Sixth Street Specialty Lending Inc (TSLX) 2021 Q4 法說會逐字稿

Good morning, and welcome to Sixth Street Specialty Lending, Inc.'s Fourth Quarter and Fiscal Year ended December 31, 2021 earnings conference call. (Operator Instructions)

As a reminder, this conference is being recorded on Friday, February 18, 2022.

I will now turn the call over to Cami VanHorn, Head of Investor Relations.

Thank you. Before we begin today's call, I would like to remind our listeners that remarks made during the call may contain forward-looking statements. Statements other than statements of historical facts made during this call may constitute forward-looking statements and are not guarantees of future performance or results and involve a number of risks and uncertainties. Actual results may differ materially from those in the forward-looking statements as a result of a 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, we issued our earnings press release for the fourth quarter and fiscal year ended December 31, 2021, and posted a presentation to the Investor Resources section of our website, www.sixthstreetspecialtylending.com. The presentation should be reviewed in conjunction with our Form 10-K filed yesterday with the SEC. Sixth Street Specialty Lending, Inc.'s earnings release is also available on our website under the Investor Resources section. Unless noted otherwise, all performance figures mentioned in today's prepared remarks are as of and for the fourth quarter and fiscal year ended December 31, 2021. As a 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, Cami. Good morning, everyone, and thank you for joining us. With us today is my partner and our President, Bo Stanley; and our CFO, Ian Simmonds. For our call today, I will review our full year and fourth quarter highlights and pass it over to Bo to discuss our originations activity and portfolio metrics. Ian will review our financial performance in more detail, and I will conclude with final remarks before opening up the call to Q&A.

After the market closed yesterday, we reported fourth quarter adjusted net investment income and adjusted net income per share of $0.63 and $0.57, respectively. This resulted in a full year adjusted net investment income per share of $2.16 or return on equity of 13.6%, and a full year adjusted net income per share of $3.12 or a return on equity of 19.7%. These results were primarily driven by record levels of both funding and repayments, which helped us operate within target leverage levels throughout the year while also experiencing meaningful activity-driven income.

At quarter end, we had approximately $0.20 per share of cumulative accrued capital gains incentive fees on the balance sheet and approximately $0.11 per share would be payable in cash, if our entire portfolio would be realized at their quarter-end mark in normal course. The rest of the accrued fees are tied to unrealized gains from the valuation of our debt investments, inclusive of call protection, which if prepaid, would require recognition of fees and investment income and trigger a reversal of previously accrued capital gains incentive fees related to these investments.

In Q4, the impact of such reversals was $0.03 per share. This was offset by a similar amount from realized and unrealized gains that are above our prior quarter valuation marks, resulting in the reversal of less than $0.01 per share of accrued capital gains incentive fees on the balance sheet. As we discussed in previous quarters throughout 2021, we've excluded accrued capital gains incentive fees amounts in the presentation of adjusted results on the basis that the expense accrual requirement for this item creates noise around the fundamental earnings power of our business.

As of December 31, 2021, the amount of capital gains incentive fee due to the adviser in cash was 0 because the gains driving the fee accrual were unrealized. Throughout 2021, we continue to focus on capital efficiency by distributing a record level of $3.59 per share during the calendar year through a combination of our base, supplemental and special dividends. Over that period, we've generated a total economic return to shareholders, measured by the change in net asset value per share plus dividends per share, of 19.1%, exceeding our annual -- our average annual economic return rate since IPO of 12.9% through 2020. These returns were primarily driven by the over earning of our base dividend through net investment income, accretive capital market transactions and realized and unrealized gains on investments.

Yesterday, our Board approved a base quarterly dividend of $0.41 per share to shareholders of record as of March 15, payable on April 18. Our Board also declared a supplemental dividend of $0.11 per share related to our Q4 earnings to shareholders of record as of February 28, payable on March 31. Our year-end net asset value per share pro forma for the impact of the supplemental dividend that was declared yesterday is $16.73, and we estimate that our spillover income per share was approximately $0.42. We would like to reiterate that our supplemental dividend policy is motivated in part by tax and RIC distribution considerations and our goal of steadily building net asset value per share over time remains very much part of our philosophy. The distribution of the special and supplemental dividend this past year have significantly reduced our excise tax obligations, generating estimated annual savings of $0.08 per share relative to retaining that capital.

With that, I'll now pass it over to Bo to discuss this quarter's record investment activity.

Thanks, Josh. I'd like to start by sharing some perspectives on the broader credit markets and discuss the record levels of activities we experienced through Q4. In the leveraged loan markets, LCD first-lien spread ended the year 29 basis points tighter than where they started the year and second-lien spread actually tightened 197 basis points. In Q4, first-lien spread saw a widening of 12 basis points, while second-lien spread tightened by 11 basis points. In 2021, new leverage loan issuance volumes reached a record level of $797 billion, fueled by a new high of sponsor-backed middle-market M&A volume of $55 billion in Q4 alone and general corporate M&A activity, in part a product of uncertainty from proposed tax changes that likely accelerated strategic plans on the part of business owners, given the robust valuation environment.

2021 saw a continued recovery scene play out for most risk assets. Total return for the leveraged loan index in 2021 was up -- was 5.2%, up from 3.1% in 2020. Although 2021 returns were robust, the range of outcomes by sector were once again divergent with cyclicals such as energy responding most significantly in industries with high exposures to negative secular trends such as radio and television, weighing down the index. Other sectors such as equipment leasing, food services and products and drugs also experienced returns below index average, given the impact of supply chain issues and staffing cost pressures that have been a hallmark of the inflationary environment. Despite this, default rates for leverage credit generally are at historic lows. These impacts meaningfully inform our approach to origination opportunities and reinforce our selective approach to themes and sectors. Understanding the unit economics and cost structures of borrowers remains a core component in our ability to appropriately position our portfolio to be resilient through economic cycles.

Turning now to our investment activity. As Josh mentioned, earlier, we generated record levels of commitments and fundings and experienced a record level of repayment activity in Q4 2021. As noted in our Q3 '21 earnings release, much of our investment activity was weighted towards the back half of 2021, and this continued with $835 million of commitments and $656 million of fundings during the final quarter. Our deal volume in the fourth quarter span across 15 new and 4 existing portfolio companies. We continue to invest across several themes, including software and services, given their attractive revenue characteristics and high variable cost structures.

For the full year, our commitment and funding levels exceeded our previous record high figures with $1.4 billion of commitments and $1.1 billion of fundings. Total repayments for the year were just over $1 billion, which meant the net portfolio growth of $113 million for the year. To dive into further detail on our Q4 activity, we continue to focus on our specialized sector sub themes, including software and business services. As we briefly mentioned last quarter, we agented a $975 million first-lien loan to Boomi with a $379 million commitment and opportunistically contributed $150 million equity co-invest, both parts of the capital structure being alongside affiliated Sixth Street funds. Boomi's high-quality scaled recurring revenue base with attractive retention characteristics follows our thematic approach to investing in industries where we have deep understanding and expertise.

Other investments in the space during the quarter included Information Clearing House and several of our upsides to existing portfolio companies, including Higher Logic, ReliaQuest and Piano Software. Outside of software and services, our dedicated team of resources provides us the opportunity to diversify our portfolio by investing in other core areas of expertise. We expanded our retail ABL exposure during the quarter through a $300 million first-lien term loan to Price Chopper Supermarkets to facilitate a merger with Tops Markets, which closed in October. As agent, we committed $200 million across Sixth Street, including $75 million through TSLX and syndicated a portion to a third party, generating a syndication fee of more than $0.01 per share.

We also leveraged the Sixth Street platform by working alongside our dedicated energy team to originate a direct to issuer $275 million first-lien term loan to TRP Energy during the quarter. While we remain opportunistic to our exposure in the energy sector, this investment presented an attractive risk-adjusted return at the top of the capital structure and an opportunity to deploy capital in the most actively developed basin in the U.S. with low breakeven drilling inventory. At year-end, our exposure to the energy sector represented 3.7% of our portfolio at fair value.

In addition to macroeconomic factors, we attribute a meaningful portion of our elevated deal activity during the quarter to our relationship with borrowers and sponsors that we've built over the years. During the quarter, we leveraged our existing relationship through our commitment to PageUp. PageUp was an existing portfolio company before our investment in Q4 and were able to benefit from the relationship to agent $190 million senior secured credit facility with speed and certainty of execution. Including upsizes, 28% of aggregate commitments during the quarter resulted from previous or existing portfolio companies.

Turning to the repayment side. We had a record activity in Q4 with 10 full and 5 partial portfolio repayments, totaling $528 million. Net portfolio growth for the quarter was $129 million. This robust level of repayment activity driven largely by M&A transactions during the fourth quarter, resulted in a combination to net investment income from activity-related fees of $0.19 per share. Of the $0.19 per share, $0.11 was driven by accelerated OID and $0.08 was driven by prepayment fees.

To highlight one of our largest payoffs during the quarter, JCPenney repaid the outstanding balance on its $300 million asset-based FILO term loan with call protection, resulting in a 14.5% IRR. We believe our retail ABL strategy continues to be a core strength of ours as we've now generated a gross IRR of 20.4% on fully realized retail ABL investments. In addition to the ABL FILO, JCPenney also repaid the outstanding balance of its $519 million exit term loan during the quarter. As a reminder, in connection with JCPenney's emergence from bankruptcy in December of 2020, 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 as well as the EarnoutCo and PropCo interest.

Separate from the ABL and FILO, we have generated a 32.6% IRR and a 1.36x MoM from the combined impact of our JCPenney Securities. As of December 31, 2021, investments in our retail ABL strategy comprised approximately 7.2% of our investment portfolio at fair value. Consistent with our investment philosophy in prior quarters, we have been selectively making equity co-investments alongside our debt positions, such as our investment in Boomi, as previously mentioned.

During the quarter, we generated $22.4 million of realized gains on our equity investments, primarily in Nintex, Motus, Riskonnect and the EMS Linq. These positions generated an average MoM of approximately 5x 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 income producing securities at amortized cost. Yield remains flat at 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 9.8% compared to a yield of 9.6% on exited investments. Our ability to maintain these yield metrics reflects our continued selectivity in our origination approach across themes and sectors.

Moving on to the portfolio composition and credit stats. This quarter, our portfolio equity concentration came down slightly to 6% on a fair value basis from 7% in Q3, and up about 2 percentage points from a year ago. The year-over-year increase is primarily driven by the increase in fair value of our existing equity positions given net new fundings into equity positions during the year were relatively flat. Across our core borrowers from whom these metrics are relevant, we continue to have conservative weighted average attach and detach points of 1.0x and 4.5x, respectively, with their weighted average interest coverage remaining relatively stable at 3.0x.

As of Q4 2021, the weighted average revenue and EBITDA of our core portfolio companies was $114 million and $32 million, respectively. Finally, the performance rating of our portfolio continues to be strong with a weighted average rating of 1.13 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 across 2 portfolio companies.

With that, I'd like to turn it over to Ian to cover our financial performance in more detail.

Thank you, Bo. As Josh and Bo mentioned, we finished the year with a strong quarter from an earnings and investment activity perspective. In Q4, we generated net investment income per share of $0.63, resulting in full year net investment income per share of $1.97. Our Q4 net income per share was $0.57, resulting in full year net income per share of $2.93. As Josh noted, we accrued $0.19 per share of capital gains incentive fees in 2021. However, none of this amount was payable at year-end. Excluding the $0.19 per share that was accrued this year, our adjusted net investment income and adjusted net income per share for the year were $2.16 and $3.12, respectively.

At year-end, we had total investments of $2.5 billion, total debt outstanding of $1.2 billion and net assets of $1.3 billion or $16.84 per share, which is prior to the impact of the supplemental dividend that was declared yesterday. Following this quarter's net funding activity, our ending debt-to-equity ratio was 0.95x, up from 0.9x in the prior quarter. However, due to the quarter-end timing on a number of fundings, our average debt-to-equity ratio decreased slightly from 1.01x to 0.99x quarter-over-quarter. For full year 2021, our average debt-to-equity ratio was 1x, up from 0.91x in 2020 and well within our previously stated target range of 0.9 to 1.25x.

Our liquidity position remains robust with $1.2 billion of unfunded revolver capacity at year-end against $156 million of unfunded portfolio company commitments eligible to be drawn. Our year-end funding mix was represented by 74% unsecured debt and our weighted average remaining life of debt funding was 3.6 years compared to a weighted average remaining life of investments funded by debt of only 2.4 years. Consistent with our historical cadence, we expect to amend our existing credit facility in early 2022.

Looking across our debt maturities, we have approximately $100 million remaining principal value of 2022 convertible notes that will mature in August of this year. Similar to our approach on the early conversion on a portion of these notes last year, in accordance with the requirements under the indenture, we announced to holders earlier this year that we will be settling our 2022 converts with primarily stock and a small portion of cash, creating an equity issuance in Q3 '22 related to the remaining principal outstanding.

We would expect the conversion to be marginally accretive to NAV per share at the time of conversion. We will continue to assess the impact of the settlement of the converts on our leverage and return profile and look for ways to optimize ROE through the same tools we've used in the past, including through the use of special dividends.

Given interest rates are clearly top of mind for many of our constituents, I'd like to hit on the Fed's latest guidance, specifically the expectations for the forward yield curve. At the time of our Q3 '21 earnings call in November last year, we didn't expect reference rates to reach the average floor levels of our debt investments until Q4 of 2023. We now expect reference rates to return to our average floor level of 1.08% during Q2 of this year. Given that 98.9% of our debt investments are floating rate in nature and 53% of our portfolio is funded with equity, a rising rate environment provides an earnings tailwind for our business once we reach our average floors.

To give an illustrative example of the impact once we reach our floors, assuming our balance sheet remains constant as of Q4 '21. For every 100 basis point increase in rates, we would expect approximately $0.14 per share of uplift to annual net interest income. Again, in a rising rate environment, the sooner rates rise through our floors, the sooner we will benefit from this positive asset sensitivity of our matched floating rate exposures. Conversely, to the extent expected rate rises take longer to reach our floors, we anticipate a potential negative impact to net interest income.

Moving to our presentation materials. Slide 10 contains this quarter's NAV bridge. Walking through the main drivers of NAV growth, we added $0.63 per share from net investment income against our base dividend of $0.41 per share. There was a $0.40 per share reduction to NAV, primarily from the reversal of net unrealized gains on our equity positions as we book these gains as realized upon sale. There were minor impacts from changes in credit spreads on the valuation of our portfolio, and there was a positive $0.07 per share impact from the early conversion of a portion of our convertible notes and the impact from our dividend reinvestment plan.

And finally, there was a $0.39 per share positive impact from other changes, primarily realized gains on investments of $0.31 per share. A large portion of this was driven by our investments in Nintex, Motus, Riskonnect and EMS Linq, as Bo mentioned earlier. Slide 11 contains an NAV bridge for full year 2021 for your further reference.

Moving on to our operating results detailed on Slide 12. Total investment income for the quarter was $78.3 million, up 10% compared to $71.2 million in the prior quarter. Walking through the components of income, interest and dividend income was $61.8 million, up slightly from the prior quarter. Other fees representing prepayment fees and accelerated amortization of upfront fees from unscheduled paydowns were $14 million, up from $10 million in the prior quarter due to higher portfolio repayment activity. Other income was $2.6 million, up from $1.8 million in the prior quarter.

Net expenses, excluding the impact of the noncash accrual related to capital gains incentive fees, were $32.5 million, up slightly from $31.2 million in the prior quarter. This was primarily due to higher incentive fees from this quarter's over earning.

There was no waiver of management fees during Q4, given average leverage this quarter was below the 1x threshold. As Josh mentioned, during the year, we've generated a return on equity on adjusted net investment income of 13.6%. For a year of record fundings that were met with heavy repayment activity, we managed to increase our average financial leverage year-over-year to 1x, and we exceeded our full year 2021 beginning year ROE on adjusted net investment income target of 12% or $1.90 per share. Further, net realized and unrealized gains on our investments contributed to a record high ROE on adjusted net income of 19.7% for 2021 compared to 15.9% in 2020.

As we look ahead to 2022, based on our expectations for our net asset level yields, the movement in reference rates, cost of funds and financial leverage, we expect to target a return on equity of 11% to 11.5%. Using our year-end book value per share of $16.73, which is adjusted to include the impact of our Q4 supplemental dividend, this corresponds to a range of $1.84 to $1.92 for full year 2022 adjusted net investment income per share.

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

Thank you, Ian. Before we conclude, I'd like to reflect on the performance of the business, beginning with the onset of the global pandemic almost 2 years ago from today. Clearly, the pandemic imposed on all of us an environment that we had not previously experienced, creating for a period in time one of the most challenging test our business have seen to date. The immediate and uncertain economic downturn beginning in Q1 2020, was a true test for the resilience of our business and the principles for which we operate under.

During 2020, we sought to communicate our framework of managing an inherently fragile asset base by building a business model and developing principles to mitigate volatility and uncertainty. These elements included investing in high-quality sectors with a selective approach to financial sponsors and management teams, building anti fragility on the right-hand side of our balance sheet by swapping our fixed rate liabilities into floating rate, paying for the option on liquidity and maintaining a leverage level well below regulatory limits.

Our goal for any market dislocation is to position ourselves such that we not only survive the volatility uncertainty but grow and create value. Looking back, we believe we accomplished this goal, allowing us to play offense in the time of dislocation.

Over the past 2 years, we are extremely proud to note that we have generated an average annual economic return for our shareholders of 17.5%, well above industry level returns and above our average annual economic return to shareholders since IPO prior to that time period of 12.2%. We believe our performance highlights the successful application of our framework and principles. For avid readers of our presentation, we added a new page to our earnings presentation for today's call, which highlights the consistency and resilience of our returns since we completed our IPO almost 8 years ago.

Slide 5 presents key return metrics measured on both a return on equity basis, that is using adjusted net income as a numerator as well as on an economic perspective, which calculate movement in net asset value per share plus dividends. I've already highlighted our performance, but I also want to emphasize how strong our returns were during that period with calendar year adjusted return on equity of 15.9% and 19.7% for '20 and '21, respectively.

And while BDC peers that have reported to date generally appear to have provided solid terms for the calendar year 2021. That is -- it is coming off a particularly weak prior year, where the average return on equity for our peer set was less than 1%. The ability to manage our business through the course of an economic cycle remains a key differentiator of how we deliver returns to our shareholders.

Ian already provided guidance on expectations for financial performance in 2022, but to add some more color to his comments, we remain constructive on the opportunity set ahead of us. We continue to experience limited yield compression in our assets, and we expect credit losses to remain low, given our investment selection discipline and the health of our existing portfolio. And while we begin the year with significant liquidity and capacity to drive incremental return on equity through financial leverage given we're at the low end of our target leverage ratio.

In closing, I wanted to call out how excited we are at the prospect of return to a more normalized post-COVID environment as we head deeper into 2022. From a work environment perspective, the Sixth Street team officially returned to the office earlier this year, and in the case of our New York office and a new premise and is extremely motivating for me to see everyone again in person. To my colleagues and the partners in our business internal, external, we look forward to enjoying 2022 together in person.

With that, thank you for your time today. Operator, please open the line for questions.

(Operator Instructions) Our first question comes from Finian O'Shea with Wells Fargo Securities.

Josh, on the outlook for earnings, you touched on higher average leverage helping you more recently this year and such. Can you talk about the outlook to keep running at these levels if your origination footprint has grown or if it fits the overall private market activity lifting things up here?

I think you asked a good question. People are going to hop in, I have Bo, Fishman and Ian. First look, our outlook on earnings just to hit it. When you look back historically, I think I recently did this. Our outlook on earnings on a return on equity basis are basically the same outlook, which would be kind of year in and year out since we went public since 2015 or something, which is a range between 10.5% and 11.5% or 12%. So I think our outlook on earnings are exactly the same. The 2 cross winds, I would say is, one is that a little bit higher leverage than historically, but obviously, a very low -- a much lower base rate interest rate environment. So on a kind of a risk-adjusted basis compared to risk-free , we're actually earning a higher return on equity than we historically have.

As it relates to prospects of a little bit of higher leverage, our origination footprint at Sixth Street has most definitely increased significantly. And you saw that with -- this was, I think, our highest origination year ever with over $1 billion origination with rates increasing slightly a little bit. My guess is, activity will be a little less and portfolio turnover will be a little less. And so as in the final comment that constructive on the forward year given we have a whole lot of excess capital. We have excess liquidity. We can lag in the leverage, the investment environment. I think it's going to have a little bit less portfolio turnover.

And given that we don't drive our economics through origination activities, but I think there will be a little bit more ability to hold leverage, and we'll be able to drive returns that way with less portfolio leverage given the environment.

Bo, Fishman, do you have anything to add or Ian?

Yes. The only thing I'd say is that we remain constructive on the opportunity set. I agree with Josh. We'd expect -- last year was a very robust M&A environment. We expect it to be fairly robust this year, but probably not on par given the interest rate environment, but remain constructive on the opportunity set of the deal that we're seeing today.

That's helpful. And as a follow-up, is there any change in the cadence on front-end leverage? And can you remind us, I think historically, that's employed on about half of the portfolio names?

Yes. I'll give you the exact number of what percentage. Our attachment point -- if you look at our attachment points, which is what really matters. They really haven't changed. It's gone from -- I think it's -- historically, it's ranged between 0.5 on an EBITDA basis as an attachment point to 1. I think we're in that range of 0.5 to 1, closer to 1 now, but I think our attachment point really haven't changed. And we'll come back on the percentage, but I think it's relatively similar, which is what percent of our portfolio has some leverage, but on a risk basis, our attachment points really haven't changed.

Our next question comes from Kevin Fultz with JMP.

The portfolio weighted average EBITDA was $32 million this quarter, which has been trending down in recent quarters. Just curious if that's driven by finding more attractive opportunities as smaller borrowers or if it's being driven by something else you could possibly shine the light on.

Yes. Kevin, I think good question. I think it depends on -- I think last quarter, it was $37 million. If you look back in 2019, it was $33 million. In 2018, it was $31 million. In 2017, it was $25 million. So I think it's kind of in the range. It kind of also depends on what's in that if that's the core number. And the core number is usually typically, I think in between 75% and 85% of the portfolio.

And so for example, we did one second-lien this quarter, which had a much larger EBITDA that wasn't included in that. So it kind of moves around quarter-to-quarter, but I think it's -- quite frankly, we have not changed our strategy one bit. Same quality, same size companies for the most part. Same margin profile so the underwriting really hasn't changed. So I wouldn't get caught up in the quarter-to-quarter stuff because it's a function of what's in the core number, what's out of the core number and it's kind of been in the historical range.

Okay. Josh, that's helpful. And then just one follow-up. So 2021 was clearly an incredibly strong year for deployment and portfolio growth. Can you talk about your expectations for the pace of investment portfolio growth in 2022?

Sure. I think what we've modeled is, it's interesting when you think about the economics in our business. If we grow -- if we add assets, we generate higher return on equity because of the financial leverage. If we have more portfolio turnover and we are not -- unable to grow assets, we generate more economic from activity-based fees, such as accelerated OID given that we -- all of our OID, the original issue discount is not taken up front, but it's deferred and prepayment -- and some prepayments fees.

And so how we've modeled it, we don't really know what environment we're in. How we think about the world is, probably, a couple of hundred million dollars of net portfolio growth is what we've modeled. But again, I think the confidence level of the returns are pretty tight because unless we have an environment like we did this past year, where you have a ton of origination activities and a ton of repayment. And so you kind of got the benefit of both. You got the benefit of a little bit of higher leverage and the benefit of activity level fees. That's what causes breakout years, but I think we're pretty confident in our level of returns this quarter -- this year.

Our next question comes from Melissa Wedel with JPMorgan.

Many of them have actually been asked already. So hoping that we could turn to a couple of new investments. It looks like in the human resources space, there were a few new holdings listed. If I'm looking at this right, Employment Hero Holdings and PrimePay Intermediate, I was hoping we could walk through those briefly. And maybe you could talk about the opportunity there and the resilience of those businesses as you see it.

Yes. I'll turn it over to Bo. Just one caveat. Thanks for that question. They are typically software businesses that are support human resource activities on a B2B basis. So Bo, you can get into it. I think my guess is Employment Hero is one, and my guess is, PageUp is another.

Yes. I think that's exactly right, PrimePay would be tangential. So that's a sector that we've been quite active in over the past decade. Obviously, as businesses continue to digitalize and manage their businesses, HR is an important function for back offices of these businesses, including Employment Hero, which is an Australian-based company really help with the onboarding, the hiring and tracking of employees through the system with a very tight labor market. It's imperative that these companies do this in a fashion that is more constructive than in the past.

So again, the sector we really like as it relates to Employment Hero, that is a low leverage security with high return on invested capital, and really good retention rates. So that's really where we're focused on. These have really become mission-critical functions for the human resources department. And again, highlighted in an environment where a tight labor market is really important for people to be agile with their technology solutions. So that was across all of those investments that we made this quarter.

Okay. And as a follow-up, could we get an update on American Achievement. It looks like maybe that would have a little bit of a markdown further in the fourth quarter?

Yes. I think American Achievement is a relatively small position for us. It was a COVID impacted name. I think it's like $18 million. I think that's right. Somebody will correct me if I'm wrong. It's -- in the yearbook class rings, (inaudible) business, obviously, they missed the selling season in 2020 and 2021 should be better. The good news is, the industry structure is pretty good. There's a couple of players only. So I would -- our expectation to hope that would rebound around pre-COVID numbers, but it's obviously been a COVID-impacted name that has with a seasonal overlay that's been a challenge, but a relatively small position for us.

Our next question comes from Kenneth Lee with RBC Capital Markets.

Wonder if you could just share with us any updated thoughts around opportunities for more junior capital structure investment. I think you touched upon equity co-investments in the prepared remarks, I just wanted to see what the opportunities are over the near term.

Yes. As we've always said, we're going to be opportunistic in down the capital structure investments. We made probably a pure second-lien investment in a long time. This past quarter in a software name with the sponsor we know very well that came along with an equity coinvest. We've had a great track record on our equity (inaudible) program. I think Bo mentioned, I think realized investments this quarter was like 5x our money on realized equity coinvest. So we'll continue to be opportunistic. The environment is, quite frankly, obviously, an interesting environment, which is valuations have come off. People might think that's an opportunity. People might think that's a risk. On high-quality businesses, we probably think that's an opportunity, and the interest rate environment. So we'll keep focused on what we do, which is investing in high-quality businesses that can pass along to pass on pricing to their customers, but we'll be opportunistic.

Bo, any comments?

No. The only thing I would say is that if you look at the equity co-invest levels over time, it really hasn't changed. We've always kind of picked our spots and made investments particularly in areas that we have strong kind of thematic views and that we thought would be supplementary to our returns on the debt piece, but that level of activity really is not changed over time. We'll continue to be opportunistic and again, focus on those opportunities where they're available to us in sector themes that we've been following and feel like we have a real view on.

Great. That's very helpful. And just one follow-up, if I may. On the liability side, especially in the context of a potentially rising rate environment, I wonder if you could talk about how you see the funding mix or position? And whether there could be any potential opportunities around that over the near term?

Yes. I'll start and Ian can pick up. Look, we've always had this view of we have -- we match fund our assets with our liabilities, which is in a rising rate environment. Our portfolio generates more income. Half our book is funded effectively with fixed rate liabilities in the form of equity to have a fixed rate dividend profile. The payout ratio should increase on that, but we don't make a real directional call on rates outside of that -- outside of how we're positioned given the nature of our book on the equity side. And so I -- we've always swapped our liabilities.

We'll continue to probably -- we'll continue most definitely swap our liabilities. That's because in the down case, which you saw in 2020, we actually had net interest margin expansion at the time that we had -- the whole industry had some risk of increasing credit costs. And so you don't want to have a fixed rate liability profile where in an economic downturn rates go to 0. You have less income of your book even on net interest margin basis, less credit cost it's even worse. And so we'll probably keep our profile exactly the same, and there's obviously asset sensitivity in the nature of our book, given the floating nature of our assets.

Ian, anything to add there?

No. The only thing I would add is, Ken, we've committed to the investment-grade market, and we've done a pretty deliberate job moving our funding profile and the funding mix more towards the unsecured part of the opportunities there over the last 4 years. And we like that market, and I think we can be efficient in issuing into that, but we still have the flexibility of having capacity in our existing revolver and that's why we highlight the capacity that we build up over the last 2 years. It's still going to be a mix, but we -- I think the mix that you see today of about 75% unsecured is pretty good guidance.

Yes. The only thing I will -- the last thing I'll add is, look, what we think we do well is underwriting idiosyncratic credits and making investments in corporates and capital structure. And obviously, macro has a little piece to do with that, but mostly, we think of ourselves kind of on an idiosyncratic basis. Picking -- making a directional call rates is something that we really don't do. And so -- and it doesn't -- it's not in our deep core set. I think as I said this historically, competing against central governments and policymakers, I think is a tough business.

Our next question comes from Ryan Lynch with KBW.

Josh and Bo, congrats on the nice quarter and really nice 2021. I wanted to touch on kind of some of your commentary around market activity and kind of outlook of pipeline for originations. Just because -- in 2021, that was such a robust year sort of went on all sides from a portfolio activity standpoint for you and the overall market, but as we turn into 2022, it looks in a lot of those tailwinds and pent-up demand is probably somewhat diminished, and then you have that coupled with rising rates, which put pressure valuations for some of the sponsor backed business, which I think would make them less willing to transact your businesses. You guys have a little bit more of a specialty lending business, so you do some other things. But I'm just curious, from a pipeline standpoint, what are you guys seeing as far as outlook, as far as the pipeline and potential that to grow the portfolio in 2022?

Yes. Thanks, Ryan. Okay. I think most -- I think it depends on what line of business you're talking about, quite frankly. So I think when you think about -- we have multiple lines of businesses. We have kind of a sponsor business, a non-sponsor business. We obviously do some things that are, I call in lanes 2 and 3, which are more kind of opportunistic lending with good companies and bad balance sheets to bad companies and bad business models with as good assets or ABL. So we have a pretty well-rounded breadth in what we do.

My guess is, given the valuation environment, companies that used to raise equity at high valuation, for example, is probably not going to raise equity and so on their business. So that's probably -- the lower valuation environment is probably pretty bullish for activity. I think I just saw an article right now where there's large players in like the later-stage growth business were -- who are on the equity side, kind of are taking a step back. And so I think that's helpful to our business. I think the buyout and kind of the M&A is probably going to be -- actually going to be less, but overall, I think we have a pretty broad-based originations platform.

And what I would say is, our ability to grow -- you can't look at growth originations. You have to look on a net basis because net fundings are what drives economics. And so I would also think one of the actual tailwinds we have in our business is, it's probably going to be less portfolio turnover. And so I feel pretty comfortable about the broad range of our skills across different kinds of deals and what that means and that you don't have a tailwind of probably such a robust M&A activity, but you probably don't have the amount of turnover in your portfolio. So I think what most definitely feels like we'll be able to grow the book on a net basis, and we're seeing interesting things in this quarter for sure. Bo?

Yes, we've got a handful of interesting things that we're working on in kind of a normal environment in Q1 where we're rebuilding the pipeline from an M&A perspective. I agree with everything Josh said, which is, if you look at historically over time, we've generally had a kind of 2/3 to 1/3 ratio of sponsor to non-sponsored deals as we have other core sectors such as retail ABL, pharma royalty, energy that do direct the company quite often. Having that diversified stream of pipeline opportunities has helped us over time go through cycles where there's less M&A.

I would agree with you that we're probably going to see less M&A this year. That's what we're forecasting. However, I think we do have a large portfolio. We're still going to do add-ons. We'll have the ability to grow the existing portfolio from there. And then as Josh mentioned, lastly, kind of the late growth businesses, we have raised equity capital that's been very cheap over the last couple of years. That's going to become more difficult, and they're going to have to look to other solutions, such as credit solutions to continue to fund their businesses, which still have pretty robust unit economics in this environment.

Yes, that's really helpful color. Kind of on that point, you guys -- as we kind of look throughout the year, you guys have a pretty meaningful deleveraging event coming to all in the third quarter, as you guys mentioned. And the exact amount probably hasn't been decided because you said a combination of cash and stock but probably also stock to convert. I guess you did the intention to try to grow leverage kind of into that event that deleverege the event. And does your guys co-investment pals you would allow that to potentially grow more at TFLX versus some of the other funds or bigger allocation that you would maybe normally pay, knowing that, that even is kind of on horizon?

Yes, it's a great question. So I would -- you're talking about the equity settling the convert with the $100 million roughly, I don't know that...

Yes, that's right.

So what I would say is, yes, obviously, we're not talking about raising equity going forward we plan to-- we have the ability to kind of run leverage higher, what I'd say on the co-investment side, the first stop for kind of middle-market specialty lending has always been SLX. And so we don't have -- we determine our position sizing by risk tolerance and with needs -- what needs -- the needs are for the business. And so that's definitely a lever.

We also lever, which we've used historically is, we still have [42] something like that. It's still over income and so we can effectively manage economic -- the leverage in the business and the economics through special dividends. And so either we're going to grow the book, and we're going to be in our target leverage ratio. We're taking on the additional $100 million of equity or there's obviously a valve to create leverage or economic leverage in the book, through return on capital, which was historically a return on capital that we just haven't flushed out.

(Operator Instructions)

Our next question comes from Robert Dodd with Raymond James.

Congratulations on the quarter on 2021 and exactly on having a 6-year track record where the lowest data you've generated is 11.6% which kind of brings me to my question. So how much fate should we have in your guidance of 11% to 11.5% when the only time it's ever been that low were in 2014, 2015, when you were under levered and had onetime expenses. So can you walk us through a little bit, what are the assumptions that lead to the lowest expected ROE in 6 years of the business?

Well, it's a great question, Robert. I think we've had the exact same guidance every year. So...

I think that you would repeat that.

And imply what you want on that, but we've had the exact same guidance. Obviously, that 11%, 11.5% ROEs are harder in a lower interest rate environment and it actually provide a more significant value proposition to our shareholders, given the rate environment. What I would say is, when you look at activity level income, so we kind of model our business and those ROEs with very low activity level income. And so I'm going to -- I'll talk about last year's guidance and what we had modeled, and people can actually correct me if I'm wrong. Last year, we modeled only about $0.18 per share.

So if you look at back, our ROE last year was in that same range, 11% to 12%. And that in now was about only $0.18 per share in accelerated OIDs and prepayment fees and another $0.10 in amendment fees and other income. So relatively, call it $0.28 per share in non-pure interest income, okay? How the year ended up and I'm doing this math in my roughly -- I'm doing at $0.58, ended up about $0.58 per share in those categories. And so when you historically look back, just to put it out there, I think our lowest year with those levels were in 2016, which was 13 im doing this on the fly maybe $0.26 per share. So we tend to model very conservative levels of attribution from noninterest income, which is why we've always said, given our ROE range where it is and which is always we beat it.

And so the way I kind of think about it, by the way, this is what's created the spillover income, which is when you model the business with credit losses and you set the bar very low, and there's multiple levers to exceed the bar, you can -- you tend to have beats more often than that. And so that's kind of how philosophically we think we have thought about the business -- modeling and the business, which was model conservatively from a credit loss or credit cost perspective from an activity level perspective and then communicate that and that's what's historically driven the beat.

Got it. Got it. I appreciate that. You do intend to exceed the guidance. That's kind of -- on the just the other topic, structuring, I mean, or structures available in the market right now. I mean you have tended to focus on in showing that you have full protection in your structures. It certainly looks -- it's a very competitive market out there, as we know. It certainly looks from the figures on Page 5 of the presentation, but you're still able to structure those deals kind of the same way with a lot of potential core protection still in them. I mean do you expect that to change in terms of -- if the market remains this competitive, is the ability to structure with that kind of potential embedded the income going to persist? Or do you think that's going to stray over the next year?

Look, obviously, the environment has gotten more competitive. I mean, I think we do a pretty good job. When you look at -- I think about 90% of our book has -- sorry, I think 90% of our book we have some call -- I'll come back on an exact number of call protection on the book, but we still have a significant amount of call protection in the book. So what I would say is, we focus on areas where we can add value to clients, where we were in industries that we know where we tend to get the last look.

Some of the first stuff -- some of where we sell off revolvers and some first out stuff, which been alluded to, we most definitely that help them that how efficient our capital is and what call protection we can -- what we can drag. About 85% of our book has called for protection today, 85.2%. I think that's consistent historically. But it's just -- and when you look at the corollary or the analogy, which is portfolio yields, I think portfolio yields in a relatively competitive environment have held up on a vintage-by-vintage basis. So I don't know, Bo, do you have anything to add?

No, look, like what I would say is it's been an intensely competitive environment over the last 2 to 3 years. We have not seen an acceleration of that over the last 3 to 4 quarters. It's remained intensely competitive. We haven't seen stark changes in deal terms, our ability to get call protection and other features such as covenants that protect us and our investors. That has not changed. We continue to pick our spots, generally play in areas that we're bringing more to the table than just capital, have some expertise to provide certainty and that allows us to be a value-add and gets some of these call features that we think are an important part of fixed income book.

Yes. And let me -- I'll point you to one place in the earnings I think was helpful to quantify this, which is on Page 8 of the earnings presentation we lay out, which is the fair value as a percentage at call price. So that kind of gives you an estimate of how much upside in the book, if it gets called away having the fair value is 95.2% of the call price of our book. It was 96.7% last quarter. So this is actually more kind of embedded economics in the book and that range from 94.6% a year ago and this is 95.2% today. So it's kind of in the range.

Yes. I mean, that was the number I was actually referring to. I went (inaudible). I mean that's the point. I mean it's include this quarter versus last quarter. In this competitive environment, I mean...

That's a mix issue because call protection is a declining asset and so the portfolio turnover and those new vintage stuff is a higher percentage of our book, which you expect has more call protection. So that's the benefit of the kind of a mix issue.

And I'm currently

(technical difficulty)

further questions at this time. I'd like to turn the call back over to Josh Easterly for closing remarks.

Great. I want to come back to Fin's question because Fin had a question, Fin, on the first out, it's range and first-out -last-out mix, it's ranged between -- it hovered between 40, 60, 60, 40 on either side, and we're kind of exactly in that range today. I think it's 43% first -- pure first-lien at 50% last half. So it's been historically right in that mix. So I don't think it's changed. I wanted to come back as we kind of dug around and found the answer.

Look, to me, 2021 was a great year for Sixth Street in the direct lending business. I actually think 2020 was a better year just to put it out there. And so because we were able to generate significant returns across both cycle -- both environments, very proud of the team. Look forward to seeing people in the spring. I hope people enjoy their President's Day weekend. I think this is the first time we've had our earnings call before President's Day weekend. So I hope people enjoy the President's Day weekend. And thanks for the support and Ian, Cami and Mike and Bo are available for a follow-up. Thanks so much.

Thanks, everybody.

This concludes today's conference call. Thank you for participating. You may now disconnect.