cash invested.

Through our direct originations efforts, 87% of our current portfolio was sourced through non-intermediate channels. This enables us to control the documentation and investment structuring process and to maintain effective voting control in 81% of our debt investments.

As of December 31, our portfolio totaled approximately $1.5 billion at fair value compared to approximately $1.4 billion as of September 30. At quarter end, 88% of our investments by fair value were first-lien and 96% of our investments by fair value was secured.

In keeping with our theme since early 2014, we have primarily focused on investing at the top of the capital structure and our junior capital exposure remains below 12%. Additionally, since the beginning of 2013, we have reduced our exposure to non-energy cyclical industries from approximately 31% of the portfolio at fair value to approximately 7% at the end of 2015 and reduced our energy exposure from approximately 10% of the portfolio at fair value in late 2014 to approximately 3% at the end of 2015.

The portfolio is broadly distributed across 46 portfolio companies and 20 industries. Our average investment size is approximately $32 million and our largest position accounts for 4.9% of the portfolio at fair value.

At this point in the economic cycle we are focused on industries with low cyclicality and the ability to perform throughout credit cycles. Our largest industry exposure by fair value at quarter-end were to business services, which accounted for 21.2% of the portfolio at fair value, and healthcare, primarily healthcare information technology with no direct reimbursement risk, which accounted for 18% of the portfolio at fair value.

The weighted average total yield on our debt and income-producing securities at amortized cost at December 31 was 10.1% versus 10.5% at September 30 and 10.3% at December 31, 2014. This yield will vary quarter to quarter as originations and repayments in any single quarter are idiosyncratic given our direct originations model.

The weighted average yield of new investments made during the fourth quarter was 9.3% at amortized cost, which was lower than the weighted average yield at amortized cost of investments exited during the fourth quarter of 11.9%. This was due to the sizable repayments on several existing investments that had higher yields such as our $60 million investment in Milagro, which had an amortized cost yield in excess of 13%.

Meanwhile, during the fourth quarter we underwrote investments with slightly lower weighted average yields, but also lower weighted average risk profiles such as Nektar, which Bo will discuss in more detail.

With that recap of our portfolio activity, I would like to turn it over to my partner, Bo.

Thanks, Mike. I would like to begin by discussing our originations pipeline. We expect the current liquidity shortage--as traditional and/or undercapitalized lenders are unwilling or unable to underwrite and manage risk--to benefit middle-market lenders with strong underwriting capabilities and access to capital, like ourselves.

January 2016 marked the lowest number of private equity deals completed for the first month of the year in more than a decade due to disconnects in buyer/seller valuations, resulting in a general unwillingness to transact. Given our deep relationships with the middle-market sponsor community and our track record of delivering over $2.4 billion of capital in sponsored transactions since our inception, we believe we are well-positioned to fill the developing void in the market.

Through our discipline of match funding our assets and liabilities, we have created a structural advantage of long-dated capital, which in combination with the reduced market liquidity and wider credit spreads, could lead to higher net interest margins for our shareholders. In addition, we have the capability to opportunistically participate in secondary markets when outsized risk/return exists in sectors and/or companies in which we have a differentiated perspective.

We believe the ability of TSSP and TPG-affiliated funds to co-invest alongside us will continue to enhance our ability to provide larger commitments and certainty of execution for our borrowers.

Per the terms of our SEC Exemptive Relief, co-investments made by affiliated funds on the same economic terms and in the same part of the capital structure as TSLX. TSLX will continue to receive priority allocation on every US middle-market loan origination investment opportunity that our broader platform identifies.

We believe our fourth-quarter originations results speak to the robust opportunity set for well-equipped capital providers like ourselves in the current environment, and we expect this trend to continue in 2016. Our investment in Nektar during the fourth quarter aptly illustrates our competitive advantage under the current market uncertainty. During the fourth quarter, TSLX led a $250 million senior secured notes transaction for the publicly-traded biopharmaceutical company with approximately $1.5 billion of market capitalization.

Through our SEC Exemptive Relief, we were able to provide certainty of execution for the company through co-investments from our affiliated funds. Our sector expertise and diligence capabilities enable us to form a differentiated investment thesis and we structured an attractive risk-adjusted investment that included a non-callable feature.

While we are opportunistic about the current market opportunity set, we remain highly selective and particularly focused on avoiding situations where asymmetrical downside risk, both credit and noncredit in nature, exists. We seek to mitigate credit risk by investing in companies that are scaled and relevant to their supply chain. As of December 31, our core portfolio companies had weighted average annual revenues of $128 million and weighted average annual EBITDA of $33 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. As of December 31, our borrowers had, on average, 2.6 times interest coverage and 18% unlevered free cash flow yield to our last dollar invested.

Noncredit risks that we seek to mitigate include interest-rate risk, foreign currency, and reinvestment risk, the latter of which is mitigated by call protection on 88% of our investments. We mitigate foreign currency and interest-rate risk by match funding our assets and liabilities. When we fund investments in currencies other than US dollars, we borrow on a revolver in local currency, as this provides a natural hedge on our principal value against foreign currency fluctuations.

In the schedule of investments from our quarterly financial reports, we reflect the fair value of our foreign-currency-denominated investments in their local currencies so that changes in fair value can be assessed independent of currency fluctuations. At fourth quarter end approximately 95% of our income-producing securities were floating rate, typically subject to interest rate floors, and 100% of our liabilities were floating rate. In the case of our fixed notes investment in Nektar, we swapped our fixed interest income streams to floating.

With that, I would like to turn it over to Ian to discuss our quarterly and full-year financial results in more detail.

Thank you, Bo, and good morning, everyone. We ended the fourth quarter and fiscal year 2015 with total portfolio investments of $1.5 billion, outstanding debt of $653 million, and net assets of $821 million.

Our net investment income for the fourth quarter and full year 2015 was $0.44 and $1.76 per share, respectively. This is towards the upper end of our full-year guidance range of $1.63 to $1.79 per share.

Our average debt-to-equity ratio for the quarter ended December 31 was 0.77 times as compared to 0.65 times for the previous quarter. As always, we remain highly selective in our investments and take into account both our unfunded commitments and our forward pipeline when managing our financial leverage. We maintain adequate liquidity with approximately $281 million of undrawn commitments prior to regulatory leverage constraints and we believe we remain match funded from an interest rate and duration perspective.

We continue to evaluate additional ways to diversify our funding sources on an opportunistic basis and will only pursue them if they are in the best interests of our shareholders. As it relates to our leverage and the current investment opportunity set, our ability to employ co-investments from TSSP-affiliated funds, which combined have over $7 billion of dry powder, affords us the distinct advantages of driving originations independent of market cycles and of optimizing leverage to drive ROE. As we have been since our inception, we remain disciplined in our capital raising strategy and will seek to raise capital only if it's accretive on both an earnings and book value basis.

As you can see on slide 8 of our earnings presentation, during the three months ended December 31, we had a number of factors impacting our net asset value per share. We added $0.44 per share to NAV from net investment income against the dividend of $0.39 per share, and we had $0.02 per share reduction in NAV from the reversal of unrealized gains and losses from the full realization of four investments during the quarter.

There were two other factors impacting net asset value in the fourth quarter: $0.23 per share can be attributed to unrealized losses from widening credit spreads that Josh alluded to at the beginning of this call and $0.27 per share can be attributed to other unrealized losses, of which the majority, or $0.20 per share, was related to our energy investments.

As a reminder, every quarter we have an independent valuation firm review 100% of our marks for investments that have been in our portfolio for more than 45 days. At quarter end, the weighted average performance of our portfolio was 1.4 on a scale of 1 to 5, with 1 being the highest, as compared to 1.5 for the third quarter of 2015. This speaks to the underlying stability of our portfolio.

As discussed before, we have a stock repurchase plan that automatically purchases shares based on threshold prices beginning $0.01 below our most recently published NAV per share, subject to volume restrictions. Our Board has recently approved a renewal of the plan through the earlier of August 31, 2016, or such time as the $50 million repurchase amount has been fully utilized.

No shares were purchased under this plan during the fourth quarter; 2,000 shares were purchased under the plan during the year ended December 31, 2015; and subsequent to year-end, we purchased approximately 86,000 shares under the plan for a total investment of approximately $1.3 million. This repurchasing activity reflects our high degree of confidence in the value of our portfolio.

Put another way, we view this as an opportunity to repurchase a small portion of our book at a marginal discount to par at an approximately 7% discount to call price. We believe shareholders should view our stock repurchase plan as a sign of our ongoing confidence in the value of our assets. From a liquidity perspective, the 86,000 shares repurchased year-to-date was more than offset by the approximately 148,000 shares of TSLX issued on February 1 as part of our dividend reinvestment plan.

Moving to the income statement on slide 10, total investment income for the quarter ended December 31 was $43.6 million. This is down $3.2 million, or approximately 7%, from the previous quarter, primarily due to lower prepayment fees and accelerated OID associated with pay downs that we experienced in our portfolio during Q3. Our PIK income component remains low at approximately 3% of total investment income for 2015.

On slide 11, we have provided a more detailed breakout of our revenues. Our interest income was $39 million for the quarter ended December 31. This is up $2 million from the previous quarter, or approximately 6%.

"Other Fees" was $1.5 million for the quarter compared to $9.1 million in the previous quarter. This revenue line will be uneven over time as it is generally correlated to the movements in credit spreads and risk premiums. In contrast to prior periods, when elevated levels of pay downs generally resulted in elevated levels of "Other Fees", the investments that we exited during the fourth quarter had either lower embedded call protection due to their earlier vintage or had prepayment premiums that were earned in prior quarters, as was the case of our exit from Milagro.

Despite this, and as a testament to the core earnings power of the portfolio and the optimization of balance sheet leverage, fourth-quarter annualized ROE on net investment income was 11.2%, which is right in line with our annualized ROE target of 10.5% to 11.5%. If risk premiums continue to widen, we would generally expect lower levels of repayments in our portfolio and lower "Other Fees," but higher "Interest Income."

For the quarter ended December 31, net expenses were $19.7 million, which is up from $17.3 million in the third quarter after adjusting for the one-time charge of $3.2 million related to the third-quarter pay down of our SPV asset facility. During the fourth quarter, net expenses increased primarily due to higher interest expense as we increased our quarter-over-quarter leverage. Our management and incentive fees this quarter also reflect the continued voluntary waiver of base management and incentive fees related to our investment in TICC.

In closing, the business has exceeded our dividend on an NII and NII plus net realized gains basis. For the three months ended December 31, we generated an annualized ROE based on net investment income of 11.2% and for the 12 months ended December 31, 2015, we generated an ROE 11.3% on the same basis.

Over the intermediate term, and excluding the impact of LIBOR floors and possible rate increases, we expect asset level yields of approximately 10.5%, additional fees to contribute approximately 1%, and our cost of funds to be approximately 4%. This, combined with our target leverage ratio of 0.75 to 0.85 times, results in our target return on equity net of fees and expenses of 10.5% to 11.5%.

Based on our December 31, 2015, book value of $15.15 per share, this corresponds to a range of $1.59 to $1.74 per share on net investment income, which compares to our annualized dividend of $1.56 per share. We continue to generate strong, consistent earnings driven by a high quality of income from embedded economics in our portfolio.

Josh, back to you.

Thank you, Ian, and welcome to the team. A central theme underlying the results of 2015 and our successful track record since inception is our focus on identifying, mitigating, and managing risk in our portfolio.

Despite the backdrop of volatility and dislocation in credit and energy markets, our investment framework going forward remains unchanged. We believe that the fair valuation of the portfolio, cycle-sensitive capital structure and sector selection, and control features and credit documentation are the foundations of sound risk management in our business.

The trend since mid-2014 has been a general widening of risk premiums across credit asset classes. While we have reflected the spread widening in our calculation of fair value, from the perspective of our portfolio construction and asset management approach, our belief is that the US and broader global economies are generally healthy.

Much of the market volatility we have seen is driven by concerns about China's growth and the global energy sector. However, the global spillover effects of a slowdown in China's GDP are somewhat limited, with only 2% of the S&P 500 revenues exposed to China.

As for the consequences of low oil prices, research highlights a $550 billion annual wealth transfer from oil-producing countries to oil-consuming countries, with the largest gains accruing to countries with low gasoline taxes, such as the US. We believe robust consumer spending, which drives two-thirds of US GDP, will continue into 2016 due to resilient labor markets, steady housing prices, low commodity prices, and less fiscal austerity.

That said, we remain late cycle-minded in our investment approach and have shifted the capital structure and sector selection of our portfolio accordingly. Although we are optimistic about the US consumer, we are much less so on the traditional storefront retail model and believe therein lies an attractive opportunity for our business. We believe there is currently a step-function change in the pace of secular decline in brick-and-mortar retail as more consumers shift to e-commerce.

Given the significant operating costs and hidden financial leverage in traditional retail models, we believe there will be opportunities for TSLX to provide asset-based lending solutions on the highest and most liquid portions of collateral to retailers. In the case of Sports Authority, we provided an asset-based loan and remain confident that our first-lien investment sits inside the liquidation value of the company's working capital assets.

Let me turn briefly to an update on our involvement with TICC. As you may know, on December 22, 2015, TICC held a special meeting of shareholders and failed to garner sufficient support for its proposed sale transaction of its external investment adviser.

We believe the result of this shareholder vote not only reflects a demand from TICC shareholders for better management and governance, but also heralds an inflection point for the broader BDC industry to build a culture of accountability and shareholder alignment. Since the December 22 meeting, however, TICC's stock price has drifted lower, due in part to an entrenched and conflicted Board that has not taken any meaningful actions to deliver shareholder value despite its own admission that change was needed.

In light of continued inaction from TICC's Board, on February 3 we delivered a formal notice to TICC of our intent to nominate an independent candidate for election to the TICC Board and to bring a binding proposal in front of TICC's 2016 annual meeting to terminate the investment advisory agreement among TICC and the external manager, which would come to no cost to TICC shareholders. We share the broader sentiment that it's time for TICC to become a professionally-governed public company with an independent Board of highly-qualified individuals focused on maximizing shareholder value.

As a TICC shareholder seeking to protect the value of our investment, we believe that if a manager consistently demonstrates the inability to create shareholder value, then capital should be returned to shareholders. We remain steadfast in our belief that a combination of our business with TICC is a strategic alternative that offers value to both sets of shareholders, and we remain willing to engage in discussions with the TICC board.

In 2015, TSLX delivered to our shareholders a total return of 5.7%, which represented an outperformance of approximately 10 points versus the Wells Fargo BDC Index. And since inception, TSLX has delivered a total return of 47.3%, which represents an outperformance of approximately 23 points versus the Wells Fargo BDC Index. Despite our outperformance, we are disappointed in 2015 total return results given the higher ROE expectations of our business.

In hindsight, which is always 20/20, we made certain decisions that did not result in a level of returns targeted by our original underwriting case. In a continued period of volatility and low growth, one should expect TSLX, and generally our sector, to outperform given the defensive nature of our portfolio, which is evidenced by consistent cash flows and on-average 50% LTV profile through our last dollar invested.

We have been vocal over the past six months in highlighting the need to improve the corporate governance practices within our industry. And are encouraged by certain actions taken recently by a number of our competitors, including more widespread adoption of the 10b5-1 plans, which in our view is a strong way to facilitate capital allocation.

While our goal is to continue to provide outsized returns for our shareholders, we are intensely focused on preservation of our shareholders' capital and will remain committed to the principles that have brought us here. Our priorities going forward remain employing our proprietary direct origination platform, focusing on less-liquid credit investments that have superior risk-adjusted return profiles, and making capital allocation decisions to serve the best interests of our shareholders.

Our long-term focus continues to be the guiding principle behind our dividend policy, capital raising philosophy, ongoing stock repurchase programs, and our investment in human capital across our platform. We believe our competitive advantage is a combination of our people, the long-term nature of our capital, and our distinctive investment process of putting the collective wisdom of our human capital and our platform against the current investment opportunity set.

As Bo discussed earlier, given our long-dated capital, we have a significant structural advantage versus much of the rest of the market, which in the face of volatility will provide us with two distinct opportunity sets: the ability to provide primary capital to larger issuers on attractive terms and the ability to opportunistically participate in secondary markets when outsized risk return exists in areas where we have an angle. With our competitive and structural advantages, we believe we are well-positioned for a productive period ahead.

On behalf of the TSLX team, thank you for your continued interest in TSLX and for your time today. Ashley, please open the line for questions.

(Operator Instructions) Mickey Schleien, Ladenburg.

Good morning, everyone. I wanted to start with a question regarding the balance sheet. Your asset coverage ratio at December 31 was down to about 230% and spreads have continued to widen this quarter, so I imagine the ratio is even lower today.

On the one hand, we have the credit market being more lender-friendly, but the equity markets are quite weak, as we all know. So how should we think about your willingness to raise equity in order to manage leverage, while taking advantage of the investment opportunities that are out there? Are you more inclined to take advantage of those opportunities now or let the portfolio churn in anticipation of better terms down the road?

Thanks, Mickey. Appreciate the question. The good news is, I think, that our pipeline is very active and, as you said, we are seeing wider credit spreads and -- which will ultimately drive higher ROEs. And given our target leverage ratio, we're kind of in the middle of our target leverage ratio.

We have a little bit of a structural advantage in that we have $7 billion of dry powder across the rest of our platform. So if we are unable to raise equity that is both accretive on a book value basis and on an earnings basis in the BDC, we still can participate in markets. Obviously, as we have stated, the first -- those opportunities will first go to the BDC and if we don't have capital available, it will then go to affiliated funds.

The unique thing about having that capability is that we are able to actually optimize ROEs and optimize leverage in a significant way because we can continue to be very active in the market and find the highest risk-adjusted returns. And depending on if there's a balance sheet available, that will either go into the BDC or go into affiliated funds.

Okay, thank you for that, Josh. A follow-up question, you can currently capture about 900 additional basis points in second-lien versus first lien, and that's up from about 750 at the end of last year. So that's starting to get really interesting.

I understand that you're late-cycle minded, but how big does that spread have to get before you start to allocate more money into second-lien investments?

That is a good question and I will turn after over to Mike after I take a shot at it.

Look, we believe we are kind of mid to late cycle in credit investment. And because of the nature of credit, which is the nature itself has negative convexity, it doesn't make sense unless you have very, very high confidence in a junior capital investment to be allocating a lot of capital to junior capital investments where we believe we are in the cycle. And so I think it is sector-specific and risk return-specific and obviously driven by attachment points.

So when you look at -- we often talk about -- people often talk about second liens and not all second liens are created equal. Our second-lien portfolio has an attachment point of approximately 1.5 times. If we are doing second-lien, it will be in credits that have higher attachment points where we have lower possible loss of principal. And so our second-lien portfolio has attachment points of 1.5 and the last dollar is at 5 times, versus a market second-lien, depending on the sector, that might have attachment points of 4 to 7 times.

I still say we're still finding very interesting, very good risk/return in the first-lien market, so we don't feel pressure to move down the capital structure. And also, in the environment that we are in today with the syndicated loan markets, there's some dislocation there. We are also seeing larger opportunities, which will create an ability to do first-liens, but it will also take advantage of capturing originations economics of those deals, which will add to the overall yield but be in a first-lien position.

I understand. Sticking to this theme of defensiveness; you characterize the portfolio as non-cyclical or not very cyclical, but almost a quarter of it is in business services. So I was just curious; how are you defining business services? Because that would seem to imply some cyclicality. Does that have a lot of software as a service in it, for example?

It does, it does. Look, business services tend to be less cyclical than consumers or capital equipment or housing or building products. These are companies that are providing mission-critical services with high switching costs to other businesses that have a high degree of contractual revenue.

Okay. And just a couple of housekeeping questions, Josh, and then I will disconnect. What proportion of the first-lien bucket is unitranche? And if Ian could just repeat the guidance that he gave at the end of his portion of the prepared comments.

Sure, I'll start, Mickey, and just goes through those numbers. You want me to walk through the buildup of ROE?

You gave a range of NII guidance. I just wanted those numbers.

Sure. So based on our view of target return on equity of 10.5% to 11.5% and applying that to our $15.15 NAV at the year-end, that translates to $1.59 to $1.74 on NII.

Okay.

Mickey, about 50/50. So out of 88% about 50/50 is first-lien versus unitranche. And the unitranche, just to be clear, has an attachment point of a turn of leverage in front of it, about a turn of leverage.

I understand. Thank you very much for your time this morning.

Derek Hewitt, Bank of America Merrill Lynch.

Good morning, everyone. Maybe Josh or Ian, could you explain the rationale for the change in the target leverage versus your previous target? I believe it was 0.65 to 0.75. Given that we are a little bit later on in the credit cycle, credit market volatility remains elevated.

And then plus is there any rating agency feedback that you could share with us this morning?

Sure, I'll take the first part of that. On the leverage target I think the way we viewed the prior explanation of 0.65 to 0.75 was reflective of the age of our business and we were still leading up to an appropriate run-rate leverage, if that's a concept that's familiar to you.

I think now that we have the ability to co-invest -- our affiliated funds have the ability to co-invest with us, as Josh just mentioned. We have this ability to optimize where we are on both ROEs and leverage, so that affords us the opportunity to operate at that higher level of 0.75 to 0.85. And we're right in the middle of that at year-end.

Just to add onto that, Derek, first of all, we feel your pain this morning if you're on the West Coast. We happen to be on the West Coast as well, so we feel your pain being on the West Coast doing an earnings call.

When you think about how we historically managed leverage, when we gave our near-term guidance of leverage when we IPO-ed the business, I think we started off at 0.50. And so 0.65 to 0.75 was a near-term achievable leverage target. We are obviously further along two years kind of post-IPO.

The second piece of that when you think about how we manage leverage, there's two components that we focus on as it relates to leverage. One is -- or three components. One is the nature of our portfolio and the NAV movements that are embedded of our portfolio. Because we have a lower volatility, lower duration, control oriented portfolio, we expect to have lower volatility which I think showed versus the loan market. So the nature of our portfolio helps us to optimize leverage.

The other two components, when you think about how you have to manage leverage, is one is unfunded commitments, which we effectively reserved for, and the second is forward pipeline. Given our ability to co-invest across the platform, the latter, which is our pipeline, we can still serve our clients. But we have $7 billion of dry powder outside of the TSLX platform that allows us to be a little bit more forward-leaning as it relates to our target leverage ratio.

Okay, great. Thank you very much for that explanation. Then quickly looking at some of the new investments that were made this quarter, are there more opportunities like -- I believe this IDERA but I believe was a hung deal. It looks like you guys got very favorable terms. Is that still kind of an opportunity at this point or was it kind of a one-off situation?

So IDERA was fascinating in the sense that IDERA was a software business that had actually purchased -- with Jefferies financing had purchased an existing TSLX portfolio company called Embarcadero. So we knew IDERA a little bit; we knew Embarcadero I think -- Bo, correct me if I'm wrong. We probably had either a financing at TSLX or in previous businesses for like seven years?

Past seven years.

Past seven years of Embarcadero, so that provided a great opportunity. We had the ability to --.

Then the other thing that created that kind of opportunity for us, A) we knew the business very well, which we had an angle. The second is that was one of those opportunities where we co-invested across the platform. So we were able to go into Jefferies with size, with a big order, to get -- to drive terms that -- on a credit we knew that benefited the TSLX shareholders.

I would suspect there will be some opportunities like that, although the forward pipeline of leveraged loans I think is smaller than it has been historically, given the volatility and banks kind of taking a step back, so IDERA was surely a unique opportunity where we think we've created a lot of value on the first-lien loan that we know, buying that $0.90, where you have kind of 10 points of convexity in the near term.

Okay, great. Thank you very much.

Chris York, JMP Securities.

Good morning, guys. Just a couple questions. Given the dislocations in the leverage loan markets and your views in underwriting differentiation, could you update us on how you are thinking about capital allocation and then investment selection in the secondary markets?

Help me understand the question. Capital allocation between what choices? Between buying back stock, buying secondary, primary first-lien loans? What are the -- when you say capital allocation what are the --? Help me understand what you are looking for.

So secondary as opposed to primary, with the context that buybacks will pretty much be kind of taken out of your hand with the 10b5-1?

Got you. I would say, generally, we are -- I think we should start off in valuation because I think it's -- appropriate capital allocation decisions start with appropriately marketing your own book. You cannot make the right capital allocations if it's to your own stock, if it's to private credit, if it's to level two secondary loans, if you don't start marking your own book.

I think that, quite frankly, that is a theme across the sector, which is you often hear, oh, private credit moves slower than liquid credit. To me that's a little bit misguided in the sense that if you are not marking your book to relative value, you are massively missing opportunity costs and you are prone to miss capital allocation.

What I would tell you is that we have a strong bias towards private credit given our ability to underwrite, do due diligence, and control credit and put control features in the credit. All else things being equal, we would rather allocate our capital to private credit. But at some point given relative value, which we saw this in IDERA, on a company we know, it makes a lot more sense to be opportunistic.

The premise is that you can't make appropriate capital allocation decisions unless you mark your book.

That makes a lot of sense, yes. Then kind of staying on the function of or topic of secondary market purchases, would that be in the areas such as Sports Authority, Sears, Toys "R" Us that you've kind of focused on that you highlighted in your prepared remarks with the sector change in retail?

Yes and no. Sports Authority was a primarily originated loan, which we did in connection with the revolving asset-based lenders, and so Sports Authority was not a secondary loan. We do not own first-lien term loan. We own a portion of the revolving asset-based loan that has a very solid, functioning, borrowing base as it relates to the NOLV, net orderly liquidation value, or going out sale; GOB liquidation value of the working capital assets, which are of the highest quality and highest liquidity.

Just to be -- I want to be clear on that. In addition to Toys "R" Us, which again is on a -- is covered by the working capital assets and covered by a borrowing base and an asset base facility, that was actually a primary where we have allocated a little bit more capital to that situation given that -- I think that loan was $260 million total loan. And we have allocated more capital at there has been -- to that situation given that there's been softness in the leveraged loan market.

Got it. Thanks for that clarification. And then this last one is just really a housekeeping item, and forgive me if I missed it, but can you provide us an update on the estimate of undistributed income?

At the moment, we are at $0.71 per share at year-end.

Terry Ma, Barclays.

Good morning. I think most of my questions have been answered, but I just want to touch on the TICC situation for a little bit. Can you maybe give us a sense of how long you may be -- how long you plan on staying in that situation, assuming maybe the optimal outcome doesn't occur at the shareholders' meeting?

The optimal outcome being the termination of the management contract?

Correct.

Look, on TICC, that's obviously a very fluid situation. The way we think about TICC and I think the way the vote showed up in -- on the last shareholder vote as it relates to the switching of the management contract is you basically had two sets of unhappy shareholders.

You had a shareholder -- a set of shareholders that voted for approval of the change of control of the management contract, who was not sensitive to cost but wanted a change in management. So they were basically saying to themselves we need new management at any cost to the TICC shareholder.

And so you had that set of shareholders, which was about 50/50, and then you had another set of shareholders that said we're being wronged; there is a value transfer from TICC shareholders that is going to an underperforming external manager that voted no.

So I think you have two groups of equally unhappy shareholders. One group of shareholders who were willing to allow the value transfer to have a change in management and one group of shareholders who, on principle, was not willing to allow the value transfer. So we feel very confident that shareholders will show up and make the right decision.

As you know and if you looked at our presentation, I think TICC since inception has underperformed Treasuries on a net basis and so there has been a lot of value destruction. And given that there is no cost to change -- to terminate the management contract and you have, I think, two equally unhappy sets of shareholders, we feel good about that change as it relates to winning that proxy fight.

Got it, that's helpful. That's it for me, thanks.

Jim Young, West Family Investments.

Josh, you had mentioned that the fourth-quarter annualized ROE was 11.2%. And given the wider spreads in the fourth quarter and how they've continued to widen year-to-date, can you give us a sense as to what the incremental spread widening means to the potential ROE? Is it worth potentially 10 basis points, 50 basis points? But could you just give us some sense overall to improved ROEs going forward? Thank you.

I think ROEs going forward -- and, Jim, we will get you sensitivities to this. ROEs going forward is really a function of higher net interest margin, so if we are able to get 50 or 100 basis points of additional net interest margin, that will probably be 50 to 100 basis points of additional ROE. Typically how the math works. We usually publish sensitivities and we will get you sensitivities.

The other positive impact, which is not in our guidance number, is movements in interest rates. We're kind of -- and I think the industry is, but I don't know if it's talked about, we're kind of in no man's land right now. So if rates drop 25 basis points -- I'm not suggesting that the Fed is going to cut rates, but if they drop 25 basis points, that is positive to ROE. And if rates go up 50 basis points, it's positive ROE.

But we're kind of -- LIBOR has gone from 30 basis points, or 26 basis points over the last year, to I think 61, 62 basis points and we have floors that were basically 100 basis points. So we're kind of in no man's land as it relates to the rate environment. The guidance that Ian provided is basically a function of we continue to stay in no man's land.

I would say there's two -- hopefully, I answered your question. I think there is two drivers.

Jonathan Bock, Wells Fargo Securities.

Good morning, Josh, and fortunately no pain for me on the East Coast. So one question I have for Mike first relates to $115 million of syndications.

Mr. Fishman, can you tell us are those syndications to partners or are those -- in terms of funds that are choosing to co-invest alongside you or is that back end leverage?

Syndicate, it was a combination of that we syndicate in our securities to third parties. That is syndication. The first out-leverage is a separate security and is not part of the syndication.

Excellent. And so in terms of the ability to originate and distribute more, how would you describe --? We see a number of BDCs do this, and Josh mentioned it in terms of the size of both public and private balance sheet. You've got plenty of capital to keep your originators motivated and to move forth on new transactions.

How would you expect the syndication portion of your business to grow in this environment? If you have somewhat constrained balance sheet capacity at TSLX, could we still see fee income, Josh, on your syndication activity rise or do you kind of split that pro rata with your private funds? How would that fee line work?

Let's take Nektar for example, because I think Nektar is a very good example. Nektar was a combination of two, which is we effectively underwrote about $100 million of Nektar for our own balance sheet. It was I think $96.5 million of our own balance sheet.

We can't -- we are very sensitive to taking oversized underwriting positions, given the size of our capital base. So generally, we will underwrite $100 million to $150 million and that will be the engine or the whip to generate fee income.

At Nektar we underwrote $100 million on our balance sheet out of the -- so take a step back: $250 million of a security. We did sell a first-out piece on Nektar of approximately $50 million, so that left $200 million of capital that needed to be spoken for. We underwrote $100 million, or $96 million, and our affiliated funds underwrote the rest.

Our net hold on Nektar was about $74.9 million and so we syndicated to third parties and were able to create additional economics for our shareholders of about -- on that $25 million or $20 million, which created about $1.5 million of economics in Q4.

Okay. And so when I'm thinking secure syndication, Josh, you're referring to syndication within the family of TSL; is that a fair statement?

No, we syndicated $20 million to third-party GPs co-invest that TSLX had what was able to create economics for our shareholders of $1.5 million that shows up in "Other Income," Ian? In Q4.

Got it, thank you.

Unaffiliated investors is who we syndicated to.

We actually created -- sorry so MatrixCare we earned some syndication fees as well. We earned $1.8 million of syndication fees in Q4.

Got it. And Josh, we talked about the opportunity for ROE expansion and I even think Ian mentioned that certainly, even though BDC stock is volatile, the opportunities to grow interest income on the book are present. I guess the push/pull that we kind of want to understand would be one would expect velocity in the portfolio to be relatively lower, I'll use lower numbered. Clearly you have one or two prepays every so often.

But would you expect really spread expansion on new investments to really drive a lot of additional NOI to the model in light of you already being at 0.8 of leverage today?

Again, I think it's incremental. I think our guidance is consistent with what we think the environment is. It's surely incremental on new investments. We will have average -- we will have pre-pays and we will be able to reinvest those in higher spread opportunities.

If we are able to and we think we can raise -- if we are able to and we think it's accretive on a book value basis and on an earnings basis, obviously you will be able to drive higher net interest margin on new capital raised in this environment. As you know, the challenges with the BDC model is often the best environments to and the highest return on invested capital environments are those where it's difficult to raise capital.

Totally understand.

Quite frankly, again, I think the space -- it would probably be less difficult for the space to raise capital if there was a clear, consistent approach to valuation. My view, and you've heard me say this, is either managers will mark their book or the market will mark it for them.

And so this idea that we have gone through -- in leveraged loans you've had four -- in first-lien loans you've had 4 points of degradation and in second-lien loans you had 20 points over the last year. And there's stable NAV. My guess is the market doesn't believe that.

Clearly, if you look at your stock price relative to the rest of the BDC peers, I'd argue that the market is taking a look that both you, Mike, and Ian marked the book appropriately, so I appreciate those comments.

One item as it relates to your price-to-book premium to the relative right -- I'm sure everyone wants their stock price higher -- but relative to peers, even well-respected peers, deeply discounted, below 0.8 -- relates to what you could do with that premium and those shares. There are -- there is a TICC opportunity that you are referring to. Of course you've also mentioned that you -- there's the opportunity to realize value a number of different ways there.

The question that we would have is there are other books at deeper discounts to NAV today that your share price premium works very well for, and it doesn't even necessarily have to be a hostile situation in terms of an acquisition. Tell us why you wouldn't want to use your NAV premium today to the peers to acquire and grow book the way a few other BDCs have done with much success for their investors.

Look, I think that's a very good question, Jon. I think generally it's tricky. I think the people who have had success -- and I think Ares did a great job with the Allied transaction back in the cycle. They were able to buy a book that had the tailwinds of an economic environment behind them.

So instead of having -- my view is that we probably have some headwinds, not tailwinds. And so a lot of that kind of alpha that was created was created by not only the dynamic of being able to use the currency embedded in a higher-valued business, it was how was that portfolio going to come out of an economic cycle.

And so I think we are probably -- just because you can financially engineer a trade that is accretive on a book value basis doesn't mean it's the right thing to do long-term for your shareholders. And that is -- it may or may not be. That's a function of where do we think the underlying book is actually intrinsically valued and where do we think we are in the cycle.

What was interesting about TICC originally was, to some extent, that was just a big capital raise because we were going to liquidate that book, we were going to rotate out of that book, and you could fairly mark the underlying securities of that book because it was basically a level two portfolio and a more liquid-oriented portfolio. So I would say that at this moment in time, although we have a currency that could be used to, quote-unquote, consolidate this space, I think it's tricky because I think valuations are tricky. I think it's tricky because of where we sit in the economic cycle.

Got it. Just one last little question that was intriguing listening to both you and Mike talk about new originations. Understand that you have and Bo, everyone -- you have a very strong proprietary origination force, yet when we think of IDERA, granted you had bought [Embarcadero], I forget the name of it.

Embarcadero.

Embarcadero, excuse me. So you clearly had knowledge of the credit. But can you walk through how taking over a hung deal is proprietary --? Really it's just Jefferies needs help, they called everybody; you had capital or --? I guess I'm trying to understand the proprietary (multiple speakers).

That's not really how it works. I think how it works is that you have a counterparty that is looking for certain --. Look, the way we create value in our business is providing certainty; if it's certainty for issuers, if it's certainty for counterparties.

In that case -- typically our playbook is providing certainty for issuers, which is they either have an acquisition or a refinancing. We have a balance sheet. We have capabilities. We have sector knowledge.

We can go into that issuer or that sponsor and say this is -- we know the industry. We know the sector. We know the business. We can speak for X capital. Although it might be more expensive, you want to buy certainty.

In this case, Jefferies was looking for certainty in that they had 50% of the loan I think spoken for. Our platform -- across our platform we were providing certainty in the size of the capital. We spoke for $120 million.

We knew the core business. We have a great relationship with the sponsor of IDERA, which is TA, which happens to be managed basically out of their I think Menlo Park office, which is 30 miles south of San Francisco. So that was a counterparty consistent with our business model that they were looking for certainty and we were able to provide them certainty.

And so are we -- will that -- pick another hung name, [Saldera] on the second-lien, which is a broadly syndicated loan. Are we able to provide that same certainty in that same way and, therefore, translate that value to our shareholders? No. It happened to be a very special kind of -- I don't want to call it a special situation, but a unique opportunity for our shareholders.

Got it. Guys, thank you for taking my questions.

(Operator Instructions) All right, I'm not showing any further questions in queue at this time. I would like to turn the call back over to management for any further remarks.

Great. We appreciate people's time and, Ian, welcome to the dance, I guess. We appreciate people's efforts in understanding the story and we will speak to people in, I think, May if not before. 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.