Sixth Street Specialty Lending Inc (TSLX) 2021 Q3 法說會逐字稿

Good morning, and welcome to Sixth Street Specialty Lending, Inc. Third Quarter ended September 30, 2021 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 the 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 the number of factors, including those described from time to time in Sixth Street Specialty Lending, Inc.'s filings with the Securities and Exchange Commission. The company assumes no obligation to update any such forward-looking statements.

Yesterday, after the market closed, the company issued its earnings press release for the third quarter ended September 30, 2021, and posted a presentation to the Investor Resources section of its website, www.sixthstreetspecialtylending.com.

The presentation should be reviewed in conjunction with the company's Form 10-Q filed yesterday with the SEC. Sixth Street Specialty Lending, Inc.'s earnings release is also available on the company's website on the Investor Resources section. Unless noted otherwise, all performance figures mentioned in today's prepared remarks are as of and for the third quarter ended September 30, 2021.

As reminder, this call is being recorded for replay purposes. I will now turn the call over to Joshua Easterly, Chief Executive Officer of Sixth Street Specialty Lending, Inc.

Thank you. Good morning, everyone, and thank you for joining us. With me today is my partner and our President, Bo Stanley; and our CFO, Ian Simmonds. For our call today, I will review this quarter's results and then pass it over to Bo to discuss this quarter's origination activities and portfolio metrics. Ian will review our quarterly financial results in more detail, and I will conclude with final remarks before opening the call to Q&A.

After market closed yesterday, we reported third quarter adjusted net investment income of $0.55 per share and adjusted net income of $0.80 per share. This will correspond to an annualized year-to-date return on equity on adjusted net investment income of 12.9% and an adjusted net income of 21.5%. The -- This quarter's robust net investment income was driven by higher fees from elevated repayment activity relative to the first half of the year. This was also supported by a robust level of interest income from the strength in the core earnings power of our portfolio. The difference between this quarter's net investment income and net income was due to the net unrealized and realized gains from portfolio company-specific events, which Bo and Ian will discuss later in the call.

As a result of this quarter's net gains, we continue to accrue capital gain and incentive fee expenses totaling $0.05 per share, which we've excluded in presentation for this quarter's adjusted results. Again, this is because we believe the expense accrual requirement creates noise around the fundamental earnings power of our business. As the year have ended on September 30, and we were to calculate the capital gains incentive fees that are actually payable to the adviser in cash, it would be -- it would be -- it would have been zero because the gains driving this fee accrual are unrealized.

At quarter end, we had approximately $0.21 per share of cumulative accrued capital gains incentive fees on the balance sheet and approximately half of these would be payable in cash if our entire portfolio will be realized at the quarter end mark in normal course. The rest of the accrued fees are tied to unrealized gains resulting from the valuation of our debt investments, inclusive of call protection, which, if prepaid, will result in a recognition of fees and investment income and trigger a reversal of previously accrued capital gains and the fees related to these investments. If we were to hold these debt investments to maturity, realizing them in normal course at par over time, there will be an uplift to our NAV of approximately $0.10 per share related to the reversal of accrued capital gain incentive fees.

Returning to our Q3 results. The over-earning of our base dividend and net gains this quarter drove growth in our reported net asset value per share to a new high of $17.18. This results -- this represents a 2% increase from the prior quarter and is $0.02 per share in excess of our prior record high in Q4 2020 of $17.16. Recall that upon the release of our Q4 results in this February, our Board declared a special dividend of $1.25 per share. Since that time, we have fully rebuilt our net asset value per share, primarily through net gains in our portfolio, the continued overearning of our base dividend and the benefit of tightening credit spreads and the valuation of our investments. Over the trailing 12-month period, we generated total shareholder economic return of 20% through dividends and growth in net asset value per share.

Let me now provide an update on our convertible notes due in August 2022, of which $143 million principal value remain outstanding at quarter end. On September 30, these notes became eligible for early conversion and holders of approximately $43 million principal value of notes opted to early convert subsequent to quarter end. Based on the calculations laid on the indenture, the nearly all stock settlement we've elected to apply on this portion of the notes translate to approximately $0.04 per share of accretion in net asset value.

To offset the deleveraging impact of the stock settlement, our Board has declared a special cash dividend of $0.50 per share to shareholders of record as of December 7, payable on December 20. This special dividend also serves to enhance our capital efficiency by eliminating nearly all of the excise tax drag on our spillover income, which is currently estimated to be $0.02 per share on an annualized basis.

Given that the combination of these transactions is leverage neutral, the reduction in our excise tax burden will result in approximately 10 basis points of ROE uplift on an annualized basis. Yesterday, our Board also approved a base quarterly dividend of $0.41 per share to shareholders of record as of December 15, payable on January 14. Our Board also declared a supplemental dividend of $0.07 per share based on Q3 adjusted net investment income to shareholders of record as of November 30, payable on December 31. Our ending net asset value per share, inclusive of the impact of the special and supplemental dividends that was declared yesterday would be $16.61.

With that, I'll now pass it over to Bo to discuss this quarter's origination activities and portfolio metrics.

Thanks, Josh. Let me first provide our thoughts on the current direct lending environment, and how our business is positioned to serve borrowers and management teams as well as our stakeholders for the period ahead. It was 10 years ago when TSLX made its first direct lending investment and the landscape of private credit has changed dramatically since then. In the last 10 years, private debt AUM has grown over threefold in what was a relatively niche asset class has become increasingly institutionalized, attracting new managers and investors into the space. The value proposition of private credit for borrowers over this time has remained constant. Speed and certainty of execution, documentation flexibility for management teams to achieve strategic goals and the opportunity to work with value-added trusted financing partners.

The pandemic-induced market volatility and growth trends and sponsor M&A have only underscored the value proposition of direct lenders. More so than ever, we're seeing an increasing number of borrowers and sponsors turn to the direct lending market for larger financings instead of the traditional syndicated markets. We believe this broadening of the opportunity set is a net positive for our sector, and specifically for our business and our stakeholders given our ability to be solutions providers at scale through co-investment with our affiliated funds. While competition for direct lenders is likely to remain strong in both the larger cap and traditional mid-market for the foreseeable future, we believe that our thematic investment approach and differentiated underwriting capabilities will allow us to expand our borrower and sponsor relationships and continue generating attractive risk-adjusted returns for our shareholders.

Moving now to this quarter's origination activity. We funded 5 investments, including upsizes to our existing portfolio of investments, totaling $105.4 million in commitments and $65.4 million in fundings. We mentioned on our last earnings call that we had a strong funding pipeline heading into the second half of the year. Given the timing of various M&A processes, our funding activity is now back-end weighted for the fourth quarter.

Post quarter end to date, we've already funded approximately $100 million of new investments, including 1 where we have an agent on a $975 million credit facility. Based on our current pipeline, we'd expect to fund another $150 million to $250 million of net investments by year-end, included what is funded to date.

Circling back to Q3 activity, a new investment this quarter was a $317 million TSLX agent in its senior secured facility to support the sponsor acquisition of ExtraHop Networks, a provider of cloud-based cybersecurity solutions. We believe that the sponsor chose us to lead the financing as a result of our deep knowledge of the sector, and our ability to be constructive early in our financing process. This, in turn, allowed us to structure attractive risk-adjusted returns to our security, approximately $50 million of which was held by TSLX at quarter end. Also this quarter, we, in the Sixth Street platform, completed $250 million term loan facility upsize for Biohaven, a biopharmaceutical company.

Our initial $500 million Biohaven term loan facility was completed in August of last year to support the company's commercialization of its FDA-approved migraine drug, which has had strong fundamental performance post our investment to date. The upsized facility, which generates an attractive blended yield to maturity of over 11% on our total investment, will be used to support the continued commercialization of this drug and the clinical development of the company's pipeline assets. We believe that ExtraHop and Biohaven are examples of how our platform's expertise across sectors and themes allows us to source and underwrite strong risk-adjusted returns across both sponsored and nonsponsored landscape.

On the repayment side, after a quiet first half of the year, we fully realized 6 investments and partially sold 1 investment totaling $284 million in the third quarter. Our full investment realizations were driven by a combination of company-specific M&A as well as a favorable refinancing environment. Through prepayment-related fees and equity upside that we structured into these fully realized investments, we generated a weighted average MOM of approximately 1.2x based on our capital invested. From a portfolio yield perspective, funding and repayment activity this quarter had a slight positive impact to our weighted average yield on debt and producing securities at amortized cost. Yields increased from 10.1% to 10.2% quarter-over-quarter and is on par with what it was a year ago. The weighted average yield at amortized cost on new investments, including upsizes this quarter, was 11.7% compared to a yield of 9.5% on exited investments.

Moving on to the portfolio composition and credit stats. This quarter, our portfolio's equity concentration increased slightly from 6% to 7% on a fair value basis quarter-over-quarter, primarily driven by an increase in the fair value of our existing equity positions. The biggest driver was our IRG equity position, whose fair value at quarter-end reflected the pending sale of certain of the company's assets at a contracted price meaningfully above what was implied by our prior quarter's fair value mark.

The IRG sale process is expected to be completed in the first half of 2022. While we continue to be focused on investing at the top of the capital structure with approximately 93% of our portfolio being first lien at quarter end, from time to time, you may like to selectively increase our junior capital exposure in sectors and companies that we believe have strong tailwinds and resilient business models.

Finally, the performance rating of our portfolio continues to be strong with a weighted average rating of 1.12 on a scale of 1 to 5, with 1 being the strongest. We continue to have minimal nonaccruals at less than 0.01% of the portfolio at fair value. With that, I'd like to turn it over to Ian to cover this quarter's financial results in more detail.

Thanks, Bo. For Q3, we generated adjusted net investment income per share of $0.55 and adjusted net income per share of $0.80. At quarter end, total investments were $2.4 billion, down from $2.6 billion in the prior quarter as a result of net repayment activity. Total principal debt outstanding at quarter end was $1.1 billion and net assets were $1.3 billion or $17.18 per share prior to the impact of the special and supplemental dividends that were declared yesterday.

Our average debt-to-equity ratio decreased slightly quarter-over-quarter from 1.07x to 1.01x, and our debt-to-equity ratio at September 30 was 0.9x. As Bo previewed, the net funding activity we've experienced post quarter end to date has brought our debt-to-equity ratio back to approximately 1x, and we expect to finish the quarter at 1.05x to 1.15x leverage. Given that the size of the stock settlement on our convertible notes in Q4 will approximate our special dividend payment, there will be no material net impact from those 2 transactions on our financial leverage. As we head into year-end, our liquidity position remains robust with over $1.3 billion of unfunded revolver capacity at quarter end against $122 million of unfunded portfolio company commitments eligible to be drawn. Note that during the quarter, we increased the size of our revolver by $25 million to $1.51 billion with the addition of a new lender. We now have 21 lenders in our credit facility.

Looking across our debt maturities, as Josh mentioned, we have approximately $100 million remaining principal value of 2022 convertible notes that will mature in August of next year. Similar to our approach on the early conversion on a portion of these notes this fall, we plan to settle our remaining convertible notes in either cash, stock or a combination thereof, as permitted by the indenture depending on our balance sheet leverage and our investment opportunity set at the time any election is required.

As you can expect, we will choose settlement methods that consider the overall impact of conversion on our NAV and ROE. We continue to believe that maintaining a strong balance sheet with diversified funding sources and well-staggered maturities is important to our ability to create value for our shareholders in any environment. As such, we will continue to actively manage the right-hand side of our balance sheet to ensure we have appropriate funding mix diversity and remaining duration on our liabilities.

Moving to our presentation materials. Slide 8 contains this quarter's NAV bridge. Walking through the main drivers of NAV growth, we added $0.55 per share from adjusted net investment income against our base dividend of $0.41 per share. As Josh mentioned at the beginning of this call, there was $0.05 per share of accrued capital gains incentive fee expenses related to this quarter's net realized and unrealized gains. The impact of tightening credit spreads on the valuation of our portfolio had a positive $0.02 per share impact, and there was a positive $0.39 per share impact from other changes, primarily net unrealized gains on investments due to portfolio company-specific events of $0.34 per share. A large portion of this was driven by our investment in IRG, which Bo mentioned earlier.

Note that this quarter, there was a realized loss of $0.18 per share related to the sale of our pre-petition J.C. Penney term loan and secured notes. The recognition of this loss in our income statement corresponded with an unwind of prior period unrealized losses on our balance sheet, totaling the same amount, and therefore, the overall impact was NAV neutral. There was, however, a positive impact from the recognition of this loss in the form of a reduction to our excise tax accrual.

For context, recall that last December, upon J.C. Penney's emergence from bankruptcy, our pre-petition term loan and notes were converted to noninterest paying instruments with rights to immediate and future distributions in cash and other instruments, including the exit term loan and earn-out and propco interests. The combined value of these other instruments and cash distributions that we've received to date have far exceeded our total capital invested in the original J.C. Penney pre-petition securities. Through September 30, we've generated an MOM of 1.23x and a gross unlevered IRR of 26% on our total capital invested.

Moving on to our operating results detailed on Slide 9. Total investment income for the quarter was $71.2 million compared to $62.8 million in the prior quarter. Walking through the components of income, interest and dividend income was $59.4 million, stable from the prior quarter. Other fees, representing prepayment fees and accelerated amortization of upfront fees from unscheduled paydowns, were $10 million, up from $2.2 million in the prior quarter due to higher portfolio repayment activity. Other income was $1.8 million, up from $1.1 million in the prior quarter.

Net expenses, excluding the impact of the noncash accrual related to capital gains incentive fees, was $31.2 million, up slightly from $29.7 million in the prior quarter. This was primarily due to higher incentive fees as a result of this quarter's over earning. Due to the decrease in the effective LIBOR on our floating rate liability structure, our weighted average interest rate on debt outstanding decreased by approximately 5 basis points. Similar to Q2, we applied a fee waiver on base management fees related to the portion of average gross assets this quarter financed with greater than 1x leverage.

As Josh mentioned, through the first 3 quarters of the year, we've generated an annualized return on equity on adjusted net investment income of 12.9% and on adjusted net income of 21.5%. This quarter, an elevated level of portfolio repayments contributed to robust activity-related fees, and we expect this trend to continue through Q4.

Dovetailing this with our active funding pipeline, we would expect to drive strong ROE results for Q4 through the combination of activity-related fees and an increase in our financial leverage. As a result, we would expect our full year 2021 adjusted net investment income to exceed $2 per share, which is above the upper end of our beginning year ROE target of 12% or $1.90 per share.

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

Thank you, Ian. With this being the 10-year anniversary of when we first began our investment activities, we think it's a good time to reflect on the basis of any success we've enjoyed to date. We think there are 2 drivers for this, with the first being our One Team culture, our cultural philosophy of collaborating across platforms to harness best ideas and best practices allow us to continue to provide thoughtful solutions for our management teams and sponsors while also create strong outcomes for our shareholders. Examples of this include a [thematic] investing in retail ABL, financing former royalty streams, upstream E&P and growth capital, which have all contributed in their own way to the alpha in our portfolio's performance to date.

This One Team culture extends to our capital base. The power to co-invest with our affiliated funds, which, in Q3, surpassed $9 billion in cumulative Sixth Street direct lending investments has allowed us to expand our investment opportunity set, and our relationships with sponsors and management teams. Our ability to scale up through co-investment -- co-investing with affiliated funds continue to benefit TSLX shareholders as it allows us to size our funds appropriately to remain nimble in any environment or supporting middle-market borrowers.

The second driver of our success today, if any, we believe is simply our focus on doing good fundamental credit work. Our emphasis on first principles thinking and using tools to manage the inherent fragility of our credit assets are, in our view, the foundation of our strong track record to date. Since inception, we've experienced an annual -- experienced an average annual gross realized loss rate on assets of 7 basis points or a net realized gain of 5 basis points. This compares to a net loss of 115 basis points across all private credit during this period, an outperformance of 120 basis points according to the Cliffwater Direct Lending Index.

Given that BDCs are now levered approximately 1:1 debt to equity, this means, in theory, that we've generated an outperformance of 250 basis points on equity solely attributed to our credit selection. Looking ahead, we will continue to be focused on the shareholder experience.

As you can see, since around -- since the end of 2019, we've kept net asset value per share fairly stable, while distributing a total of $5.42 per share in regular, supplemental and special dividends.

One final note. Yesterday, in consultation with our Board, we decided to amend our existing $50 million stock repurchase program. So we, again, would be purchasing shares automatically when our stock trades at prices starting at $0.01 below 1.05 [times] (added by the company after the call) our most recently reported pro forma net asset value per share instead of below $1. Given the strength in our earnings power of our portfolio on -- our ongoing cadence of supplemental and special dividends, and our expectations of operating in a targeted debt-to-equity range, we believe that reinvesting in our existing portfolio of prices starting below 1.05x book value would be highly ROE accretive with a short payback period compared to any dilution in net asset value.

At the end of the day, our goal is to make the optimal capital allocation choices for our shareholders independent on what it means for asset growth and implications for fee income for the manager. With that, thank you for your time today. Operator, please open the line for questions.

(Operator Instructions) First question comes from Devin Ryan with JMP Securities.

This is Kevin Fultz on for Devin. First question, just looking at investment activity during the quarter, gross originations were fairly healthy at $572 million, but new investment commitments were fairly light at $105 million, which is similar to 80% of originations were sold down. Just curious, given where leverage is at the level of repayments, if that gross origination ever was skewed by a larger deal during the quarter? Or if the small share that you retained was the result of raising investments that were less suitable for that portfolio?

Yes. Great question. So that gross origination number, I think, is largely impacted by Biohaven, which we had capped out basically at our position size, risk position size or risk appetite for the portfolio. The other thing I would note on origination activity in this quarter, there is a -- as Ian noted and Bo in their prepared comments, there was a timing issue, which is there's been a large net origination already in Q4, and we expect that to continue. And so -- quarter was somewhat arbitrary, right? In the sense that in a moment in time, they don't tell the entire story. I think this year, obviously, the portfolio has grown significantly year-over-year. Our expectation is it will, on a calendar year basis, experience net portfolio growth too. It just happens to be slipped into Q4.

Okay. That makes sense, Josh. And then just on the repayment side, obviously, repayment activity was elevated during the third quarter. Could you talk about how repayment activity has tracked quarter-to-date, and your expectations for repayment activity through the end of the year?

Yes. So -- by the way, if -- it's funny just to take a step back and rewind. I know is hard for people to rewind. If you talk about Q2, I think there was like very little repayment activity and people were questioning what was happening with the investment income given that there was no activity-based fees. So again, there happen to be some in Q3, which helped economics and helped earnings. I think, in Q4, it feels like it's a pretty good mix, which there will be most definitely repayment activity. One that's public is Motus. We're being taken out of Motus, which was a long-time client of ours, I think in the syndicated loan market. We also had an equity co-investment in Motus. And so I would say, generally, the portfolio activity, it's pretty balanced and kind of looks like historical between repayment -- new activity and less repayments, but net portfolio growth. So that's how I would frame it, if that's helpful?

Okay. That's helpful. Congratulations on a strong quarter.

Our next question comes from Ryan Lynch with KBW.

First one I had was, Josh, do you or Sixth Street really have any high-level views on how the inflation picture will look over the coming quarters or even coming years? And are there any actions that you guys are taking within your portfolio of companies, existing portfolio of companies or potential new deals, and how to prepare for this?

Yes. It's a great question, Ryan. We most definitely have views, and I would say they're informed. The reality is, that it's a complicated issue, and I think there's divergent opinions in the firm. I'm not sure my opinion matters. But I can tell you kind of the framework, how I think about the framework. And then I could tell you about how we position the portfolio.

Look, so obviously, a lot of money printing. And if you talk -- if people talk about the inflation they really point to that. If you really look at -- there's still a decent amount of excess capacity, especially labor capacity in the markets. That labor capacity has been really sidelined given the stimulus that -- in the residual stimulus from COVID. And so I think there's $13 billion to $17 billion of -- or $13 trillion to $17 trillion of excess savings in the U.S. system.

You saw this with household debt coming down and credit card balances coming down, and those are starting to pick up. And so at some point, people are going to have to go back to work once they've burned through the stimulus and the excess savings. And I think we're getting close to an inflection point on that. I think there was a job number out today, so there was a decent amount of job creation. So I think people are starting to come back to work. given that they have -- they're burning through that stimulus. So I think that will most definitely -- that's a deflationary factor.

Look, as people know, and we've participated in the portfolio construction side, we've been an early investor in software and technology. And that industry and sector is a massive exporter of deflation on a global basis. And so I think that is a -- that surely -- I think people needed to take a step back and look at the world and the world over the last 10 to 15 years, I think, or 20 years has been really deflationary driven by globalization and technology and demographics. And I think except for globalization, which we probably were a peak globalization part of the global financial crisis, those factors are actually going to continue. So I'm not as concerned about inflation as the average bearer, so to speak. I think there's divergent views in our -- divergent views in our group.

That being said, I think how we've set the portfolio, generally speaking, is we typically finance companies and like to finance companies that have a ton of pricing power, that live in ecosystems that they have -- where they -- where pricing power exists and where they're not commodity -- where they're not "commodity providers." And so our expectation of our portfolio, given the average EBITDA margin of our portfolio, I think, is the core portfolio is probably in the 30%, 35% or 40% range, is that -- which tells you that pricing power is that if inflation does come, they will be able to pass along. And by the way, their cost structure is typically given its high margin, high gross margin -- they have -- there's less impact on inflation, but they'll be able to pass along and have pricing power.

So from a portfolio construction standpoint, I think our portfolio is super robust from an inflation standpoint. And then when you look at our -- when you look at the behavior or the model for TSLX is that -- We have a little bit -- there's a little bit of a pinch point between -- if there is inflation between the floors -- we have basically a floating-rate capital structure, floating rate left-hand side of the balance sheet, floating rate right-hand of the balance sheet, there will be EPS expansion once we get through our floors, there's a little pinch point on the floors.

But if there is inflation, my expectation is that we would kind of rip through those floors pretty quickly and be in EPS expansion. So kind of my framework for inflation, how the portfolio behaves in an inflationary environment, which is, I think, robust and then the earnings power of TSLX in an inflationary environment. Is that helpful?

Yes, that's a super comprehensive and very thoughtful response. I very much appreciate that. Kind of on the opposite and more just a technical question, I think, for Ian. Can the convertible owners can they continue to convert early until the maturity in August 2022? Or is that just like a onetime event and that they only had the option to do it then and then they'll have to decide when it comes to maturity?

Ryan, I just want to point out that I can answer technical questions too, but I will let you -- will let Ian take that.

We know, Josh. I just wanted to get Ian in there. So...

I'm just messing with you.

Ryan there's kind of 2 parts to that question. One depends on whether the early conversion triggers have been met prior to 6 months prior to maturity. So think of it as 2 periods prior to February 1 of next year there has to be an early conversion trigger met. As of today, there's no early conversion triggers met. So as of today, there's no more early conversion. Until we get to February 1, which is 6 months prior to maturity, and then the early conversion triggers are not applicable and holders can convert early at their option.

Yes, let me color that up. So the -- that's the -- Ian's right on. The early conversion trigger was a broker bid parity calculation. And for some reason, in a moment in time, the -- the broker bids were less than, I think, 98% of parity. That doesn't seem to exist today. It sometimes happens in high-paying dividend stocks. And what I would say is, we take another step back is that there's 2 basically -- there's 2 kind of holders of the convertible bonds, hedge holders and non-hedge holders.

And the hedge holders, when the bonds get deeply in the money and like really deeply in the money and the delta hedge the bonds, they basically are hedging the bonds on a one-to-one basis because they're effectively just own the stock, and therefore, they're short the dividend of TSLX, and they only have 4.5 points on the coupon and the dividend yield is much higher. And so they have a cash flow, so they really want to issue, so they really want to unwind the hedge, which is why that early -- and they can unwind their hedge basically through 2 things. One is either selling the bonds and unwinding the hedge, or -- and so the trigger exists that, which is, if the bonds for some reason are trading below parity, that they have a liquidity option so they can unwind the hedge.

It has felt like all of the hedged buyers have exercised early conversion trigger -- I mean, early conversion option. In addition to that, it feels like that environment of where the bonds trade at parity no longer exist. And so I would expect that we won't see that again. That was a point in time, given a little bit of a market dislocation on the price of the bonds and then the nature of the holders. And the nature of the holders are no longer hedged holders.

Okay. Yes. That makes sense. I understood the color behind that.

Technical answer.

Our next question comes from Melissa Wedel with JPMorgan.

Good morning, everyone. Thank you for taking my questions -- most of them have actually been anticipated or already has been answered...

Melissa, we can't hear you. Sorry, you're muffled.

Sorry about that. I hope that's better.

Perfect.

Okay. I wanted to clarify the $100 million in activity that you mentioned so far quarter-to-date. Was that gross or net?

That was gross.

Gross. Okay. And then the $100 million to $150 million of additional that you expected, that was a net number, correct?

That's correct. That's a net number that's expected.

Okay. And then just to round out that math a little bit, you also continue to expect elevated prepayment activity into 4Q?

Yes, I think what Josh said is we expect normalized repayment activity to what we've seen at typical levels and combine that with a robust pipeline coming into Q4, we expect those net fundings between $150 million and $250 million.

Yes. Look, I think the math historically, and somebody can correct me if I'm wrong, typical average repayments tend to be $200 million, $175 million to $250 million and then gross originations seem to be somewhere between $200 million and $275 million. And I would expect that we're $150 million -- $100 million to $150 million net on the quarter up.

Is that helpful? We may have lost her.

We lost her. If you can requeue. Shall we continue with the next question, sir?

Sure, sure.

From Finian O'Shea with Wells Fargo.

I guess first question for Josh or Bo on the ABL opportunity set high level. We haven't seen a new portfolio company too recently. Is this part of the private credit arena, as Bo described, where there's a lot of new entrants in terms of come in too much? Or are you just not seeing your style of opportunity -- preferred opportunity there?

Yes. So thanks for your question. Good question. So the good news is (inaudible) there is one in Q4. We actually have 1 that we've committed to that we've been actually earning a little bit of commitment fees along the way over last quarter and this quarter, that's taken some time to get regulatory approval, but that should close early next week, consistent with what you've seen in the past. I would say it's not really a private credit competition issue, it's really a broader issue, which is, when you look at pre-pandemic, what retail look liked was that you had foot traffic declining and store-based retailers. You had -- it's a low barrier industry, so you got a lot of competition.

You had share being taken from -- being taken away from physical stores from omnichannel providers and from Amazon. And so you saw a lot of pressure on those business models, including on a gross margin basis and a discounting basis. And then the consumer was kind of stable or down. And then when the pandemic hit, what you had was you had basically a culling of the herd. Retailers only the strong survive and got to reduce our footprint and rebase.

So they were themselves better positioned. There was less competition. Foot traffic has remained stable or slightly declining. Consumers are in much better shape given excess savings. And so you've had no discounting, you've had margin expansion and retailers are generally those who survived are living in a slightly better environment with a better consumer. My guess is the big secular will continue to play out. But in this moment in time, retail is relatively healthy.

Yes. No, makes sense. Just a follow-up. We can call it technical or high level, but either way it goes to Ian. Is there a change in the supplemental dividend policy? I think you used to pay out about half of the NOI spillover. I know there's a few wrinkles going on this quarter with the big special on the preferred and everything. But are we seeing any change to what you pay out for the quarter supplemental?

No, Fin, it's the same formula. I think maybe what we didn't do as good a job of articulating. We're using the adjusted NII figure to calculate that. So it's the $0.55 less the base dividend of $0.41 and then 50% of that, so that's how we got to the $0.07.

Because the [Part 2] in capital gains incentive fees, are not paid in cash and are not expected to be paid in cash any time soon that you have to make an adjustment to the adjusted net investment income number to get to the earnings power and the cash earnings part of the business.

(Operator Instructions) Our next question is from Robert Dodd with Raymond James.

Congratulations on the quarter. For what it's worth, my questions are anybody can answer them. So on the -- I suspect I know who's going to answer this one. On the kind of top portfolio mix going forward, I mean -- and I don't mean first lien, second lien, I mean more by verticals. I mean you addressed ABL, but you've got pharma royalty expertise. You've got a whole bunch of other expertise beyond just regular way LBO sponsor finance. Do you expect to shift the mix at all?

I mean, as you pointed out, right? The regular way business seems to be getting more competitive, big managers coming in, large pools of capital. You've always run higher -- typically higher IRRs, NOIs, whichever metric you want to look at.

Because of those more niche verticals so a lot of big players don't participating, so should we expect the kind of the number of verticals you're willing or want to operate in to increase or expand as a piece of the mix as the more vanilla ends of the market get increasingly competitive?

Yes. So it's a great question. And I'll let Fishy answer it. No, I'm just joking. But Fishy is here, he can hop in. And I like your approach to who you direct the question at, but I'll take a shot, then Bo and everybody else. First of all, look, I think you're right. We try to be very thoughtful in the sectors and lanes that we've operated in. And quite frankly, there is inefficiencies where we operate. What you find over now in the 10-year anniversary of the business, you found us having higher IRRs or higher ROAs or higher spreads and less defaults, significantly less defaults, like actual net gains versus losses. And so we've found lanes that offer higher risk-adjusted returns. That's the power of the Sixth Street platform.

The power of the Sixth Street platform as we have 400 people now and we have a whole bunch of people in sectors and hunting and thinking about what's happening in those individual ecosystems, and where we can have direct dialogue with companies and pick our lanes and pick them in a thoughtful way where we can find the balance of providing a tremendous amount of value to our issuers, but also value to our shareholders.

I think you will see us continue to evolve -- this year, retail was down. My expectation is retail will come back when that industry is less healthy in the secular override the cyclical vis-a-vis the consumer. I think you'll see us do some energy stuff in the coming moment given the pullback of capital in that space. I think you'll continue to see us still attack software as we have, and we have a little bit of an incumbency benefit there. And so I just think that there is -- on the pharma side, we'll continue to be a thoughtful investor there as well.

So I just think that there were -- given -- that Sixth Street Specialty Lending, Inc., is really focus on the middle market and focus on specialty verticals, I think you'll continue us to see us do our thing and across sectors, when we find good relative value and good risk-adjusted returns and where we can provide value to our issuers. Fishy, do you have anything to add. Fishy is just in the background, always judging, but he's here as well.

I think the only thing I would add is we say software, right? It's such a broad category and encompasses so much. I think one of the things we've done is kind of dig deeper. There's a lot of sub verticals, whether it's healthcare, IT or education or EdTech or payments. I mean, there's such a -- we're developing, I guess, expertise, I would call it, in subverticals of something that's very, very broad. So we're constantly looking for, I would say, a differentiated view in different areas. And just -- I know we just throw around software. So that's the only thing I would talk about.

Bo, anything to add?

No. I mean I guess what I would add is when I look forward at the Q4 pipeline, it's across a number of themes and a good mix of both sponsor and nonsponsor deals. I think that has been the power of the platform that's constantly rotating thematic approach where we have hundreds of investment professionals speaking directly to management teams, sponsors, intermediaries to find the best risk-adjusted return. So that's -- and I think that's going to be represented in our Q4 results.

Yes. And then -- Robert, I know you didn't ask this question, but I think it's worth saying. Look, we didn't get the spillover question, and I want to talk quickly about the spillover. Look spillover given the unrealized gains in the portfolio, spillover is going to quickly increase again. That being said, I am not sure the value of keeping a bunch of spillover income in the system. Ultimately, what matters is the forward earnings power of the business and protecting the dividend vis-a-vis the forward earnings power of the business. And so we've tried to do a decent job of being thoughtful and appropriately choosing our capital structure and eliminating the excise tax, although that excise tax will probably build again given as we convert the unrealized book to realize, will create more spillover income.

That being said, I think our philosophy is a little bit shifting. And we're using that as a lever to optimize our capital structure at any given time to create the right balance to generate forward earnings in the power and earnings of the business, and making sure that we keep ROEs in an acceptable level. So I wanted to hit that.

The other thing I wanted to hit, I think Ian's earnings estimate, which was in excess of $2 per share, I would probably slightly reframe that. It's probably going to be well in excess of $2 per share for Q4, my guess. And so I won't define well in excess, but it's going to be...

That was going to be next question.

Yes. People should model $2 a share for the year, that would be wrong. So -- or I think would be wrong. But -- and then Robert, offline, we could debate the spillover income piece because I think the spillover income concept was this idea of providing protection to the dividend. Ultimately, if you're paying the dividend through spillover income, you're reducing net asset value per share from that moment forward. So we're trying to really find that balance of kind of letting spillover income increase, which it will, and then using it as a -- kind of letting the air out of balloon to make sure we keep the optimal financial leverage and make sure that we don't have a drag on our use of the excise tax.

I appreciate that, and you're not the only one whose view on spillover, maybe philosophically evolving as well. But I look forward to that debate later.

And this concludes our Q&A. I would like to turn the call back to Joshua Easterly for his final remarks.

So thank you. Thanks for the time and attention and participation from everybody. What I would say is, this year -- this time of the year always makes you feel a little bit sad because it's not going to be for -- it's going to be a longer period before we connect next, I think, in February sometime, given the Q4 additional timing to facilitate the year-end audit. So first, I want to wish people a happy Thanksgiving a lot to be thankful for this year and a lot to reflect on.

It's obviously been a difficult 2 years for people and given the pandemic and the uncertainty in the world and a lot of other issues of this diversity and equity issues that are real and affecting parts of our communities. So -- and we obviously have to deal with them as a society deal with the reckoning of some of our history. And so -- but a lot to be thankful for. So thank you for your time and efforts tonight. I do believe from our team, I hope people have a healthy holiday season and can take some time to sit with their family given the last 2 years.

Thanks, everybody.

Thank you, ladies and gentlemen, for participating in today's conference, and you may now disconnect. Good day.