Sixth Street Specialty Lending Inc
NYSE:TSLX
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Sixth Street Specialty Lending Inc
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Good morning and welcome to TPG Specialty Lending, Inc.’s March 31st 2019 Quarterly Earnings Conference Call.
Before we begin today's call, I would like to remind our listeners that remarks made during the call may contain forward-looking statements. Statements other than statements of historical facts made during this call may constitute forward-looking statements and are not guarantees of future performance or results and involve a number of risks and uncertainties. Actual results may differ materially from those in the forward-looking statements as a result of a number of factors, including those described from time to time in TPG Specialty Lending, Inc.’s filings with the Securities and Exchange Commission. The Company assumes no obligation to update any such forward-looking statements.
Yesterday, after the market closed, the Company issued its earnings press release for the first quarter ended March 31, 2019, and posted a presentation to the Investor Resources section of its website, www.tpgspecialtylending.com. The presentation should be reviewed in conjunction with the Company's Form 10-Q filed yesterday with the SEC. TPG Specialty Lending, Inc.'s earnings release is also available on the Company's website under the Investor Resources section. Unless noted otherwise, all performance figures mentioned in today's prepared remarks are as of and for the first quarter ended March 31, 2019. As a reminder, this call is being recorded for replay purposes.
I would now turn the call over to Josh Easterly, Chief Executive Officer of TPG Specialty Lending, Inc.
Thank you. Good morning, everyone, and thank you for joining us. I will start with an overview of our quarterly results and hand it off to my partner and our President, Bo Stanley to discuss origination and portfolio. Our CFO, Ian Simmonds will review our financial results in more detail and I will conclude with our final remarks before opening the call to Q&A.
After the market closed yesterday, we reported results for the first quarter 2019. Net investment income per share was $0.41, and net income per share was $0.59, both exceeding our first quarter base dividend of $0.39.
The difference between this quarter’s net investment income and net income was primarily driven by unrealized gains of $0.11 per share from the impact of tightening credit spreads and the valuation of our portfolio and mark-to-market gains of $0.05 per share related to our interest rate swaps from the flattening of the forward LIBOR curve.
Our Q1 results corresponding to an annualized return on equity on a net investment income and net income basis of 10% and 14.5% respectively. Reported net asset value per share at quarter end was $16.34, an increase of $0.21 compared to the prior quarter after giving effects of the impact of the Q4 supplemental dividend which was paid during Q1.
Net asset value movement this quarter was primarily driven by unrealized gains related to a partial recovery of credit spreads following year-end volatility and the flattening of the forward curve as discussed.
Yesterday, our Board announced a second quarter base dividend of $0.39 per share to shareholders of record as of June 14 payable on July 15. Our Board also declared a Q1 supplemental dividend of $0.01 per share to shareholders of record as of May 31, payable on June 28. We believe our dividend framework is an effective way to enhance shareholders cash return while satisfying our risk-related distribution requirements and preserving the stability of net asset value.
As part of our ongoing assessment of our optimal capital allocation for our business, yesterday, we announced a change to our existing $50 million stock repurchase plan instead of purchasing shares automatically when our stock trades, our price is starting at a penny below our most recently reported net asset value per share, we will be doing so starting at a penny below 1.05 time is our most recently reported pro forma net asset value per share, which corresponds our price of $17.15 based on Q1 pro forma net asset value of $16.33.
Given our focus on efficient capital allocation and shareholder returns, independent awarded means for asset growth and the implications of fee income for the manager, we believe we should be reinvesting in our existing portfolio when there is an ROE accretive – when it’s ROE accretive and the payback period is short.
It’s our belief that what’s hindsight or soften post-constrained or repurchasing our stock at book value is no longer applicable given our differentiated portfolio and fee structure and most importantly coupled with the change in regulatory framework which has transformed the earnings power of our business.
Circling back to our business, if we can positively impact the earnings profile of our business through efficient capital allocation in the form of stock repurchases, we should do so.
Our stock repurchase plan is based on the careful assessment of trade-off between the de minimus near-term dilution on book value and the length of the payback period as well as reinvesting in our portfolio and foregoing the future opportunity to make new investments in a higher spread environment. We laid out our analysis on Slide 17 of our earnings presentation material.
With that, I will turn the call to Bo to walk you through our portfolio activity and portfolio.
Thanks, Josh. The deal environment in Q1 continue to be competitive given the record levels of capital raised for the direct lending strategy over the past few years. Meanwhile, on the supply side, broader M&A activity in Q1 was relatively subdue coming off in volatile year end. Our strategy continues to focus on sector themes and being opportunistic scenarios that coincide with our platform’s underwriting expertise.
We aim to differentiating our capital in the space by leaning on the capabilities and capital base across the TSSP platform. As always, we are guided by our investment discipline and downside orientation in order to construct a high quality portfolio that performs throughout market cycle.
To that end, during the first quarter, we generated $179 million of originations across four new investments and upsized it to four existing portfolio companies. $27 million of originations were allocated to affiliated funds and $7 million of originations consisted of unfunded commitments. On the repayments front, Q1 was relatively quiet following an elevated repayment levels during Q4 of last year.
In this quarter, there were $33 million of repayments across two full realizations and two partial investment realizations and sold outs resulting in a nice portfolio growth of $112 million.
Turning to specific investment activity, two out of our four new names this quarter were sponsored M&A transactions that intersected with our thematic focus or ability to offer certainty of execution with the competitive advantage and our ability to create strong risk adjusted returns for our shareholders.
Now, I’d like to provide an update on our few of our ABL investments. On February 18, Payless filed voluntary petition for relief under Chapter 11 of the bankruptcy code given the continuing challenges facing brick and mortar retailers. Post quarter end, we were fully repaid on our loan which resulted in an unlevered - gross unlevered IRR of 80% on our investment.
During the quarter, we also received full repayment of our Sears DIP loan in connection with the company’s exit from chapter 11. Subsequently, we participated in a $250 million asset-based loan to support Sears’ go-forward operations.
We’ve been a lender to the company since late 2015. Given our relationship and familiarity with the company’s capital structure and its collateral, we believe we created a strong risk-adjusted return opportunity for our shareholders.
Retail ABL continues to be one of our various themes given the ongoing secular trends in our platform’s differentiated capabilities and relationships in this area. As the direct lending asset classes become increasingly competitive, we have continually developed and evolved our investment themes in order to generate a robust pipeline of strong risk-adjusted return opportunities.
Given the pipeline generated to our direct originations platform, post-quarter end, we’ve had approximately $150 million in net fundings. In broad strokes, these post-quarter fundings exemplify our focus on thematic originations and the power of the platform.
Turning now to our portfolio metrics and yields. The underlying credit quality of the portfolio is in good shape with no investments on non-accrual status at quarter end. Portfolio composition has remained consistent quarter-over-quarter with 97% of investments being first lien on a fair value basis.
We remain diversified across 48 portfolio companies in 18 industries with financial services and business services as our top two industry exposures at 20% and 18.6% of the portfolio at fair value respectively.
As a reminder, the vast majority of our financial services portfolio companies are B2B integrated software payments businesses with limited financial leverage and underlying bank regulatory risk. At quarter end, nearly a 100% of our portfolio by fair value was sourced through non-intermediated channels. This allows us to structure meaningful downside protection on our debt investments.
To provide some numbers around this, at quarter end we maintained effective loading control on 81% of our debt investments average 2.1 financial covenants per debt investment and had meaningful call protection on their debt portfolio of 103.4 as a percentage of fair value as a way to generate additional economics as our portfolio get repaid in the near term.
At March 31, the weighted average total yield on our debt and income-producing securities at amortized cost was 11.6% compared to 11.7% at December 31. This slight decrease was primarily due to the downward movement in LIBOR in our floating rate portfolio.
With that, I’d like to turn it over to Ian.
Thank you, Bo. Our portfolio grew at a measured pace in Q1 ending the quarter with total investments of $1.82 billion compared to $1.71 billion at year end 2018. Total debt outstanding at quarter end was $742 million and net assets were $1.07 billion or $16.34 per share, which is prior to the $0.01 per share Q1 supplemental dividend that we declared yesterday.
And as Josh mentioned, our net investment income was $0.41 per share and our net income was $0.59 per share. Given this quarter’s net funding activity, our ending debt-to-equity ratio was 0.69 times compared to 0.59 times in the prior quarter and our average debt-to-equity ratio during the quarter was 0.66 times.
Overall, this was a quarter where we started with low financial leverage and had limited activity-related fees and yet, we were still able to generate a 10% annualized ROE on net investment income and over earn our quarterly base dividend.
Inclusive of the first quarter end net fundings that Bo discussed, we estimate our leverage today stands at 0.83 times. Given our portfolio activity to-date and the strength of our investment pipeline, we expect our average leverage to increase for Q2 which drives ROE expansion even in the absence of activity-related fees more on this slide.
Turning to our presentation material, Slide 8 contains an NAV bridge for the quarter. Working through the various components, we added $0.41 per share from net investment income against a base dividend of $0.39 per share, a tightening of credit spreads resulted in a positive $0.11 per share impact on the valuation of our portfolios and there was a positive $0.05 per share impact to NAV from unrealized mark-to-market gains on the interest rate swaps our fixed rate debt.
Of the changes, primarily net unrealized gains from portfolio company-specific events resulted in a positive $0.03 per share impact.
Moving to the income statement on Slide 9, total investment income was $52.5 million, down from $74.7 million in the prior quarter, primarily due to elevated level of activity-related fees earned during Q4. Interest and dividend income was $49.5 million, down $2.5 million from the previous quarter given a slight decrease in the average size of our investment portfolio.
Other fees, which consist of prepayment fees and accelerated amortization of upfront fees from unscheduled paydowns were $0.8 million compared to $21.2 million in the prior quarter, which experienced record high repayment levels. Other income was $2.1 million compared to $1.5 million in the prior quarter.
Net expenses were $25.5 million, down from $29.7 million in the prior quarter and primarily due to lower management and incentive fees. The weighted average interest rate on average debt outstanding was 4.7%, up 20 basis points from the prior quarters due to an increase in the average effective LIBOR across our debt instruments and a higher unsecured funding mix.
Note this is effectively a one quarter turn lag on the LIBOR reset date for our interest rate swaps and then for the beneficial impact of this quarter’s LIBOR decrease on our interest rate swaps that roll through next quarter’s cost of debt.
Further, if we are able to continue revamping the portfolio at the measured pace that we have today, we would expect the weighted average rate on average debt outstanding to decrease given high utilization of our lower cost revolver funding.
Regarding our liability structure, on our last call, we indicated that with respect to the upcoming maturity of our $115 million convertible notes, our base case scenario is to repay those notes given the liquidity and low marginal cost of funding available under our revolver. This continues to be the case.
Taking into account post quarter end net fundings, we currently have significant liquidity, with approximately $714 million of undrawn revolving capacity. Nevertheless, we continue to monitor the debt capital markets and would look to issue new unsecured notes if we are able to do so at a swap-adjusted price that resulted in minimal pro forma drag on our ROEs.
Before passing it back to Josh, I’d like to provide a quick review of our ROE metrics. In Q1, we generated an annualized ROE based on net income of 14.5%, compared to 5.3% in the prior quarter and an annualized ROE based on net investment income of 10% compared to 16.4% in the prior quarter.
The quarter-over-quarter swing in ROE on net income was primarily driven by the fair value impacts of our valuation of risk management practices, namely incorporating credit spread movements in the fair value of our debt portfolio and implementing interest rate swaps on our fixed rate liabilities to match the floating rate nature of our assets.
The quarter-over-quarter change in ROE and net investment income was primarily driven by lower activity-related fee income in Q1 given fee income in the prior quarter was elevated. Over the trailing 12 month period, we’ve generated an ROE on net income of 11.7% with an average balance sheet leverage of 0.79 times.
We’ve added Slide 16 to our presentation material this quarter to isolate the impact of balance sheet leverage on the earnings power of our business. The table at the top of the page shows our unit economics based on annualized results for the first quarter. Below that, the sensitivity table illustrates that for each asset level yield, holding constant operating expense ratio and increasing financial leverage corresponds to an increase in ROE.
We know that this concept is relatively intuitive. So the sensitivity table is really meant to help people calibrate the magnitude of leverage on ROE for our business. Looking ahead to Q2, based on the increase in our leverage from an average of 0.66 times in Q1 to our estimate of 0.83 times today, we would expect to experience approximately 70 basis points of annual ROE expansion even if we have seen the same low level of activity-related fees and asset yields as Q1.
Note that we generally wouldn’t expect low repayment activity to persist even in a higher spread environment. Given idiosyncratic events for our borrowers, which drives portfolio repayments.
As I articulated on the last call, based on our expectations over the intermediate term, the net asset level yields, cost of funds and balance sheet leverage, we expect to target an annualized return on equity of 11% to 11.5%. This corresponds to a range of $1.77 to $1.85 for the full year 2019 net investment income per share.
Again, if the market environment allows us to operate a higher end of that target leverage range for sustained periods of times – for the time, we would expect to drive up to approximately 250 basis points of incremental ROE for our shareholders.
With that, I’d like to turn it back to Josh for concluding remarks.
Thank you, Ian. To wrap up, we had a solid Q1 with strong momentum building through the second quarter.
As some of you know, this March mark our fifth anniversary of our IPO and our first five years as a publicly traded company, we delivered a total return of 99% for our shareholders which represents an outperformance of 80 percentage points versus the Wells Fargo BDC index, an outperformance of 79 percentage points versus the leveraged loan index and an outperformance of 32 percentage points versus the S&P 500.
We are humbled by the ongoing support of our shareholder base and we will continue to focus on delivering the best possible shareholder experience.
Given our long-term shareholder orientation, we care deeply about the sustainability of the BDC sector. In that regard, we believe our sector is faced with a number of structural impediments that access a constrained and effective corporate governance.
These include the 3% rule the acquired funds fees and expense rule and certain 40 act voting and quorum requirements which together have limited the ability of shareholders seek change in the underperforming external management arrangements resulting in persistent shareholder value disruption. Earlier this week, we formally responded to the SEC’s request for comments on the proposed modification to the 3% rule.
In short, we believe the SEC’s new proposal continues effective corporate governance given the voting restrictions on any shares owned above 3%. The price of an equity security reflects the economic value of the security plus the value of governance. And therefore there is limited – to acquire incremental shares above the 3% limit if the right of governance is not included.
Our recommendation to the SEC we believe, allow the effective corporate governance while reporting the investor protections as originally intended the 3% rule. Unfortunately, we understand that why external managers are persistently underperforming BDCs when we want to preserve the existing 3% ownership and volume limitations because these limitations effectively serve as important to all the change which we have seen across the sector.
Our letter to the SEC along with the presentation laying out our perspectives are posted to the Investor Resources section of our website. We welcome anyone with comments or questions and reach out to me or our Investor Relations team.
With that, I’d like to thank you for the continued interest and for your time today. Operator, please open the line for questions.
[Operator Instructions] And our first question comes from the line of Leslie Vandegrift with Raymond James. Your line is now open.
Good morning. Thank you for taking my questions. Just first in the prepared remarks, you discussed the M&A market in the first quarter was slower than fourth and we saw that in the level of repayments and you wouldn’t expect it to say that low of a long-term, but in the near-term, what’s your outlook there?
Hey, Leslie, good morning. I’ll turn it over to Bo. I think generally, when there is a lot of volatility, M&A takes a pause, given that sellers and buyers have a hard time, kind of reaching price agreement. So, you expect we are in a lower kind of volatility environment or have been in Q1 and Q2. You would see that M&A start picking back up. Bo, do you have anything to add?
Yes, and that’s exactly right. We saw a pause in late Q4 with the volatility that carried on until early Q1. We saw a marked pick up in mid Q1 and that’s continued into Q2.
Okay. Thank you. And then on couple of the portfolio investments, first IRGSE, just there is a revolver there. I mean, it’s small, it’s not a large investment, but there is a revolver there that keeps popping back on to the scheduled investments. Is that something – is there a reason to repetitive mean for that or why it keeps one quarter it’s there.
Yes, hey, Leslie. So, yes, we continue to make, obviously, I said one of the investments has struggled. We have continued to make investments in the business including driving school. There has been net investment in the business as we continue to kind of evolve that business plan and continue to kind of drive what we hope to be is going to invest and although taken longer and it’s been harder than we expected.
Okay. And on the Transform SR Holdings, the new Sears name, you got through their process with the $25 million debt and now it’s a $75 million ABL. Can you talk about kind of the investment thesis there? Where do you see the value going forward with Sears and the structure you have on that?
Yes, so, it’s the same thesis with – specifically with Sears and generally with all of our asset-based loans which is quite frankly this hasn’t to anything about the prospects of any of our retail asset-based loans, but we underwrite them to liquidation value.
I think our last dollar is 80% of NRLV, liquidation value of the inventory, which hold up very, very well and when most of the stores were liquidated, in the all series format. So, again, this is not commenting on Sears specific prospects. We continue to believe that all brick and mortar retail is extremely challenged.
But you would expect, we underwrite these transactions to a liquidation given the secular challenges and the volatility of earnings and the fixed cost structure that exists in all brick and mortar retail. So that is actually very similar on a structure basis with the same protections and borrowing-based mechanism that you had and advance rate that you had in the last years.
Okay. Thank you. And on the comment letter to the SEC that you mentioned, I don’t see it on there, but is it – do you have that – is that out on the public form for SEC or is that one of the private submission?
So, first of all, it’s on our website. There is two pieces of the material. You should read it, it’s a great read if I have to see it for myself. It is – there is a comment letter and there is a presentation, both of those were submitted to the SEC. Both are available on the – publicly on the SEC’s website.
It was posted yesterday and then, it is also on our website in the Investor Resources section presentations, on top of the presentation. So, both the letter and the presentation.
Okay. Thank you. And then just on the last question here on the repurchase plan on the change to go from – buyback shares under 1.05 now. So, I guess my question, first of all, what prompted the nature of this, I mean, since IPO I think at 11 days you tried it below on plan from that. So, what was the push for that? And also, what do you think your stock does and if it creates interim net volatility?
Yes, so, here is how we think about it. So, I don’t think anybody ask JPMorgan, quite frankly, why are you buying back stock above book value. I think that BDCs given the regulatory framework have not changed, that book value is less meaningful versus kind of what’s accretive or dilutive to return on equity.
And on ROEs of business and what are the payback periods. And so, I think, over the last kind of six or seven months, we have been talking about it as a group, we tend to think – we tend to approach this in a very intellectual kind of honest and rigorous framework and if we said to our subs, look as we start the right price of the book value and the earnings power of business is structurally changed, shouldn’t we think about making and adjustment in the purchase price on the 10b5-1 program.
And quite frankly, people in this space have not bought back shares even if it’s massively below book value, because management team don’t want to forego the opportunity for fees for the external manager. That is the only reason quite frank and maybe – but that’s the only reason why I can think of, whether it’s not to do that.
And our view is, forget about the fees – the possible fees for the external management keep on driving ROEs, keep investing in the business, create an efficient capital structure and the payback periods are very, very short. I think the payback periods are seven months which anybody if you said there is a seven month payback period on investments.
We think that’s very short where the additional ROE accretion given the change in funding mix and leverage offsets the de minimus dilution to net asset value. So, I think the – we continue to push ourselves to think about the appropriate capital allocation framework for our shareholders.
And so, you are exactly right, where the stock has traded, maybe doesn’t matter. But at some point it will matter or it might matter and we should be – we should put our shareholders in a position to benefit by being proactive in having frameworks – having a framework that proactively creates value for our shareholders. Is that helpful?
Yes. Thank you. And I guess, just last one. I missed it in the prepared remarks. What was the spillover income at the end of the quarter?
Hey, Leslie, it’s Ian. It’s $1.19 per share and I know through prior questions that you’ve had, you are always focused on the components of that and the distributable earnings and there is some helpful disclosure that the team has put into note 12 in our Q and you will find that Page 42.
Thank you. I appreciate that. Thank you for taking my questions.
Thanks, Leslie.
Thank you. And our next question comes from the line of Rick Shane with J.P. Morgan. Your line is now open.
Hey guys. Thanks. I just have one quick question. When we are looking – when you are talking about the converts maturing, it sounds like the strategy is just to pay that down on the revolver for now. I am curious how the rating agencies look at that and the opportunity to extend your maturities through future unsecured note offerings instead.
Ian?
Sure. Hey, Rick. I think, we had conversations with the rating agencies last year around what our range of unsecured versus secured mix is going forward. And as you saw us delever through the end of 2018, that mix shifted dramatically towards unsecured.
So it’s probably at the high end of where we thought our unsecured mix would be as we relever through this year and even if we do end up refinancing the 2019 notes through our secured facility, we are still going to be well within the range that we talked about with the rating agencies.
But your question is well crafted because it’s something that we do focus on, I think that one of the comments in Joshua’s prepared remarks, we are not just going to go out to the market and take a transaction that’s available. We want to make sure it’s not going to impose a significant ROE dilution as a result of changing the mix of funding.
So, it’s something that we basically balance and I think even in our prepared remarks, we talked about being opportunistic on the funding side as it relates to unsecured debt.
Yes, I guess, that’s exactly right. Two other comments. One is that, we have rating agency reviews throughout the year including in the first quarter. The comments we made on our Q – on our Q4 earnings call and in this earnings call are pretty consistent. So the rating agencies, you can rest assured, we’ve had discussions with the rating agencies regarding this issue.
And I would expect no adverse change, because, A, it’s we’re obviously continuing our dialogue with them and B it’s consistent with our historical policies that was communicated to them. The second thing I would say, which is – we said this before, it’s reissuing a unsecured convert is very difficult in my mind for us.
I think as the earnings power, the convert market typically looks our historical wall and the historical wall I think is going to be lower than the future wall, because the earnings power that’s structurally changed across the sector. And so, you will not get the benefit of that in the coupon.
And so, put it in another way, I think what we have said is, if you issue – if we get to the 1.25 times debt-to-equity ratio, which I am not seeing we are going to get there anytime soon. Earnings per share as it’s kind of at 225 to 235 range and if both of those holds, it seems like you are getting a pretty valuable option that didn’t exists in the prior to the regulatory change.
And so, I think what we are really – unless that perspective changes in the convert market, we will really focus on the unsecured market versus the revolver market and the impact on ROEs and we feel very good about our retaining and keeping our IG rating is, given the performance of the business.
Great. Very helpful guys. Thank you.
Thanks, Rick.
Thank you. And our next question comes from the line of Ryan Lynch with KBW. Your line is now open.
Hey, good morning. Thanks for taking my questions. First one, I just wanted to follow back on the buyback commentary. So, just wanted to get a little more thoughts around why you set the buyback at 1.05 of book.
You mentioned the small bit of dilution which would create a seven months sort of payback period based on the earnings growth. So if that’s the case, why not set it at a higher level? 1.10 of book value, when I think all of it really do the same amount of accretion or there are same amount of earnings accretion, but a little bit more book value dilution. Just expand that payback period a little bit.
So why not set it higher? Number one. And then, also why have it as a programmatic program? Why not have it maybe more opportunistic?
And just wanted to get your thoughts behind that, because, in an environment where are you are trading, where TSLX is trading closer to book value, I would assume that that’s going to be a very distressed environment given the nature of how you stock prices traded historically, which would also mean it’s probably a very attractive environment for deploying capital.
So, the second part would just be, why is it a programmatic one versus maybe a more opportunistic one where you guys can have some discretion?
Yes, let me answer the second question first, because I think it’s easier or it’s on top of my mind. Why not discretion versus programmatic? You can only look to the sector and see on the discretionary ones, how much actually people have bought back stock.
The open window periods for us given our conservative nature of about three weeks and so, the idea that we can actually – we open up our open window four days post – three days post quarter earnings and close it three weeks thereafter. The idea that we are going to kind of hit – I mean, lucky not to hit the window and do something inside for our shareholders, I think is – the probability is very, very low.
So, did I answer that question? And then as it relates to the…
Yes, that makes sense.
As it relates to the – I think your point regarding the correlation between where the stock is trading and the opportunity for reinvestment spreads, I think is a good one. And so, how much are we foregoing when there is volatility, when the 10b5-1 program that’s getting hit. How much are we foregoing to invest in reinvestment to – to invest in a higher reinvestment spread environment.
That got into the exact sizing of the program. And so, we don’t think we are giving up that much flexibility at a $50 million program. If we had a $300 million program on, we’ve obviously be giving up a lot of flexibility and giving up a toll to create ROEs in a higher reinvestment spread environment. The – why not 1.10 versus 1.05?
The answer is, quite frankly, the payback periods are shorter at 1.05. We thought we needed to walk before we ran for this marketplace. We are a little bit of a odd dock compared to the sector in general, because people don’t even buyback stock below book value.
And so, we just thought that it was a good idea walking and over time we will evolve it to find to optimize the right – again the right capital allocation policy for our shareholders.
My guess is, if I would have came on today and said, great news, 1.10 buyback, diluting shareholders, we – some of you may have thought us for being innovative and thoughtful putting shareholders first and some of you might have thought that we are – that we – spent which time in San Francisco which we are today but, and do we think that we should have been doing. But I think that is – it’s a measured framework.
Yes, that makes sense. I really appreciate that commentary. Thanks for taking my questions today.
Thank you. And our next question comes from the line of Terry Ma with Barclays. Your line is now open.
Hey, good morning. So, just looking at the additional fee income component in your union economics. It’s been pretty consistent historically, but, I guess, just looking out as you ramp your leverage and drove your asset base, would you still be able to generate the same level of fee income?
Yes, I mean, look, I think what you had was you had, if you take a step back and kind of think about the big picture, Q4 we had a lot of fee income, we pull forward future earnings, delever the books and then, we happen to be – and that happened earlier in the quarter and then in – at the end of Q4, you had a point of volatility that where you are going to have a churn in the book and that churn usually creates fee income.
At the same time, we sort of at a lower leverage ratio and so, we would expect I think fee income was about 50 basis points this quarter typically it’s 180 basis points. So it was about a third of it historically has since then our IPO. So I would expect that, as volatility flows, we will find the right – the business will find the right equilibrium between growing and to leverage and some natural churn in our books.
But as the quarter stands today, we’ve made a lot of progress on net fundings. We had about $150 million of net fundings and I think on Monday, we will have $180 million in net fundings. My guess is we will see some churn in the quarter. But we really haven’t seen it yet.
And so, we will at some point, get a – the right – we are pretty close to feel like giving the right kind of equilibrium between portfolio growth and churn. I think, when you take a look back, this was the lowest level of pay-offs in the last five years.
Got it. That’s helpful. Thank you.
Thank you. And our next question comes from the line of Christopher Testa with National Securities. Your line is now open.
Hi, good morning. Thanks for taking my questions. Just wanted to talk a bit about ABL. Obviously, it’s been an area of much success for you guys. With all the retail bankruptcies in the first quarter being larger than all of last year, I am just wondering, the environment ever gets so bad that it kind of gives you any cause about getting more heavy into this space.
Hey, Chris. Look, the – what really matters is, how we think the inventory will liquidate as it compares to what – where we are lending against it. And so, what we’ve seen is, is given that the consumers in – like – I think don’t complain that the consumer is not in good health versus the – what’s happened in retail. That is historically been the correlation. Retail goes as well as the consumer. That is not the – that’s not what’s happening here, right.
Consumer is in good health. There is a business model issue and a structural issue with retail, but more so given the fixed cost base and given the discerning mediation of both kind of fast brands and plus Amazon and omni-channel business models. And so, it’s really the liquidation value of inventory and the liquidation value of the inventory has held up great.
So, we continue – not that we are ruling against our clients, but we continue to hope for a decent amount of structural change. So we can provide capital and provide – be a solution provider into that space. And quite frankly, the liquidation values continue to hold up very, very, very well.
Got it.
And those – you are exactly right. I think you had more unit closings year-to-date than you had of last year. And that was mostly driven by I think our client which was PayLess.
Got it. Okay. Now that’s helpful, Josh. And kind of sticking with the theme on ABL. If that stress does continue at kind of the pace that it’s been at, do you think that actually or tends to maybe actually higher spread that you are able to achieve or is that’s something that do you think it’s going to stay in the 0.7, 0.8 range, where you guys typically have been making these loans?
Yes, I mean, we should - the answer is, there will continue to be some competition in capital formation. And so, I don't see spreads massively increasing, but there is a massive difference between spreads and total return, given how the asset class behaves, given call protection, given upfront fees, given the duration of the asset class.
And so, I think our retail – the people can correct me if I am wrong. But I think our retail ABL strategy generated close to 20% IRR, 22% IRR, did correct me, since inception. And so, obviously we haven’t been charging LIBOR 1800 spreads.
But the other thing I would say is that, look, this is a very tough business model for the manager and the GP, which is just a framing for people, which is, you – if you think about the business model, and if the pan of fee is that I can put $100 of capital that stays out for five years. And then, I continue to grow my business even if it’s a 10% IRR, that’s very good for the manager.
If I put out a $100 in capital, 20% IRRs for 18 months, that is not very good for the manager but very good for the shareholder and we continue to do things that are very good for the shareholder.
Got it. So, no argument there. And I know, you had mentioned in the prepared remarks too that, a lot of your financial services composition is trying to B2B and a lot of technologies. Given that banks are investing more and more in technology especially as they deal with some really high efficiency ratios, just wondering if you are seeing the opportunity set there kind of expand to be more kind of FinTech sort of investments and things that directly serve banks.
Yes, so. And I’ll tell it’s all the above, because you’ve kind of our FinTech guy. We have a – you are right, our portfolio – financial services portfolio is really FinTech-oriented. And it’s really integrated, a combination of payments plus software, predominantly on the B2B side. And we continue to like that area. We continue to be very, very deep into that sector.
I know that sector quite frankly very, very well where that allows us to add value to the ecosystem and sponsors that we do stuff in that business, we do stuff in that sector. But Bo, anything to add?
No, as Josh mentioned, this has been a thematic focus of ours over the last three five years. I think long before people started to focus on it. The thesis was B2B payments, spending in our intersect software and B2B payments specifically was a decade behind where the consumer was from the adoption standpoint on the payment side.
So there is a tremendous amount of embedded growth and very resilient business models that we can lend to. So we become thought leaders in the space. Continue to focus on direct outreach to companies and when that intersects with our sponsored effort, it’s been a tremendous amount of flow for us. I think we put out $1 billion in the theme across the platform over the last five years.
And it will continue to be a focus. And you are exactly right, banks are more and more focused in the space which is creating opportunities as well.
Got it. Thanks for that detail guys. And Ian I just want to double check something my phone might cut out. What was the difference in prepayment income this quarter compared to last?
A lot. No. Prepayment income last quarter was about 21.2 and it was about $1 million this year – this quarter. So significant.
Okay. And that includes the fees and the OID acceleration right?
That’s right.
Okay. And last one for me and I’ll hop back in the queue. Just more of a general question. Are you guys seeing more and more of the kind of poor turns and sort of – stores creeping for the core middle market from what used to be just confined to the – for all the syndicated market and the aperture of the middle market.
Are you seeing, that same sort of stocking or light or collateral dilution creeping to, say, $50 million EBITDA companies and alike?
Yes, that trend has continued. I think, the it’s a continuation of sort of poor underwriting standards and poor documentation standards, as different managers, you have different experiences and so, that trend has continued and I wouldn’t say that has accelerated over the last couple of quarters, but that certainly continued.
Got it. Okay. Appreciate your time this morning. Those are all my questions. Thank you.
Okay. Thanks, Chris.
Thank you. And our next question comes from the line of Chris York with JMP Securities. Your line is now open.
Hey guys. Tom Wenk in for Chris York this morning. Just one question for Josh or Bo, regarding your investment opportunity set. You guys have been successful sourcing and underwriting special situations and unique investments that come with a bit of complexity.
So, given the focus or given the success, we ask you guys whether you have any interest or if you’ve ever really thought about extending financing solutions to companies in the expanding cannabis industry?
Yes, it’s a great question, given that we are sitting here in San Francisco. The answer is, I don’t think we are willing to take that reputational or regulatory risk. I think it’s still a schedule 1 and by the way, we’ve been approached, I think it’s still a schedule 1 drug on a Federal basis. And there are – and there are interstate commerce issues.
The second is, is that, quite frankly, we have a large private fund complex that I think would – we would probably take a view on this. And so the answer is, we’ve been approached. We have passed and it’s probably not something for us. I don’t have a view on the sector and quite frankly, don’t have any – I am obviously not a user of the product.
So, I don’t have a view on if it’s an investable sector from a unit economic basis. I do have a view that it’s not investable from a reputational standpoint.
Got it. All right. Understood. That’s it for me guys. Thanks.
All right, tell Chris – I think Chris is out doing some public service. So we will wish him well on that and thank him for his efforts.
Yes. Thanks guys.
Thank you.
And our next question comes from the line of Finian O'Shea with Wells Fargo Securities. Your line is now open.
Well, hi guys. Thanks. Good morning. Can you talk about the originations this quarter on sponsored M&A new money deals? It looks pretty dominant their way 6.50 and you are OID. Is this kind of one-off – is this kind of one-offs where you saw risk-adjusted return or does this maybe represent more of what you have seen as you lever up higher?
Yes, look, let me do it. So, buying that big co obviously is that should be a footnoted investment. So the return is much higher.
Correct.
So, you know, as you know, how our schedule investment works, there is some, whether it’s a small revolver or first out piece and there is – there is subject to scam. And so, I think, you are not seeing the total economics there.
And then, Fin, you were breaking up a lot. I think you also asked just, on the sponsored side, I would say, post quarter end, there has been a decent amount of non-sponsored business included in – that’s been out in the public which is including our investment in Bernie's, our investment in a specialty pharma company.
And so, it’s been a, a mix of non-sponsored and sponsored business and post quarter and there has been a decent amount of sponsored business.
Right.
You were breaking. It’s muffled, so it’s really hard to hear.
Sorry about that. I hope you can hear me better and just one maybe, but I’ll just ask one more on your fund raising trends and activity outside of the BDC. Are you raising more in direct lending capital?
Yes. So, it’s a great question. We don’t really raise any capital and direct lending capital or have done so historically. So just to give people, which we think is a huge benefit to the platform. We have a direct middle-market one you find in Europe.
As people may or may not know, it’s hard to do non-U.S. borrowers, both from a regulatory standpoint, from a tax standpoint in the BDC. Non-U.S. investors have withholding tax as it relates to income where they don’t have for non-U.S. domicile companies which they don’t have withholding tax on the core business.
And so, the only really separately dedicated focus direct middle-market lending fund is in Europe. We have a multi-strat credit fund that co-invests on bigger opportunities with TSLX. That co-invest is subject to TSLX getting whatever at once on a deal first, and so it’s not problematic. And so, it gives the flux up, but not subject to the flux down for TSLX shareholders.
And then the last thing is, we have raised a kind of a structured, more down a capital structure fund to provide capital to middle-market companies that is deeper down the capital structure and that is typically having a large non-cash pay upon it. That would not be appropriate for TSLX shareholders given that we view the dividend as a effectively a fixed charge in liability.
But we don’t – we view – we have to think about the world in two ways is which we think scale is the enemy of returns, because you are competing against the higher the leverage loan market, but we do need scale, because on occasion, there is a great opportunity like Cheryl gas or other opportunities where you need capital to scale.
And so we’ve historically have done that to our private funds. But those private funds are not dedicated direct lending funds. And it come behind TSLX and then allocation process.
Thank you guys.
Thank you. And our next question comes from the line of Derek Hewett with Bank of America Merrill Lynch. Your line is now open.
Good morning everyone. I guess, first, I find the revised buyback policy actually quite refreshing. So I think congrats on putting a spotlight on that issue.
That said, I guess, this would be for either Josh or Bo. I think given that pro forma leverage, I think you guys said it was about 0.83 times at this point, what do you think you would need to see the increase leverage to the kind of that that 0.9 to 1.25 target range, that was called out following regulatory reform?.
Yes, it’s a great question. I think it feels like – look, things can change. It feels like we are on our way. I don't think, we'll be at 1.25 by the end of the year. But I felt like we are on a way and directionally headed that way. It feels like we are a little bit better situated than we were in Q4. And that the sense is that, if there is churn and financial leverage, we'll have an increase in fee income that supports our ROE.
I mean, the good news and the bad news about this quarter quite frankly is, the good news is, is that with no fee income and low financial leverage, we over-earned our dividend and we had a 10% ROE and then a 14.5% ROE on a net income basis. There is a lot of latent earnings in the book as we grow leverage given where we are.
So, that, I think that's the good news as well. The bad news is obviously is that, it's as good as a headline quarter, you might have had previously. But I think the good news is there is a lot of latency in the earnings.
Bo, anything there?
No, I think that's exactly right.
Okay. That's it for me. Thank you.
Great, well.
Thank you. And that concludes today's question-and-answer session. So with that, I'd like to turn the conference back over to the CEO, Mr. Josh Easterly for closing remarks.
Great. Thank you so much. First of all, thanks everyone for your time and interest. And we are a couple of weeks before Mother's Day. Lucy was a new mother last year. She missed this call. So, hopefully last and hopefully that this year has been a great year for you, Lucy and to everybody out there, hopefully they enjoy their – enjoy the family time on Mother's Day. I will speak to you in the summer.
Thanks, everyone.
Thank you.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a wonderful day.