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

Good morning, and welcome to Sixth Street Specialty Lending, Inc.'s Fourth Quarter and Fiscal Year Ended December 31, 2024, Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Friday, February 14, 2025. I would now like to hand the conference over to Ms. Cami VanHorn, Head of Investor Relations. Please go ahead.

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, 2024, 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, 2024. 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. Thank you for joining us. With us today is our President, Bo Stanley; and our CFO, Ian Simmonds. For our call, I will review our full year and fourth quarter highlights and pass it over to Bo to discuss activity in the portfolio. Ian will review our financial performance in more detail, and I will conclude with final remarks before opening the call to Q&A. After the market closed yesterday, we reported strong fourth quarter results with adjusted net investment income of $0.61 per share or an annualized operating return on equity of 14.2% and adjusted net income of $0.54 per share on an annualized return on equity of 12.5%. As presented in our financial statements, our Q4 net investment income and net income per share, inclusive of the unwind of the noncash accrued capital gains incentive fee expense or $0.01 per share higher than the adjusted figures. In Q4, we earned $0.15 per share of activity-based fees, including dividend income, representing the highest amount in 7 quarters. We continue to build net asset value per share from $17.12 as of September 30, to $17.16 as of December 31. Additionally, our base dividend remains well covered with adjusted net investment income of $0.61 per share, exceeding our base quarterly dividend by $0.15 per share or 33%. For the full year 2024, we generated adjusted net investment income per share of $2.33, representing an operating return on equity of 13.8% and full year adjusted net income per share of $1.97 or return on equity of 11.6%. As we've always said return on equity on net income is a measure that matters. On that basis, we generated nearly 12% for 2024. This remains well above our estimated 9% cost of capital and significantly above the Q3 LTM average return on equity for the BDC sector of approximately 9.1%. Further, we developed -- delivered an increase of 70 basis points on net asset value per share from $17.04 as of December 31, 2023, to $17.16 as of December 31, 2024. Looking back at 2024, all results were driven by a number of factors, including a shift in interest rates, additional activity-based fees, credit headwinds and movement in new investment spreads. We'll highlight the impact from each of these components, starting with the tailwinds. First and most obvious, interest rates remained higher for longer, providing an earnings boost for the sector. 12 months ago, the forward curve indicated interest rates of approximately 3.6% today. This compares to a 3-month -- 3-year SOFR swap rate today of approximately 4% or 40 basis points difference. Higher base interest rates for LTM operating ROEs for the sector through Q3 of 12.3% and 13.9% for TSLX, well above the long-term sector average of 8.9%. For TSLX, the rate environment in 2024 contributed approximately $0.03 per share of net income above our guidance. In addition to slightly uplift from rates. We earned $0.44 per share of gross activity-based fee income, including dividend and other income in 2024, representing the highest amount since 2021. A significant portion of the income came in the fourth quarter as we experienced a resurgence of repayment activity in our portfolio. This resulted in a $0.15 per share of activity-based fee income for the quarter above our trailing 3-year historical average of $0.09 per share. This fee income is a product of our in-depth underwriting and selective investment approach as we carefully structured investment include call protection and other features that create value for shareholders. In 2024, activity-based fee income contributed approximately $0.15 per share of net investment income above our guidance. Now pivoting to the headwinds. Consistent with our message for the last couple of years, we expected credit to weaken on the margin in tails emerge. Over the last 12 months, we experienced idiosyncratic credit deterioration across 2 portfolio companies. Astra Acquisition Corp. and Lithium Technologies, both of which we added to nonaccrual during the year. And the lost interest income from these 2 investments after being placed on nonaccrual status resulted in a $0.07 per share negative impact to net investment income in 2024 relative to our forecast. Even with the lower fair value on these investments, we continue to grow net asset value year-over-year by 70 basis points. This compares to a decline of approximately 160 basis points on average for the BDC peer group through Q3 2024 compared to Q4 2023. For the same period, net asset value per share for TSLX increased 50 basis points, representing roughly 210 basis points of outperformance. And finally, new investment spreads moved tighter throughout the year, driven by the significant amount of capital raised in the direct renewspace combined with muted M&A volume. This is the supply and imbalance that we've talked about on several of our previous earnings calls. To illustrate the movement of spreads in 2024, we will compare Q4 2023 to Q3 2024, given we are still early in the fourth quarter reported cycle. As of Q4 2023 the weighted average spread on first lien performing assets in our portfolio and for public BDCs was 8.3% and 6.4%, respectively. This compares to a weighted average spread as of Q3 2024 of 8% and 6.1%, respectively, representing a decline of 30 basis points for TSLX and the public BDC sector. As the market moved tighter to 2024, the impact of tighter spreads on new deals lowered our net investment income by approximately $0.07 per share compared to our forecast for the year. That being said, we continue to put on new deals at wider spreads relative sector as evidenced by our weighted average spread on new deals in Q3 2024 being approximately 150 basis points wider than the average for our public BDC peers. Although there were puts and takes, we met our guidance on an operating income basis for the year. Looking ahead to 2025, we believe the earnings potential for BDCs is largely tied to portfolio spreads. To put it simply, the deals you do today will ultimately be the driver of returns in the future. As an illustrative example, we've calculated the estimated return on equity, assuming our entire portfolio had a weighted average spread equal to the weighted average spread we earned on new investments in the fourth quarter of 6.4%. Based on our balance sheet as of year-end, the 3-year SOFR swap rate of 4%, 1.5% OID over a 3-year average life and consistent with our union economics over the last year. A weighted average of 640 basis points implies a return on equity of 9% and 10%, assuming 0 to 50 basis points of credit losses on assets. We can compare this to earnings potential for the sector by using the weighted average spread of new first liens in the third quarter of 529 basis points for public BDCs. To simplify the analysis will assume management incentive fees, leverage cost of funds and our operating expenses are based on the Q3 LTM average for the sector. Using the 3-month SOFR swap rate of 4%, 1.5% OID over a 3-year average life and the long-term annualized return net loss rates according to Cliffwater Direct Lending Index of 102 basis points, a weighted average portfolio spread at 529 basis points generates approximately 5% return on equity for the sector. It is important to note that these return estimates assume a 3-year swap rate of 4%. If base rates move lower, ROEs will move lower, two, given the asset sensitivity and some liability sensitivity for the BDC space. As we have said in the past, today's front book is tomorrow's back book. This was the big theme we highlighted during our Q2 earnings call 6 months ago and remains top of mind when we make our investments. To be clear, the analysis is for illustrative purposes only. If our entire portfolio will call it away, our return on equity in the term would be boost given the impact of embedded call protection and amortization of upfront fees. While it may feel like the value proposition for direct lending is eroding on the margin given spread levels in the market today. We set up our business with a differentiated sourcing channels to deliver a sustainable return profile for our shareholders. We continue over earning our cost of capital even in a more competitive tighter spread environment and believe this will be a key contributor to the dispersion in returns to the sector in the future. Yesterday, our Board approved a base quarterly dividend of $0.46 per share to shareholders of record as of March 14, payable on March 31. Our Board also declared a supplemental dividend of $0.07 per share related to our Q4 earnings to shareholders of record as of February 28, payable on March 20. Our year-end net asset value per share adjusted for the impact of the supplemental dividend that was declared yesterday of $17.09, and we estimate that our staller income is approximately $1.23 per share. With that, I'll now pass it over to Bo to discuss this quarter's investment activity.

Thanks, Josh. I'd like to start by laying on some additional thoughts on the direct lending environment and more specifically, how we are positioned for the opportunity that we are anticipating in 2025. 2024 was another year of lower M&A volumes as interest rates remain elevated and valuation gaps persisted between buyers and sellers in the market. While a setup for 2025 is not entirely different from that of 2024, we are optimistic about the higher activity levels this year for a few reasons. First, valuation gaps have narrowed after multiples reached trough in 2023 and from the peak prices paid for businesses in 2021. The reality is that if a buyer paid an excess multiple a few years ago and multiples have since contracted, that implies additional growth in the businesses required before they can earn back their money, let alone a reasonable return. Achieving that growth generally takes time and companies that have had yet another year to go back into earnings. Second, in a more stable macroeconomic backdrop. Compared to 2024, interest rates have stabilized to what we may now consider the new normal while inflationary pressures have largely subsided, at least for the time being. While still higher for longer, we believe that the normalization of rates, while still being -- while still more -- we'll bring more buyers back into the market in 2025. Lastly, pressure has continued to build in the system, the sponsors sitting on record amounts of dry powder. Each of these factors will take time to fully materialize, but they set a promising stage for increased activity levels this year. Amidst the slower M&A backdrop in 2024, we had an extremely productive year of putting capital to work in differentiated investment opportunities. In Q4, we provided total commitments of $479 million and total fundings of $324 million across 9 new portfolio companies and upside at the 7 existing investments. In terms of commitments, Q4 was our busiest quarter in 3 years since Q4 of 2021. For the full year 2024, we provided $1.2 billion of commitments and closed on $839 million of fundings representing an increase from the 2023 levels of $959 million and $808 million, respectively. In 2024, we stayed active in the market by leveraging our omnichannel sourcing capabilities across the 6 REIT platform. This, including being a valuable solution provider in both the sponsor and nonsponsor channels. In the sponsor finance market, our thematic investment allows us to provide speed and certainty in the sectors we like and know well, thereby positioning us as a differentiated source of capital in what has become the most competitive segment of the direct lending market. As for the nonsponsored businesses, the breadth of 6 REIT's platform provides us with the ability to originate credits away from the regular way sponsor finance business. In 2024, 37% of total fundings were to nonsponsored businesses. It is generally in this less traveled theme of the market where we earn incremental spread while maintaining an appropriate risk return for our shareholders. Given our access to a wide top of the funnel across multiple origination channels, our investment pipeline is not solely linked to M&A volume but rather stems from long-standing relationships, sector expertise and flexible capital approach. To highlight a differentiated investment in Q4, also our largest funding for the quarter we closed on a new investment to TRP Energy. This was structured as a new term loan facility that recapitalized the business in connection with an asset exchange. As part of the transaction, TRP refinanced its existing term loan engine by Sixth Street, resulting in approximately $0.07 per share from the combination of prepayment fees and dividend income. This investment allows us to stay -- invest alongside a trusted management team through a new deal with call protection. We believe this investment underscores the power of the Sixth Street platform and creating unique investment opportunities. To touch on another nonsponsor investment we made in 2024. Arrowhead Pharmaceuticals was in the press in Q4 announcing a large-scale global licensing and collaboration agreement with Sarepta Therapeutics. After receiving HSR approval last week, the transaction will be effective in Q1, and we anticipate a repayment of a portion of our loan in accordance with agreed upon prepayment terms. Based on these terms, we expect to earn $0.07 per share of estimated activity-based fees in Q1 of 2025. Similar to our investment in TRP Energy, this opportunity was a direct result of deep expertise across the Sixth Street platform. We have been established and a core competency in specific themes within the health care sector over a number of years, which has positively benefited our shareholders, demonstrated by an asset-level weighted average IRR and MOM of 14.7% and 1.4x on fully realized health care investments in the TSLX portfolio. Both of these examples highlight the differentiated portfolio we have created. This is further demonstrated by the examining the overlap of investments in the TSLX portfolio with other BDCs and comparing that to an investment overlap across the BDC sector. As of Q3 2024, TSLX at approximately 25% less portfolio overlap compared to the overlap on average for the sector. Pivoting to funding trends in Q4, 98% of our new investments were in first lien loans, reinforcing our long-term focus on investing at the top of the capital structure. All 9 new investments were across platform deals where we leverage the size of Sixth Street's capital base to lead and participate in transactions that presented attractive risk-adjusted return opportunities. This contributed to Sixth Street aged in 88% of the deals funded in TSLX in the fourth quarter. In today's crowded marketplace of direct lenders, we believe our skilled capital base serves as a competitive advantage as we are able to lead transactions ultimately allowing us to drive shareholder returns. Moving on to repayment activity. As Josh highlighted earlier, we experienced a significant pickup in payoffs during the fourth quarter to finish off the year. Total repayments in Q4 were $305 million. For the full year, repayments totaled $794 million, reflecting a 69% increase over 2023 and resulting in net funding activity of $45 million for 2024. To characterize the repayment activity we experienced during the fourth quarter, we saw a mix between payoffs related to M&A and refinancings. Two of our payoffs driven by M&A, TRP Energy and Kyriba, resulted in the repayment of our existing investment, followed by the opportunity to continue lending to the business through a new money term loan. In terms of repayments driven by refinancings, we continue to pass on deals getting done at spreads that do not present an appropriate return profile for our shareholders. From a portfolio yield perspective, our weighted average yield on debt and income producing securities at amortized costs decreased quarter-over-quarter from 13.4% to 12.5%. Half of this decline of 46 basis points was from lower interest rates and the rest was a mix between yields on new fundings and spread step-downs on an existing investment. In today's tighter spread environment, we have continued to participate in investment opportunities that we estimate will earn a return that is greater than our cost of capital. This is illustrated by only 5.1% of our portfolio by fair value in senior secured loans with spreads below 550 basis points. Further, less than 1% of our portfolio by fair value carries a spread below 500 basis points. We highlight this for the reasons we have outlined in the previous earnings call regarding the importance of earning our cost of capital. Moving on to the portfolio composition and credit stats. Across our core borrowers for whom these metrics are relevant, we continue to have conservative weighted average attach and detach points of 0.6x and 5.1x, respectively and their weighted average interest coverage remains consistent at 2.1x. As a reminder, interest rate coverage assumes that we apply reference rates at the end of the quarter to run rate borrower EBITDA. As of Q4 2024, the weighted average revenue and EBITDA for our core portfolio companies was $336 million and $110 million, respectively. Median revenue and EBITDA was $147 million and $53 million. Finally, the performance leading of our portfolio continues to be strong with a weighted average rating of 1.10 on a scale of 1 to 5, with 1 being the strongest represent an improvement from last quarter's rating of 1.14, driven by growth in the portfolio from new investments and the repayment of a 2 rated investment during the quarter. Nonaccruals represent 1.4% of the portfolio at fair value with no new investments added to nonaccrual status in Q4. With that, I'd like to turn it over to my partner, Ian, to cover our financial performance in more detail.

Thank you, Bo. 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 $0.62 resulting in full year net investment income per share of $2.39. Our Q4 net income per share was $0.55, resulting in full year net income per share of $2.03. We experienced an unwind of $0.06 per share of capital gains incentive fees in 2024, resulting in adjusted net investment income and adjusted net income per share for the year of $2.33 and $1.97, respectively. . At year-end, we had total investments of $3.5 billion total principal debt outstanding of $1.9 billion and net assets of $1.6 billion or $17.16 per share, which is prior to the impact of the supplemental dividend that was declared yesterday. Our ending debt-to-equity ratio was 1.22x, up slightly from 1.19x in the prior quarter our average debt-to-equity ratio also increased from 1.14x to 1.23x quarter-over-quarter. For full year 2024, our average debt-to-equity ratio was 1.19x down slightly from 1.2x in 2023. In terms of our balance sheet positioning at year-end, we had $674 million of available revolver capacity against $205 million of unfunded portfolio company commitments eligible to be drawn. As discussed on last quarter's call, we satisfied the maturity of our 2024 unsecured notes during the fourth quarter through utilization of undrawn capacity on our revolving credit facility. Following that repayment, our nearest maturity does not occur until August of 2026. Consistent with our ongoing messaging of being an annual issuer, we anticipate accessing the unsecured market in calendar year 2025 to extend our debt maturity ladder and maintain our target funding mix. Last month, we kicked off the annual process of amending and extending our revolving credit facility. While the current maturity on the facility is not until 2029, we have historically extended the maturity on an annual basis, driven by our asset liability matching principle of maintaining a weighted average duration on our liabilities, that meaningfully exceeds the weighted average life of the assets funded by debt. We anticipate marginally lowering the drawn spread and undrawn fee on the facility upon closing of the amendment in Q1. Moving to our presentation materials. Slide 10 contains this quarter's NAV bridge. Walking through the main drivers of NAV growth, we added $0.61 per share from adjusted net investment income against our base dividend of $0.46 per share. The impact of tightening credit spreads on the valuation of our portfolio had a positive $0.08 per share impact to net asset value. There was a $0.07 per share decline in NAV from net unrealized losses driven by portfolio company-specific events. Other changes included $0.12 per share reduction to NAV as we reversed net unrealized gains on the balance sheet, primarily related to investment realizations in TRP Energy and Kyriba. And finally, there was a $0.05 per share uplift from net realized gains on investments, largely from our equity investment in Murchison oil and gas. Pivoting to our operating results detail on Slide 12. We generated a record level of total investment income of $123.7 million, up 4% compared to $119.2 million in the prior quarter. Walking through the components of income, interest and dividend income was $113.8 million, up from $110.9 million in the prior quarter, driven by net funding activity. Other fees representing prepayment fees and accelerated amortization of upfront fees from unscheduled paydowns were also higher at $5.1 million compared to $4.3 million in Q3, driven by the activity-based fees earned on repayments that Bo highlighted earlier. Other income was $4.8 million, up from $4 million in the prior quarter. Net expenses, excluding the impact of the noncash accrual related to capital gains incentive fees were $65.9 million, up slightly from $65.8 million in the prior quarter. Our weighted average interest rate on average debt outstanding decreased approximately 70 basis points from 7.7% to 7%. This was largely driven by the decline in reference rates coupled with a funding mix shift following the repayment of 2024 unsecured notes in the fourth quarter. As a reminder, our liability structure is entirely floating rate, which means our cost of debt will move in the same direction as interest rates. Before passing it back to Josh, I wanted to provide a framework for how we are thinking about guidance for this year. We anticipate the key variables in 2025 to be similar to those in 2024, including the movement of interest rates and new issue investment spreads, which will impact the amount of interest income and activity-based fees we expect to earn. Based on our model, which incorporates the forward curve and assumes spreads on new deals and leverage remain consistent with the fourth quarter, we expect to target a return on equity on net investment income for 2025 of 11.5% to 12.5%. The lower end of this range reflects muted activity-based fees, while the upper end reflects a more normalized level of activity-based fees. Using our year-end book value per share of $17.9 which is adjusted to include the impact of our Q4 supplemental dividend. This corresponds to a range of $1.97 to $2.14 for full year 2025 adjusted net investment income per share. As a reminder, our base dividend is $1.84 per share on an annual basis, which we believe remains well protected. With that, I'll turn it back to Josh for concluding remarks.

Thank you, Ian. I started the call by sharing my thoughts on the unit economics of the sector, and we'll wrap up today by closing the loop on that topic. Competition in direct lending market is fierce and spreads on new issue loans were historical tights. Last year, the combination of interest rates and existing portfolio spreads on older investments contributed to above average operating earnings for the sector. As we anticipated, credit was a headwind to earnings in 2024 for the sector. This year, we expect largely to offset in terms of tailwinds and headwinds to the sector. As back books converted in front book, we will see portfolios as a potential challenge earnings. The math we illustrated earlier highlights that capital has been misallocated at least as it relates to return on equity and where firms in the sector sit on the cost curve. We expect this to become evident in 2025 as weighted average portfolio spreads converge to prevailing spreads in the market today. On a positive note, we believe the majority of credit issues to be known and therefore, we expect credit improve from here. We share these views because we care about maintaining the value proposition for the sector. Ultimately, we are a long sector and it's important that other direct lenders understand their cost of capital and price risk appropriately. We're dedicated to upholding our standards to ensure that our sector remains a desired place for investors -- both equity and debt investors. We look forward to working hard to deliver for all our stakeholders throughout 2025 and beyond. With that, thank you for your time today. Operator, please open the line for questions.

[Operator Instructions] Our first question is going to come from the line of Finian O'Shea with Wells Fargo Securities.

I want to ask about the origination outlook sounds better and tie it to a name you mentioned. I couldn't find, it may be a new commitment, but TRP Energy, it sounded like the type of cap solutions deal that delevers the first lien and recaps it. Correct me if I'm wrong there. But is that the source of a lot of the new opportunity you're feeling? And what kind of spreads or returns do you get from that opportunity?

So TRP was not that type of transaction. TRP was a first lien financing, obviously, in a space that we have expertise in, and that is kind of, I would say, off the run and energy. On that, we feel really good about the risk return. We are seeing the capital solutions stuff. I think that comes -- that will be prevalent in 2025 origination, but that was not TRP. I'm not sure there was any in -- I guess, I don't think there's any in that book today. I think we have a couple in our pipeline that would -- or at least 2 that have closed actually in Q1 that are kind of -- continue to be more after on capital solutions oriented. And those range from obviously, in the top end of the range, somewhere between SOFR 600 up to SOFR 850. But TRP was not one of them.

Very good. And a follow-up I want to ask about IRG. I think you've been working on that one for a while. We took a touch of a mark this quarter. So any update you could give us on that?

Yes. We're working on getting those assets sold. They own super valuable, the portfolio of company-owned super valuable assets, we think in land in Palm Beach or West Palm Beach. We hope to have a resolution there in the next quarter or 2 quarters on that.

[Operator Instructions] And our next question is going to come from the line of Brian Mckenna with Citizens JMP.

So it was great to see such strong results in the quarter despite the 100 basis point decline in base rates into year-end. And then looking at Page 5 of the deck, you've really delivered impressive results and strong ROEs on just about every kind of operating environment over the past decade. So the question is, why does your model work so well in any and all backdrops?

Yes. Thanks, Brian, thanks for the question. Yes, I mean, look, we worked really hard to be right on credit. And so when you look at our historical loss rates over time. They've been well significantly below the sector loss rates and the asset set -- the asset returns in the industry. So that -- it starts with loss rates, it starts with being an investor first. Second is, I think we have a bigger top of the funnel, which is historically, a lot of our competitors have focused early on the sponsor model or response origination channel. That origination channel is the most competitive where you have -- are kind of the most whippy on spreads. And so I think it's a function of having a bigger top of the funnel where we're able to find off the run opportunities that offer better asset level returns and then minimizing credit losses. And so when you look at the unit economics of the space, you can see it historically -- give me 1 second. So the unit economics of the space have historically been, I think our weighted average return on assets have been a couple of hundred basis points higher on the portfolio and then credit losses have been -- if you look at software has been about 2.2% on equity, and we've been half that. And so we've been 208 -- I guess, historically since our IPO, 208 basis points higher on asset yields. Again, that's mostly because of a top of the funnel wider aperture and we've had significantly less credit losses since inception since our IPO compared to the space. So those are the 2 big drivers of our performance over time.

Okay. That's super helpful. And then just a bigger picture question here. I mean there's clearly a lot of capital being raised and deployed in private credit today. And then obviously, the public credit markets are also very active. So borrowers have a lot of different choices across the market. But from your seat, why do borrowers ultimately end up choosing Sixth Street as a lending partner?

Yes. Great. So look, I think, a, again, we have top of the -- I think on the sponsor side, it's because -- and both are coming in suit because we travel in the same industries, we can provide certainty and speed and some flexibility and size that is really important for a sponsor who kind of value speed and certainty and 5 or 1 of a handful -- a handful of firms that can write $500 million-plus checks across the platform. And then on the nonpunser side, we tend to have deep industry expertise and can provide those same kind of value, which is speed, size and certainty, but in less traffic areas.

I think that's exactly right. Our thematic investing approach, especially in the sponsor universe allows us to get up the curve quickly, provide speed and certainty. They have confidence that we can deliver, and we have a lot of long-standing relationships outside of the sponsor community. We're really solutions providers for the sectors.

Our next question is going to come from the line of Mickey Schleien with Ladenburg.

Josh, you talked about the imbalance in the sponsored market, but we did finally see some stabilization of spreads. And I'm curious what your outlook is in terms of the ability for those spreads to remain stable over the next 12 months? Or do you expect more pressure to redevelop.

Yes. So Mickey, it's a right question. Look, I think what we tried to do at the beginning of our earnings call is to compare those spread levels and what those imply for return on equity for this space. And my hope is, and maybe this is a hope, my hope is that the market mechanism will work, which is the market will kind of wake up and say, Oh my God, what does that mean for return on equity as your front book converts to your back book? And that will be a mechanism to provide feedback for the space about how to price asset level returns. And so I'm not sure, quite frankly, at the bottom level, not what we're investing, but the bottom level of spreads on the sponsor space, it works given the cost curve and return on equity for the space. I think our mass sets determine equity is going to be somewhere, based on the cost curve based on the SOFR swap rate and based on losses somewhere between 5% and 7% compared to a cost of equity between 9% and 10%. And so hopefully, the market will, kind of, provide that feedback if capital is most allocated. Now maybe the cost of equity is too high for the space, and that will adjust. But my hope is that there's a reinforcing market mechanism for the space that will at least provide some level of spreads.

That's really interesting and quite helpful. Just one follow-up question. The TSLX BDC is relatively small compared to your broad platform at Sixth Street. I'm curious whether you have interest in growing the BDC as the platform keeps expanding and growing on a relative basis?

Yes. Look, it's a great question, Mickey. It's kind of a -- it's an interesting way of how we built Six Street because I think it's look, the goal of Sixth Street is we want to be investors, and we're an investor first model. And so when you look at Six Street as a platform, we're about, I don't know, $100 billion of AUM, but we're -- that's across 8 to 10 strategies that we think we have raised constrained capital so we can invest across cycles, just like we do in the direct lending market. And so we'll grow our direct lending business. And as people know, we have Sixth Street Specialty Lending partners, which focuses on that larger cap investments. But we'll grow our direct lending business as we see there's opportunity where we can both provide an efficacious solution to our sponsors and provide an acceptable return on capital for our investors. But the model is kind of built to be investor first because we believe as long as we can't really provide capital to sponsors or to issuers unless we're providing returns to our clients and that flywheel only exists if we're doing a good job for the people who provide us the capital and trust our -- capital to us.

And our next question comes from the line of Ken Lee with RBC Capital Markets.

Really appreciate the commentary around the portfolio overlap. Just curious, would you attribute the less overlap mainly to the proportion of nonsponsored transactions that you have? Or part of it is also due to the size of the portfolio company. Just curious in terms of the contribution there.

Yes. I think directionally, it's probably the nonsponsored side. I think there's -- on the sponsor side, for sure, there's a little bit of that. But directionally, I think it's the nonsponsor side that contributes mostly to the lack of portfolio overlap compared to the rest of the space. if that's helpful.

Yes. No, that's helpful. That's helpful. And just one follow-up. You talked a lot about spreads on new investments, but just curious in terms of what you're seeing now, are you seeing any changes in terms of documentation in of loan terms. Just wanted to see whether those items have been impacted by the level of activity you're seeing there?

No. I think typically, Bo can comment. I think typically, the document and underwriting standards outside of the spread has been pretty kind of consistent over the last 18 months.

12 to 18 months, they've been pretty consistent. You'll see some easier syncratic pop up where you see lack of discipline in documentation on those ones will pass outright. But for the most part, you've seen stabilization now.

Our next question comes from the line of Melissa Wedel with JPMorgan.

Following up on something you mentioned before -- earlier in the prepared remarks, you talked about some new deals being put on with call protections I'm just curious, has anything changed in terms of the typical structure on call protection? And is that characteristic of sort of most of the new investments you're putting on the balance sheet?

No. No, actually, you kind of opened up something that just going to hit in closing remarks, but call protection is a -- as a percentage of fair value. So if you look at fair value divided by the call price is actually at its lowest level in the portfolio today. So it's -- and that's a function of, I think, a combination of newer vintage investments plus that we've been able to retain call protection. So that's at 93.6%. So our entire portfolio got called away, we would have a lot of embedded economics and that's kind of at the that embedded economics is at the highest level. So call protection has been pretty stable. I would say we're able to generate more call protection on the more off-the-run investments and the more nonsponsor. So generally, I think all protection on the sponsor stuff has been pretty stable and it does exist.

Okay. That's helpful. You also mentioned expertise and exposure in the health care space. Just curious, as you look across the portfolio, do you see any sort of reimbursement risk embedded in there?

So look, our health care exposure has been really health care tech in spec pharma. It has not been on the services side, which has been a difficult place for the space on the services side, given wage inflation and on services. So we -- the -- I think there was always -- there was a reimbursement on pharma that was priced in the market a couple of years back. We don't expect more of that. But we have a pretty differentiated health care strategy in health care portfolio.

Our next question is going to come from the line of Robert Dodd with Raymond James.

Going back to the spread question. Because obviously, you pointed out, I mean there's a supply-demand mismatch and it has been for the last few years. But -- so what's the probability you think that like spreads actually stay as tight if we see a rebound in activity? I mean some of the spread compression arguably makes sense on our spread per unit of leverage because leverage pay down on new deals as it's quite came up. But is that trend going to reverse if we see an increase in activity? Are we going to see the last couple of years, there's been more A-grade companies in the mix, we see more B-grade and spreads move there. I mean I don't think spreads move just because investors want them too. But are there other dynamics if there is a meaningful somewhat meaningful rebounding activity in terms of quality of company mix, spread per unit leverage, anything like that kind of push the needle.

Yes, let me -- look, I -- by the way, I wasn't suggesting that my hope can drive spreads. What I was -- What I was suggesting was that ultimately spreads is a function of supply and demand in equilibrium, right? And so on the supply side -- supply capital side, my hope is that when people wake up and see -- and it's not hope, but how the market should work, is that as people's front book compared to their back -- converts into their back book and the market provides them a signaling function that is no longer meeting the return on equity, and it's a destroying shareholder value. that some of that supply at lower prices will be cut off. Like that's what should happen, right? What should happen is that the market says, no, no, no. Your cost of capital is a 9, you can't really allocate capital at 450 spreads. And no matter what you think about the risk-adjusted return and the stock should trade down at below book value, and that should be a signal to managers of the capital to cut supply off at lower levels. So supply hopefully comes out of a market as there's more transparency in that conversion of front book to back book. On the demand side -- so that's the supply side. On the demand side, increased M&A and other demand for capital, but most of probably given increased M&A catches up to the supply of private credit, that should also move spreads up. So you have -- and what's happened over the last 12 months is that you've had a lot of supply of capital move in the space. The incentives are for people to put capital to work. There hasn't been a real transparent signaling function about if that capital is being allocated appropriately because the back book hides it and then on the demand side, you've had low M&A that hasn't caught up. So that's kind of the basic supply and demand equilibrium framework for spreads.

Understood. So presumably, you don't think that kind of imbalance can be corrected on any shortcut given that the guidance assumes spreads stay where they are? Is that fair? We think it might be a longer-term phenomenon for the market to self-correct there?

Well, I don't know. I mean it's just self-correct. I'm not sure it's going to depend on how strong the market signals are and when. And when M&A comes back. I mean when you look at our specific guidance, I guess -- and this has come up now twice. I think the guidance I provided is a little bit of just us being conservative. Like we like to over-deliver on expectations. I guess that's kind of the credit mindset of the firm, which is do no harm kind of over deliver. To give you a little perspective, I think 10 out 10 years, we beat the loan of a guidance framework. 9 out 10 years, we've been above the top half. And 7 out of 10 years, we've been above the top level of guidance. So I think when you look at our guidance and implies actually low levels of M&A portfolio turnover, I think is in our guidance at somewhere between 15% and 20% versus 25% this year. So it implies a low level of which drives activity level fees. So I think our guidance is relatively conservative. I think what we did was say, hey, spreads like let's try to, again, with a framework of over-delivering this assumes spreads don't get better, less assume portfolio turnover gets a little bit worse. What does that mean? And that's what's spit out in guidance. But again, we have a track record where we're delivering. So I would not -- what I would not add do Robert, which I think you do because you're quick, that PhD is like -- makes you quick. But I think what you've done is, as you kind of said, Hey, I'm looking at their guidance, what does that mean for the environment. I would -- you got to put our guidance in the historical context of our relationship with the Street.

And our next question comes from the line of Maxwell Fritscher with Truist.

I'm on for Mark Hughes. I just wanted to get your view on how do you expect the mix of incumbent borrowers versus new borrowers to trend over 2025?

I mean, we've historically put work in our existing portfolio and create new portfolio relationships. I think the number of portfolios relationships have increased significantly, but it's going to be a mix. I don't know if I have a specific view. We'll take what the -- I mean, obviously, we like to put money and work on our existing portfolio company where we can that the portfolio company you know, started in the portfolio company that's new to you, but it's going to be a mix and what the opportunity gives us. What the market gets us.

Understood. And then the large sequential increase in the average new commitments in the new portfolio companies. What's driving that, I assume, is that just TRP Energy?

Let me come back to you a little quick. Let me just see if I understand your question.

About [indiscernible].

Yes, give me one second. Yes, so I mean TRP was $54 million. So it's not that big of an outside. It's not that big of an outside. Most of them were between the median was probably $40 million. So not that big.

[Operator Instructions] Our next question comes from the line of Paul Johnson with KBW.

Sixth Street made a few new partnership announcements over the course of the last few months, but the most recent one, the First Citizens, equipment financing partnership. I'm just curious, does this partnership or any other partnerships that you could, I guess, potentially enter? Would this provide any deal flow that fits into TSLX's funnel?

Yes. We don't expect the First Citizens equipment leasing. That's really an equipment we've seen partnership with First Citizens. So we don't expect that to kind of fit into the corporate direct lending portfolio for TSLX. But there will be partnerships, and there will be cross-platform opportunities that if they're appropriate for TSLX will most definitely they will get allocated appropriately.

Got it. And then just on the nonsponsor opportunities within the portfolio. I'm just curious how frequently you typically expand financing or provide add-on financing with existing borrowers in your portfolio that have come in through primarily the non-sponsored channel? Or are these kind of more shorter-term payoff opportunities?

Yes. They're actually a mix. Like if you look at TRP, TRP was an existing portfolio company that entered into basically an asset swap. And so we were able to expand that relationship. But that's on one side, where we're able to expand those relationships and the amount of capital that we deploy. And then on the other side, there is some that's more transitory that our capital is a bridge or, for example, the retail ABL strategy. So it's really a mix of both. I would say, on the margin, now there's exceptions to the rule like TRP, but on the margin, they tend to be more transitory. These are opportunistic in nature.

That's right.

But we don't -- we -- our capital for that channel and that strategy is durable, and we want to be long-term investors.

Got it. That's very helpful. And then the last 1 is just I would ask how you guys are feeling from a capital standpoint, leverage has been pretty stable throughout last year, you guys are right at 1.2x in the upper end of your target. The market seems to be signaling a pretty optimistic year for activity this year, how do you guys feel? And do you think this is an opportunistic time to potentially be raising more capital for shareholders just given your valuation and the outlook for the year? Or how do you guys think about maybe line of sight on repayments?

Yes. So I would -- look I would say given where spreads are, and I don't expect us to grow significantly and issue new capital. Obviously, the puts and takes on issuing new capital accretive to shareholders given the share price. But because that capital is permanent and you're not really going to return that capital unless you trade below book value, you have to believe you can invest that capital at accretive ROEs for a long period of time. And I don't see us jumping in at spread levels that don't ultimately work for what we think the cost of capital is for this space. And so that may change. And if that changes, we'll put capital work, we'll raise capital and put capital work. But our first north star is that investors have entrusted us with their capital, and there is an implied return on equity for that capital and we're going to do everything we can to make sure we meet and beat those expectations as it relates to the return on equity on that capital.

That makes sense. Those are great answers.

Those are great answer, but there are answers. We are -- we -- look for us to have a long-term sustainable platform to server issuers, we got to meet the return on equity and meet investor expectations. And that is deeply important to 63 and deeply important to me personally.

And I would like to hand the conference back to Josh Easterly for his closing remarks.

Great. Well, first of all, I appreciate all the questions. I hope people enjoy their holiday weekend. We're always around. We're always available. But thank you from the team. And people -- again, I hope we're going to either weekend.

This concludes today's conference call. Thank you for participating. You may now disconnect. Everyone, have a great day.