Sixth Street Specialty Lending Inc (TSLX) 2018 Q1 法說會逐字稿

Good morning and welcome to TPG Specialty Lending, Inc. March 31, 2018 quarterly earnings conference call. Before we begin today's call I would like to remind our listeners that the remarks made today -- during this 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 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 close, the Company issued its earnings press release for the first quarter ended March 31, 2018 and posted a presentation to the Investor Resources section of its website, www.TPGSpecialtyLending.com. The presentation should be reviewed in conjunction with the Company's Form 10-Q filed yesterday with the SEC.

TPG Specialty Lending, Inc.'s earnings release is also available on the Company's website under the Investor Relations section. Unless noted otherwise, all performance figures mentioned in today's prepared remarks are of and are for the first quarter ended March 31, 2018. As a reminder this call is being recorded for replay purposes. I will now turn the call over to Josh Easterly, Chief Executive Officer 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 results before turning the call over to my partner and our President, Bo Stanley, to discuss our origination and portfolio metrics for the first quarter 2018. Our CFO, Ian Simmonds, will review our financial results in more detail and I will conclude with final remarks before opening the call to Q&A.

I would like to start this morning by highlighting our strong financial results for the quarter. In Q1 we generated an annualized return on equity on a net investment income and net income basis of 12.7% and 13.8% respectively. Net investment income per share was $0.51 and net income was $0.56 per share, which exceeded our previously declared dividend of $0.39 per share.

Net asset value per share at quarter end was $16.27, an increase of $0.21 compared to the prior quarter after giving effect to the impact of the Q4 supplemental dividend which was paid during Q1. Net asset value movement during Q1 was driven by a combination of the over earning of our base dividend, the positive impact of unrealized gains from tightening credit spreads on investment valuations, the accretion from our equity raise and realized gains.

Yesterday our Board announced a second-quarter dividend of $0.39 per share to shareholders of record as of June 15 payable on July 13. Our Board also declared a Q1 supplemental dividend of $0.06 per share to shareholders of record as of May 31 payable on June 29.

Consistent with our objective of maximizing distributions to shareholders while preserving the stability of our net asset value, we have declared a total of $0.28 per share in incremental dividends over the past five quarters based on our formulaic supplemental dividend framework, while increasing net asset value from $15.95 to $16.21 per share at the end of March after giving effect to the impact of the $0.06 Q1 supplemental dividend to be paid in Q2.

Over the last 12 months we have increased dividend payments to shareholders over our base dividend by 15.4% while generating a 1.3% increase in net asset value per share over the same period.

In previous earnings calls we highlighted the importance of our disciplined underwriting and capital allocation policies as key attributes leading to the robustness of our financial results. Remaining highly selective through our thematic sourcing approach and our ability to identify and underwrite unique off the run investment opportunities represents our competitive advantage given the level of capital formation in the private credit markets.

Bo will discuss this in more detail later in this call. With that I would like to turn the call over to Bo who will walk you through our quarterly originations and portfolio metrics in more detail.

Thanks, Josh. Q1 was a solid originations quarter for us with gross originations of $565 million and fundings of $314 million distributed across seven new portfolio companies. Of the $565 million of gross originations, $233 million were syndicated to affiliated funds or third parties and $18 million included in unfunded commitments.

The investment environment remains highly competitive primarily due to strong capital inflows into the middle market credit asset class. Our investments this quarter were primarily into the business services sector, continuing our strategy of focusing on sectors and themes that dovetail with our platforms expertise, allowing us to structure comprehensive financing solutions with attractive risk return profiles.

While we are not immune to the pricing pressures in the broader credit markets, we believe direct originations and underwriting capabilities are key drivers of our consistent portfolio yields over time.

At March 31, the weighted average total yield on our debt and income-producing securities at amortized cost was 11.2% compared to 10.8% at December 31, reflecting an increase from the prior quarter as a result of the upward movement of LIBOR, which contributed approximately 50 basis points, and partially offset by the impact of lower yields on new assets relative to yields on exited assets.

Expressed another way, we experienced asset sensitivity across our portfolio of 40 basis points, reflecting the benefit of LIBOR increases across the period and offset slightly by some marginal spread compression. The weighted average total yield of amortized costs on new and exited debt investments during the first quarter were 10.6% and 12.5% respectively.

Note the weighted average yield on exited assets was temporarily inflated this quarter as a result of excess spread through default interest we were earning on one investment. This particular investment had extended its hold period through the original maturity and, as a result of delay in finalizing a refinancing transaction, generated incremental yield across the most recent period. Adjusted for the impact of this name, the weighted average yield on exited investments was 11.9%.

We continue to remain focused on investing at the top of the capital structure. At March 31, 95% of our investments by fair value were first lien, 98% of our portfolio by fair value was senior secured, and our junior capital exposure was 2%. The fair value of our portfolio at quarter end as a percentage of call protection was 95.8%, which means that we have protection in the form of additional economics should our portfolio get repaid in the near-term.

As we had expected following a year of elevated repayments activity, portfolio growth was more visible this quarter as the level of repayments within our portfolio slowed. Our recent equity raise highlighted the robustness of our originations pipeline as we were able to effectively deploy capital into new deals that generate an incremental return on equity in excess of our cost of equity.

Repayments in Q1 totaled $106 million aggregate principal amount from four full realizations and two partial sell downs compared to average quarterly repayments across 2017 of $238 million.

Across our entire portfolio, 99% of our portfolio by fair value was sourced through non-intermediated channels. Given the late cycle environment we believe embedded in downside protection features and loan documentations are critical as they allow us to quickly identify and implement risk mitigation measures in the case of underperformance in order to minimize potential losses.

We maintain effective voting control on 84% of our debt investments and average 2.3 financial covenants per debt investment, consistent with historical levels. At quarter end, our portfolio is well diversified across 48 portfolio companies in 17 industries. Our average investment size was approximately $40 million and our largest position, iHeart, accounted for 6.2% of the portfolio at fair value.

Regarding iHeart, our hold size is well supported by the structural protections of our borrowing base governing loan which is fully secured by high-quality collateral. As much of the information about iHeart is in the public domain, we can provide you a further update on the status of our investment since we last spoke in February.

On March 14, the company filed for Chapter 11 with a restructuring support agreement, or RSA, from a majority of its senior and junior creditors. We note that as part of the filing we negotiated a cash collateral order for the company where, among other things, we received current interest, reserve default rate interest and receive replacement liens on our collateral. In addition, the company must remain in compliance with our borrowing base.

Last week on April 28 the iHeart debtors filed the joint Chapter 11 plan of reorganization. Specifically as it relates to our investment, the plan provides that ABL credit agreement claims are unimpaired under the plan, and the holders of the ABL credit agreement claims shall receive payment in full in cash or reinstatement of those claims.

As we indicated during our last earnings call, we expect repayment on our principal investment in iHeart to occur during the course of this year.

At quarter end business services was our largest industry exposure comprising 18.3% of the portfolio at fair value followed by financial services at 13.9%. Note the vast majority of our financial services portfolio companies are to B2B integrated software payment businesses with limited financial leverage and underlying bank regulatory risk.

From a portfolio quality perspective, we had no investments on nonaccrual status at quarter end. The overall performance of our portfolio continues to be steady with a weighted average rating of 1.16 based on our assessment scale of 1 to 5 with 1 being the highest, as compared to 1.22 for the prior quarter.

Across our portfolio, since inception to March 31, we've generated an average gross unlevered IRR weighted by capital invested of approximately 19% on fully realized investments totaling over $2.7 billion of cash invested. With that I'd like to turn it over to Ian.

Thank you, Bo. We ended the first quarter of 2018 with total investments of $1.91 billion, total debt outstanding of $854 million and net assets of $1.04 billion, or $16.27 per share, which is prior to the impact of the $0.06 per share supplemental dividend to be paid during Q2 2018. As Josh mentioned, our net investment income was $0.51 per share and our net income per share was $0.56.

As reinforced by our capital markets activity this quarter, strong origination activity resulted in a period where our portfolio fundings outpaced repayments. Our average debt-to-equity ratio in Q1 was 0.84 times, slightly below the top end of our target leverage range of 0.75 to 0.85 times and our leverage at quarter end was 0.82 times.

Our equity raise was extremely efficient from an ROE perspective as we had effectively deployed capital ahead of raising the incremental equity. At the time of the raise leverage was approximately 0.91 times and the impact of the new equity brought our leverage back to the middle of our target range.

As we have articulated previously, understanding the impact on our business unit economics is important in the decision to raise additional capital. At the time of the offering we calculated a cost of equity of 9.2%, which is simply our annualized base dividend over the offering price less underwriter commissions.

Using the weighted average yield at amortized cost on new assets we invested in during Q1 of 10.6% resulted in incremental return on equity of those new assets of 12% to 13% based on the expected life of those assets, which more than satisfies our capital allocation criteria.

Moving back to the presentation material, slide 8 contains an NAV bridge for the quarter. Walking through the various components, we added $0.51 per share from net investment income against a dividend of $0.39 per share. And we had a $0.06 per share reduction in NAV from the reversal of net unrealized gains from investment realizations. A further $0.09 per share can be primarily attributed to the positive impact of credit spreads on the valuation of our portfolio.

Our equity issuance during the quarter provided approximately $0.05 per share of accretion to NAV. Included in other changes on this slide is $0.04 per share from realized gains, which includes gains we generated from realizing part of our investment in Triangle Capital, as well as the negative impact of the mark-to-market on our outstanding swaps, which amounted to approximately $0.07 per share.

The mark-to-market impact reflects the net present value of future settlement obligations under the terms of our various swap contracts. This impact has become more pronounced as the short end of the forward LIBOR curve has shifted up. However, by definition these mark-to-market changes unwind as we get closer to maturity on each swap instrument.

Finally, applying the declared supplemental dividend of $0.06 per share to our reported NAV per share at March 31 of $16.27 provides pro forma NAV per share of $16.21.

Moving to the income statement on slide 10, total investment income for the first quarter was $57.8 million, up $8.9 million from the previous quarter. Breaking down the components of income, interest and dividend income was $46.8 million, up $3.1 million from the previous quarter, driven by an increase in the average size of our portfolio as well as the benefit of higher LIBOR on the total interest income earned.

Other fees, which consist of prepayment fees and accelerated amortization of upfront fees from unscheduled pay downs, were $5.1 million for the quarter compared to $3.4 million in the prior quarter as a result of higher prepayment fees experienced in Q1. Other income was $5.9 million for the quarter, an increase of $4.2 million compared to the prior quarter primarily due to syndication fees and other fees.

Net expenses for the quarter were $25.8 million, up from $21.5 million in the prior quarter, primarily as a result of higher interest expense, incentive fees and other operating expenses. This was due to the combination of an increase in LIBOR, higher amortization of deferred financing costs associated with our credit facility amendment in February 2018 and our 2023 notes offering in early 2018.

Our weighted average interest rate on average debt outstanding increased by approximately 15 basis points quarter over quarter. Even in the face of a 30 basis point increase in effective LIBOR across our borrowings, this was partially offset through a 12 basis point benefit from our funding mix and an additional 3 basis points benefit through lower pricing on our revolving credit facility that we amended in February.

At quarter end we had significant liquidity with $421 million of undrawn revolver capacity subject to regulatory constraints and remain match funded from both an interest rate and duration perspective. In order to match our liabilities with the floating-rate nature of our portfolio, we've entered into interest rate swaps for each of our fixed rate unsecured instruments that correspond with the notional amount and term of those notes.

Before passing it back to Josh, I wanted to circle back to our ROE metrics. In Q1 we generated an annualized ROE based on net investment income of 12.7% and an annualized ROE based on net income of 13.8%. These compare to ROEs for the prior quarter of 11.1% and 11% respectively. This quarter our ROEs reflect the positive impact from a combination of operating at the higher end of our target leverage range, as well as the impact of capturing incremental fee income from idiosyncratic portfolio company activity.

As we've articulated, we continue to expect a target return on equity of 10.5% to 11.5% based on our expectations for the interest rate environment, net asset level yields, cost of funds and financial leverage. With that I'd like to turn it over to Josh for concluding remarks.

Thank you, Ian. While we are pleased with our first-quarter results, we remain focused on the challenges for direct capital providers in today's environment. Given the competitive dynamics in the credit markets, we believe our thematic-based direct origination strategy is a key differentiator in our ability to generate consistent shareholder returns.

As our business evolves we believe we have an ongoing responsibility to evaluate and expand upon our tools for value creation on behalf of our shareholders.

For our upcoming special meeting of shareholders on May 17, shareholders are being asked to vote on a proposal authorizing TSLX with approval from our independent Board of Directors to issue shares of our common stock at a price below net asset value. Last year, the same proposal was approved with overwhelming support. Over 94% of all shareholders who voted and over 88% of all non-affiliated shareholders who voted.

We were humbled and we will continue to take our duty to responsibilities to our shareholders regarding capital allocation with the utmost seriousness. It is one of the most important decisions we make.

While we have no intention to do so in the near-term, we are seeking the flexibility because we believe there could be moments in time that it would be in the best interest of our stockholders. Ironically sometimes the best investment opportunities exist during periods of elevated volatility and credit market dislocation when it's more likely that our stock could trade below net asset value.

We believe that having the flexibility to access capital markets in these types of environments is an important tool that can help us drive long-term stockholder value during these periods of market distress.

It's our hope that we've built over time a reputation with our stockholders as long-term oriented disciplined capital allocators. Our framework is simple: we don't intend to issue common stock when our stock is trading above net asset value unless we expect it will be ROE accretive.

And we don't necessarily believe that one should never issue common stock below net asset value if market opportunities allow for sufficiently high risk adjusted returns that will ultimately be accretive to net asset value through over earning one's cost of capital.

We have posted a presentation detailing our philosophy and our framework behind the proposal in the Investor Resource section of our website. I encourage those with questions to reach out to me and our Investor Relations team.

Speaking of financial flexibility, I wanted to take a moment to speak briefly on the recent passage of the legislation that provides an opportunity for BDCs to apply for a lower statutory asset coverage ratio.

In our view the most significant existential risk that a BDC structure faces is the risk that broader market events and individual portfolio company specific credit issues puts downward pressure on the fair value of investments that could, at worst, result in a breach of statutory asset coverage requirements. Such a breach could severely limit the ability for a BDC to operate, constraining further borrowings and therefore the ability to pay distributions to shareholders and interest to lenders.

We believe fundamentally that the reduction in asset coverage ratios through the legislation removes this existential risk providing regulatory relief, which we believe in and of itself is specifically a positive to creditors in the sector through an increased regulatory buffer and therefore is fundamentally a significant structural enhancement.

That said, we also believe regulatory relief and the removal of this existential risk should be separated entirely from the application of financial policies for individual firms.

Our view is that any firm considering changes to financial policies in light of the regulatory changes should have in place an appropriate framework to guide risk management, including liquidity, funding mix and downside scenarios incorporating an understanding of total loss absorbing capital total loss absorbing capital.

Fundamentally, given low historical leverage across the sector, the application of a lower asset coverage ratio puts more spotlight on the ability of management teams to consider both the left and the right side of the balance sheet in making appropriate risk management decisions.

Historically the focus has largely been on the asset side. Leverage magnifies both returns and losses. As a result, we believe the potential application for leverage changes may provide a great opportunity for a select few BDCs in the sector, but could create meaningful incremental risk for most of the sector shareholders given the medium returns on equity that have been generated -- have been below the sector's cost of equity.

To be clear, we have not made any changes to our asset coverage or financial policies. We expect to continue to work with our stakeholders, including our shareholders, noteholders, lending partners and rating agencies to determine the appropriate path forward for us.

Our hope, and that may be misplaced, at least on the corporate governance side, is that a combination of corporate governance, borrowers and shareholders and capital markets, banks the bond market rating agencies will result in the appropriate allocation of additional flexibility across the sector.

Thank you for your continued interest and your time today. Operator, please open up the line for questions.

(Operator Instructions). Leslie Vandegrift, Raymond James.

Just a first quick modeling question on the spillover income at the end of the quarter. What was the level at the end of first quarter?

We are now at $1.01 per share is our estimate.

Perfect, thank you. And then, you gave a little bit of color on the iHeart update. And you went through, as of the end of first quarter, the different default interest, etc., that you were to receive until obviously the reorg is done. Can you give a little bit of color there? I know you said only what was public, but just on when those -- how long those payments last and what the levels are there?

Sure. So first of all, just to be clear, we have the right to default rate of interest, we reserve that right. We have not accrued any default rate of interest. So that is not in the P&L in Q1.

The second question is, look, our view is that the company can probably save -- the company is dealing with a whole host of issues including some litigation that relates to their legacy notes and a ratable lien clause. And so, the company is focused on those issues.

But if you take a step back, the company can have -- on our conventional asset-based financing and given how much cash the company generates and has generated given they are no longer -- the only interest they are paying current is on our asset-based facility. The company could generate -- could replace our financing with a debt financing at a much lower cost than our current debt financing and it would be accretive to the company.

That being said, the enterprise value of that company is very, very large. And so, the accretion over the enterprise value is probably small, so it's probably further down on the company's priority list. But I would suspect at some point they get around to us and they would refinance our facility with a lower cost debtor-in-possession financing.

Okay, perfect. Thank you. Again, at the end you were talking about the new leverage limits, the reduced asset coverage regulations. And I know you said you all are still in the process of considering it and have not yet asked the Board or shareholders. But what would be the big holdbacks there if you decided not to ask for it?

Yes, look, so I think people have talked about this. Obviously we were quite surprised that S&P did not take a similar view, which at its core this is regulatory relief. And regulatory relief is good for shareholders and specifically good for -- specifically good for creditors in the space. And so, I think we are still working through the rating agencies and how to think through that, which will obviously affect where we come out.

I think the constraints -- just to put it on the table, the constraints in the space for rating agencies have been as follows. One is that if BDC management teams are doing their job they should be marking their book to fair value. We do it based on movement and credit spreads. Therefore market events could lead to significant net asset value decline.

And then the second thing is that to keep your RIC status or pass-through status you have to -- you can't retain capital and you have to distribute 90% of your income, which from a credit perspective makes it tough. And so, when you look at the space on a pre-dividend basis, the space -- I think our fixed charge coverage ratio is about 5.5 times. The space is a lot lower than that, maybe 4.5 times.

But if you fully load it for dividends, the space is kind of 0.9 to 1 times. We are at 1.3 times. I think the fallacy in the thinking is that you have the ability to not meet the RIC requirements, which quite frankly in the worst-case would cause additional friction at the US corporate level tax rate.

And the difference between given the tax plan that was passed last year, that friction is a lot less reduced, but clearly provides you the opportunity to rebuild capital and would be slightly damaging to shareholders.

But so, I think S&P has been a little bit rigid in the way they think about: A, divorcing the regulatory relief from actuary change in financial policy; and, B, thinking about in a downside scenario that actually BDCs can actually retain capital, and the cost of retaining that capital for the ecosystem is much, much less than it used to be given the reduction in corporate tax rates.

And so, I think we have a plan to work through our process, work through with rating agencies. And then we had not made any definitive plans for either a shareholder vote or a Board vote. And I would suspect that we are divorcing the two -- we are divorcing the two considerations. One is regulatory relief. With all things being equal, you would take that. But obviously all things are not equal given some of the rating agency noise. And then we are divorcing that from actually the financial leverage discussion.

In our prepared comments what I would say again is that the space, quite frankly, hasn't earned -- hasn't earned its cost of equity historically even in a benign credit environment.

So I would think that the opportunity to add financial leverage is limited to a few and, absent a significant change in risk management on the asset side, which I'm skeptical of, or a reduction in fees, absent those two things I think it's difficult, except for a select few in the space, to see massive ROE accretion. But quite frankly, I think we would qualify as those select few given our performance.

Okay. But on that point about improved asset credit quality, if you were to get the increased leverage and not just as the insurance policy, like you said, against -- as regulatory relief, what kind of assets do you believe would be appropriate for that extra turn? And again, not necessarily all of it, but for the incremental leverage.

It's hard right now, Leslie. We are not going to talk about hypotheticals because I don't think we have -- we haven't got to the change in financial policies. What I would say is our guiding principle is that it would have to be -- if you're going to add leverage, in theory our cost of equity should go up.

And in a business that we are massively focused on over earning our cost of equity, you should take away that we would -- our guiding light or North Star would -- that it would be -- has to be significantly ROE accretive. And that would be a function of both. That would be a function of our strategy.

Last question. Last week, the subcommittee in the House on financial services appropriations had a meeting and the Chairman of the SEC was there. And they mentioned that he would review the AFFE rules as they apply to BDCs that was brought up. Do you have any color on that?

The only thing I would add to that, Leslie, that was Chairman Clayton's prepared remarks and there was a question from one of the members of the committee. I think the broader support for looking for a solution, it's more the mechanics of how that solution gets implemented and that's what we are working through.

Yes, and I think we are hopeful, that being said, that the mechanics are complicated given they've already answered the question on an FAQ basis so they don't have that tool available. And so, I think although hopeful it has to be somewhat grounded by -- it's complicated. I think there was a movie called It's Complicated or something, but it's complicated.

Jonathan Bock, Wells Fargo.

And it would make sense that a romantic comedy would be at the top of your list, Josh, in naming movies, so I appreciate that. One question I want to start with, it's a quick technical one. So Ian -- let's move across and forget about 1 to 1 or regulatory caps for a moment. If you were to utilize or fully borrow up your borrowing base, how much availability do have and really where would that put you on a debt-to-equity perspective today if you just use what you have?

So, I think we made comments in our prepared remarks about our capacity under our existing revolver is $421 million. That represents the undrawn amount at quarter end.

And that's subject to the borrowing base -- because sometimes available -- capital available and what bankers are doing with advanced rates can be a little (multiple speakers).?

The borrowing base is not the constraint there.

Yes. Given our existing borrowing base we could borrow all of that available capacity. The constraint for us remains the regulatory constraint of 1 to 1.

Hey, Jonathan, let me -- the constraint is actually the commitment letter -- level. The underlying collateral, so the borrowing base is the lesser of the commitments and effectively the borrowing base or availability. On a $1.9 billion portfolio the non-constrained borrowing base, if you assume, depending on underlying asset mix, is 70% to 75% of that. So that number is $1.3 billion or $1.35 billion, something like that.

That being said I would suspect -- so that would mean that you could utilize all that leverage. That being said, I would suspect the following which is given that our -- given that banks have the protection of the hard coded 200% asset coverage in our existing revolving credit facility, which is consistent across the space. My guess is that if we were to ask them, which I think they would be amenable to reducing that asset coverage test, I think there would be some discussion around borrowing base or some discussion around how the additional leverage is funded.

I would not suspect -- I would not take that the banks will reduce the asset coverage and not touch the borrowing base because, quite frankly, the borrowing base was a little bit illusionary given the -- effectively the regulatory test -- the 200% asset coverage regulatory test that was hard coded in the credit agreement that you called out.

Got it, okay. So, I appreciate that. And now clearly, Josh, you talk about those that have more than earned their cost of capital and efficiently underwritten credit risk and done great jobs. Clearly that is you and it's a point to make that you should be very proud of your team, the Board, etc., on your performance.

So now kind of it remains to be seen -- as we move forward you've also had a significant amount of success on idiosyncratic, both yourself and Bo, in levering at the asset level for select deals. And that has been very advantageous for everyone, allowing you to retain or earn a higher spread, but then also have a first lien attachment that you can work out in the event of a problem, which you are really adept at doing.

The question is as you look forward does asset level leverage change? May banks take a different view as to what they might advance on a, let's for example, a last out? Or is the borrowing base going to be a little less stringent between a last out and a first lien attachment? I would just be interested in that evolution, given you are really good at levering at the asset level, and then now you might have the opportunity to lever at the holdco level.

Let's take a step back. I think you actually overstate our skills, which I appreciate, at levering out the asset level. So let's go through the portfolio, because I think it is important.

So about -- of our first lien exposure about half is first lien, with dollar one attachment point and on half, we have a small revolver or some type of other small term debt. But just to put that in perspective, the first lien last out piece has an attachment point of about 1.5 times. So there is not significant actually embedded leverage in the existing book. Actually our second lien book has an attachment point at 1.7 times.

So, we don't have -- I appreciate the comments, but we don't have a ton of structural leverage at the asset level in our book. We have a little bit. That being said, our borrowing base already has a -- and the borrowing base I think is attached to our credit agreement -- already has a separate advance rate on that bucket.

And so, again, there's another negotiation to be had. But given the attachment points, which are not what one may think they are, and given that we've already had that discussion, I would suspect that it doesn't significantly change outside the broader conversation of the client base.

Okay, great. And then this just gets to just a continuation of a theme that we kind of identified. And given the breadth of the funnel, whether you could do a sponsored financing or an opportunistic financing -- you look at them all. This just gets to yourself, and I will actually direct it to Bo as well.

When you are looking at the opportunities in today's environment as you see them, I understand that you are selling them down and you are taking appropriate levels of risk, do you believe that now is the time to perhaps up your concentration limitations just because there are fewer opportunities than in the past?

And given the fact that you have proven an ability to underwrite complex transactions that few others figure out to the benefit of shareholders, it would seem that you perhaps want to take outsized concentration positions in today's environment only because you can generate excess ROE.

There's a flip side because there's risk in taking a little bit more or having a little bit heavier hold. And I would just like to know how you are balancing that because that is a theme everybody continues to worry about.

These are great questions and, by the way, I'll let Bo and Fishy answer it too. Fishy as a guest star, as always. What I would say is generally our concentration has actually got less, so we have one large outsize position in iHeart, but our concentration -- our largest position last quarter was 6.7%. Today it is 6.2%. Our top 10 positions last quarter were 40%. Today it is 37%. So we have a little bit less concentration risk generally in our book.

I would say this. I think there are -- we are seeing, and we are about to close one I think today. We are seeing some really great opportunities. And in a market that is tough, two of the best deals we've probably seen in 20 years I've been doing this have been iHeart and the one we are closing today.

And literally -- and so, I would say on those types we might take a single outsize position. But if we ever choose to increase our actual leverage profile, financial leverage profile, I think diversity will actually be more important in that process for us. As you add financial risk and you obviously have -- your mistakes are magnified as it relates to an impact on MAV.

And so I would say we will continue where we see single name great opportunities lean in. Generally I would think that directionally you will see concentration increase across our book on -- when you take a wider view. And I don't know if, Bo or Fishman, you have anything to add on that.

That was well said.

I got that right I guess.

Then maybe I will -- this is just a follow-up. I will go right to Bo and your guest star, would be -- guys, could you describe perhaps -- when you are looking at this and we hear one of the best deals we've seen in 20 years, and clearly iHeart was an outstanding outcome. Can you give us a sense of what's creating these opportunities?

Is it a company, is it potential just financial issues and so there's -- kind of like a white knight style financing? Maybe just broader theme as to what is developing that in a period where not a lot of folks are actually easily finding good deals? They can and they will work hard for it, but maybe just an underlying theme of how you are -- what you'd be doing that makes you so excited about it?

Hey, Jonathan, this is Bo; I will take that. We have continued with the increased capital formation in the space and the increased competitive pressure focused on theme generation and rotating theme generation. And that helps put us in position to help dampen those competitive pressures where our capital is actually valued.

If you look at our origination activity this quarter, the largely M&A driven, it was all thematic-based where we can use our direct origination and also the breadth of the platform to put us in position to actually add value other than just capital.

As it relates to some of these larger idiosyncratic deals, correct, we are focused on opportunities where our expertise is structuring and thematic expertise and the breadth of the platform puts us in a position where only few, if any, can provide that type of capital.

Got it. And then -- this is the last one. I appreciate you taking mine. Do these types of transactions, will they have some form of cross-ownership with TAO?

Obviously iHeart, Tao is a large holder, which TAO is an affiliate fund. And then on the one we are closing today -- we expect to close today, which is a very large transaction, Tao will also be an investor.

That's good to know.

On that point, Jonathan, it is the ability to provide -- the ability to provide scale where it's needed, but not be constrained by scale in tough markets. I think when you take a step back and you look at where we have won or why we have won and that attribution, quite frankly -- the human capital in our business, so the people who are working every day, it's just clearly not Mike myself or Bo.

And then it's being able to not be constrained by -- the constraints in this business, you have to be long only and you have to be invested. And so, if that were not so big that scale is a constraint, because we have to be fully invested. But through our exemptive relief we actually get to synthetically provide scale and provide certainty on situations where we have an edge. And so, that has been the attribution of our success second to our people.

Rick Shane, JPMorgan.

Look, one of the positive attributes about TSLX is that you are asset sensitive. But that's certainly -- the trade-off to that is that it makes your counterparty liability sensitive in a rising rate environment. Underlying fundamentals are still really good, but am curious how you guys think about interest rate shocks impacting your portfolio companies and how you help them mitigate that.

Yes, that's a great question, which is I think -- let me rephrase it. Your point is that somebody owns interest rate risk; it is either us or issuers. And given that we have a floating rate book our issuers own that risk. And the way that we mitigate that risk with a credit risk driven by them owning that interest rate risk is we invest in the top of the capital structure with high free cash flow businesses, high fix charge businesses onto where we invest in the capital structure.

So, in an environment with the guys who are going to -- the investment strategies I think that are going to get hurt the most is not guys like us where we are investing top of the capital structure; it's floating rate portfolios on deep down the capital structure as rates rise and companies can't grow earnings as fast. And quite frankly they no longer -- they could no longer get the entire tax shield from raising rates. They are going to be on the outside looking in as -- and own a significant amount of that risk.

So it's really a function of the businesses we finance and where we see the capital structure. And given that on average where we sit, interest coverage of like 2.5 to 3 times, we have a lot of -- a significant margin of error and a lot of room on rising rates for our issuers. So is that helpful?

It is. The follow-up to that is do you know whether or not -- I assume you do -- whether or not the issuers actually swap out some of that interest rate risk? Is it part of your deal structure in fact?

In this market, quite frankly, the power to force issuers to hedge interest rate risk is long gone. And so, the way we've managed that is to choose where we invest in the capital structure. Unfortunately back maybe four or five years ago you used to have the ability to tell people they have to swap 50%. And quite frankly, given where the (inaudible) where that was costing them a lot. And now I think in this environment that's been long gone for a couple years.

Okay, great. Thank you, Josh.

Hey Rick, one more thing, you asked a very good question on the last earnings call, which is our asset beta compared to our funding beta. I think Ian pointed out, which is we had decent asset beta this quarter and, quite frankly, our funding beta was way less than 1 given mix changes and given our re-price revolver. So I wanted to follow back up with you on that as well.

Terry Ma, Barclays.

You guys talked a little bit about the emerging themes in your portfolio a couple quarters ago. But can you just give me a little more color on your thesis for the business services and education spaces? Maybe talk about what the level of competition is in those spaces and how comfortable you are with the higher concentration now.

Yes, I will turn it over to Bo. Just real quick on education what I would say is it's not for-profit education. It's typically IT or software in education and Bo could talk to you about how there is a ton of spending and (inaudible) budgets and all that good stuff. But Bo or Mike?

So business services, as you know, is a theme that we've been following for some 15, 20 years with Mike's leadership. It is a theme that we continually develop sub themes around which educational technology, as Josh mentioned, is one of those sub themes.

What we notice in that market, particularly in the K-12 market, is their adoption of technology solutions to help them both manage the school systems and how education is delivered, as well behind the adoption curve of many industries. So it provides a massive tailwind of adoption.

There also tend to be very sticky embedded solutions within those educational ecosystems. So that is a theme that we developed a sub theme around and have been active in in this quarter, in fact had a funding around, so yes.

Switching costs are high. The return on invested capital for customer acquisition is super high. The underlying fundamentals of the business are strong and you will continue to see more spending. And so, we will continue to be active. I think quite frankly the space -- we have been active in that space with some of our counterparties.

I would expect that will continue to be the case, but we have a little -- got a good little niche carved out for ourselves and that, quite frankly, there are a couple other guys who compete with us and we do things within that space as well.

Got it. That's helpful. And then just a follow-up on the higher leverage. It sounds like the ratings agencies, or S&P specifically, is the main hurdle. But can you maybe just outline all the separate steps you need to take before you go and ask for Board approval and the shareholder vote? And maybe just talk about where you are in those steps and maybe just a timeframe?

Look, I think we are kind of right in the middle, for lack of a better word, of the sausage making. And I think that I've laid out the considerations. I would suspect a timeline -- we are not wedded to a specific timeline. I think, again, I think the regulatory relief, all things being equal, it would be massively helpful to the sector and to our stakeholders.

And so, if you said to me that S&P had a change in heart, we would push forward without changing our financial policy but getting the regulatory relief as soon as possible. But we need to continue to have conversations with all of our rating agencies and so continue to work through that.

I think, again, we are going to stay away a little bit from hypotheticals and talk about specifics around process. Happy to talk about considerations but, again, we are really focused on regulatory relief. I think a massive change in financial policy is a tougher question versus removing the existential risk and gaining the regulatory relief.

(Operator Instructions). Doug Mewhirter, SunTrust.

Good morning, guys. This is Michael on for Doug. Thanks for taking our questions. So previously you had mentioned that your ABL business could reach about 20% of book. So are you still seeing opportunities in retail or does it remain tough to grow this book? And as loans tend to be short in duration are the borrowers -- and especially as the borrowers are paying down quickly?

Yes, look, I think today my guess is it's about 10% of our book or something like that. I would like it to get to 25%. I think it's most definitely difficult given the duration. I would say this. The amount of -- all things being equal, it is -- the amount of human capital spend on the management company side to create that risk return for our shareholders is significant with a lower payback period given the short duration and the ability to keep assets on the balance sheet.

But we think it's very good for shareholders and we will continue to pursue that strategy. And so I would -- we are so active in the space. We are seeing stuff -- I think hopefully we will continue to be a leader in that space and we will -- I would cap it at 25% of our book. I don't think we will reach 25%.

Okay, that's helpful. Thank you for that. And then I guess turning to your energy exposure; back in 2017, you went back to the oil patch investment with Rex Energy. Have you made any new investments in this quarter, especially with oil rising? And can you give us an update as your energy exposure as a percentage of your total assets?

Yes, sure. So, we've actually -- we made -- post energy selloff we've actually made two large investments, one was Rex and one was NOG. And so, we like both those investments very much. They both go into the theme of upstream collateral and -- upstream collateral that's hedged, good assets, low on the cost curve. I would say some balance sheet issues that will create opportunities for us there.

And so, we will continue to look for opportunities there. I think our total energy exposure is what percent, Ian? Is about 5% of fair value. I think our peak energy exposure, which was pre the November OPEC meeting, and I want to say now that 2016 was about 10%. And so, we have room -- and we manage that risk very well.

We have room to increase that if we find good opportunities, but we have not made a -- outside of NOG and Rex. And both those we have opportunity to put additional capital in which we like. We have not added a new one.

Okay, that's helpful. Thank you. And then I guess lastly, and I believe we may have asked this last quarter, but have you seen any change in appetite for borrowing after the tax cuts? And maybe even within your portfolio of companies have you seen any sort of fundamental change with their businesses?

No, what I would say is you didn't ask this question -- I'll answer the question you asked to be fair, which is I don't think we've seen any fundamental changes in the business.

As it relates to the tax cut, I think to watch out as follows, which is free cash flow yields and equities got more attractive, IG credit got more attractive on a risk basis, noninvestment grade credit got least attractive on a relative basis given that non-IG credit -- those companies have more likelihood to have the limitation on (inaudible) ability.

And so -- I would say shockingly that there hasn't been, even though there is some limitation -- there is a limitation on deductibility of interest, you haven't seen changes in appetite from financial sponsors on leverage, which I think is a little bit of the watch out as it relates to credit quality.

And I'm showing no further questions in the queue at this time. So it would be my pleasure to hand the conference back over to Mr. Josh Easterly, Chief Executive Officer, for some closing comments and remarks. Please proceed, sir.

Great, so two things. First, everybody -- I wish everybody a happy Mother's Day, which I think is 10 days off. Specifically to our own Lucy Lu which this will be her first Mother's Day and so, Lucy, I think you're listening. All of us here wish you a happy Mother's Day.

And second of all is Q1 tends to be a quick turn -- Q4 is a delayed reporting period, Q1 is a quick turn. And I'm very proud of our team and their efforts on the quick turn this quarter. It takes a lot of effort as it relates to our Board, especially given the curveball we got thrown with the rating agencies on the omnibus spending bill.

So thanks to the team, wish everybody a happy Mother's Day. Please feel free to reach out to myself, Ian, Bo or Mike with any questions.

Ladies and gentlemen, thank you for your participation on today's conference. This does conclude our program and we may all disconnect. Everybody have a wonderful day.