Sixth Street Specialty Lending Inc (TSLX) 2017 Q4 法說會逐字稿

Good morning and welcome to TPG Specialty Lending, Inc.'s December 31, 2017 Fourth Quarter and Fiscal Year Ended 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 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 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 forward-looking statements.

Yesterday, after the market closed, the company issued its earnings press release for the fourth quarter and fiscal year ended December 31st, 2017, and posted a presentation to the Investor Relations section of its website, www.tpgspecialtylending.com. The 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 Relations section. Unless noted otherwise, all performance figures mentioned in today's prepared remarks are as of and for the fourth quarter ended December 31, 2017.

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

I will now turn the call over to Josh Easterly, CEO of TPG Specialty Lending, Inc.

Thank you. Good morning, everyone, and thank you for joining us.

I will begin today with an overview of our quarterly and full year highlights before turning the call over to my partner and our President, Bo Stanley, to discuss our origination and portfolio metrics for the fourth quarter and full year 2017. Our CFO, Ian Simmonds, will review our quarterly financial results in more detail. And I will conclude with final remarks before opening the call to Q&A.

I'd like to start this morning by highlighting our strong financial results for the quarter and full year 2017. Net investment income per share for Q4 was $0.45 per share, resulting in a full year net investment income per share of $2.00, well in excess of our fiscal year base dividend per share of $1.56. Net asset value per share at quarter-end was $16.09, an increase of $0.06 compared to the prior quarter after giving effect to the impact of the Q3 variable supplemental dividend. This was primarily driven by the over-earning of our base quarterly dividend and the positive impact of net unrealized gains specific to certain portfolio companies.

Yesterday, our board announced a first quarter 2018 base dividend of $0.39 per share to shareholders of record as of March 15th, payable on April 13. Our board also declared a Q4 variable supplemental dividend of $0.03 per share to shareholders of record as of February 28, payable on March 30. Consistent with our objective of maximizing distributions while preserving the stability of our net asset value, we declared a total of $0.22 in incremental dividends related to 2017 earnings based on our formulaic variable supplemental dividend framework, while increasing our net asset value per share from $15.95 at the end of 2016 to $16.06 at year-end after giving effect to the impact of the $0.03 Q4 variable supplemental dividend to be paid in Q1.

Our supplemental dividend framework has allowed us to maintain or increase our book dividend yield as we grow net asset value per share. For reference, our book dividend yield was 11.2% in 2017 compared to 10.3% in 2016.

In 2017, we generated an economic return of 11.9% as measured by growth in net asset value plus dividends per share. In addition, we continued to generate strong returns for our shareholders with a calendar year total return of 15.4%, which represents an outperformance of over 15 percentage points versus the Wells Fargo BDC Index. Since our IPO through year-end 2017, we have delivered a total return of 76.3%, which represents an outperformance of nearly 65 percentage points versus the Wells Fargo BDC index for the same time period. We remain humbled by our results to date.

In a year where competitive headwinds led to tighter credit spreads, higher leverage and lower covenant quality in the middle-market lending space, we attribute the robustness of our 2017 financial results to our disciplined underwriting and capital allocation philosophies. By maintaining our investment selectivity and commitment to thematic sourcing and underwriting, we've been able to generate stable, attractive portfolio yields and ROEs despite the challenging operating environment. Bo and Ian will discuss this in more detail later on the call.

From a portfolio quality perspective, we had no investments on non-accrual status at year-end. The overall performance of our portfolio in Q4 remained steady, with a weighted average rating of 1.22, based on an assessment of scale 1 to 5, 1 being the highest; as compared to 1.21 for the prior quarter and 1.44 for Q4 2016. Across our portfolio, since inception to December 31, we've generated an average gross unlevered IRR weighted by capital invested of approximately 19% on fully realized investments totaling over $2.6 billion of cash invested.

Post year-end, we took further strides on enhancing and diversifying our funding sources. In January, we completed our inaugural registered senior unsecured notes issuance. And this month, we reduced the pricing and extended the maturity on our revolving credit facility.

With that, I'd like to turn the call over to Bo, who will walk you through our originations and portfolio metrics in more detail.

Thanks, Josh.

In Q4, the loan environment continued to favor borrowers, as private debt fundraising completed its most successful year on record, and competition from both existing marketing participants and larger players headed down market drove strong demand for middle-market loans.

Taking a closer look at our activity for the quarter -- our new investments consisted predominantly of either lower middle-market companies with defensive market positioning and diversified revenue streams or larger companies with sound business fundamentals in need of capital structure optimization. In either case, we leaned on opportunities that enabled us to structure the level of pricing, terms and downside lender protection features required for the targeted return profile for our portfolio.

To put some numbers around this quarter's activity, we generated our highest quarterly level of gross origins since inception of approximately $1.07 billion, driven primarily by 2 transactions that we sole-led and agented, a $400 million first lien facility for Northern Oil and Gas, which we discussed on our call in November, and a $550 million ABL credit facility for iHeartCommunications. For both of these transactions, the lack of bank underwriting appetite in the light of complex capital structures and regulatory constraints provided us the opportunity to capture attractive risk-adjusted returns for our shareholders. Equipped with our platform's deep expertise in asset-based lending and our ability to underwrite larger financings through co-investments from affiliated funds, we were able to structure loans with robust collateral coverage, call protection and meaningful financial covenants.

Of the nearly $1.07 billion of gross originations during the quarter, $770 million were syndicated or allocated to affiliated funds, and approximately $25 million consisted of commitments we've funded post-quarter-end or expect to fund, resulting in total funded activity of $272 million.

On the repayments front, we had $136 million of aggregate principal amount of repayments this quarter from 4 full realizations and 1 partial investment sell-down. One of the realizations was our investment in the Sears Canada DIP loan. Consistent with our underwriting expectations, we were fully repaid on our investment in Sears Canada, which, along with other economics, resulted in gross unlevered IRR on our investment of approximately 30%.

Reflecting on our deal activity in 2017, we achieved our highest level of gross originations and fundings since inception of $2.3 billion and $989 million, respectively. However, we also experienced record repayments of $952 million from 30 full and 4 partial realizations and sell-downs, resulting in full year net fundings of $38 million.

Approximately 60% of our originations during the year were non-sponsor-related, which highlights the diversification of our sourcing channels. For both sponsored and non-sponsored transactions, our ability to underwrite larger commitments through the scale and expertise afforded to us as part of the TSSP platform has enabled us to capitalize on more niche financing opportunities like iHeart and Northern Oil, as well as upper middle-market sponsor acquisitions that required extensive diligence and underwriting capabilities. During the past year, together with our affiliated funds, we provided commitments of 8 financings that were each $150 million or greater.

At year-end, 98% of our portfolio by fair value was sourced through non-intermediated channels compared to 89% a year ago, as we opportunistically sold investments accumulated during periods of market dislocation in late 2015 and early 2016, amid robust secondary market prices throughout 2017.

As a result of our focus on controlling the investment structuring process, at year-end, we've maintained effective voting control on 82% of our debt investments and averaged 2.3 financial covenants per debt investment, consistent with our historical levels. We believe embedding downside protection features and loan documentation are critical in today's late-cycle environment, as they allow us to quickly identify and implement risk-mitigation measures in the case of underperformance in order to minimize potential losses.

As we navigate the ninth year of the economic cycle, we remain focused on investing at the top of the capital structure. At December 31, 93% of investments by fair value were first lien, 97% of our portfolio by fair value was senior secured, and our junior capital exposure, consistent with the prior quarter, remained steady at 7%.

As for our overall portfolio yields, the weighted average total yield of our debt- and income-producing securities at amortized cost was 10.8%, consistent with the prior quarter; and up 40 basis points from the year-end 2016. The weighted average total yielded amortized cost on debt fundings and pay-downs during the quarter were 9.3% and 11.7% respectively. Adjusted for the expected duration of iHeart, the weighted average total yielded amortized cost on new debt fundings is 11.0%. Note that the downward yield impact of this quarter's net fundings was offset by the increase in the effective LIBOR rate on our floating-rate debt portfolio.

At year-end, our portfolio was well diversified across 45 companies and 17 industries. Our average investment size was approximately $38 million, and our largest position, iHeart, accounted for approximately 6.5% of the portfolio at fair value. We believe our hold size is well supported by the structural protections of our borrowing base governed loan, which is fully secured by high-quality collateral. In addition, we believe we have strong downsize protection given our agent role position at the top of the capital structure and the strength of the company's free cash flow profile on a reorganized capital structure.

At December 31, Financial Services was our largest industry exposure, comprising 14.0% of the portfolio at fair value, followed by Business Services at 13.8%. Note the vast majority of our Financial Services portfolio companies are B2B integrated software payment businesses with limited financial leverage and underlying credit and bank regulatory risk. Given the late-cycle environment, we've maintained our exposure to non-energy cyclical industries, which excludes asset-based loan investments, at a historical low of 4% of the portfolio at fair value compared to 31% at the beginning of 2013.

As for energy, our strategy, which we've communicated since early 2016, has been to opportunistically provide conforming first lien reserve-based loans for upstream companies that have significant hedged collateral value at current price levels. Over the past 2 years, we've selectively increased our portfolio's energy exposure from approximately 3.0% at fair value at the beginning of 2016 to 5.5%, and we expect to remain opportunistic in the sector. Despite the volatility in commodity prices, we've been profitable cumulatively on energy investments to-date, even in light of some challenges on Mississippi Resources.

Since we began our investing activities in 2011, we've developed and acted upon a number of themes based on the broader macro environment and sector-specific trends, ranging from restaurants and building products in 2011 and 2012 to ABL retail and financing of pharma royalty streams in today's late-cycle environment. While our themes have rotated over the course of the cycle, our approach to sourcing and investing remain the same, which is to stick to the sectors and themes where the expertise and relationships of the broader TSSP and TPG platforms provide us with a competitive advantage, a robust direct origination strategy, and underwriting discipline focused on downside protection and secondary sources of repayment.

With that, I'd like to turn it over to Ian.

Thank you, Bo.

We ended the fourth quarter and fiscal year 2017 with total investments of $1.69 billion, total debt outstanding of $715 million and net assets of $969 million or $16.09 per share prior to the impact of the $0.03 per share supplemental dividend to be paid during Q1 2018. As Josh mentioned, our net investment income per share was $0.45 for the fourth quarter, resulting in a full year net investment income per share of $2.00. Our full year net income per share was $1.86, which exceeded our full year guidance of $1.67 to $1.83 per share, which was based upon an expected ROE of 10.5% to 11.5% applied to beginning NAV.

For the variable supplemental dividend. 50% of this quarter's over-earnings against a base dividend per share of $0.39, rounded to the nearest cent, amounts to $0.03 per share. Consistent with the prior 3 quarters, the NAV movement constraint element of the formula had no impact on the calculation of this amount.

As a result of the rebound in net fundings this quarter, our debt-to-equity ratio at December 31 was 0.74x, approaching the lower end of our target leverage range of 0.75x to 0.85x. Our weighted average leverage ratio for Q4 and full year 2017 was 0.72x and 0.67x respectively.

During January, we made various enhancements to our overall debt funding flexibility and costs. Specifically, we issued $150 million principal amount of 4.5% 5-year senior unsecured notes, the net proceeds of which were used to pay down debt outstanding under our revolving credit facility. Consistent with our risk management philosophy of matching our liabilities with the floating rate nature of our debt portfolio, we entered into an interest rate swap matching the notional amount and term of the new notes. This was an opportunistic financing that provided access to a previously untapped market for us at an attractive pricing of LIBOR plus 199 basis points on a swap adjusted basis, which at the time was inside the cost of our secured revolver spread, resulting in minimal pro forma drag on ROEs.

In addition, earlier this week, we amended our revolving credit facility, reducing the effective pricing from LIBOR plus 200 to LIBOR plus 187.5 basis points, and extending the final maturity to February 2023 on the significant majority of commitments. In light of our recent $150 million notes offering and limitations on revolver utilization given regulatory leverage constraints, we may look to explore reductions on the non-extended portion of revolver commitments in order to reduce the ROE drag of unused revolver fees going forward. Given the ongoing support of our lenders and our demonstrated access to liquidity and diversified funding sources, we believe we are well positioned for the opportunity set ahead.

Moving to our presentation materials, slide 8 contains an NAV bridge for the quarter. After giving effect to the Q3 supplemental dividend that was paid during Q4, we added $0.06 per share from net investment income in excess of our base dividend, which was offset by the reversal of net unrealized gains from 4 full investment realizations during the quarter. $0.02 per share was related to the net positive impact of credit spreads on the valuation of our portfolio, while $0.04 can be attributed to the net positive impact of other realized and unrealized net gains, including those specific to certain portfolio companies. If we were to adjust the ending NAV per share of $16.09 for the variable supplemental dividend declared based on Q4 earnings that we will pay in Q1 2018, the ending NAV per share is $16.06.

Moving to the income statement on Slide 11, total investment income for the fourth quarter was $48.8 million, down $3.5 million from the previous quarter, primarily driven by lower "Other fees". This line item, which consists of prepayment fees and accelerated amortization of upfront fees from unscheduled pay-downs, was $3.4 million compared to $6.8 million in the prior quarter, consistent with the lower repayment activity that we experienced during Q4.

"Interest and dividend income" was $43.8 million, up $1.8 million from the prior quarter, given an increase in the size of the portfolio and the impact of a rising LIBOR. "Other income" was $1.7 million, down $1.9 million from the prior quarter, primarily due to the absence of syndication fees, which tend to be episodic in nature. Our PIK income component remains low at 2.2% of total investment income for the quarter and 2.8% for the full year 2017.

Net expenses for the quarter, excluding interest expense, were $14.0 million, down $1.3 million from the prior quarter, primary due to the lower incentive fees and other operating expenses. As for the quarter-over-quarter increase in interest expense, this was primarily driven by the timing of the interest rate swap settlement on our 2022 convertible notes during Q3 and Q4. Adjusted for this impact, the weighted average interest rate on average debt outstanding, excluding amortization and fees, for Q4 remained steady with the prior quarter at 3.5%, despite an increase in our effective LIBOR borrowing rate. This was due to higher utilization of our lower-cost revolver funding as positive Q4 net funding activity resulted in an increase in average debt outstanding.

On the topic of ROEs, during Q4, we generated an annualized ROE based on net investment income and net income of 11.1% and 11.0% respectively. For full year 2017, we generated an ROE based on net investment income of 12.5% with an average leverage ratio of 0.67x compared to 11.9% for 2016, when we operated an average leverage ratio of 0.80x. Similar to 2014 and 2015, the strength of our 2017 ROE was supported by heightened portfolio activity that resulted in elevated levels of prepayment fees and accelerated OID from unscheduled pay-downs. Recall that in 2014 and 2015, we operated below our target debt-to-equity ratio at 0.50x and 0.64x and still generated ROE based on net investment income of 13.3% and 11.4% respectively. Our ROE based on net income for 2017 was 11.6%, which again was slightly above the high end of our target ROE range of 10.5% to 11.5%.

Looking ahead for 2018, we expect the spread-related driver of repayments to moderate, which will allow us to return to our target debt-to-equity range of 0.75x to 0.85x and drive ROEs consistent with our targeted range through our interest and dividend income line similar to 2016. You may recall that in 2016, we achieved 100% base dividend coverage through "Base NII", which we define as net investment income excluding activity-driven income and its impact on incentive fees.

While we continue to have substantial protection in the form of additional economics, should our portfolio get repaid in the near term, as illustrated by the fact that the fair value of our debt portfolio as a percentage of call protection at December 31 was 95.6%, we expect activity-related fees to be a less prominent driver of ROE in 2018 as compared to 2017. That said, we believe there are some idiosyncratic catalysts that could be a driver of near-term earnings from activity-related fee income. For example, the contractual maturity of our ABL investment in iHeart is 3 years, which is the duration we use for the amortization of upfront fees. However, given the progress of iHeart's restructuring, the details of which are in the public domain, our expectation is that our loan will be fully repaid in a much shorter time period.

Over the intermediate term, we continue to target a return on equity of 10.5% to 11.5% based on our expectations for the interest rate environment, asset level yields, cost of funds and financial leverage. Using our year-end 2017 pro forma book value of $16.06, this corresponds to a range of $1.69 to $1.85 for full year 2018 net investment income per share.

With that, I'd like to turn it over to Josh for concluding remarks.

Thank you, Ian.

While underlying market dynamics made 2017 a very challenging year to source and underwrite attractive risk return opportunities, we're pleased with the risk / reward that we've been able to create for our shareholders. For the first 3 quarters of the year, the size of our investment portfolio actually decreased slightly as repayments outpaced fundings. True to our philosophy of avoiding undue risk in highly competitive markets and opportunistically growing during periods of market volatility and dislocation, we remain disciplined with respect to growth and instead focus on ways to optimize the economics of our business. This can be seen in our return on average assets, which increased from 11.9% to 13.1% year-over-year; our average run rate operating expense ratio, which decreased from 67 to 64 basis points year-over-year; and our recent enhancement in our debt funding sources.

With the year-end passage of U.S. tax reform, we have been assessing how tax reform may impact leveraged borrowers in our market. At a high level, the 5 key pillars of the new tax code include: a reduction in corporate tax rate, a limitation on the deductibility of interest expense, a full deductibility of certain capEx, changes in the utilization of NOLs, and deemed repatriation provisions. The net impact of these measures is, in some cases, offsetting and will vary by borrowers' capital, capital intensity, leverage profiles, geographic footprints and tax attributes. But broadly speaking, many of the highly leveraged borrowers in our market could face elevated cash tax expense going forward, including the effect of an increasing LIBOR, which in our view supports our late-cycle portfolio construction approach, including where we invest in the capital structure.

As for our outlook for 2018, we are cautiously optimistic as fundamentals in the credit markets remain relatively sound, and all major global economies are growing in rare harmony. However, we believe there are various unknowns including inflation, Central Bank policy, domestic politics, and the broader impact of the aforementioned tax reform, which could drive periods of market volatility, as we're experiencing today.

For us, highly volatile markets represent opportune windows to capitalize on outsized risk-adjusted returns for our shareholders in companies and/or sectors where we have a differentiated perspective. To illustrate this, for our fully exited investments we made or committed to during periods of market volatility in late 2015 and 2016, we generated an average gross unlevered IRR weighted by capital investment of approximately 27%.

As investors, we're always looking for ways to generate additional value for our shareholders where we think we have unique expertise and insight, and this may include from time to time exploring strategic alternatives in the BDC space. Over the course of Q4, we've purchased approximately 1.4 million shares of Triangle Capital Corporation, or approximately 3% of the company's shares outstanding, at a weighted average price per share of approximately $9.70 or 0.73x the company's then reported net asset value per share, which we believe provides a margin of safety for our investment. The thesis for our equity investment is ultimately a commercial one, as we believe the outcome of TCAP strategic review will likely drive TCAP's stock price closer to net asset value or result in a value-enhancing transaction, both of which would benefit TSLX's position and therefore our shareholders.

Although we were invited to be a part of the TCAP strategic review process, we declined given what we believe to be onerous and non-customary provisions in the nondisclosure agreement that would've resulted in relinquishing our voice as TCAP's fifth-largest shareholder and our liquidity in the TCAP stock. We take our fiduciary obligations very seriously, and despite our interest in participating in the strategic review process, we ultimately believed that consenting to the company's nondisclosure agreement would not be in the best interest of our shareholders. As reflected in our financial results, we've elected to voluntarily waive base management and incentive fees related to our investment in TCAP.

With that, thank you for your continued interest and for your time today.

Operator, please open the line up for questions.

(Operator Instructions) And our first question will come from the line of Jonathan Bock with Wells Fargo.

Starting first with just the size of iHeart relative to the overall assets or NAV, certainly quite large. And I understand, as we talked about the thesis of the investment, clearly it's an attractive one. Josh and Bo, maybe a balance over how you view taking fairly concentrated exposures? And while clearly it's worked, one question folks are probably going to be asking -- this is so sizeable -- is that iHeart might turn out to be an outstanding investment, but would you say that there is a strategic shift to perhaps take even chunkier investments in today's environment, risk-adjusted return environment? Because it's really hard to find adequate risk-adjusted return carte blanche. So just a thought on diversification in particular, because investors are weighing whether you should be extremely diversified or take concentrated high-octane investments in this environment?

I think the question is, what is the nature of the investment?

Yes.

This is not a cash flow investment, this is an investment in a regular-way market. If iHeart was properly restructured, their cash flow term loans and bonds would've priced at LIBOR 175 to 200. And so the question is not -- on a spectrum of high-octane to no octane, this is no octane. It's not even in the middle. It is an asset-based facility that, given that iHeart was highly levered below us in the capital structure, they were unable to roll -- a lot of the banks were unable to roll, given the criticized asset leveraged lending rules. Not only that, in the public domain, which what has always been clear given the cleansing process that's been happening with the restructuring -- so iHeart cleanses their creditors by providing updates on negotiation. And every one of those processes, the ABL is repaid in full or unimpaired. So there hasn't been a strategic shift about going chunky. It was an idiosyncratic choice as it relates to the nature of the iHeart investment and the quality of that loan versus -- in the quality of that collateral. It's an asset-based loan that's margin against basically investment-grade accounts receivables. And if people know about iHeart, as a name, iHeart does $1 billion to $1.1 billion of EBITDA, has actually been very stable; on a consolidated basis, does $1.6 billion to $1.7 billion of EBITDA when you include the outdoor business. So the loan is very well protected, and it has a near-term catalyst with the restructuring.

So then, maybe moving on to Jive Software, quickly -- so is the Jive Software loan also expected to prepay, understanding that the new loan to Lithium Technologies was to support that acquisition? Or do both stay outstanding for some reason?

Yes, I think Bo -- I think there's kind of a little bit of misunderstanding, which was Jive Software was a name, they had spun out a piece of that business, which created a new financing opportunity to another sponsor. But that is the only case.

Correct. I mean, the piece that was spun out of Jive was much more strategic to Lithium than it was to Jive. So we allowed for that, and it gave us a unique perspective to finance, to be part of the financing for Lithium. But neither one of them are expected to pay off anytime soon.

And then, look, the one thing that's easy for all of us on the call, and I'd imagine everyone's going to ask about -- TCAP, it's a $13 million investment, so I want to try to keep it just as close as we can here, because it is really a small piece. But I would like to, just in light of the fact that, Josh, there've been some negative press in The Wall Street Journal about the space and some significant misinformation on the part of just either reporters or others on the space, I'd like to put in context your view on where the space is today, and then, more importantly, what managers can be thinking about generating strong risk-adjusted returns for folks, either through hanging up the hat and through a sales process, or generating strong risk-adjusted returns for clients the way you've been, in contrast to what I'd imagine The Wall Street Journal put out in a terrible article on Tuesday.

Yes. Look, I skimmed the Wall Street Journal article. To be honest with you, I don't get fussed about what the media says about our business. Quite frankly, there are a lot of great BDCs in this space that are creating very high risk-adjusted returns on capital with relatively low financial leverage. And so just to put our kind of performance in perspective, this year our ROEs on net income -- look, the only thing that really matters was, I think, 11.6% for net this year, 11.6%. And we made mistakes. And so I think if you look at -- I did the back of the envelope -- we had about $0.25 in hits in net income related to Mississippi, predominantly Mississippi. So even in an environment where we weren't perfect, and we took both small unrealized and realized losses, we generated an 11.5%, 11.6% ROE being levered at massively less than 1 to 1. And so I'm pretty bullish about people who have the requisite skillset that continue to generate high returns on risk capital in this space. And so I didn't get really fussed about The Wall Street Journal. That being said, the average return in this space, as we've talked about, really since we've gone public, hasn't been great, has been somewhere between total returns of between 5% and 6% ROEs. But that's driven down by the tails on the left. And there's a lot of talented groups of people, and there's a decent opportunity set to continue to earn decent returns on capital with not a lot of financial leverage. And as it specifically relates to TCAP -- look, you're right, it's a small position. We were hopeful that building our position would allow us to have an edge in the process. And hard to do when you can only be 3%. But we chose not to participate in the process, because it would require for us to potentially give up our vote in future shareholder meetings. And so the probability of being successful, given that we're kind of value-oriented guys, and then being the fifth-largest shareholder without a voice, didn't seem to make sense for our shareholders.

And our next question will come from the line of Leslie Vandegrift with Raymond James.

One quick follow-up on iHeart -- thanks for the color earlier in the call, but on the ABL, see it's a last-out as well. So you had, between that and Northern, about $770 million in syndication / sell down for the quarter?

Yes.

The lowest-fee quarter for the year. And this is a last-out you would usually get a fee on top for not being the first out on that position. So looking for why this fee didn't come with these positions and selldowns.

Yes. So let's take a step back. I think there's one premise that's slightly wrong. On last outs, we actually generate no fee income. So the additional both closing fees that are skimmed and spread is -- either the spread is recognized over the loan or the closing fees are upfront or amortized upfront. So for example, our closing fees on iHeart were, I think, 2.4% -- Ian, what was it, total percent? 2.4%, 2.6% or something like that. 3% about. So that is in the unamortized OID. If it was a -- if we were selling -- effectively, the accounting rules are that you can only recognize fee income when it's essentially a same security, and there's 2 different securities. As it relates to Northern Oil -- that transaction we underwrote and instead of syndicating it, we had co-invested that entirely to an affiliated fund. And so us and an affiliated fund took the entire position and the exemptive relief order requires that affiliated fund and invest on the same economic basis as TSLX. What I would say is that, although there wasn't specific fee income in the quarter, given that we were able to provide certainty to Northern Oil by providing a large underwritten commitment between us and our affiliated fund, that we think we generated massively outsized economics on a go-forward basis with TSLX shareholders.

And so you've discussed the L+475 on that, the coupon, because of the shorter duration and all the other --

Yes, I think it's -- roughly, this L+475, that doesn't include the skim.

That doesn't include the skim?

Yes. No, there is -- the yield to worst at 3 years, I think, is like 9%. The yield to expected duration is like 11%. And so obviously, there's a big delta between the LIBOR+475 and -- is running at 9% on a -- when you amortize OID plus the additional spread income. And then there will be -- at some point, if it doesn't last 3 years, there will be a significant unamortized portion that runs through the P&L. And so kind of the yield, the true yield of that, given the pace of the restructuring, is somewhere between -- my guess is 11% and 13%.

And then, on the few others you did in the quarter, new originations of loans, those were a little bit lower on the coupon, although not low, but LIBOR+700 to LIBOR+775, so below averages. What's the outlook for 2018? Are we looking at those kind of size deals on the coupons?

Yes. So I think Lithium was LIBOR+800, 1% floor, 9% plus fees, so that's right in the sweet spot. Industrial Physics was LIBOR+700, I think 1% floor, plus fees. And so those had -- I can run the math, but those had amortized yields probably somewhere in the 10% to 11% range when you include fees. Because, remember, we defer our fees and they run through our P&L over the contractual life. So those are kind of right in our wheelhouse as it relates to our typical transactions. Ironically, we did look at -- there tend to be some -- for whatever reason, Q4 over the last couple of years, there tended to be where we put on assets have a lower amortized yield. So for example, in Q4 of '15, yielded amortized costs on new investments, 9.3%. And Q4 of '16, it was 9.1%. And Q4 of '17, it was 9.3%. But, adjusted for iHeart, it was 11%. And so there tends to be some bump. I mean, there tends to be some quarter-to-quarter variation.

And then, what did you end the quarter or the year with spillover income?

We put that estimate into the risk factors. So if you look at Page 33 in the 10-K, it's disclosed as approximately $64 million, so it's $1.07 per share.

Our next question comes from Mickey Schleien with Ladenburg.

Josh, I'm just curious about the exit from the Symphony CLO. I realize it was a small investment. But I'd like your color in terms of whether that deal was called, or did you exit for other reasons, perhaps such as a tightness in the more liquid markets?

Yes, it might've been since called, it wasn't called when we exited. We put on some structured credit investments during the dislocation of late 2015, early '16. That included Symphony, that included Oak Hill. As prices in those markets came back, and on a go-forward basis, yields were below kind of what we viewed our kind of cost of capital was, we exited those positions. And so we ended up having -- I think those positions probably returned a 15% IRR or something like that. So we captured the capital gain as it relates to where we bottomed, which was kind of the low to mid-80s, and the running spread and where we sold them, which were kind of, I think, in the mid-90s.

And our next question will come from the line of Rick Shane from J.P. Morgan.

Just one question this morning. Over the last year, LIBOR is up 70 basis points. Normalizing for swap payments, your funding costs were up 70 BPs, your asset yields were up about 40 basis points. So implicitly your funding beta is about 1, your asset beta is about 0.6. I am wondering, as we move into 2018 -- look, the whole thesis here is asset sensitivity -- as we move into 2018, you move off LIBOR floors. You've done things to lower your funding costs, you're trying to optimize your commitment fees. Do you think we will move into a situation where the betas on the funding costs and the betas on the asset yields start to move more in sync?

Yes, Rick. That's a great, great question. I think that is our hope. What you basically said is we've had a -- some spread compression in the business. We've had a lot less spread compression inthe entire space. I think what the data says is the guys with over $2.5 billion of assets have had a lot more spread compression compared to us. We've had a little bit of asset sensitivity. But that is our hope. I think volatility will help that, but that is surely our hope. What is interesting is, even as -- and so I think what you're saying is what you've picked up in LIBOR you've lost in margin. And our hope is that trend will end. But as the economy keeps going, risk premiums get tighter, and so that will continue to be my worry. But the nice thing about our business was return on average assets, given how we've built the portfolio, in this year was -- what was it, Ian, return on average assets this year? It was 12.4%. And so we've actually had much higher return on average assets than the yield on our portfolio given our portfolio construction. And so the headline kind of spread compression is less impactful than you would see, given where we've been able to get economics elsewhere.

And our next question will come from Doug Mewhirter from SunTrust.

In terms of your ABL business, which definitely fluctuates with the market conditions and opportunities, it seems like there's still a lot of opportunity out there in retail land. Would you agree? And do you have, I guess, the capacity in terms of your asset allocation policies, to sort of increase the size, knowing that it's hard to really grow it quickly because they pay down so quickly -- but are there enough opportunities out there where you could actually even take another small step up in the size of your retail ABL portfolio?

Yes, I think, no question. Look, we've invested in retail ABL of about $450 million. The portfolio as it stands today is only about $120 million as of quarter-end. And so we continue to be very active in that space. And in total asset base, including retail, we've probably invested -- PSIX, which came off a long time ago, and other names, we've probably totally -- and iHeart -- we've probably invested $700 million to $800 million. And so we like that, given the uncorrelated nature of the assets. And could we bring our retail ABL business up to 20% of our book, the question is? Yes. I'm not sure if it's possible given the duration, even though the opportunity set. But there surely would be appetite on the risk side to double it from $120 million to $250 million to $300 million, if the opportunity allowed us. We have been -- we did not participate, for example, in the Toys FILO and the bankruptcy. I think in retrospect, we're glad we haven't given how that case has gone, although I think that's probably a pretty good piece of paper, just wasn't what we thought was the right risk-adjusted price. So we tended -- we still -- we're not in the business of doing everything that's retail asset based. We still have a very discerning eye, but we would most definitely want to increase our book if we could.

And my second and final question -- if you or Bo could comment just on your general origination pipeline, and it seems like there's conflicting information out there. Some executives think it's sort of a target-rich environment, and there's lots of opportunities. And others think, well, because it's competitive, and then maybe that there's not as much opportunity to grow your, I guess, regular way portfolio -- just a comment on what you're outlook is for 2018 in terms of deal flow?

The deal flow environment feels pretty good at this point coming into the Q1. I think we continue to thread the needle on opportunities that overlap with our theme generation and where we're focusing on deploying capital. So I feel optimistic heading into the New Year. It's hard to project out -- our originations are very idiosyncratic each quarter -- it's hard to project out for the full year. But sitting where we are today, I feel pretty strong, I feel pretty good about our originations activity.

Yes, look, I think the spread compression has -- the low-volatility spread compression has slowed. I think high-yield has actually increased a little bit, so I think that's good, generally, for the environment. I think we continue to be very highly selective of what we do and tend to be thematic-based where we think we have an edge, but it feels okay. I'm not sure if that's that helpful. It surely doesn't feel like it's 2010 or 2011, and you haven't seen the volatility -- or you've seen a lot of volatility in the equity markets, you haven't seen that roll through the credit markets that you saw in Q4 of '15 and Q1 of '16. With all that being said, we like our platform. We like the depth and breadth of our originations. We like that we do both direct-to-company and sponsor stuff and we like the thematic. So I'm pretty highly confident we'll continue to find good risk-adjusted return stuff.

(Operator Instructions) And our next question will come from Terry Ma from Barclays.

I appreciate the broad comments on the impact of tax reform. But could you just give a little bit more color on how it impacts your existing portfolio from a cash flow perspective? Any sectors in there that it may impact more than others?

Yes, so I think our portfolio is actually in pretty good shape. Our average leverage, I think, is, like, 4.7x. The breakpoint is, like, I think 6x, and so there will be a handful of borrowers that will surely have more cash taxes given the limitation of deductibility. I generally think -- and this is a broad statement, and we -- this is not our portfolio, we're much further up the capital structure. But when you look at the highly leveraged universe of the leveraged loan market, both in the high-yield and in the broadly syndicated market, I think the market is slightly not taking into account the tax reform bill as it relates to deterioration on credit fundamentals. And so effectively, you have a limitation of 30% of EBITDA, so think of it as 3 to 1 interest coverage. Anything that doesn't have 3 to 1 interest coverage is going to have limitation on -- offset slightly by -- or offset significantly by that lower tax rate, but anything that -- you're going to have limitation on deductibility of interest expense. And so I think that is the "watch out", is that in a rising LIBOR environment, where if you think LIBOR today is at 1.5%, 1.6%, and in the broadly syndicated market, for example, the average loan is 300 -- And so if you think LIBOR is going to 3%, that means interest costs are going from effectively 4.5% to 6%, and so increasing by 25% and on a highly levered borrower, none of that is going to be -- have a tax shield. And so my guess is nobody thinks that borrowers are going to grow earnings by 25%. And so there were going to be weakening credit fundamentals given the limitation of interest deductibility on a subset of highly levered borrowers, which is not representative of our subset given we're at 4.7x levered. But I think that is a "watch out" for credit fundamentals in a rising rate environment, given I don't think that people are going to be able to grow earnings as quick as base rates go up.

Got it. Have you seen any change in incremental demand for new debt or maybe appetite from your competitors or other peers?

We were just talking -- we had a board meeting yesterday, and we were just talking about this. The demand for debt and for leverage has been unfazed. And so I think when sponsors look at the world and they kind of say, God, who cares if I don't get the tax effect on that last turn of leverage, it's cheaper than my expected returns on my cost of equity or from my private equity fund -- and so you have not seen a change in capital structure or sponsor behavior or demand for capital at all. Bo, I don't -- By the way, we have a special guest appearance today, Mike Fishman. Mike, I don't know if you have a view on this.

We haven't seen -- I haven't seen any change, so I totally agree. Sponsors are levering businesses no differently today than they have prior to the tax reform.

Not only have we not seen that, we haven't seen or heard evidence of the thought of that, so we've seen no change to date.

Our next question will come from the line of Christopher Testa with National Securities.

Just touching on the energy exposure a bit, can you talk about the extent to which your portfolio companies might be upbeat on potential regulatory reform, if that's been something that they're optimistic about? And my second part of the question is just, given the optimism in the space in general, just how much of an increase in opportunity set are you seeing kind of at the top of your funnel?

Yes. Look, I don't think we've -- I don't have a view if those issuers on regulatory reform have a feeling of upbeatness or not. As it relates to the top of our funnel, there are still a decent amount of broken capital structures in the space. And where we have really -- where we have chosen to play energy -- and if you look at the names in the last year, we've put on 2 names -- one is Rex, and one is NOG (Northern Oil) -- both have broken capital structures, which gives us the opportunity to earn high risk-adjusted returns on capital, senior in the capital structure, and then RBL (reserved-based lending) format, where we're not taking commodity price volatility risk or as much on hedged collateral. And so both Northern Oil -- for example, I think Northern Oil had $800 million of bonds below us trading at $0.84 now or something like that. And so we that is where we've been playing the sector, which is we're not -- we don't have a thesis where we're bullish or bearish on commodity prices. What we are is, it's an offshoot of our asset-based lending. And quite frankly, every one of the loans we've done would've been done by a bank at 600 basis points of tighter spread if the capital structure had been cleaned up. And so there are still a decent amount of companies that are broken capital structures, given that those capital structures were built in the unsecured market at a much higher commodity price environment. And so we'll be opportunistic of where -- what we do or what we add in the space.

That's great color. And just on the iHeartCommunications deal, how much of that was syndicated out versus allocated to your affiliated funds?

Yes, that's a good question. So the total loan was $550 million. There was $300 million of last out, and so the rest -- we took $115 million. The rest was allocated to affiliated funds, of the last out.

Got it. And just given your commentary on repayments likely slowing down and thus your leverage coming up, does that include the potential for the iHeart to prepay early, or is that just excluding that?

No, I think that includes that. I mean, I think how we think about iHeart is on a kind of an expected duration basis. And so we expect to be kind of in our target range including a payoff of iHeart.

And our next question will come from the line of Jim Young with West Family.

Josh, at the beginning you had mentioned that in 2017, you saw tighter spread, more leverage and looser covenants. And my question -- basically, it's two-part -- is, number one, given the recent market volatility, have you seen any change at the margin with respect to spreads, leverage and covenants in the marketplace? And then secondly, as you look at how, with your crystal ball that you have in looking out into '18 and seeing how the credit markets evolve, what do you think credit investors aren't focused on and should be paying more attention to?

Hopefully you're getting unseasonably nice weather in Chicago as they had in New York yesterday. Unfortunately, we happen to be on the West Coast, so we're up early and not enjoying the weather. But I would say we have not seen the volatility and change kind of appetite for credit or -- it feels like it's kind of evened out a little bit. I don't think we're seeing -- and Bo can comment on this, and I'll talk about what people are missing on expectations -- but I don't think -- we're not seeing the rapid spread compression that we saw in '17 that we are in early '18. And we're not seeing, I guess, the rapid deterioration of lender protection. Our portfolio hasn't really changed on a year-over-year basis. I think leverages went from like 4.5x to 4.7x, interest coverage is basically the same, and we have the exact same number of covenants. So we've been more insulated because we've been picky, we didn't actually grow. And so our portfolio, I think we feel pretty good about it given the environment. Bo, you have a view, or Fishy?

Yes, I would say that's right, Josh. We haven't seen the step function here in the first quarter of 2018 of spread compression and the structuring deterioration that we saw in Q1 of last year when a lot of new capital came in and was very aggressive putting it out. I think demand has remained pretty consistent, so if we didn't -- The market volatility didn't improve things, but we haven't seen any more deterioration than we saw last year.

Yes. I would say yes. I feel like we've seen a bottoming out on spreads. For '18, I think a "watch out" might be whether there's any more covenant deterioration. I think a lot -- as Josh said, a lot of it's happened, but there are players in the market that are willing to take less structure.

And look, I think the big "watch out" for me on kind of what credit investors are missing and why we've been very defensive in how we position our book -- defensive meaning asset-based loans uncorrelated to earnings, recoveries on quarterly earnings -- is that as you take a step back, we talked about tax reform. We talked about limitation of interest deductibility. And on the companies that are on a margin where they've crossed a line, a rising LIBOR is going to have a material linear impact on levered free cash flow, so that is a big watch out. The other watch out is, when you think about economic cycles, and we're probably at the beginning of a tightening cycle, but the economic cycles -- as one person said to me, if you want to be a great investor, you should really think about and study inflation because what the economic cycle, what typically happens is you have rising rates. We have inflation, which forces a policy hand of rising rates, which slow investment and slow consumption, which leads to recession. You then have loosening monetary policy, which spurs consumption. And so we're kind of at the beginning of -- we could debate for a long time inflation, but the -- if you see a ton of inflation, wage inflation, and a large monetary response, obviously, that will lead to tightening business activity, tightening consumer activity, which will lead to some type of recession or some type of correction. And so I think we're pretty -- I think we're -- as we think about inflation, you're starting to see a little bit of wage inflation. I think it's pretty controllable, but I think the "watch out" is rising rates crossed with tax reform and inflation, and the monetary response and the business cycle.

And our next question will come from the line of Chris York from with JMP Securities.

So considering your balance sheet leverage expanded is now just below your target range. And volatilities are turning the markets, which should increase demand potentially for the certainty you provide to borrowers below the BSL market. Can you update us on your potential interest in growth equity today?

Our potential, what was that?

Potential interest in growth equity.

And raising equity? Is that the question?

Yes, correct.

Since our IPO nearly 4 years ago, although we've traded above book value 99% of the days, we only raised equity when we think it's accretive on a book value basis and when we think it's accretive on an ROE basis, i.e. that the costs of where we can invest in assets in that moment in time, post fees, post losses, exceeds our cost of equity. And so both those things have to line up. And so I don't -- we take the philosophy, for better or worse, which is we'll do it just-in-time. And so in this moment in time, I don't think we think there's -- we're not planning to do an equity raise, given where we are, our target leverage ratio and our book in this moment in time. I don't know if, Ian, do you have anything to add?

No, and obviously it's very much dependent on those factors that you outlined. But beyond that, we don't have visibility.

Got it. And then while we heard your comments, I'm unclear about not using your position in TCAP to pursue business combinations. The potential acquisition of TCAP would have increased your assets to $3 billion, so should we think about that size as a frame for a max fund size that you would want to maybe run this strategy longer-term without affecting your ability to be selective and continue to generate leading BDC returns?

I want to -- I do want to make -- We pick our words very, very carefully. And so I do want to make a qualifying statement as it relates to TCAP. We chose not to be involved in the process. You should not conclude that we will not use our position in TCAP if we think there's an opportunity to pursue a business combination where we think there is massive value for our shareholders. That doesn't seem like that is in the cards at the moment, but I don't have insight into the TCAP process. I don't have insight, but who knows? We are the fifth-largest shareholder. There are a group of shareholders on top of that list. And if the deal that comes out of that process, if a deal comes out, is not something that we think is good for the company, we may choose to reengage in a different way. So I want to be very clear about TCAP, because we pick our words very carefully. Does that -- I want to make sure that you understand that.

Yes, that makes sense.

Look, as it relates to why TCAP, would we want to be $3 billion of assets in this environment and grow our book from $1.7 billion to $3 billion of assets in this environment? The answer is absolutely no. Could you -- would you -- if you could it in a very value-oriented way where it would be very accretive to TLSX shareholders and we could provide a solution to TCAP shareholders, would we want to do that? Yes. Ultimately, would that mean that we would rotate the book and return capital to shareholders upon realizing a discount? We would not be a buyer of TCAP above net asset value, because that would give us the -- would not allow us the ability to return capital to shareholders if we couldn't reinvest in a very accretive way. I think, over time, we like the small size of -- we like being in this middle, which is we have a $1.7 billion balance sheet, but also have -- we're part of a $24 billion credit platform where we're able to speak for larger transactions. And so we're not burdened by the size of our capital base, and so we're able to create industry-leading returns. But we're able to toggle up and do interesting things to create value for our shareholders like Northern Oil and iHeart. We like that a lot. And so we think that model creates -- that flexible model creates a lot of value for our shareholders by generating kind of off-market returns on capital. And so it's hard to answer the question of what's the optimal size. I can tell you the optimal size for us right now is $1.7 billion. Because we have the opportunity to grow, given that we can raise equity. And so is the optimal size $3 billion in a different market environment? Maybe. But right now, the optimal size is $1.7 billion.

Very thoughtful answer with context on multiple topics. Last one, Josh, considering that Mike's role has evolved internally, and there appears to be some attractive direct lending opportunities from banks in Europe, are there any discussions internally, maybe themes or investment opportunities in Europe, that could result in investments in your portfolio?

Yes, look, Mike is -- hopefully Mike being next to me today shows you that Mike's role hasn't changed that much. He's spending much more time in Europe. We have a dedicated direct lending fund in Europe. It's not super tax efficient, quite frankly, for our foreign shareholders in the U.S. BDC to have non-qualifying assets, including European assets, in the BDC, given that there aren't withholding tax on dividends, given the extenders legislation for foreign shareholders, except for non-qualifying assets. And so we would expect not to do a lot of European stuff, given we have a direct lending fund, and it's not super capital efficient for non-U. S. shareholders of the BDC given the withholding tax. Ian, anything to add there?

No, I think you captured it.

Fish, anything to add?

No.

Thank you. And I'm showing no further questions in the queue at this time, so it's my pleasure to handle the conference back over to Mr. Joshua Easterly, Chief Executive Officer, Director and Chairman of the Board, for some closing comments and remarks. Sir?

We appreciate everybody taking the time. It felt like one of the longest Q&A sessions. As people know, we're really happy to engage about our business and what we think about the market, and there were a lot of great questions. We also wish people a happy spring -- it feels like spring is coming early -- and a happy Passover and Easter at the beginning of April and late March for people's family. And the team is always available, and so thanks for your time today.

Thanks everyone.

Ladies and gentlemen, thank you for your participation on today's conference. This does conclude our program, and you may all disconnect.