Sixth Street Specialty Lending, Inc. (TSLX) Earnings Call Transcript & Summary

Good morning, and welcome to Sixth Street Specialty Lending Inc.'s June 30, 2020 Quarterly Earnings Conference Cal. 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 risk 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 close, the company issued its earnings press release for the second quarter ended June 30, 2020, 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 under the Investor Resources section. Unless noted otherwise, all performance figures mentioned in today's prepared remarks are as of and for the second quarter ended June 30, 2020. 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. 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. We and everyone here at Sixth Street, hope you and your loved ones are able to stay safe and healthy in this uncertain environment. We spoke in May. Our hope has been that by August, there would've been -- there would be more clarity on the path and time line of return to full business activity. However, the current health crisis continues to take a toll on human lives as well as the economic health of households and businesses around the world. While the Fed and U.S. government have provided rapid and extraordinary fiscal monetary support, it remains to be seen how long a return to normalcy will take and what the long-term impact of COVID will ultimately be. As shared in our stakeholder letter less than 2 weeks ago, we've always believed that any business model, including the BDC model has inherent constraints and risks. These risks make it fragile and particularly vulnerable to market shocks and uncertainty. That is why over the last years, we've taken steps across our business, not only to mitigate the undesired outcomes of the inherent fragility, but also to allow us to create value in periods of volatility. These elements we've introduced into our business model include our focus on high-quality underwriting and cycle-appropriate portfolio construction, match funding the nature of our liabilities with our assets, proactively managing liquidity and liability role risk, setting a financial policy that preserves our reinvestment option. And finding the optimal business model to provide both the benefits of scale and outsize returns for our stakeholders. While still early in the unfolding of this COVID-induced downturn, we believe that the strength of our Q2 results is an early indication of the value we can create for our stakeholders in the period ahead. With that, let me turn this quarter's highlights, which are consistent with the preliminary earnings results we provided on July 23. After the market closed yesterday, we reported second quarter net investment income of $0.59, against our Q2 base dividend of $0.41. Net income per share of Q2 was $1.43. These results correspond to an annualized return of equity on net investment income and net income of 15.6% and 38%, respectively, and an annualized year-to-date return on equity on net investment income and net income of 13.1% and 7.6%, respectively. Net investment income this quarter was reported -- was supported by elevated prepayment and other fee activity in our portfolio, most notably our realized investment in Ferrellgas. Our strong net income this quarter was primarily due to the unrealized gains related to the impact of market spread tightening during this quarter as well as a robust net investment income. Over the course of Q2, LTD first-lien and second-lien spreads, we traced 60% and 71% of the respective Q1 spread widening. Consistent with the broadly syndicated market, the impact of this on valuation of our portfolio this quarter resulted in a reversal of approximately 60% of our Q1 spread-related unrealized losses, which was reflected as an unrealized gain for Q2. Net asset value per share was $16.08, increasing by 6.7% from our pro forma March 31 net asset value per share of $15.07, which accounts for the impact of the $0.50 aggregate special dividends per share that was paid during Q2. Ian will walk through the quarter's net asset value bridge in more detail. Taking a step back, our net asset value per share at quarter end, if we were to add back our $0.50 per share of special dividends paid to shareholders in Q2, would be $16.58, which brings almost entirely back to our starting level of $16.77 at the beginning of the year. Even though our spread-related unrealized losses have only been reversed by 60%. This is because we've been able to rebuild net asset value in other ways, including through the over-earning of our base dividend, outperformance on some of our small equity positions and unrealized mark-to-market gains on our interest rate swaps. Yesterday, our Board declared a third quarter base dividend of $0.41 per share to shareholders of record as of September 15, payable on October 15. Consistent with what we said last quarter, based on a view the core earnings power of our portfolio, we do not anticipate making any changes to our base dividend level in the near or medium term. There were no supplemental dividends declared relating to Q2 earnings as a result of the net asset value test in our framework, which specifies that no supplemental dividends are declared at a pro forma net asset value per share, adjusted for the impact of any supplemental dividends over the current and preceding quarter declines by more than $0.15 per share. Any downward impact on net asset value as a result of special dividends, not supplemental dividends are added back for the purpose of the net asset by value test. If we compare this quarter's net asset value per share, adding back our $0.50 per share of special dividends of $16.58 against our Q4 2009 pro forma net asset value of $16.77, there was $0.19 of NAV per share decline against a limit of $0.15. Therefore, we are $0.04 short of being able to declare a supplemental dividend of $0.50 of this quarter's over earning. Based on our current outlook and pursuing no material declines, our net asset value per share as a result of exonerates events, like the market volatility we observed in March, we would expect to resume declaring supplemental dividends on over earnings in Q3, provided that our reported net asset value per share at September 30 is greater of $14.92. With that, I'd like to turn the call over to Bo to walk through the activity and health of our portfolio in more detail.

Thanks, Josh. I'll begin with a quick overview of our market backdrop during the quarter. Amid economic uncertainty, M&A activity continue to be significantly muted as buyers and sellers struggle to agree on valuations. Meanwhile, in the second quarter, there was significant tightening of risk premiums in the broader credit markets. A disconnect emerged between asset prices and economic reality, which we believe was primarily fueled by extensive Fed and government intervention, driving investor demand back into risk assets. As a result, secondary prices across credit rose sharply in Q2, and there was an abundant liquidity in the investment-grade and high-yield markets for a broad variety of issuers, including those in sectors most impacted by COVID. In light of these market dynamics and given our focus on maintaining strong risk-adjusted returns across our portfolio, Q2 originations activity was relatively light at $89 million of commitments and $77 million of fundings. These fundings were across 6 new and 6 existing portfolio companies. The majority of our fundings on a dollar basis this quarter was providing a new financing in connection with the recapitalization of Moran Foods, where we replaced our existing ABL loan with a new one at a higher spread and refresh call protection. Other new investments included small opportunistic purchases of BBB CLO liabilities and limited junior debt co-investments alongside our affiliated funds and growth businesses with attractive risk-adjusted returns. As a result, our portfolio is first-lien exposure decreased slightly from 97% to 96% quarter-over-quarter on a fair value basis. Repayments during Q2 totaled $211 million across 3 full and 2 partial paydowns. Ferrellgas and Nektar, which were our 2 largest portfolio names at the end of Q1, were both fully repaid early in the quarter. As a result, net repayment activity for the quarter was $134 million. During the quarter, as M&A activity slowed and the immediate opportunity set for our secondary market purchases and rescue financings became less actionable given Fed intervention, our team continued to work hard to build a pipeline of opportunities where we can create value through our core competencies of deep sector expertise and the ability to underwrite complexity. As we previewed in our letter on July 23, we've been active in capital deployment post quarter end. As of today, Q2 fundings totaled approximately $135 million, primarily led by 2 new investments. In broad strokes, our reputation is creative solutions providers, particularly amongst participants within our sector themes put an important role in outsourcing of these investments. Our deep diligence and underwriting capabilities, along with the scaled solutions we're able to offer as part of the $34 billion Sixth Street platform, allowed us to structure investments with attractive spreads, strong call protection and other fees that enhances the overall risk-adjusted return profile of our portfolio. Today, we continue to have a robust pipeline, which we are constantly working to build through our direct sourcing channels. Looking ahead, we believe the competitive advantage of our human capital will become increasingly evident as a financing solution sought by companies, management teams and sponsors will only grow in complexity in this uncertain environment. As it relates to our portfolio at quarter end, the overall performance of our portfolio continues to be solid with approximately 98% rated 1 or 2 on a performance rating scale of 1 to 5 with 1 being the highest. And minimal nonaccruals at approximately 0.4% of the portfolio on a fair value basis, representing 3 investments. To revisit Josh's introductory remarks, we have long recognized the inherent fragility of the left-hand side of the balance sheet. Our assets are callable loans, which means that the investments where we are over-earning due to borrower outperformance are typically the ones that get called away. And in periods of volatility when credit spreads widen, the value of our assets tend to decline. In order to combat the fragile elements of the left side of our balance sheet, we have over the years focused on strong underwriting discipline and defensive portfolio construction, which includes sector, business model and management team selection. We believe these efforts have played a role in the performance of our portfolio to date. However, we'd be remised not to highlight our portfolio company's high-quality management teams who took quick action at the onset of COVID to optimize cost structures and protect their liquidity positions. Albeit still early, our portfolio has performed above our expectations given the macro backdrop. The slight increase in this quarter's nonaccruals from approximately 0.1% to 0.4% of the portfolio by fair value at quarter end was driven by our Neiman markets first-lien term loan, not our ABL FILO term loan, in the residual nonDIP roll up portions of our JCPenney first-lien term loan and secured notes. Given what we believe may be less-than-par recovery, we have applied the regularly scheduled cash interest payments we received during the quarter to the amortized cost of our physicians, all of which were acquired at prices less than prior. As we covered in our preliminary release in July, our retail ABL exposure at quarter end was stable from prior quarter at 9.4% of the portfolio at fair value. $0.99 Moran Foods and Staples, businesses that were generally deemed essential during COVID shutdown, continue to benefit from tailwinds in the current environment and together represent 44.5% of our retail ABL exposure at quarter end. Our largest retail ABL exposure is our FILO term loan in Neiman Marcus, which was 3.6% of our portfolio at fair value at quarter end. Our current expectation based on the company's plan of reorganization in case milestones is that we refinanced upon Neiman Marcus exit from bankruptcy, which is expected to occur in the fall of 2020. With Sixth Street as lenders of size in each of Neiman and JCPenney's prepositioned capital structure, we were able to have meaningful roles in driving the DIP financing process and terms. As a result, we believe our $11.5 million par value DIP loan for Neiman and our $6 million par value DIP loan for JCPenney at quarter end offer attractive risk-adjusted returns given the structural protection of DIP loans in combination with our contractual economics. Our portfolio's energy exposure at quarter end was 3.9% at fair value but has since fallen to 2.8% on a pro forma basis given partial paydowns on Verdad and Energy Alloys post quarter end. We expect to be fully repaid on Energy Alloys during Q4 2020 as the company completes an out-of-court wind down via liquidation of its assets. Our portfolio composition and credit stats for Q2 remained relatively stable from prior quarter. Top industry exposures continue to be business services at 22% of portfolio at fair value, followed by financial services and health care at approximately 17% and 11%, respectively. Based on the financial information through March 31 of our core portfolio companies, the average net attachment point at last dollar average was 0.4x and 4.3x compared to 0.3x and 4.1x, respectively. Our average interest coverage ratio was 3.3x compared to 3.2x in the prior quarter. We would caveat that these figures, given the timing lag and trailing nature do not fully reflect the impact of economic shutdown that persisted through most of Q2. However, based on an ongoing engagement with borrowers, we do not expect a material deterioration of credit metrics across our portfolio in the near term. This quarter, out of our portfolio of 65 names, we had only 1 investment outside of the retail sector ones we discussed earlier, complete an amendment with COVID cited as a direct cost. To the extent State reopenings are paused or reversed, we would expect that this figure will increase in order to provide our borrowers with additional flexibility on covenants. As of today, we do not expect any defaults on debt service obligations in the near term. Now on to our portfolio yields. The weighted average total yield on our debt and income-producing securities at amortized cost increased by approximately 10 basis points quarter-over-quarter to 10%. Breaking this down, there were 15 basis points of yield uplift from the impact of new and exited investments this quarter and 10 basis points of uplift from the impact of amendments. These were partially offset by 15 basis points of downward yield impact from the Neiman and LIBOR prior to it reaching our average floors of 115 basis points across our floating rate assets. Quarter-over-quarter, the weighted average spread over the 3-month LIBOR of our floating rate investments increased by 100 basis points, almost entirely due to the benefit of our LIBOR floors. With that, I'd like to turn it over to Ian.

Thank you, Bo. I'll begin with an overview of our balance sheet. Total investments at fair value decreased slightly from $2.05 billion to $1.98 billion quarter-over-quarter primarily due to net repayment activity in our portfolio, partially offset by the positive valuation impact of tightening credit spreads on the fair value of our investments. Total principal amount of debt outstanding was $875 million, and net assets were $1.08 billion or $16.08 per share. Our average debt-to-equity ratio was 0.87x, and our ending debt-to-equity ratio was 0.81x, down from 0.96x in the prior quarter. At quarter end, we had $1.08 billion of liquidity under our revolver against $73 million of unfunded portfolio company commitments available to be drawn. Given the net funding activity thus far in Q3, our leverage today is approximately 0.91x, and our liquidity stands at $975 million with an estimated $75 million of unfunded portfolio company commitments available to be drawn. In our recent letter to stakeholders, we discussed at length the structural limitations that make BDC model innately fragile. To review, these include the requirement to be long only, the need to be fully invested in order to generate a dividend level that the market expects and the fact that they aren't limitless, alpha-generating direct middle-market lending opportunities. This is further complicated by strict regulatory requirements and a mark-to-market valuation framework. Bo discussed the elements we've introduced to the left-hand side of our balance sheet to address the inherent fragility of our business model, and I'll now cover our efforts on the right-hand side of the balance sheet. As Risk managers and capital solutions providers, we believe paying for the option on liquidity during periods of low volatility is critical in our ability to operate and create value for both stakeholders and clients in periods of high volatility. At quarter end, our liquidity represented approximately 54% of our total assets, and we had nearly 15x coverage on our unfunded commitments available to be drawn by our borrowers based on contractual requirements in the underlying loan agreements. This compares to a peer median of approximately 5x at March 31. Our robust liquidity, combined with our financial leverage of 0.91x today, means that we have substantial investment capacity and flexibility during these uncertain times. To put some numbers around the cost of our option on liquidity, if our revolver was sized to have only 5x coverage of our unfunded commitments at quarter end, similar to the median of our peers, we would have picked up approximately 25 basis points of ROE on an annualized basis or approximately $2.6 million. However, through our ability to be opportunistic in both new portfolio investments and investments in our own capital structure in the past few months, we believe we have already realized a return on this investment. During the quarter, given our strong liquidity position, we were able to opportunistically purchase $29.7 million principal amount of our 2022 convertible notes and $2.5 million principal amount of our 2024 notes at prices below par. Concurrent with these purchases, we permenantized a portion of the unrealized mark-to-market gains on the interest rate swaps corresponding to those notes by effectively canceling pro-rata portions of our swaps. Taking these gains into account, our weighted average purchase price on the combined $32.2 million of notes was approximately 94%. To put this into perspective, the benefits of these purchases alone, namely our gains on the swaps and the reduction to our blended cost of debt covered the majority of our cost of the option for liquidity on the entire year. Moving on. To address the size and access constraints that BDCs face in the funding markets, we've also been paying for insurance to mitigate our refinancing risk. We extend the maturity of our 5-year revolver every 12 to 15 months. And opportunistically issued notes in the unsecured market to create a diverse funding profile with staggered long-term maturities. Our next maturity is approximately 2 years away at only $143 million principal amount, and our funding mix at quarter end was comprised of 73% unsecured and 27% secured debt. The average remaining life of our investments funded with debt was 2.2 years compared to a weighted average remaining maturity on our debt commitments of 4.2 years at the end of Q2. With respect to our fixed-rate liabilities, we continue to use interest rate swaps to match our liabilities with the predominantly floating-rate nature of our assets. In periods of economic uncertainty, which typically can coincide with falling rate environments, these swaps have enhanced our capital, liquidity and earnings profile. At quarter end, we had approximately $34 million of unrealized mark-to-market gains on our interest rate swaps, of which $15 million was embedded in our NAV. The remainder was reflected in the carrying value of our 2024 unsecured notes at quarter end, given the application of hedge accounting on our swaps associated with those notes. Turning to our presentation materials. Slide 8 is the NAV bridge for the quarter. As Josh mentioned, the impact of credit spread tightening on the valuation of our portfolio was a significant driver of NAV movement this quarter, with unrealized gains of $0.72 per share. Walking through the other drivers of NAV movement this quarter, we added $0.59 per share from net investment income against the base dividend of $0.41 per share. There was a $0.15 per share reduction to NAV as we reversed net unrealized gains on the balance sheet related to investment realizations and recognize these gains into this quarter's net investment income. Other changes resulted in a positive $0.25 per share impact to this quarter's NAV. This was primarily driven by unrealized gains related to some of our equity positions. Moving to the income statement on Slide 9. Total investment income of $70.2 million compared to $66.3 million in the prior quarter. This was driven by other fees which consists of prepayment fees and accelerated amortization of upfront or amortization of upfront fees from unscheduled paydowns of $14.3 million compared to $7.6 million in the prior quarter. The largest driver of this quarter's fees was Ferrellgas. Other income increased to $6.5 million compared to $2.8 million in the prior quarter. Interest and dividend income was $49.5 million, down $6.4 million from the prior quarter due to the decrease in the average size of our portfolio. It was also due to the impact of a falling LIBOR, which was mitigated by the average floors across our floating rate debt. Net expenses decreased by $1.8 million quarter-over-quarter to $29.8 million, primarily driven by lower interest expense from a lower effective LIBOR and a decrease in our average debt outstanding. This quarter's weighted average cost of debt outstanding decreased by approximately 60 basis points to 3.3%, reflecting the decrease in the effective LIBOR in our debt outstanding as well as a small accretive impact of our opportunistic notes repurchases. Given the one quarter timing lag on the LIBOR reset date for our interest rate swaps, we have relatively good visibility into our cost of debt for the quarter ahead as we think about our net interest margin for Q3 and beyond. So only LIBOR remains below the average floors on our assets. Any incremental declines in LIBOR will benefit our cost of debt and flow directly to our net interest margin for any given level of asset yields and leverage. Assuming an average leverage for Q3, in line with our current level of 0.91x and based on our Q2 asset level yields, we would expect net interest margin expansion for Q3 of approximately 90 basis points. This would imply a year-over-year net interest expansion in our business of approximately 115 basis points. Unlike most of our peers, with unswapped fixed rate liabilities that are likely experiencing net interest margin compression in this low rate environment, we have been able to enhance the earnings power of our portfolio in this period of economic uncertainty. On this note, let me wrap up with an update on our earnings guidance for the remainder of the year. Given our results for the first half of 2020 and our current outlook, we would expect our full year net investment income per share to be on the upper end of our previously communicated range of $1.84 to $2.01. Given the strength of our pipeline and the prospect for higher asset level yields given our capabilities as a solutions provider in this environment, we feel good about our ability to continue generating attractive ROEs for the period ahead. With that, I'd like to turn it back to Josh for concluding remarks.

Thank you, Ian. While we're pleased with our Q2 results, I'm proud of what the team has been able to accomplish to date in these challenging times, we're operating with the mindset that there will be prolonged economic challenges ahead of us. However, our deliberate efforts in creating a business that not only survives volatility and uncertainty but thrive on it continues to result in small wins. Hindsight is always 2020. And therefore, we are continually learning along the way. We will continue to evolve and refine our thinking in our processes to create a differentiated business model and experience for our stakeholders and our clients. Before moving to Q&A, I'd like to spend a moment to reflect on the impact of COVID on our communities. When we take a step back, if evident to the economic fall of this pandemic has had a disproportional impact of people with lower incomes, less job security and those locking caregiver flexibility. The aggressive impact of COVID was magnified by the inherent inequalities, racial, gender, socioeconomic, to name a few, as built into our institutions over time. As a result, in a business that strives to be leaders and communities, we can't help but fill an imperative to support change that helps create a better and more inclusive society. Over the past few months, in addition to trying to facilitate honest conversations with our teams on these topics, Sixth Street has been contributing resources to organizations, addressing inequality as well those directly counteracting COVID's economic impact. We've also been, for some time now, in exploring ways to addressing underrepresentation in finance through our recruiting and business partnership efforts. We think a silver lining of COVID is that these issues of inequality are being brought to the forefront, and we will continue doing our part as an organization to be an agent of change. With that, I'd like to thank you for your continuing interest and your support today. Operator, please open up lines for questions.

[Operator Instructions] Our first question comes from Rick Shane with JPMorgan.

Glad everybody is doing well. I wanted to talk to you a little bit about your relative cost of capital versus peers and your relative multiples. I know that, in general, you think of cost of capital on an absolute basis in terms of your investment strategy. But right now, your relative advantages are so significant. I'm wondering how you think about monetizing that. Is it through the possibility of acquisition? Is it through growth in a period when your peers can't necessarily grow and access capital in the same way that you do or could?

Rick, thanks for the question. So look, I don't think we get caught off at a moment -- in a moment looking at our cost of capital. We kind of have a view of the world, which is the market will tell you our cost -- the market will tell us our cost of capital, but that will fluctuate during times, and so we try to look at our cost of capital across cycles. On the M&A front, I think it's very hard to -- at this moment in time to get any accretive M&A done. Historically, the only kind of M&A in the BDC space has either been very, very small, externally managed BDCs that have really, really deep credit problems. We're -- at the time we have done work, we don't think that the kind of the valuation -- we think the market valuation is kind of reasonable to reflect those credit problems or on internally managed BDCs, where it's easier to get something done. Quite frankly, there's not that many scaled internally managed BDCs left. So I think as we think about the path forward to create value for our stakeholders on a go-forward basis, my view is continuing to buying high risk-adjusted return, opportunities to put our balance sheet to work. And we'll see if -- and I think that is ultimately the path for value creation. And that's kind of been our North Star since inception. And I think it's worked pretty well for our stakeholders. So I think we're most definitely in the latter camp versus a former camp as it relates to the value-creation path going forward.

Got it. My head is spending between latter and former in the context of your thoughts.

The organic growth between capital work in high risk-adjusted opportunities where our competitors are more capital constrained and we're not capital constrained versus the inorganic acquisition path.

Got it. Okay. I appreciate that. Look, to some extent, obviously, you're a financial company. But if you think about it in the context of being a manufacturing business, you make loans, and right now -- and it's been persistent, but I think right now, it's more disparate than it's been at any point in a long time. Your cost of goods sold is so advantageous versus your peers. I'm just wondering if there are more aggressive ways to take advantage of that.

Yes. I mean just to be -- like it's a little bit circular, I think. I think our cost of goods sold, so our cost of capital is low on a relative basis because the market thinks we are a very prudent allocator of capital, and that we try to build in a large margin of safety as it relates to the assets we're creating versus our cost of goods sold, i.e., have high gross margin. And when things go wrong, we're still able to create high returns on capital. I think the more you lean into the, " Hey, I'm super low in the cost curve," the more you'll probably end up eroding that relative advantage. If that makes sense?

It absolutely does. And again, understanding what motivates you guys in this issue helps us understand sort of where you're going, that makes a lot of sense.

Thanks, Rick.

Our next question comes from the line of Ryan Lynch with KBW.

First off, I really appreciate the shareholder layer that you guys provided, that was very thoughtful and informative. So thank you for that. Though, some of your comments earlier, you mentioned that M&A has been really muted in the market, which has pressured market activity as buyers and sellers struggle to agree on valuation. But then you also mentioned that you have a robust pipeline today. And so I'm just wondering, what has really changed in the marketplace to grow your pipeline? Has there been more market activity, generally speaking, or are you guys just getting better hit rates on some of the deals that you guys are searching for as well as can you kind of clarify when you talk about a robust pipeline, are you talking about just the potential for deal activity to pick up from the depth? You're talking about the pipeline returning to levels more seen in 2019.

Sure. Thanks, Ryan. Yes, as I mentioned, I think we're encouraged by both the depth and quality of the pipeline recently. And it's really across all channels that we focused on, so direct to company ABL. And now we're starting to see some sponsor-led opportunistic M&A activity. So we're encouraged to see that. I will say, as compared to Q2, where there was a pipeline, the quality is getting better. So we're continuing to be selective, and we'll always be selective and really focus our capital on the opportunities that we think are best for our shareholders. But it is across each of those channels. We're not seeing yet as a lot of new platform M&A from sponsors, rather more opportunistic M&A from existing portfolio companies. But still, again, I think the quality is up from what we saw, not only in Q2, but really throughout most of 2019.

You guys have a -- do you guys have a preference? Or do you guys favor in this environment more deep value sort of rescue-financing deals? Given just the tumultuous market backdrop, and I would assume that those opportunities are probably going to come up quite a bit, and you can get obviously extremely good pricing in terms or would you guys want to more lean into more secular grower stories, companies that don't -- haven't really been affected by COVID downturn, but obviously, the structures in terms of those aren't going to be as favorable. Do you guys have a preference?

We really don't have a preference. I think the beauty of the platform is that the expertise of our people and it even goes across each of those channels. We're obviously very active investing financings from time to time when we think the opportunity set is good. And we also like to pursue growth opportunities for businesses that are growing greater than GDP, have secular tailwinds and tend to weather downturns, economic downturns better. So we really focus the opportunity set based on the core competencies of our team, which is very diverse.

Okay. Fair enough. And then just one last one. You mentioned really only one investment outside of the 2 retail ones you talked about has completed in a net-net. You don't expect any new defaults in the near term. I mean that's surprising but, obviously, in a very positive way that you guys have a lot of confidence in your portfolio going forward. Can you just talk about with that assertion you guys made, what is the economic backdrop that you guys are using as a base case to make that assertion? And then from a higher level, why do you think that your portfolio has held up so well and performed so much better than other BDCs thus far in this?

Bo, let me hit some of that and then you can jump in or Fishy can jump in. Look, I think when you look at our portfolio, we didn't have -- we have very -- we had a small amount of cyclical exposure and cyclical business models typically have high fixed costs. And so that we avoided kind of the clinical cyclical business model generally. When you look at our top 3 industries, which include business services, financial services, but really fintech and health care, which is really either pharma royalty financings or health care IT, you just had -- those typically had variable cost structures and a strong kind of less-cyclical exposure and strong secular tailwinds. And so to me, it was just a -- most of the outside retail, which obviously has been impacted, we were just set up to have a kind of a cycle -- what we would call late-cycle mining portfolio construction or cycle-appropriate portfolio construction, means that might change over time. And so when we look at our portfolio, it's really a bottoms-up view versus a top-down view, i.e. slow recovery, V-shaped, U-shaped. It's really how these companies are doing. What are their forecasts? Are those realistic forecast? And so our view is really a bottoms-up view. I don't know, Bo or Fishy or any have anything to add, but it was really just business model and sector exposure.

I -- that's exactly right. I don't have a lot to add. I think we also had, as we mentioned in the script, we had a lot of really high-quality management teams that's focused on liquidity and appropriate cost structures early in the cycle, and that is accretive to our benefit as well.

Our next question comes from Finian O'Shea with Wells Fargo Securities.

First question on new deals this quarter. There were a couple that are PIK paying. You historically shied away from that reasonably so for the BDC structure, but what makes these more suitable or safer than opportunities that might be very attractive if it weren't for their PIK structure?

Yes. So look, TSLX and our affiliated funds, our growth platform originated those investments. And quite frankly, you hit on the nail on the head. Given the underlying business models that were growing at significant rates and the capital requirements for that growth, we did a -- we did structures that allowed the PIK. We're really bullish on the company, really bullish in the markets they serve, really bullish on the management teams. Unfortunately, the BD -- the Sixth Street Specialty Lending only could take small amounts, given we have a policy about how much PIK we're willing to have in the book. And so if those structures were not PIK structures, we would have had significantly more appetite for those in the BDC, but given our financial policy and given our risk limitations around PIC, they were relatively small size. In what was the -- I think they were each like kind of $5 million or $7 million or something like that?

Yes, that's right.

So that -- Bo, do you have anything to add there?

No, I think you hit it on the head.

I think frankly, it was $3.75 million, and it was a convertible note. And service channel was a $5 million investment at a 12% PIK. Again, those were much larger deals we have, but we thought they were very, very high risk-adjusted returns. Quite frankly, those companies might need more capital in the future that have a -- that are not PIK nature. When they -- when growth slows, they become more mature and, quite frankly, one of the reasons why we actually made the co-invest even in small sizes. If they -- if you -- if we weren't in those capital structures, we would not be able to provide those financings on a go-forward basis when they become appropriate for the BDC, given that the rules around joint transactions and affiliated transactions with affiliated funds. And so there -- we love them as a stand-alone investment. We also think there's going to be opportunity to put more capital in that are more appropriate for the BDC going forward.

Okay. And another portfolio name, AvidXchange, you've had that for a while. And I think the growth platform also took part in an equity round or I'm not sure if there's a few capital structures there. But the BDC got a very small piece of it. There's 2 it looks like. Can you give us some color on the nature of that capital raise and why the very small BDC allocation?

So there was a Bo, correct me -- I think there were 2 pieces. There was a Staple financing between a senior-secured facility and a redeemable pref with warrants, correct, Bo?

Correct.

And you -- and there were a strip and so the redeemable pref with warrants was much larger than the senior-secured facility. So again, the exact same considerations that we discussed before. AvidXchange is actually a kind of a more mature business. It's in the B2B payment space but much more mature business. But again, it came down to having the right -- having been appropriate for the BDC, which has a cash paid dividend as a liability that we're always thoughtful about.

That's right. The only thing that I would add is that's a business that we've known well since 2015. We think it's excellent risk/reward, but again, sized appropriately given the PIK component.

Our next question comes from Robert Dodd with Raymond James.

Just a kind of general question. I mean obviously in the prepared remarks, you brought up, obviously, the amount of stimulus that's been put in and that's one of the contributing factors to spreads retracing so much of the widening they went through before. So there's -- obviously, there's benefit to NAV on that. What do you think the risks are given how much private capital there still is out there as in all that rate is a result of this COVID issue that those spreads continue to retrace to NAV benefit, but potentially to the opportunity set getting excessively competitive, again, as it was, call it, last year, but before we had this COVID event.

Yes. So you hit it, Robert, as you always do, the good news and the bad news. The good news is the -- with the spread retracing, there has been a benefit to NAV, a benefit of the capital in the BDC space, a benefit to people not getting closed out, stakeholders not getting closed out of their option, i.e., having issues with -- from a regulatory framework or from lenders in the space. So that's the good news. The bad news is, the question is has it truncated, that coupled with the amount of private credit dry powder has it truncated the go-forward opportunity. I think -- is that the question?

Yes.

Yes. So look, I would say it's surely -- it's most definitely, I won't say, Uber competitive. It's a lot less competitive than a year ago. We actually saw when you look at the data, you actually saw yields -- absolute yields, not only on a spread basis, but actually come up quarter-over-quarter, I think, in our book. And so I think in -- so I think last yield amortized cost last quarter was 9.9%. It's at 10%. On a spread basis against LIBOR, it's much wider. The new investments we put in, in Q -- that we've put in Q3 to date have been much wider. And so it's surely not -- I don't think it's been -- it's surely not what it would have been if the Fed hadn't stepped in. There would have been a ton of issues across the BDC space, I think, and across -- generally across risk assets if the Fed didn't step in. I think we would have been very well positioned to take advantage of that. But we would have had less investment capacity, we would have been more concerned about liquidity. So I think if it is what it is, I don't think that there is the go-forward opportunity set. At least, what we're seeing today has been completely truncated. And we feel like there's probably some -- there is some good opportunities out there. And we've executed on that in Q3. Mike, do you have anything to add, Fishy, I always try to throw Fishy in the mix, just to keep it on the coast. Fishy is on the West Coast.

No. I have nothing.

Thanks. Nice value-add there, Fish.

If I could ask just to kind of bifurcate that a little bit, maybe, because to your point, spreads widened in Q3, but the biggest investment in Q3 was the extension of renewal, if you will, of the ABL with whose name I've written down so as I've misplaced it. So is that -- is the opportunity set, given ABL financing there's a much more specialized labor-intensive business. I mean is that where the spreads and yields are staying wider versus in the traditional cash flow lending such that it is, given renewed activity there? Is there going to be an increased divergence between available returns in, for a lack of word, a specialized book versus a commodity lending book? And should we expect maybe the ABL book to grow faster as a result?

Yes. I think that's a good question. So what I would say is that -- so we made 2 large investments in Q3. One was ABL deal, receivable financing and one was, which quite frankly, had very much wide spreads. It was complicated, had very much wide spreads historically available. And then one was a -- we don't call -- it's a cash flow loan, although it's a company that has high-recurring revenue embedded -- ERP like embedded in their customer base. So we think there's a second way out. And so it's not -- and so we don't think about we're not pure-cash flow lenders in that sense. That loan, we had -- we got warrants. I think Bo, correct me if I'm wrong, 7% of the company is struck at the money. And so -- and it was done at probably 200 -- 150 to 200 basis points wider with more call protection than what would have been done pre-COVID.

Correct.

And -- so look, I think you're going to see wider spreads across credit asset classes, and quite frankly, if lenders are not pricing stuff with wider spreads, they're effectively telling their investor base and telling their stakeholders that they see no uncertainty in the world. Like there's no -- like wider spreads or to compensate us, they compensate investors for uncertainty. And I can't imagine anybody in the world if they're being disciplined as it relates to allocating capital, doesn't think that uncertainty has increased significantly over the last 6 months. And so I expect that you'll see wider spreads or you should see wider spreads if people are doing their jobs and being fiduciaries to their stakeholders across the opportunity set. My guess is on the margin, you're going to see wider spreads for specialized kind of lending opportunities. Where there is complexity, you'll see more drastic because people, when they already have problems in their book, don't want to take on more kind of problems through complexity. But it would be shocking to me if people are trying not -- are pricing the same things as competitive as they were a year ago. A year ago, there was a lot less uncertainty. And again, you got to get paid for the uncertain world we're in.

Our next question comes from Mickey Schleien with Ladenburg.

Yes. Glad to hear you're doing well. I sort of want to follow up on Robert's question and ask you about the market zone, Josh. We're obviously in a yield-hungry world, and there's a lot of capital which is formed to invest in private debt and disintermediate the banks. And when we look at the forward LIBOR curve, which has been wrong many times, nevertheless, it implies that very low interest rates will persist for years. But like we've all talked about this morning loan spreads are tightening again. GDP looks like it will bounce back a lot in the third quarter with the economies reopening, obviously, from very poor results in the first half of the year. But after that, the forecast looks pretty weak. Which could keep the fed from tightening again. So this scenario, to me, seems to point to continued pressure on portfolio yields. A lot of that has been in place for a while, but as you pointed out, you generally maintained excellent portfolio yield. So I'd just like to step back for a moment and ask what factors in your origination process and perhaps your relationships provide you the ability to generate the loan terms that we see, particularly the fee structures that have helped to mitigate that pressure like we saw with Ferrellgas this quarter.

Yes. So look, I think, a, we're willing to -- I think there's a couple of different pieces of our business, a good question, Mickey. The first one is, like we have really deep expertise in some sectors. And we're involved in those sectors. We're involved in those ecosystems. And so I think as it relates to those -- as it relates to that piece of our business, we -- our counterparties don't think we're a commodity lender. They think they can at speed and certainty because we have deep knowledge in the nuances of how those industries and how those ecosystems work. And so I think that's most definitely been helpful on our sponsor business. The second thing is that the -- we're not in the asset-gathering game. Like we're in the creating returns, serving our clients and creating returns for our stakeholders game. And so I think part of the spread widening, I mean, as far as supply tightening over time is people or competitors or the industry growing much faster than the actual true demand for capital from GDP. And you've seen this in when you see -- when you look at historically over time, right, the corporate sector is massively levered. That corporate debt has grown faster than GDP. And so asset managers have leaned into growing assets and they've traded growing assets for creating high stakeholder returns. And so we surely have a different model on that front. And just -- and if people haven't looked at it, the corporate sector had -- it's going to be really interesting. And actually, this is why I think this is why I'm quite bullish on the opportunity set. If you look up through 2007 pre-global financial crisis, the corporate sector had a lot less GDP than it did. The corporate as a percentage of GDP was a lot less than it did pre-COVID. So the corporate sector started the cycle much more levered and, quite frankly, has issued much more debt in post-COVID than post-global financial crisis. And so you're going to end up with a massively over-levered corporate sector when things settle out with what I would expect to be relatively anemic growth, especially if you look at the LIBOR curve and which 3 will create an opportunity for providing creative financings where there's complexity. And then outside the sector expertise outside of our desire not to grow the business, but kind of shade creating stakeholder returns and serving our clients, we're willing to deal with complexity in another way that is really not a great investment from the investment manager standpoint because those assets tend to churn more. You can't build -- you can't stack assets because of the booked churns, and therefore, you can't grow fees, but they tend to be a great return for shareholders. We've been willing to do that, and we'll continue to do that for our stakeholders.

I appreciate that. It's a great philosophy, and I really appreciate it. In light of what you just said, Josh, how do you see LIBOR floors trending on new deals over time. In other words, for the most part, everyone's deals are now benefiting from LIBOR floors that were negotiated 2 or 3 years ago, but LIBOR has crashed. Is the market being more accommodative? Or are lenders sort of sticking to their guns on LIBOR floors?

Look, look, I think the -- if you look at our -- the vintages across our labor floors, 2020 vintages for LIBOR floors were really no different than 2019.

And post-COVID, is that still the case?

Yes.

Okay. Good. That's good to hear.

And quite frankly, again, like I actually think to Rick Shane's point is we sit the lowest on the cost curve, right? And effectively, we have lower fees, we have lower -- given our floating rate liability structure, we're the lowest on the cost curve. So I would -- I would if things work with the way they should work, people should be more focused than we are, and we should have -- there should be less pressure on keeping and maintaining net interest margin, which we should benefit from because we're the lowest on the cost curve.

I understand. Josh, in terms of your particular expertise, obviously, one area is taking advantage of the tail spin in the brick-and-mortar retail space. And we've seen a number of bankruptcies in the last few days, and you've been very adept there. How do you see competition developing in that segment? Are there new entrants coming in to try to take advantage and dislocating deal terms? Or are you still in a position where you think you can get comfortable risk-adjusted returns there?

Yes. So the good -- there's most definitely more competition. The good news is there's more supply of opportunity as well.

Yes.

All right. So in that space, quite frankly, that's not good news, right? It's obviously very -- is being a little bit flip. It's obviously very -- it's when you take a big step back and you look at communities, and there's a lot of hourly workers that are being affected. But from an opportunity set, there's a lot more opportunities. There is slightly more capital formation, but it feels like there's key to risk adjustment -- continues to be this key to risk-adjusted returns there as well.

Our next question comes from the [indiscernible] with Delphi Capital.

Yes. I have 2 questions. The first question is that how many loan modifications out of total borrowers did you make last quarter? And how are you going to deal with loan modification request? This is my first question. And the second question is that I'd like to know the impairment -- loan impairment station last quarter. And if you have loan impairment, I'd like to hear from you the expected recoveries of those loan impairments.

Let me answer the second question first. So the -- I would refer you to our scheduled investments. The scheduled investments have -- in BDCs, you have to mark your assets at fair value. And so those would incorporate recoveries and time lines, those fair value. So you -- and on Level 3 assets, those are mark-to-model, but again, they incorporate time and recoveries in the fair value and then on Level 2 assets that incorporates effectively, the markets collective view on time lines and recoveries that for fair value, i.e., if a loan trades at $0.40, the recovery -- the market views that the recovery is something above $0.40 based on whatever the ultimate recovery based on an assumed time line. So I would refer you to schedule investments and you can look at fair value. On the first question was there were effectively 3 -- there was no really uptick, and we constantly are doing amendments of waivers for companies given the structure of our loan agreements. That relate to, quite frankly, if they open a -- typically, if they open up a new checking account, they need to come to us and get an amendment of waiver, we need to get a control agreement in place. And so generally, there was not a material uptick in amendments of waivers. The -- there was 3 COVID-related kind of -- or kind of what I would say, nonnormal amendments of waivers. Two of those were Neiman and JCPenneys, which is obviously retail related and has filed a bankruptcy that we're involved in. And the third one was a consumer company.

And I'm currently showing no further questions at this time. I'll turn the call back over to Joshua Easterly for closing remarks.

Great. Well, look, we really appreciate people's time. And we hope everybody has a good remainder of the summer and a good Labor Day and clearly, it's going to continue to be interesting. And for anybody who's a parent to figure out what's happening with their kids going to school and not going to school, and obviously, the investment environment continues to remain tricky, but we'll continue to work very hard for our stakeholders and for our clients in providing valuable creative solutions, so they can create value for their stakeholders, and we'll continue to work for our stakeholders. Thank you very much.

Thanks, everyone.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.