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 Sixth Street Specialty Lending, Incorporated First Quarter Ended March 31, 2021 Earnings Conference Call. Before we begin today’s call, I would like to remind our listeners that remarks made during this 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, Incorporated’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, 2021, and posted a presentation to the Investor Resources section of its website, www.sixthstreetspecialtylending.com.
The presentation should be reviewed in conjunction with the Company’s Form 10-Q filed yesterday with the SEC. Sixth Street Specialty Lending, Incorporated’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, 2021. As a reminder, this call is being recorded for replay purposes.
I will now turn the call over to Joshua Easterly, Chief Executive Officer of Sixth Street Specialty Lending, Inc.
Thank you. Good morning, everyone, and thank you for joining us. With me today is my partner and our President, Bo Stanley; and our CFO, Ian Simmonds. We hope that everyone one is well. For our call today, I’ll provide highlights for this quarter’s results and then pass it over to Bo to discuss this quarter’s origination activity and portfolio metrics. Ian will review our quarterly financial results in more detail, and I will conclude with final remarks before opening the call to Q&A.
After market closed yesterday, we reported strong first quarter financial results with adjusted net investment income per share of $0.53, corresponding to an annualized return on equity of 13.3% and adjusted net income per share of $0.88, corresponding to an annualized return on equity of 22.1%. This quarter, we continued to accrue capital gains incentive fees, expense related changes and net realized and unrealized gains and losses. This non-cash expense, which was not paid or is not payable, was approximately $0.07 per share for the quarter.
Our Q1 net investment income and net income per share, inclusive of accrued capital gains and incentive fee expense was $0.46 and $0.81, respectively. Pausing on the impact of these adjustments for a moment, as an illustration, if we were to – if we were in the year as of March 31, the $0.08 per share of cumulative accrued capital gains incentive fee expenses that we had at quarter end would not be paid or payable since the gains must be realized in order for us to be eligible to receive these fees.
In addition, it’s also worth noting that a portion of these unrealized gains today are related to the impact of call protection and the valuation of our debt investments, which, if realized, would be ultimately flow-through net investment income and therefore, trigger a reversal of associated accrued capital gains, incentive fees, expenses.
Now back to our results. Our strong net investment income this quarter continued to be a function robust net interest margin attributable to our floating rate liability structure in this low rate environment in connection with LIBOR floors on our debt investments. Net investment income was also supported by higher interest and dividend income from an increase in the average size of our portfolio as well as fee income from portfolio repayment – prepayment activity.
The difference between this quarter’s net investment income and net income was a result of net realized and unrealized gains, primarily from the small portion of our portfolio represented by equity investments. As well as net unrealized gains from the impact of credit spread tightening from the valuation of our debt investments. At quarter end, net asset value per share was $16.47, up 3.8% from pro forma net asset value per share at year-end of $15.86 that we discussed on our last earnings call.
As mentioned, net realized and unrealized gains from our investments were meaningful contributors to this quarter’s net asset value per share growth. Other contributors included accretion from our follow-on equity raise in February, and the continued over-earning of our base dividend. Ian will discuss our net asset value bridge in more detail later on this call.
Yesterday, our Board approved a base quarterly dividend of $0.41 per share to shareholders of record as of June 15, payable on July 15. Our Board also declared a supplemental dividend of $0.06 per share based on Q1 adjusted net investment income to shareholders of record as of May 28, payable on June 30. Pro forma for the impact of the Q1 supplemental dividend for quarter and net asset value per share was $16.41.
If we were to take a step back and think about how our business has performed through the pandemic, one way to do this is look at the total economic returns, which measures the change in net asset value per share plus cumulative dividends per share since January and since the year-end 2019, which is just part to the onset of the pandemic. We’ve generated a total economic return of 21.8%.
Another lens is to look at total net asset value per share growth, which, in our case, should incorporate our special and supplemental dividends per share. Since year-end 2019, we grew our net asset value per share, adjusted for the impact of the special supplemental dividends by 9.5%. We’re pleased that our ongoing focus and building a business model for not only performance but thrived in periods of market uncertainty, delivered such strong results for our stakeholders.
As important, over the past year, our business model allowed us to provide capital to our portfolio companies, their management teams and sponsors when many of our competitors weren’t able to do so in order for them to create value for their own respective stakeholders. Having an enduring business model, despite of the regulatory and other constraints of – for BDCs not only provides value for shareholders, but it also allows us to be stable – a stable and certain provider of capital to our portfolio companies.
With that, I’ll now pass it over to Bo to discuss our portfolio activity and metrics.
Thanks, Josh. Let me start with some observations on the competitive environment in Q1. We continued – with continued accommodative fiscal and monetary policies from the Fed and the U.S. government investor appetite for risk assets remain elevated, bolstered by the search for yield and prospects for strong near-term growth. This sentiment was evident in the leveraged loan market, where strong demand pushed pricing in terms in favor of borrowers.
During Q1, LCD spreads tightened across the securities and ratings spectrum, with all-in yields for new issuers reaching post-financial crisis lows. Illiquidity premiums, as measured by the spread differential between large corporate and syndicated middle market loans, fell to seven-year lows. In covenant-light as a percentage of new loans issued, reached a record kind of 89%. In the direct lending market, elevated competition from BDC purists in private funds with record levels of dry powder meant that we continue to skew our originations activities towards opportunities where we had clear competitive advantages as a capital provider.
Despite the competitive backdrop, we continue to see borrower demand for financing partners with deep sector expertise in a broad range of underwriting capabilities. For this quarter, we had $145 million of commitments and $130 million of fundings. These fundings were across two new and six upsizes to existing portfolio companies. Our new investments this quarter were both first lien loans for mission-critical software providers with the traffic revenue characteristics. We were also active during the quarter by supporting our existing portfolio companies on their strategic growth and capital needs with nearly 45% of this quarter’s fundings serving our existing borrowers.
Our repayments in Q1 slowed after a busy 2020, totaling $85 million across four full and three partial investment realizations and sell downs. This resulted in net funding activity in Q1 of $45 million. The larger repayments this quarter were predominantly M&A driven, with the exception of our $17 million power value Neiman exit term loan. With a strong market backdrop in late marks, Neiman issued notes in the high-yield market to refinance its exit term loan, which had call protection of 110% at the time of repayment.
This call protection, in addition to the acceleration of unamortized OID on our loans, contributed meaningfully to our fees this quarter. Recall on our Q3 2020 earnings call, we disclosed that approximately $4 million of backstop fees related to our exit term loan commitment were booked as OID and that these fees were payable in common stock of the reorg company. Post quarter end, we sold our entire Neiman equity position at a price above our 331 mark, thereby fully exiting all of our Neiman investment.
Looking back, we’ve been a provider of liquidity and transitional capital for the retailers – for the retailer as its management team navigated through a pandemic and a Chapter 11 process. We believe this has been a fruitful partnership that has allowed both parties to create value for our respective stakeholders. Based on our total capital invested in Neiman since 2019, we’ve generated a gross unlevered IRR of approximately at 25% on our fully exited investments, which includes a post quarter-end sale of TSLX equity position.
Turning now to a quick update on J.C. Penney. Recall that in December, upon the company’s emergence from Chapter 11, our prepositioned debt and dip loan positions were converted to non-interest paying instruments, but with rights to immediate and future distributions and cash and other securities. During the quarter, our $13.3 million fair value dip loan position was extinguishing connection with the closing of a PropCo. And we received a small cash distribution, along with equity interest in the PropCo.
At quarter end, our PropCo equity interest had a level 2 fair value mark of $18.1 million. Across Q1, our J.C. Penney investments drove $5.4 million of net realized and unrealized gains or a positive $0.08 per share impact to our NAV quarter. At quarter end, our portfolio’s retail and consumer exposure was 11.4% at fair value, and nearly 80% of this consisted of asset based loans.
Cyclical names, which exclude our asset-based retail loans and energy investments, continue to be limited at 4% of the portfolio. And our energy exposure at quarter end was 1.7%. During Q1, our portfolio’s first lien composition decreased slightly from 96% to 95% on a fair value basis. And our equity investments increased slightly on a fair value basis due to the combination of our J.C. Penney PropCo equity interest as well as valuation tailwinds from a robust equity market and M&A environment.
At quarter end, our equity investments represented 4.3% of the portfolio at fair value compared to 3.7% in the prior quarter. In Q1, our portfolio’s weighted average yield on debt and income-producing securities as amortized cost was 10.1% compared to 10.2% on the prior quarter. This slight decrease was primarily driven by the impact of new versus exited investments. The weighted average yield at amortized cost on new investments were 10.6% this quarter compared to a yield of 12.8% on exited investments.
Shifting now to the portfolio and underwriting and credit quality. We continue to be thoughtful about our loan structuring process with utmost focus on protecting our principal against losses from credit risk and other market factors. At quarter end, we averaged approximately two financial covenants per loan and had an effective voting control on 87% of our debt investments.
In addition, we continue to have meaningful call protection on LIBOR floors across our debt portfolio. We believe our financial results over the past 12 months underscore our disciplined underwriting and its importance in driving differentiated outcomes. From a credit quality standpoint, we continue to see stable to positive performance trends across the significant majority of our portfolio.
Quarter-over-quarter, non-accruals decreased from 0.9% to 0.02% of the portfolio at fair value, following the completion of American Achievement’s out-of-court restructuring. As previewed on our last earnings call, our first lien loan for American Achievement remained outstanding post reorg. In the interest that we received, while the loan was on non-accrual status, was applied to our loan principle.
As part of the restructuring, the lender group received a majority stake of the common equity and subordinated notes in the restructured business. At quarter end, these subordinated notes accounted for all of our outstanding investments on non-accrual status at fair value. This quarter, our portfolio’s weighted average performance rating on a scale of 1 to 5, with 1 being the strongest, was 1.14, improving from 1.18 in the prior quarter. And credit metrics across our core borrowers remained relatively stable quarter-over-quarter, with weighted average attach and detach points of 0.4 times and 4.3 times, respectively. The weighted average interest coverage on our core borrowers was stable at 3.2 times at quarter end.
With that, I’d like to turn it over to Ian.
Thanks, Bo. In Q1, we reported adjusted net investment income per share of $0.53 and adjusted net income per share of $0.88. As Josh mentioned, we have approximately $0.07 per share of accrued capital gains incentive fee expenses this quarter. Inclusive of this non-cash expense, our net investment income and net income per share were $0.46 and $0.81, respectively. At March 31, we had total investments at fair value of $2.4 billion, up from $2.3 billion in the prior quarter as a result of net portfolio fundings as well as the positive impact of valuations on the fair value of our investments.
Total principal debt outstanding was $1.1 billion, and net assets were $1.2 billion or $16.47 per share, which is prior to the impact of the supplemental dividend that was declared yesterday. Average debt-to-equity during the quarter was 0.93 times, up from 0.87 times in the prior quarter, and the quarter end debt-to-equity ratio was 0.92 times.
Note that shortly after quarter end, we drew on our revolving credit facility to facilitate the payment of our $1.25 per share special dividend, which had a record date of March 25. Pro forma for this overall withdrawal, our quarter end debt-to-equity ratio would have been approximately 1 times, and our quarter end liquidity would have been $1.2 billion against $93 million of unfunded portfolio company commitments eligible to be drawn.
As you may know, we did a small equity raise in February, almost immediately on the heels of declaring the special dividend. The leveraging impact of a dividend payment in combination with our healthy investment pipeline and visibility on limited near-term repayments implied that our pro forma leverage would be on the higher end of our target leverage range of 0.9 times to 1.25 times.
In order to preserve our reinvestment option amid a building pipeline of opportunities, we did a small equity issuance sized at less than 6% of our pro forma market cap with net proceeds approximating the size of our special dividend payment. What we did essentially was swap out capital that had excise tax associated with it and replaced it with new capital without the burden of excise tax. This allowed us to create NAV and ROE accretion for our shareholders while remaining leverage neutral.
Turning now to our presentation materials. Slide 8 is the NAV bridge for the quarter. Looking through the notable drivers of this quarter’s NAV growth, we added $0.46 per share from net investment income against our base dividend of $0.41 per share. The equity raise provided $0.23 per share of stand-alone accretion to NAV, when we take into account the impact of dividends on the newly issued shares, netted an actual NAV accretion of approximately $0.13 per share.
There was a $0.21 per share reduction to NAV as we reversed net unrealized gains on the balance sheet related to investment realizations and recognize these gains into this quarter’s income. The impact of tightening credit spreads on the valuation of our portfolio had a positive $0.15 per share impact, and there was a positive $0.42 per share impact from other changes, primarily driven by net realized gains on investments of $0.21 per share and other net unrealized gains from portfolio company specific events. The realization of our small equity investment in capsule technologies upon a sale to Philips drove the bulk of our realized gains this quarter.
Moving on to our operating results detail on Slide 9. Total investment income for the quarter was $66.2 million compared to $62.2 million in the prior quarter. Breaking down the components of income, interest and dividend income was $55.9 million, up $3.2 million from the prior quarter, primarily due to the increase in the average size of our portfolio.
Other fees, the majority of which consisted of prepayment fees and accelerated amortization of upfront fees from the Neiman exit term loan prepayment were $8 million compared to $4.3 million in the prior quarter. Other income was lower at $2.3 million compared to $5.2 million in the prior quarter.
Net expenses, excluding the impact of non-cash accrual related to capital gains incentive fees, were $29 million, up $2.7 million from the prior quarter. This was primarily led by higher other operating expenses compared to the lower seasonally adjusted other operating expenses that we had in Q4.
Note that our annualized Q1 operating expenses as a percentage of total investments at fair value was 58 basis points, in line with our trailing full quarter average of 60 basis points. The weighted average interest rate on our average debt outstanding decreased slightly this quarter by 3 basis points, primarily due to the shift in funding mix as a result of an increase in the average size of our portfolio.
Shifting to yesterday’s 10-Q filing, you may have noticed that we reported for the first time, the calculation of diluted EPS on our income statement and in the notes on our financial statements. This accounting disclosure was triggered by the fact that the average share price of our stock exceeded the adjusted conversion price on our 2022 convertible notes during the Q1 reporting period.
To satisfy this disclosure requirement, we’ve chosen to early adopt ASU 2020-06, which requires among other things, the calculation of diluted earnings per share using the if-converted method. This method assumes conversion of our convertible securities at the beginning of the reporting period and is intended to show the maximum dilution effect to common stockholders regardless of how the conversion can actually occur.
As mentioned on our last earnings call, we have the flexibility under our 2022 convertible notes indenture to settle in cash or stock or a combination thereof. These notes are not eligible for conversion today, but when it comes time to make a determination on settlement method, our decision will be one that, among other considerations, optimizes the impact on our NAV per share, ROEs, financial leverage and liquidity position.
At quarter end, our balance sheet and funding profile were in excellent shape following several liability management actions taken during the quarter. As mentioned on our prior earnings call, this January, we capitalized on the attractive issuance environment in the investment-grade capital markets and issued $300 million of 2.5%, 5.5 year unsecured notes. And in February, with the ongoing support of our lending partners, we increased the commitments under our revolving credit facility from $1.335 billion to $1.485 billion, and extended the final maturity on $1.39 billion of these commitments to February 2026.
Subsequent to quarter end, the maturity on an additional $70 million of existing revolver commitments was also extended to February 2026. Pro forma for the impact of the special dividend payment post quarter end, our total liquidity at quarter end represented 51% of our total assets and unsecured debt represented 79% of our quarter-end funding mix. Further, the weighted average remaining life of our debt funding was 4.3 years compared to a weighted average remaining life of investments funded by debt at quarter end of only 2.4 years.
As we look ahead to the year, we continue to target a return on equity of 11.5% to 12%, corresponding to a range of $1.82 to $1.90 for full year 2021 adjusted net investment income per share. Note that this target range excludes the impact of any accrued capital gains incentive fee expenses.
With that, I’d like to turn it back to Josh for concluding remarks.
Thank you, Ian. I’d like to close our prepared remarks say by encouraging our shareholders of record for our upcoming annual meeting and special meetings on May 26 to participate in both. Consistent with the past four years, we’re seeking shareholder approval to issue shares below net asset value, effective for the upcoming 12 months.
To be clear, to date, we have never issued shares below net asset value. Under prior stockholder authorization granted to us for each of the past four years, we have no current plans to do so. We merely view the authorization as an important tool for value creation and financial stability and periods of market volatility.
The earlier days of the pandemic were case study on how peers of volatility often provide highly attractive return on equity opportunities, when it’s more likely that our stock would trade below net asset value. As you know, as we were well positioned heading into the pandemic with ample liquidity and capital cushion, and therefore, we were able to opportunistically deploy capital to create shareholder value without needing to access this tool for financial flexibility.
Looking ahead, those who know us that our bar for raising equity is high. We only raise equity when trading above net asset value on a very disciplined basis, who would only exercise the authorization to issue shares below net asset value as there was sufficiently high risk-adjusted return opportunities that would ultimately be accretive to our shareholders through overrunning our cost of capital in the associated dilution. If anyone has questions on this topic, please don’t hesitate to reach out to us. We’ve also provided a presentation, which walks through this analysis in the Investor Resources section of our website.
Turning now to our sector in the broader private credit markets. It’s hard not to take the opportunity to be a little reflective post the shocks for the global economy, which the pandemic provided, coupled with the fact that the private credit asset class has grown at a meaningful pace. In our humble opinion, much of the sector sale their earnings cost of capital and provide value to shareholders with a return on equity on net income over the last year of approximately 2.1% and 5.5% on average since our March 2014 IPO.
We think this reflects a failure to understand one’s cost of capital, the price credit spreads, which includes one’s fees and expenses, and to incorporate credit losses into one’s economic model. This clearly shows in our sector’s net asset value per share degradation of the LTM period of approximately 6.5%, and a cumulative net asset value per share degradation of approximately 15.5% as of March 2014 IPO.
We spent a lot of time thinking about the keys to the success of business model. Ultimately, we believe, is what allows you to provide value across market environments to your investors as well as portfolio companies, management teams and sponsors, even though these two goals may seem, at times, at odds with each other.
By adding resiliency to left and right-hand sides of our balance sheet through, among other things, focusing on set disruption, proactive liability management and maintaining appropriate liquidity and capital cushions. We’ve been able to sort of stability, sort of stable, stability and capital for our clients, including portfolio companies, management teams and sponsors or in carriers of uncertainty while providing of the returns to our shareholders.
Critical to this has been our focus on finding a balance of scale. That is to ensure that we bring deep sector expertise and capital to help an issuer to achieve its goals, but also create sustainable value for stakeholders. An environment where there’s not – where there’s finite alpha truck lending assets.
To date, we’ve achieved this by sizing our BDCs strategically based on our view of the market opportunity set and being part of the $50 billion Sixth Street platform, which have significant resources to benefit portfolio companies’ management teams and sponsors.
Finally, one more topic related to voting. Our broader Sixth Street business over the past year has joined other organizations and pursuing efforts to strengthen access to voting in the United States. These include the Civic Alliance, which is a coalition of businesses supporting safe and accessible elections. And last month, we joined a group of growing lift of corporate general counsels and law firm managing partners in the statement announcing efforts to restrict the constitutional right for eligible Americans to vote.
The statement is signed by Sixth Street general counsel called for leadership from our elected officials that take a stand against election laws at different franchise underrepresented groups across our country. We are proud to stand by our core democratic values and join our peers in the business community on these initiatives.
With that, thank you for your time today. Operator, please open the lines for questions.
[Operator Instructions] Our first question comes from the line of Melissa Wedel with JPMorgan. Your line is open.
Thanks everyone. Appreciate you taking my questions today. You provided a lot of information this quarter, and it’s much appreciated. The transparency is quite helpful. I guess, just to start off, given the elevated prepayment income that you saw in the first quarter. Certainly, over time, you talked about how that can be pretty lumpy. We know that, that’s going to ebb and flow based on individual development with portfolio companies. But I’m wondering how your – what your line of sight is into any other developments within the portfolio that we should be thinking about that could drive any volatility on that line item to the extent that you have any line of sight on it.
Hey, good morning, Melissa. Thank you. So I think actually, this quarter was actually relatively muted, as it relates to payoffs. So I think payoffs this quarter were $85 million. And the correlation between payoffs and accelerated OID and other investment income is relatively high compared to the average quarter, which is probably 2 times greater, so around $200 million.
And so I think when you look at the attribution in our income statement, I think it was also relatively low. So typically, when you look at it on a per share basis, interest from our investments – and interest income have been $0.81. It was $0.83 this quarter. Interest from investments of the fees have been $0.13 so that’s prepayment fees in this quarter was about $0.12.
So I would say it was probably slightly on the lower side. I think, I mean, when you look at other income, was about $0.03 per share compared to historically about $0.06 per share. So also, I think, relatively low – those other activity based fees were relatively low this quarter. And I think there was a – it was kind of, quite frankly, a little bit of a quiet quarter, both on the origination side and on the payoff side. Ian, anything to add there? I think the other thing is from a – there was obviously – Q4 tends to be a large quarter.
And as you pull forward of Q4, some activity in Q1. And so you saw payoffs elevated in Q4, you saw fundings elevated in Q4. So Q1 was kind of a little bit of a quiet quarter on both the origination and payoff side and a little bit of a quiet quarter on the activity base – therefore, on the activity based income side. Ian, anything to add there?
Yes. I would just add, Melissa, that we look at the amortization of upfront fees from unscheduled payments in tandem with the prepayment fees, if there are any, on a particular payoff. So when Josh was quoting the $0.12 per share from that category, that’s because we combine those two particular line items. But as you said, it’s actually relatively in line with what we’ve experienced over the last 10 or so quarters.
And just a little more detail. That was specifically driven through Neiman, I think, Ian, right, which was the unamortized portion was related to when we did the Neiman’s exit term loan, we got a backdrop being Neiman’s equity. The fair value of that equity was on the balance sheet of our costs, as a cost basis, and therefore was the OID against the term loan when the term loan paid off at both the prepayment on the accelerated OID, which was the value of the equity rolled through the income statement.
All right. I appreciate that. One quick follow-up then. Given sort of the outperformance in 1Q on adjusted NII versus the ROE targets that you established at the beginning of the year, wondering – you didn’t take up the target. And just wondering how you’re looking at that for the rest of the year. Thank you.
Yes. So thanks. I mean, look, we try to create a – and hopefully, we could keep this up, a history of beating our guidance. And which is, kind of looking at the base earnings in quarters where we have a highly confident number on return on equity and NII per share. And when you set out very high confidence of 95%, often time exceed. So if you set a confidence level of 50%, half the time you’ll exceeded and half the time, you won’t exceeded. So when we give our guidance per share, we’re really trying to set a confidence level 95%.
Thanks guys.
Thank you. Our next question comes from the line of Devin Ryan with JMP Securities. Your line is open.
Great. Good morning, everyone. And thanks for the overview. First question just on kind of the investing landscape. So the spread on new investments has come down clearly relative to kind of the peak levels. It’s kind of the peak of the pandemic. But you’re still meaningfully above pre-pandemic level. So just a little maybe more color on whether that’s the types of deals you guys are putting in the portfolio? Or are you still seeing deals probably pricing at a premium today?
Yes. I mean, I’ll turn it over to Bo. I mean, look, the challenge was looking at any one quarter is it kind of moves around because the sample size is pretty low. I would say this quarter was broadly kind of reflective of the things we’re trying to focus on and do. We’ll do things tighter, we’ll just see some things wider. But I think it’s broadly reflective I think on the – generally on the investing environment, the big theme, you see this across risk premiums across asset classes, in most asset classes, and there are some industries that this doesn’t exist, for example, real estate.
But the cycle has kind of skipped. And so when you look at – and people or pricing and underwriting standards are kind of assuming that, which I think is probably right. And so things ahead of, I think [indiscernible] again, the cycle has skipped. Consumers are in – has excess savings, are in the greatest health they’ve ever been in. Now there’s obviously a distributor process consumers. But broadly speaking, that’s the case. Corporates are in relatively good shape, especially given low interest rates and financial earnings rate change.
Most of the pandemic pains fell on the government’s balance sheet. And so I think broadly speaking, we’re kind of back into the first to second inning. I do not think we’re in the 10th, 11th inning over time of a cycle. We’re kind of back at the beginning, the cycle is skipped and I think people are pricing risk premiums that way, which is expected low default. And default recoveries – recoveries given default will probably be pretty high for the next couple of years.
Okay. Appreciate it. That’s great color. Maybe a bigger picture one, Josh, if you can. Just always appreciate your view on the industry more broadly. And clearly, here we sit today, roughly a year past – more than a year past the start of the pandemic. And looking at your portfolio, it’s in terrific shape. Non-accruals are down to 0.1% of the portfolio cost. The overall portfolio has performed incredibly well. And obviously, a very strong quarter.
So as we think about just kind of the business models, we’ve just kind of gone through a real-life stress test. How do you think about kind of the case for maybe a further re-rating in the stock or maybe in the space more broadly and kind of distinguishing between the leading firms that really kind of showcase how well they can perform in an environment like the last year versus maybe firms that didn’t fare as well now that we can kind of look back a little bit and retrospect a little color from you.
Yes. I’ll give you a couple of different swing thoughts. First of all, I think it’s – we didn’t really experience the cycle. Now there was mostly – there was very significant dispersion around managers. But quite frankly, you don’t really feel the full way of cycle given the fiscal monetary stimulus. And so I don’t know if people can share or think about expecting that every – going forward. Given that return on equity in the space was, on average, I think, was 2% now that will come up a little bit because NAVs have increased this quarter. But quite frankly, relatively not great, although there were people who had great performance. I think our return on equity for the year, last year, was 15.8%.
And some of our peers, Ares had a great year. Some of our – people are – there are most definitely people outperformed. I think generally, what you’re seeing in valuations, I think the space has rerated. I think you’re seeing the space trade at or closer to net asset value, which I don’t think is – since we’ve been public, has been really the case. And I think you’re seeing greater dispersion and on both the left tail and the right tail of based on performance.
And so I think it’s most definitely – I think it’s kind of getting to a healthy spot where the asset class or where the sector was, when we first did this post global financial crisis was, looked at pretty negatively by a lot of institutional investors. And now I think people can see the dispersion and that dispersion is based on skill sets and of – and talent and management teams and business models and how they approach the market.
So I think I like it. And I think, hopefully, sponsors and issuers and users of capital, put that in their own model, which is in their head, which is they – hopefully, they value a stable source of capital for – in their partnerships and for their portfolio companies and people understand the sector and that they – and that value – that stable source of capital will be valued to their own endeavors and so [indiscernible] I don’t know, but anything they add there, Fishman? Fishman’s always a guest speaker on this because he has the most wisdom out of everybody. But anybody – Ian, don’t laugh at him, I said Fishman has, what if he actually does – but anything to add, Bo?
No, I think that was well said, Josh. I think the dispersion of managers wasn’t fully tested, given the unprecedented fiscal and monetary stimulus. But we’ll have regular cycles again at some point, that will be reflected in the results, but I agree largely with your thoughts.
Okay. Terrific. Well, I’ll leave it there. Thank you guys.
Great, Devin. Thank you so much.
Thank you. Our next question comes from the line of Ryan Lynch with KBW. Your line is open.
Hey, good morning. Thanks for taking my questions. First one is, you guys are clearly a very big lender into the software space. And as the market continues to evolve and as software becomes a more desirable sector to lend to. It seems like annual recurring revenue lending is becoming more and more prevalent. So from your standpoint, since you guys track in the software space a lot, how do you think about lending on ARR versus cash flow to be software companies? And then just a high level ballpark, what percentage of your portfolio and your software names were those initial loans done on an ARR versus a cash flow lending basis?
Yes. Thanks, Ryan. We’ll come back to you in the latter part of the question. I don’t know if we have it off the top of our head, but we’ll come back to you. On the first part of your question, look, I would say we’re investing. And not every dollar of cash flow is created equal and not every dollar of subscription revenue of ARR is created equal. And so I think, unfortunately, given the buoyancy of the software space, which has kind of risen all both those business models haven’t been tested.
And so we’re extremely focused on quality business models and business models that are robust and so it really is – there are some businesses that we think that have good return on capital or investing a ton best-in-class unit economics, and we want them to grow and switching costs are high, and we want to support those companies in their growth endeavors. And so ARR structure works. And there are some cash flow companies that we think is the software – cash flow deals in the software space that, for example, that EBITDA is not burdened by R&D, capitalized R&D, that churn is high, that there’s a whole bunch of technical bet and margins are not sustainable given the technical debt and that we won’t lend to on a cash flow basis.
And so we’re investors and so what I would say is not every dollar of ARR is created equal, not every dollar of EBITDA is created equal. And you really got to look at business models and how robust those business models are. Bo or Fish, do you have anything to add?
Yes. The only thing that I would add is we’ve been lending broadly to the technology sector, which includes software for over 20 years. And have developed a lot of pattern recognition along the way on how various end markets within technology performed through cycles. We’re very nuanced in our approach. We’re focused dramatically in subsectors. We don’t think of software as a sector. It’s omnipresent. It’s – obviously, the digitization of the economy is happening before us, and it’s probably accelerated through COVID. So you’re feeling a lot of tailwinds from that.
But we get very nuanced within the subsectors and figure out areas that we feel like there’s going to be ongoing strong unit economics and return on invested capital in the space. So that will – but to Josh’s point, we don’t look at – we look at investments – as investors, we don’t look at an ARR loan or a cash flow loan differently. We’re pressure testing how we think those revenue streams are going to perform and what our margin of safety is if things don’t go to plan.
I would just add we also look through to the end markets, lending to a software business going through the pandemic in the restaurant industry or the cruise industry. It’s a lot different than if we were lending to, like the grocery or retail or different parts of the retail industry. So we pay attention. There’s no shortcut. You have to pay attention to a lot of factors, end markets being one of them, because, as Bo said, technology is ubiquitous, and you’ve got to dig deeper in your analysis.
As always, Fishy comes in with the wisdom, rounding not every dollar of EBITDA or weaker revenues created equal, end markets matter. And Fishy, thank you for the – you’re dead on. Is that helpful, Ryan?
Yes, yes. That’s helpful. Got a response from the full team. So the other question I did have, you mentioned that – you guys brought up on the call, the convertible bonds you guys are now doing different – has shown some different reporting metrics on that. And so I know that’s still a little bit over a year away of when that will actually becomes due and you guys have to make a decision on how to repay that.
But as we sit here today, I guess, preliminarily, if you guys had to convert that today, what would you guys look to do? Because it looks like if you guys paid that off with issuing shares, it looks like that could be accretive to NAV would be a deleveraging event. You paid it off in cash, it looks like they’d probably be dilutive to NAV, but it wouldn’t be a deleveraging event based on…
Ryan, you’re dead on. So the good news is we get the – it’s not binary. We could – we have the flex on how we settle, how much cash in stock. And you hit the bookings exactly right. And so it’s going to be a function of the framework is, where we are, debt-to-equity how dilutive is it on ROEs, NAV or how accretive it is on ROEs and NAV. And we have the flexibility of settling on how we settle that. And so I think the bookings in are we settle all – and again, it’s not binary. So we could – we’re in between these bookings. But if we settle on cash, it’s dilutive, and it doesn’t go through the P&L, it goes through a pick, but it is dilutive per share of what Ian?
$0.36.
And if we settle all in stock, it’s…
It’s accretive by $0.16.
So that is – that will be a function of where we’re sitting, how much capital we have, where, obviously, the good news is we have time and we can manage it and if we have visibility of how settle of, but you hit it.
Okay. Got you. Appreciate the time today and really nice quarter quys.
Thanks, we appreciate it. By the way, that was the heart of financing we’ve ever done and it had the most value in it. But that was literally the hardest financing we ever had a round up. Obviously, in hindsight, I think, Ian, what we bought back around…
About $27 million, yes.
$27 million of those notes at a cost to us of about $0.90, which was a helpful investment in our own capital structure doing COVID. And so enhance that we could have done more. But we were not only making – in COVID, not making investments to support our portfolio companies or making investments on capital structure. Those two in combination create a lot of value for our shareholders.
Got you. Thanks, guys.
Thank you. Our next question comes from the line of Finian O’Shea, Wells Fargo. Your line is open.
Hi guys, good morning. So most questions have been asked and answered. Just one here on the dial transaction, that looks to be moving along. Does that lead you to pursue any potential ownership change? Or have your concerns been subdued by this time?
Yes. Look, I would say our concerns haven’t been subdued. We’re obviously – and we’re obviously very disappoint in the Vice Chancellor’s initial decision. We think she got the facts wrong and we are wrong. That’s why we appealed. As we said, we honor our deals, and we’ve backed our partners on other deals, too. We have – again, we’ve known the principles at our rock for many years and a great deal respect for them as a competitor to our firm. The Delaware Supreme Court yesterday has decided to hear our appeal on an expedited basis. So that is being heard on May 12. And so they granted and we’re doing it on an on bunk basis. So all five of the Justices versus the panel three, we’ll hear the appeal on May 12. Obviously, ongoing litigation and so that’s all I can say.
Okay. That’s helpful. That’s all for me. Thank you.
Thank you. [Operator Instructions] Our next question comes from the line of Robert Dodd with Raymond James. Your line is open.
Hi guys, and congratulations on the quarter. A question on kind of repayment expectations, kind of maybe more long-term. I mean, I realize Ian’s comment limited near-term repayments expected. But if I look at your book, you’ve got a little over 50% of the debt book marked above 1% and 2% of cost now. My presumption is that’s factoring in co-pro, which you structured very well. So the question is, are your concerns elevated about maybe not in the near-term, but as we go through this – the rest of this year, given how competitive the market is. Is there elevated risk of – risk is an issue like because you get paid if we get repaid early. But elevated risk of maybe portfolio contraction with repayments? Or do you think the pipeline is going to be sufficient even in a very competitive market where you’re very picky on the credit side to grow the book this year? Or is the elevated level – what appears to be an elevated level of repayment expectations, a headwind?
Yes. Actually, look, our expectation is that in the near-term, we’re going to grow the book. And so when we look at what’s out there, there’s a couple, but the pipeline more than offsets it. And so given as you know, the interaction between repayments, which typically creates some income and – but also deleverage the business. And given the breadth and depth of our sourcing and how we go-to-market.
I feel pretty confident that we’re actually, on a net basis, are going to grow the book in the near-term it’s the nice thing about being part of a very large platform is we’re involved in obviously sectors and look, I think, again, M&A drive, repayments and – but also drives new deal flow. And I feel – I actually feel more bullish in our ability to grow the book today than I have historically. Bo or Fishy, anything to add there?
No, I think you’re spot on. I think historically, when you look at our repayment activity, it’s largely been driven, not all the time, but largely been driven by M&A activity, which also – when there’s elevated M&A activity, there’s also elevated opportunities. I would expect 2021 to have elevated M&A activity. We’re seeing that in the formation of the pipeline currently. But with the backdrop of strong asset valuations and expected tax changes, I think you’re going to see elevated M&A activity, which will drive both new opportunities and repayments. But I’m with Josh, I’m more bullish on growing the book than there being shrinkage.
Got it, got it. Appreciate that. I mean the question that follows on is obviously interact with kind of Ryan’s question on the convert. How high – I mean, obviously, we know the target range, would you be willing to operate essentially at the high end of that target range for a, I want to say, a prolonged period? But obviously, one of the options with the – it would deleverage you. That’s not until August next – in 2022, right? It’s a long time out. But what’s the balance there on how you’d be willing to go? Because you can always just not do new deals if you get too high. But what’s the balance versus the potential of something that’s accretive to NAV if it’s not too deleveraging, it’s a really good outcome on multiple fronts. So what’s the view there?
Yes. Look, as you know, it is summer of next year. And so like it’s hard to make a call about your capital 18 months from now. And again, you have the ability to flex settle, which I think is helpful. So it’s not binary. And so I just – it’s hard to make a call 18 months. We obviously understand those levers very well, which is all things being equal you rather do something with the converse as accretive, the net asset value than dilutive. And so yes, if you had perfect visibility would you like to run a little bit hot, knowing that you can settle in stock and the answer would be yes.
But again, I think that’s some time off, we’re going to have a lot of – we’ll have more visibility. The good news with time and as time passes, you get more clarity. And so – but we most definitely understand those levers, and we’ll – as we do with everything, we’ll be thoughtful as it relates to our shareholders.
Got it. Thank you.
Thank you. Our next question comes from the line of Derek Hewett with Bank of America. Your line is open.
Good morning, everyone. And congrats on another strong quarter. So maybe Josh or Bo or even Michael, Sixth Street has been one of the top-performing BDCs since inception back in 2013. So how should we think about the size of the portfolio kind of given your investment strategy, plus just the overall growth in private credit? Or kind of in other words, are there enough opportunities to potentially double or even triple the size of the portfolio in either the intermediate or longer-term?
Yes. Derek, it’s good to hear from you. Look, I don’t think we’re actually like as the hallmark of how we’ve always run the BDC is we’re focused on shareholder returns and not growing assets. And so if we can find assets that provide that earn or exceed our cost of capital and provide shareholder returns will grow. If we can’t, we will not, and we’ve sized the book to be fully invested in the trough opportunity set. So I – we have a growth, and I think we tried to hit this a little bit, which is growth is not a – and let me put it this way. One of the reasons why we think we’ve had the performance we have for shareholders is the way we think about how we don’t grow the book just to grow the book and we think of shareholders first.
And we will continue to think about the world that way. And we work for shareholders. The funny thing is, is that I know the space kind of thinks about the asset management space thinks about themselves as having permanent capital. And the way we think about the world is a little bit differently, which is we don’t have permanent capital, our shareholders have permanent capital. We just happen to manage it on a year-to-year basis, and we’ll continue to work hard for shareholders. And so that our Board and our shareholders keep inviting us back to manage that those assets.
Okay, great. Thank you.
Thank you. I’m showing no further questions in the queue. I would now like to turn the call back over to Joshua for closing remarks.
Great. Thank you so much for everybody’s presentation. We’ll speak to you at the end of the summer, if not sooner. And then obviously, Mother’s Day is coming up, so obviously, to all the mothers out there, thank you for supporting your families during a very difficult time. And obviously, the pandemic has most definitely been hard. And my guess is some of that – a lot or some of that burden has fallen on your shoulders. So thank you, and we’ll talk soon. Bye.
Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation. You may now disconnect.