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’s Inc. December 31, 2017 Fourth Quarter and Fiscal Year Ended 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 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 forward-looking statements.
Yesterday after the market close, the Company issued its earnings press release for the fourth quarter and fiscal year ended December 31, 2017, and posted a presentation to the investor relation section of its website, www.tpgspecialtylending.com. The presentation should be reviewed in conjunction with the Company's Form 10-K filed yesterday with the SEC. TPG Specialty Lending, Inc.'s earnings release is also available on the Company's website under the investor relation section.
Unless noted otherwise, all performance figures mentioned in today's prepared remarks are as of and for the fourth quarter ended December 31, 2017. As a reminder, this call is being recorded for replay purposes.
I will now turn the call over to Josh Easterly, CEO of TPG Specialty Lending, Inc.
Thank you. Good morning, everyone, and thank you for joining us. I will begin today with an overview of our quarterly and full year highlights, before turning the call over to our partner and our President Bo Stanley to discuss our origination and portfolio metrics for the fourth quarter and full year 2017.
Our CFO, Ian Simmonds, will review our quarterly financial results in more detail. And I will conclude with final remarks before opening up the call to Q&A.
I’d like to start this morning by highlighting our strong financial results for the quarter and full year 2017. Net investment income per share for Q4 was $0.45 per share, resulting in a full year net investment income per share of $2, well in excess of our full year base dividend per share of a $1.56.
Net asset value per share at quarter end was $16.09, as compared to an increase of $0.06, compared to the prior quarter after giving effect to the impact of the Q3 variable supplemental dividend. This was primarily driven by the overearning of our base quarterly dividend and the positive impact of net unrealized gains specific to certain portfolio companies.
Yesterday, our Board announced a first quarter 2018 base dividend of $0.39 per share to shareholders of record as of March 15, payable on April 13. Our Board also declared a Q4 variable supplemental dividend of $0.03 per share to shareholders of record as of February 28, payable on March 30.
Consistent with our objective of maximizing distributions while preserving the stability of our net asset value, we declared a total of $0.22 and the incremental dividend related to 2017 earnings based on our formulaic variable supplemental dividend framework, while increasing our net asset value per share from $15.95 at the end of 2016 to $16.06 at year end after giving effect the impact of the $0.03 Q4 variable supplemental dividend to be paid in Q1.
Our supplemental dividend framework has allowed us to maintain or increase our book dividend yield, as we grow net asset value per share. For reference, our book dividend yield was 11.2% in 2017, compared to 10.3% in 2016.
In 2017, we generated an economic return of 11.9% as measured by growth in net asset value plus dividends per share. In addition, we continue to generate strong returns for shareholders for the calendar year total return a 15.4%, which represents an outperformance of our 15 percentage points versus the Wells Fargo B2C index.
Since our IPO through year end 2017, we have delivered a total return of 76.3%, which represents an outperformance of nearly 65 percentage points versus the Wells Fargo B2C index of the same period – same time period. We remain humbled by our results to date.
In a year, where competitive headwinds led to tighter credit spreads, higher leverage and lower covenant quality in the middle market lending space. We attribute that robust of our 2017 financial results to our discipline underwriting in capital allocation philosophies.
By maintaining our investment selectively and commitment to thematic sourcing and underwriting, we've been able to generate stable attractive portfolios yields and ROEs, despite the challenging operating environment. Bo and Ian will discuss this in more detail later on the call.
From our portfolio quality perspective, we had no investment on non-accrual status a year end. The overall performance of our portfolio in Q4 remains steady with a weighted average rating of 1.22, based on an assessment of scale of one to five, one being the highest and as compared to 1.21 for the prior quarter and 1.44 for Q4 2016.
Across our portfolio, since inception through December 31, we have generated an average gross unlevered IRR weighted by capital invested of approximately 19% on fully realized investments totaling over $2.6 billion of cash invested.
Post year end, we took further strive in enhancing and diversifying our funding sources. In January, we completed our inaugural registered senior unsecured notes issuance and this month, we reduce the pricing that’s in the maturity of our revolving credit facility.
With that, I'd like to turn the call over to Bo, who will walk you through our originations and portfolio metrics in more detail.
Thanks, Josh. In Q4, the loan environment continued to favor borrowers as private debt fundraising completed its most successful year on record, in competition from both existent market participants and larger players had a down market drove strong demand for middle market loans.
Taking a closer look at our activity for the quarter, our new investments consists of predominantly of either lower middle market companies with defensive market positioning and diversified revenue streams, or larger companies with sound business fundamentals and the need of capital structure optimization. In either case, we linked on us required for targeted return profile for our portfolio.
To put some numbers around this quarter's activity, we generate our highest quarterly level of gross origination, since inception of approximately $1.07 billion, driven primarily by two transactions that we sold led in agent [Audio Gap] $400 million first lien facility for Northern Oil and Gas, which we discussed on a call in November and a $40 million ABL credit facility for iHeart Communications. For both of these transactions, the lack of bank underwriting appetite and a lot of complex capital structures and regulatory constraints provided us the opportunity to capture attractive risk adjusted returns for our shareholders.
A clip of their platforms, these expertise’s and asset base lending and our ability to underwrite larger financing through co-investment from affiliated funds, we’re able to structure loans with robust collateral coverage call protection and meaningful financial covenants.
Of the nearly $1.07 billion of gross originations during the quarter, $770 million are syndicated or allocated to affiliate funds and approximately $25 million consists of commitments we funded post quarter end or expect the fund, resulting in total funded activity of $272 million.
On the repayments front, we had a $136 million of aggregate principal amount of repayments this quarter from four full realizations and one partial investment sell down. One of the realizations with investment in Sears Canada DIP loan, consistent with the underwriting expectations, we were fully repaid on our investments in Sears Canada, which along with other economics resulted in gross unlevered IRR on our investment approximately 30%.
Reflecting on our deal activity in 2017, we achieved the highest level of gross origination and fundings, since inception of $2.3 billion and $989 million respectively. However, we also experienced record repayments of $952 million from 34 and four partial realizations and sell downs resulting in full year net funding of the $38 million.
Approximately, 60% of our originations during the year were non-sponsor related which highlights the diversification of our sourcing channels. For both sponsored and non-sponsored transactions, our ability to underwrite larger commitments to the scale and expertise afforded to us as part of the TSSP platform has enabled us to capitalize on more niche financing opportunities like iHeart and Northern Oil, as well as upper middle market sponsor acquisitions that require extensive diligence and underwriting capabilities.
During the past year together with other affiliated funds, we provide the commitments of eight financing as that are each $150 million or greater. At year end, 98% of our portfolio by fair value was sourced through non-intermediated channels, compared to 89% a year ago, as we opportunistically sold investments accumulated during periods of market dislocation in late 2015 and early 2016 of mid robust secondary market prices throughout 2017.
As a result of our focus on controlling the investment structuring process at year end, we've maintained effective voting control in 82% of our debt investment and average 2.3 financial covenants for debt investment, consistent with our historical levels.
We believe in betting downside protection features in loan documentation, a critical in today’s late cycle environment, as they allow us to quickly identify and implement risk mitigation measures in the case of under-performance, in order to minimize potential losses.
As we navigate the ninth year of the economic cycle, we remain focused on investing at the top of the capital structure. At December 31, 93% of investments by fair value and first lien, 97% of our portfolio by fair value with senior secured and our junior capital exposure consistent with the prior quarter remained steady at 7%.
As for the overall portfolio yields, the weighted average total yield of our debt and income producing securities at amortize cost was 10.8%, consistent with the prior quarter and up 40 basis points from the year end 2016. The weighted average total yielded amortized costs on debt fundings and pay downs during in the quarter were 9.3% and 11.7% respectively. Adjusted for the expected duration of iHeart, the weighted average total yielded amortized costs on new debt fundings is 11%.
Note that the downward yield impact of this quarter's net fundings was offset by the increase in effective LIBOR rate on our floating rate debt portfolio. At year end, our portfolio was well diversified across 45 companies and 17 industries. Our average investment size was approximately $38 million and our largest position iHeart accounted for approximately 6.5% of the portfolio at fair value.
We believe our whole size is well supported by the structural protections of our borrowing base governed loan which is fully secured by high quality collateral. In addition, we believe we have strong downside protection given our agent role position at the top of the capital structure and the strength of the company's free cash flow profile on a reorganized capital structure.
At December 31, financial services was our largest industry exposure comprising 14% of the portfolio at fair value, followed by business services at 13.8%. Note the vast majority of our financial services portfolio companies are B2B integrated software payment businesses with limited financial leverage and underlying credit and bank regulatory risk.
Given the late cycle environment, we've maintained our exposure to non-energy cyclical industries which excludes asset based loan investments at a historical well over 4% of the portfolio fair value, compared to 31% at the beginning of 2013.
As for energy, our strategy which we've communicated since early 2016 has been to opportunistically provide conforming first lien reserve base loans for upstream companies that have significant hedge collateral value at the current price levels.
Over the past two years, we so likely increased our portfolios energy exposure from approximately 3% at fair value at the beginning of 2016 to 5.5%, and we expect to remain opportunistic in the sector. Despite the volatility and commodity prices, we've been profitable cumulatively on energy investments to date. Even in light of some challenges of Mississippi Resources.
Since we began our investing activity in 2011, we've developed and acted up on a number of namespace on the broader macro environment, sector specific trends, ranging from restaurants and building products in 2011 and 2012 to ABL retail and financing of former royalty streams in today's late cycle environment.
While our teams have rotated over the course of the cycle, approach the sourcing and investing remain the same, which is to stick to the sectors and themes where the expertise and relationships of the broader TSSP and TPG platforms provide us with a competitive advantage, a robust direct origination strategy in underwriting discipline focus on downside protection and secondary source as a repayment.
With that, I'd like to turn it over to Ian.
Thank you, Bo. We ended the fourth quarter and fiscal 2017 with total investments of $1.69 billion, total debt outstanding of $750 million and net assets of $969 million or 16.09 per share, prior to the impact of the $0.03 per share supplemental dividend to be paid during Q1 2018.
As Josh mentioned, our net investment income per share was $0.45 for the fourth quarter, resulting in a full year net investment income per share of $2. Our net investment income per share was a $1.86, which exceeded our full year guidance of a $1.67 to a $1.83 per share, which was based on an expected ROE of 10.5% to 11.5% applied to beginning NAV.
For the variable supplemental dividend, 50% of this quarter's overearning against the base dividend per share of $0.39 rounded to the nearest cent amounts to $0.03 per share. Consistent with the prior three quarters, the NAV movement constraint element of the formula had no impact on the calculation of this amount.
As a result of the rebound in net fundings this quarter, our debt to equity ratio at December 31 was 0.74 times, approaching the lower end of our target leverage range of 0.75 to 0.85 times. Our weighted average leverage ratio for Q4 and full year 2017 was point 0.72 times and 0.67 times respectively.
During January, we made various enhancements to our overall debt funding flexibility and cost. Specifically, we issued a $150 million principal amount of 4.5% five-year senior unsecured notes, the net proceeds of which we used to pay down debt outstanding under our revolving credit facility.
Consistent with our risk management philosophy of matching our liabilities with the floating rate nature of our debt portfolio, we entered into an interest rate swap matching the notional amount and term of the new notes. This was an opportunistic financing that provided access to a previously untapped market for us adding attractive pricing of LIBOR plus 199 basis points on a swap adjusted basis, which at the time was inside the cost of our secured revolver spread resulting in minimal pro forma drag on ROEs.
In addition, earlier this week, we amended our revolving credit facility reducing the effective pricing from LIBOR plus 200 to LIBOR plus 180.75 basis points and extending the final maturity of February 2023 on the significant majority of commitment.
In light of our recent $150 million notes offering and limitations on revolver utilization given regulatory leverage constraints, we may look to explore reductions on the non-extended portion of revolver commitments in order to reduce to the ROE drag of unused revolver fees going forward. Given the ongoing support of our lenders and our demonstrated access to liquidity and diversified funding sources, we believe we are well positioned for the opportunity set ahead.
Moving to a presentation materials, Slide 8 contains an NAV bridge for the quarter. After giving effect to the Q3 supplemental dividend that was paid during Q4, we added $0.06 per share for net investment income in excess of our base dividend, which was offset by the reversal of net unrealized gains from four full investment realizations during the quarter.
$0.02 per share was related to the net positive impact of credit spreads on the valuation of our portfolio, well $0.04 can be attributed to the net positive impact of other realized and unrealized net gains, including those specific to certain portfolio companies. If we would have adjust the ending NAV per share of $16.09 for the variable supplemental dividend declared based on Q4 earnings that we will pay in Q1 2018. The ending NAV per share is $16.06.
Moving to the income statement on Slide 11, total investment income for the fourth quarter was $48.8 million, down $3.5 million from the previous quarter, primarily driven by lower other fees. This line item, which consists of prepayment fees and accelerated amortization of upfront fees from unscheduled pay downs, was $3.4 million compared to $6.8 million in the prior quarter, consistent with the low repayment activity that we experienced during Q4.
Interest and dividend income was $43.8 million, up $1.8 million from the prior quarter, given an increase in the size of the portfolio and the impact of raise in LIBOR. Other income was $1.7 million, down $1.9 million from the prior quarter, primarily due to the absence of syndication fees, which tend to be episodic in nature. Our PIK income component remains low at 2.2% of total investment income for the quarter and 2.8% for full year 2017.
Net expenses for the quarter, excluding interest expense, were $14 million, down $1.3 million from the prior quarter, primarily due to lower incentive fees and lower other operating expenses. As for the quarter-over-quarter increase in interest expense, this was primarily driven by the timing of the interest rate swap settlement on our 2022 convertible notes during Q3 and Q4.
Adjusted for this impact, the weighted average interest rate on average debt outstanding excluding amortization and fees for Q4 remain steady with the prior quarter at 3.5%, despite an increase in our effective LIBOR borrowing rate. This was due to high utilization of our lower cost revolver funding as positive Q4 net funding activity resulted in an increase in average debt outstanding.
On the topic of ROEs during Q4, we generated an annualized ROE based on net investment income and net income of 11.1% and 11% respectively. The full year 2017, we generated in ROE based on a net investment income of 12.5% with an average leverage ratio of 0.67 times, compared to a 11.9% for 2016, when we operated at an average leverage ratio 0.8 times.
Similar to 2014 and 2015, the strength of our 2017 ROE was supported by heightened portfolio activity that resulted in elevated levels of prepayment fees and accelerated OID from unscheduled paydowns.
Recall that in 2014 and 2015, we operated below our target debt to equity ratio at 0.5 times and 0.64 times and still generated ROE based on net investment income of 13.3% and 11.4% respectively. Our ROE based on net income for 2017 was 11.6%, which again, was slightly about the high end of our target ROE range of 10.5% to 11.5%.
Looking ahead for 2018, we expect the spread related driver of repayments to moderate, which will allow us to return to our target debt to equity range of 0.75 times to 0.85 times, and drive the ROE consistent with the targeted range through our interest and dividend income line, similar to 2016.
You may recall, but in 2016, we achieved 100% base dividend coverage through base NII, which we define as net investment income excluding activity driven income and its impact on incentive fees. While we continue to has substantial protection in the form of additional economics should have our portfolio get repaid in the near-term, as illustrated by the fact that the fair value of our debt portfolio as a percentage of call protection at December 31 was 95.6%.
We expect activity related fees to be a less prominent driver of ROE in 2018, as compared to 2017. That said, we believe there are some idiosyncratic credit catalysts that could be a driver of near term earnings from activity related fee income.
For example, the contractual maturity of our ABL investment in iHeart is three years, which is the duration we use for the amortization of upfront fees. However, given the progress of iHeart restructuring, the details of which are in the public domain, our expectation is that our loan will be fully repaid in a much shorter time period.
Over the intermediate term, we continue to target our return on equity of 10.5% to 11.5% based on our expectations for the interest rate environment, asset level yields, cost of funds and financial leverage, using our year end 2017s pro forma book value of $16.06 per share. This corresponds to a range of a $1.69 to a $1.85 of full year 2018 net investment income per share.
With that, I'd like to turn it over to Josh for concluding remarks.
Thank you, Ian. While underlying market dynamics made 2017, a very challenging year to source underwriting attractive risk return opportunities, we're pleased with the risk reward that we've been able to create for our shareholders.
For the first three quarters of the year, the size of our investment portfolio actually decreased slightly as repayments outpaced fundings. Due to our philosophy of avoiding undo risk in highly competitive markets and opportunistically growing during periods of market volatility in dislocation, we remain disciplined with respect to growth and instead focus on ways to optimize the unit economics our business.
This can be seen in a return on average assets, which increase from 11.9% to 13.1% at year-over-year. Our average run rate operating expense ratio, which decrease from 67 to 64 basis points year-over-year and our recent enhancement in our debt funding towards us.
With the year end passage of U.S. tax reform, we have been assessing our tax reform may impact leverage borrowers in our market, at a high level the five key pillars of the new tax quote, new tax code include a reduction in corporate tax rate, a limitation of the deductibility of interest expense, the full deductibility a certain CapEx, changes in the utilization of NOLs and deemed repatriation provisions. The net impact of these measures is in some cases offsetting and will vary by borrowers capital, capital intensity, leverage profiles, geographic footprints and tax attributes.
But broadly speaking many of the highly leveraged borrowers in our market could face elevated cash tax expense going forward, including, with the effect of increased LIBOR, which in our view supports our late cycle construct – portfolio construction approach, including where we invest in the capital structure.
As for outlook for 2018, we’re cautiously optimistic as fundamentals in the credit markets remain relatively sound in all major global economies are growing in rare harmony. However, we believe there are various unknowns including inflation, central bank policy, domestic politics and the broader impact of the aforementioned tax reform which could drive periods of market volatility as we're experiencing today.
For us, highly evolve of markets represents opportune windows to capitalize on outsize of risk adjusted returns for shareholders and companies and our sectors where we have differentiated perspective. To illustrate this, for our fully exit investments we made to committed [Audio Dip] to during periods of market volatility in late 2015 and 2016, we generate an average growth on levered IRR of weighted by capital investment of approximately 27%.
As investors, we’re always looking for ways to generate additional value for our shareholders, where we think we have unique expertise and insight, and this may include from time to time exploring strategic alternatives in the BDC space.
Over the course of Q4, we purchase approximately 1.4 million shares of Triangle Capital Corporation of approximately 3% of the company's shares outstanding, at a weighted average price per share of approximately $9.70 or 0.73 three times, the company has been reporting net asset value per share, which we believe provides a margin of safety for our investment.
The thesis for our equity investments ultimately a commercial loan, as we believe the outcome of TCAPs strategy review will likely drive TCAPs stock plus closed net asset value or result in a value enhancing transaction, both of which would benefit TSLX position and there for our shareholders.
Although, we were invited to be a part of TCAPs strategic review process, we decline that we believe to – what we believe to be onerous and non-customary provisions and a non-disclosure agreement that would have resulted in relinquishing our voices TCAP set larger shareholder and our liquidity in the TCAP stock.
We take our fiduciary obligations very seriously and despite our interest in participate in the strategic review process, we ultimately believe that consenting to the company's non-disclosure agreement not be in the best interests of our shareholders. As reflected in our financial results, we've elected to voluntarily waive base, management and Senate fees related to our investment in TCAP.
With that, thank you for your continued interest and for your time today. Operator, please open up the line for questions.
Thank you, sir. [Operator Instructions] And our first question will come from the line of Jonathan Bock with Wells Fargo. Your line is now open.
Thank you for taking my questions, and good morning, and also congratulations. So starting first with just besides of iHeart relative to the overall assets or NAV, certainly quite large, and I understand, as we talked about the thesis of investment. Clearly, it's an attractive one. Josh just – and Bo maybe a balance over, how you view taking fairly concentrated exposures and well clearly it's worked. One question folks will probably going to be asking this is so sizable. Is that, iHeart might turn out to be an outstanding investment? But would you say that there is a strategic shift or to perhaps take even chunkier investments in today's environment – a risk adjusted return environment, because it's really hard to find adequate risk adjusted return card blotch. And just a thought on diversification, in particular, because investors are weighing whether you should be extremely diversified or take concentrated high octane investments in this environment?
Yes. Hey Jonathan, good morning. So I'm offended by you referencing to high octane. So I think there is a – question is what is the nature of the investment, which is not a cash flow investment. This is an investment that is in a regular way market without IRR. If IRR was properly restructured and restructured their cash flow, term loans and bonds would have priced out LIBOR 175 to 200. And so the question is not – this is on a spectrum of high octane to no octane. This is no octane, it's not even in the middle. It is an asset base facility that given the iHeart was highly levered below within the capital structure. They weren’t unable to roll the banks or lot of banks were inevitable given the [indiscernible] lending rules. Not only that in the public domain, what is clear – was always been clear, given the cleansing process that's been happening with the restructuring.
So iHeart cleanses their creditors by providing updates on negotiation and every one of those processes the ABL is indicate in full or unimpaired. So there hasn't been a strategic shift about the going chunky, it was a idiosyncratic choice as it relates to the nature of the iHeart investment and the quality of that loan versus the – and the quality of that collateral and asset based loan, that's margin against basically investment grade accounts receivables. And if people know about iHeart as the name, iHeart does a $1 billion to $1.1 billion of EBITDA, it’s actually been very stable on a consolidated basis, and doing $6 billion, $7 billion of EBITDA when you include the outdoor business. And so the loan is very well protected and it has a near term callus with a restructuring. So I'm a little typical fashion and as early in the morning, I'm well offended by that squib your question, as it relates octane versus…
I will take offending your sensibilities for attractive risk adjusted return. So I appreciate that and one can expect that. So then maybe moving on to Jive Software quickly, so is it Jive Software loan also expected to pre-pay, I understand that the new loan to Lithium Technologies was to support that acquisition. Or do both stay outstanding for some reason?
Yes. I'll take, Bo had little bit. I think there's kind of a little bit of misunderstanding which was Jive Software was a name, they had spun out a piece of that business, which created a new financing opportunity to another sponsor. But there is – that is the only I definitely capable of that.
Correct. I mean the piece that was spun out of Jive was much more strategic to Lithium than it was to Jive. So we allowed for that and it gave us a unique perspective to finance to be part of the financing for Lithium but neither one of them are expected to payoff in any concern.
Okay, great. And then look at it, the one thing it's easy for all of us on the call, I just imagine that everyone going to ask about it TCAP and it's a $13 million investment. So I want to try to keep it just as close as we can here, because it is really a small piece. But I would like to just in light of the fact that Josh, there's been some negative press in The Wall Street Journal about this space and some significant misinformation on the part of just either reporters or others on the space. I'd like to put in context your view on where the space is today. And then more importantly, what managers can be thinking about generating strong risk adjusted returns for folks either through hanging up or they had and through a sales process? Or generating strong risk adjusted returns for clients, the way you've been in contrast to what I'd imagine the Wall Street Journal put out in the terrible article on Tuesday?
Yes. So I looked at – I skim the Wall Street Journal article. To be honest with you, I don't get fuss about, what the media says about our business. Quite frankly, there are a lot of great BDCs in the space that are creating very high risk adjusted returns on capital with relatively low financial leverage and so just to put our kind of performance in perspective this year. Our ROE on net income what's going to really matters was – I think 11.6% of net for this year, a 11.6%. And we made mistakes. And so I think if you look at I did the back of the envelope, we had about $0.25 and hit the net income related to Mississippi, predominately Mississippi.
And so even in an environment where we weren't perfect and we took both small unrealized and realized losses. We generated an 11.5% – 11.6% ROE being levered at less than massively less than one to one. And so I'm pretty bullish about know people were out of the requisite skill set to continue to generate high returns on risk capital in this space. And so I don't – I think it really fuss about the Wall Street Journal. That being said, the average return the space as we've talked about really over since we've gone public and it hasn't been great – somewhere between total returns of between 5% and 6% ROEs. But there are – that's driven down by the tails in the last and there's a lot of talented group of people and there's a decent opportunity which had to continue on – decent returns on capital without not a lot of financial leverage.
And as it specifically relates to TCAP, look your right. It’s a small position. We were hopeful that build in a position would allow us to have a debt to have an edge in the process. And hard to do when you can only be 3%. But we chose not to participate in the process because it was quiet for us potentially give us – give up our vote in future shareholder meetings. And so the probability of being successful given that we're kind of value or into guys and then not being the fifth largest shareholder without a voice didn't seem to make sense for our shareholders.
Thank you so much.
Thank you. And our next question will come from the line of Leslie Vandegrift with Raymond James. Your line is now open.
Good morning, thanks for taking my question this morning. One quick follow-up on iHeart. Thanks for the color earlier in the call, but on the ABL and see it's a last out as well yet. So you had between that and Northern about 7% to 70% and syndication fees fell down for the quarter. So well it’s to be – close to the quarter for the year. And this is the last at which you would usually get, be on top for not being the first on a position. Although looking for what – why this hasn’t been come with dispositions and sells downs.
Yes. So let's take a step back. I think it was premise slightly wrong on when our last out, we actually generate no fee off them. So additional both closing fees that are skimmed and spread is – either the spread is recognized over the loan or the closing fees are upfront or amortize upfront. So for example, our closing fees on iHeart were I think 2.4% in well as a total percent. 2.4% or 2.6% or something like that, 3% above. And so that is in the unamortized OID, if it was – if we were selling effectively the accounting rules are that you can only recognize fee income – when it essentially a same security in this two different securities. As it reaches to Northern Oil, that transaction we underwrote and instead of syndicating it, we had co-invested that entirely to an affiliate fund. And so us and affiliated fund took the entire position.
And the exemptive relief order requires the affiliated funds and investment on the same economic basis as TSL at. What I would say is that, although there wasn’t specific fee income in the quarter, given that we were able to provide certainty to Northern Oil by providing a large underwriting commitment between us and our affiliated fund. That we speak – we generated massively outsize economics on a go forward basis for TSL of shareholders.
All right. Thank you for acknowledging that. And so you discussed the L plus 4.75% on that the coupon because of the shorter duration or other…
Leslie, this L plus 4.75% that doesn't include to skim.
It doesn’t include the skim.
Yes. there is yields are worst at three years, I think, it’s like 9%. The yield kind of expected duration is like a 11%. And so that obviously there's a big delta between the LIBOR 4.75%, it's running at 9% on a – when you advertise OID plus fee additional spread income. And then it will there will be some point, if it doesn’t last three years. There will be a significant unamortized portion that run to the P&L. And so the kind of the yield the true yield of that given, the pace of the restructuring is somewhere between – my guess is a 11% and 13%.
Okay. All right. And then on the few other, she did in the quarter, no origination of loans. Those are a little bit lower on the coupon and not low, but LIBOR plus 4.75% so below averages. What's the outlook for 2018, in way of looking at those kinds of size deals on the coupons?
Yes. I think Lithium was LIBOR 800 one floor 9% plus fees. So that's right in the sweet spot. Industrial Physics LIBOR 7.00%, I think one four plus fees. And so when you –those had I could run the math of those had the amortized yields probably somewhere in the 10% to 11% range, when you include fees. Because we remember we differed our fees and we run through a P&L over the contractual life. So those are kind of right in our wheel house as it relates to our typical transaction.
Ironically, we did look at the – there tends to be some – I don't – whatever we think Q4 over the last couple of years tends it to be – where we put on assets have a lower amortized yields, so for example, in Q4 2015 yield amortized cost and the new investments 9.3% and in Q4 2016, it was 9.1% and Q4 2017, it was 9.3%, but it was for adjusted for iHeart, it was 11%. And so there are tend to be some bump and I assumes to be some quarter-to-quarter variation.
And then what did you end the quarter or with the year with lower income?
Hey, Leslie. We put that estimate into the respective. So if you look at Page 33 in the 10-K, it's disclosed as approximately $64 million. So it's a $1.7 per share.
All right. Thank you for answering my question this morning.
Thank you. Our next question comes from out of Mickey Schleien with Ladenburg. Your line is now open.
Yes. Good morning, everyone. Josh, just curious about the exits from groups Symphony CLO, I realize it was a small investment. But I like your color in terms of whether that deal was called? Or did you exit for other reasons, perhaps such as the tightness in the more liquid markets?
It wasn’t – it might have been since called – it wasn't called, when we acted. We put on a – we put on some structured credit investments during the dislocation of late 2015, early 2016 that included a Symphony, that included Oak Hill as price and those markets came back and you got to go forward basis yields were below kind of what we have reviewed our kind of cost of capital was. We after those positions, and so we ended up having – I think those positions, how we returned a 15% IRR or something like that. So we captured the capital gain as a relates to where we bottom which was kind of in the low to mid 80’s and the running spread and we resorted them which were kind of in the – I think in the mid 90's.
Thanks for that. That's very helpful. That's it for me this morning.
Thank you. And our next question will come from the line of Rich Shane with JPMorgan. Your line is now open.
Hey, thanks guys. Just one question this morning. Over the last year LIBOR up 70 basis points, normalizing for swap team and sure funding costs were up 70 bps. Your asset yields were up about 40 basis points. So implicitly your funding data is about one. Your asset data is about 0.6. I'm wondering as we move into 2018, look the whole thesis here is asset sensitivity. As we move into 2018, you move off LIBOR floors, you’ve done things to lower your funding costs, you’re trying to optimize your commitment things. Do you think we will move into a situation where the beta is on – the funding costs and the betas on the asset yields start to move on things?
Yeah, Rick, that’s a great – that’s a great, great question. I think that is our hope. We've had – what you basically said is we’ve had some spread compression in the business. We've had a lot less spread compression in the entire space. I think what the data says is a guide that’s over $2.5 billion of assets have had a lot more spread compression compared to us. We’ve had a little bit of asset sensitivity, but that is our hope. I think volatility will help that, but you know that is surely our hope. What would as interesting is even as – and so, I think what you’re saying is what you've picked up and in LIBOR you’ve lost in margin. And our hope is that trend will end.
But as the economy keeps going, risk premiums get tighter and so that that will continue to be my worry. The nice thing about our business was return on average assets given how we built the portfolio. And this year was what was the return on average asset this year? It was 12.4%. And, so, we’ve actually had much higher return on average assets than the yield on our portfolio given to our portfolio construction. And so the headline kind of spread compression is less impactful than you would think given where we've been able to get economics elsewhere.
Okay, okay that makes sense. Thanks, Josh.
You’re welcome.
Thank you. And our next question will come from the line of Doug Mewirther with SunTrust. Your line is now open.
Hi, good morning. In terms of your ABL business, which is definitely fluctuates with the market conditions and opportunities. It seems like there's still a lot of opportunity out there in retail land and would you agree? And do you have I guess the capacity in terms of your asset allocation policies to sort of increase the size knowing that it's hard to really grow it quickly because they pay down so quickly. But are there enough opportunities out there where you could actually even take another small step up in the size of your retail ABL portfolio?
Yeah I think no question. Look we’ve invested in retail ABL of about $450 million. The portfolio as it stands today is only about $120 million as of quarter end. And so, we continue to be very active in that space. And total asset base lending at even – including retail, we probably invested PSIX, which is came off a long ago and other names we've probably totally and in IR we probably invested $700 million to $800 million. And so we like that given the uncorrelated nature of the assets. And could we bring our retail ABL business up to 20% of our book? That question is yes.
I'm not sure if this is possible given the duration even though the opportunities set. But there's surely would be appetite on the risks side that doubled it from $120 million to $250 million to $300 million. If they opportunity allowed us up. We have been – we did not participate for example in the Toys FILO in the bankruptcy. Well I think in retrospect, we're glad we haven't given how that case has gone although I think that's probably a pretty good piece of paper or just not wasn't – what we thought was the right risk adjusted price. So we tend to – we still – we’re not in the business of doing everything that’s retail asset base. We still have a very discerning eye, but we would most definitely want to increase our books if we could.
Okay, thanks. That’s helpful. And my second and final question, if you or Bo could comment just on your general origination pipeline. It seems like there's some conflicting information out there. Some executives think there's – it’s sort of a target rich environment and there are a lot of opportunities. I just think well because it's competitive and then maybe – that there's not as much opportunity to grow your – I guess your regular way portfolio. Just comment on what your outlook is for 2018 in terms of deal flow.
The deal flow environment feels pretty good at this point coming into Q1. I think we continue to thread the needle on opportunities that that overlap with our team generation and where we're focusing on deploying capital. So I feel optimistic heading into the New Year. It’s hard to project out, our originations are very idiosyncratic each quarter. It’s hard to project out for the full year, but sitting where we are today I feel pretty strong, I feel pretty good about our originations activity.
Look I think the spread compression has – the low volatility spread compression has slowed. I think high yield actually has increased a little bit. So I think that's good generally for the environment. I think we continue to be very highly selective of what we do and tend to be thematic based where we think we have an edge. But it feels okay. I'm not sure if that's helpful. It surely doesn't feel like it's 2010, or 2011. And you haven't seen the volatility, or you’re seeing a lot of volatility in equity markets, you haven't seen that roll through the credit markets that you saw in Q4 of 2015 and Q1 2016. With all of that being said, we like our platform, we like the depth and breadth of our originations. We like that we do both direct to company and sponsor stuff and we like the thematic.
So I’m pretty highly comfortable continuing to find good risk adjusted return stuff.
Okay great. That's all my questions.
Thank you. [Operator Instructions] And our next question will come from the line of Terry Ma with Barclays. Your line is now open.
Hey guys. So I appreciate the broad comments on the impact of tax reform. But can you just give a little bit more color on how it impacts your existing portfolio from a cash flow perspective? Any sectors in there that may impact more than others?
Yes, so I think our portfolio is actually in pretty good shape. Our average leverage, I think, is like 4.7 seven times, the breakpoint is like, I think, six times. And so there will be a handful of borrowers that will surely have more cash taxes given the limitation of debility. I generally think and this is a broad statement. And this is not our portfolio we're much further up the capital structure. But when you look at the high leverage universe of the leverage loan market, both in the high yield and in the broadly syndicated market, if the market is slightly not taking into account the tax reform bill as it relates to deterioration on credit fundamentals.
And so effectively you have a limitation of 30% of EBITDA. So think of it as 3:1 interest coverage. Anything that doesn't have 3:1 interest coverage is going to have limitation on offset slightly by – offset significantly by that lower tax rate. But anything that – you’re going to have limitation on the deductibility of interest expense. And so I think that as a watch out is that in a rising LIBOR environment where if you think LIBOR today is at 1:5, 1:6 and in the broad and the broadly syndicated market, for example, the average loan is $300. And so if you think LIBOR is going to three, that means interest costs are going from effectively 4.5% to 6%, increasing by 25%. And on a highly levered bar none of that is going to be have a tax yield. And so my guess is nobody thinks that bars are going to grow earnings by 25%.
And so we there are going to be weakening credit fundamentals given limitation of interest deductibility on a subset of highly levered borrowers, which is not representative of our subset given we’re at 4.7 times levered. I think that is a watch out for credit fundamentals in a rising rate environment, given I don't think that people are going to be able to grow earnings as quick as base rates go up.
Got it. Have you seen any change in incremental demand from your debt, or maybe appetite from your competitors or the peers?
We were just talking about this. The demand for debt and for leverage has been un phased. And so I think when sponsors look at the world and they kind of say God who cares if I don't get the tax effect on that last ton of leverage is cheaper than my expected returns on my cost of equity or from my private equity fund. And so you have not seen a change in capital structure, or sponsor behavior or demand for capital at all. By the way we have a special guest, our Vice President, Mike Fishman. Mike I don't know if you have a view on this.
We haven't seen, I haven't seen any change. So I totally agree sponsors are levering businesses no differently today than they have prior to the tax reforms.
Not only we’ve not seen, we haven't seen or heard evidence of the thought of that. So we've seen no change to date.
Okay, got it. That’s very helpful. That's it from me. Thank you.
Thank you. And our next question will come from the line of Christopher Testa with National Securities. Your line is now open.
Hi, good morning. Thanks for taking my questions. Just touching on the energy exposure a bit, can you talk about the extent to which your portfolio companies might be upbeat on potential regulatory reform, if that's been something that they're optimistic about. And my second part of the question is just, given the optimism in the space in general, just how much of an increase in opportunity set. Are you seeing kind of at the top year funnel?
Yes. So look, I don't think we've – I don't have a view if those issuers on regulatory reform – as it relates to the top of our funnel. There are still a decent amount of broking capital structures in the space of where we have really – where we have chosen to play energy. And if you look at the names in the last year we've gotten two names, one is Rex and one is NOG, both have broking capital structures. Although, which gives us the opportunity to earn higher risk adjusted returns on capital, fee in the capital structure and the RBL format, where we're not taking commodity price volatility risk, where as much on hedge collateral.
And so both Northern for example, I think Northern had $800 million of bonds below us trading $0.84 now or something like that. And so there is – that is where we've been playing the sector, which is we’re not – we don't have a thesis what we can – where we're bullish or bearish on commodity prices, what we are is – it's an offset over an asset base lending and quite frankly everyone of the loans we've done – would have been done by bank at 600 basis points of higher spread at the capital structure have been cleaned up. And so there are – so these amount of companies are broking capital structures given those capital structures were built in the unsecured market at a much higher commodity price environment. And so we’ll be opportunistic of where – what we do, what we had in this space.
Got it. That’s great color. Thank you. And just on the iHeart Communications deal, how much of that was syndicated out versus allocated to your affiliated funds.
Yes. So that’s a good question. So the total loan was $550 million. There was $300 million of last sell. And so the – we took 1.205% allocated to affiliated funds of the last out.
Got it, okay. And just given your commentary on repayments likely slowing down and that's your leverage coming up. Does that include the potential for the iHeart to – it’s a prepay early or is that just excluding that.
I think that includes I mean, I think how we think about iHeart is kind of expected duration basis. And so we expect to be kind of in our target range, including a payoff of iHeart.
Got it. That's all for me. Thanks for taking my questions.
Thank you. And our next question will come from the line of Jim Young with West Family. Your line is now open.
Yes. Hi, Josh. At the beginning you’d mentioned that in 2017 you saw tighter spreads, more leverage and lose your covenants. And my question is basically, it’s two part. Number one, given the recent market volatility, have you seen any change that the margin with respect to spreads, leverage and covenants in the marketplace? And then secondly, as you look at how with your crystal ball as you have and looking at into 2018 and seeing how the credit markets evolve. What do you think credit investors aren’t focused on and should be paying more attention to? Thank you.
And I think, Jim, hopefully you giving unfeasibly nice weather in Chicago as they had in New York yesterday. Unfortunately, we have to be on the West Coast. So we’re up early and not join the weather. But I was say we have not seen the volatility and change kind of appetite for credit or it feels like it’s kind of even down a little bit. I don’t think we’re seeing a book and comment on this and I’ll talk about what people are missing on expectation.
But I don’t think we’re not seeing the rapid spread compression that we saw in 2017 that we’re in early 2018. And we’re not seeing, I guess that the rapid deterioration of lender protection. Our portfolio has a real change in the year-over-year basis. I think leverage is went from like 45 to 47, interest coverage basically same we have exactly number of covenants. So we’ve been more answers already because we’ve been picky, we’d actually grow and so our portfolio, I think we feel pretty good about it given the environment. But Bo, have you – you have a view of fishy.
Yes. I would say, that’s right, Josh. We haven’t seen this step function here in the first quarter of 2018, our spread compression and restructuring deterioration that we saw in Q1 of last year, where the lot of new capital came in and was very aggressive putting it out. I think demand has remained pretty consistent, so we didn’t – the market volatility didn’t improve things, but we haven’t seen any more deterioration that we saw last year.
Yes. I would say yes, I feel like we’ve seen a bottoming out on spreads. For 2018 I think I’ll watch out might be whether there’s any more covenant deterioration. I think a lot – as Josh said a lot of its happen, but there are players in the market that are willing to take less structure.
And look I think the big the big watch out for me and on kind of what credit investors are missing and why we’ve been very defensive and how we position our book defensive meaning asset base loans uncorrelated their earnings, recoveries and uncorrelated earnings, is that as you take a step back, we talked about tax reform, we talked about limitation interest deductibility and on the companies that are in the margin where they’ve crossed the line, rising LIBOR is going to have a material, a linear impact on leverage free cash flow. So that’s a big watch out.
The other watch out is when you think about economic cycles and we’re probably at the beginning of a timing cycle, but the economic cycles – as one person said to me, if you want to be a great investor, you should really think about and study inflation. Because the economic cycle what typically happens is, you have rising rates. We have inflation which forces a policy and rising rate, which slow investment and slow consumption, which leads to recession. You then have losing monetary policy, which spurs consumption. And so we’re kind of at the beginning of – we could debate for a long time inflation.
But if you see a kind of inflation, wage inflation and any large monetary response, obviously that will lead to a tightening business activity, tightening consumer activity, which will lead to some type of recession or some type of correction. And so I think we’re pretty – I think we’re – as we think about inflation, you are starting to see a little bit wage inflation. I think it’s a pretty controllable, but I think the watch out is rising rates, across the tax reform and inflation and the monetary response and the business cycle.
Thank you.
Thank you. And our next question will come from Chris York from JMP Securities. Your line is now open.
Good morning, guys, and thank you for taking my questions. So considering your balance sheet leverage expanded, it’s now just below your target range and volatility is returning to markets, which should increase demand potentially for the certainty provides borrowers below the TSL market. Could you update us on your potential interest in growth equity today?
Potential what was that?
Potential interest in growth equity.
And raising equity – is that the question.
Yes, correct.
Since our IPO, for nearly four years ago, although we’ve traded a book value 99% today is – we only raise equity when we think it’s accretive on a book value basis and when we think it’s accretive in our ROE basis i.e. that the cost of our – where we can invest in assets in that moment time, post fees, post losses, exceeds our cost of equity. And so both those things have to line up. And so I don’t – we try and we take the philosophy for better words, which is we’ll do it just in time.
And so on this moment in time, I don’t think we think there’s – we’re not planning to do an equity raise given, where we’re target leverage ratio on our book in this moment in time. I don’t know, Ian anything to add.
No. Obviously it’s very much dependent on those factors that you outlined, but beyond that we don’t have this ability.
Got it, okay. And then while we heard your comments on clear about not using a position TCAP to pursue business combinations. The potential acquisition of key TCAP would have increased your assets to $3 billion. So should we think about that size as a frame for a maximum size that you would want to maybe run the strategy longer-term without affecting your ability to be selective and continue to generate meeting PC returns?
Yes, great. Thanks, Chris. So I want to – I do want to make repeat our words very, very carefully and so I do want to make a qualifying same as really as a TCAP. I – we chose not to be involved in the process. You should not conclude that we will not use our position in TCAP. If we think there’s an opportunity to pursue a business combination, we think there is massive value for our shareholders. That doesn’t seem like that is in the cars at the moment, but I don’t have insight into TCAP process. I don't have insight but – who knows, we are a the fifth largest shareholder, there are a group of shareholders on top of that list. And that deal that comes out of that process, if the deal comes out it is not something that we think is good for the company. We may choose a reengage in a different way. So I want to be very clear about TCAP and we pick our words very carefully into that. I want to make sure that you understand that.
Yes. Thank you for that.
Look at as it relates to why TCAP – when we want to be $3 billion of assets in this environment and grow our work from $1.7 billion to $3 billion of assets in its environment. The answer is absolutely no, it could you – if you could do in a very value oriented way, we would be very accretive that TSLX shareholders and we could provide a solution of TCAP shareholders. Would we want to do that? Yes, ultimately what that mean that we rotate the book and return capital to shareholders up on realizing a discount. We would not be a buyer of TCAP above net asset value, because that would give us – would not allow stability to return capital to shareholders, if we can it reinvest in a very accretive way.
I think over time we like the small size of – we like being in this middle which is we have a $1.7 billion balance sheet. But we also have, we're part of a $24 billion credit platform, where we able to speak for larger transactions. And so we're not burdened by the size of our capital base, since we were able to create industry leading returns and but we're able to toggle up and do interesting things to create value for our shareholders like Northern Oil and iHeart we like that a lot. And so we think that the model creates – that flexible model creates a lot of value for shareholders by generating kind of off market returns on capital.
And so I've hardly to answer the question of what the optimal size? I could tell you the optimal size for us right now as a $1.7 billion and we have the opportunity to grow given that we can raise equity. And so it is the optimal size $3 billion in a different market environment, maybe if it, but right now the optimal size $1.7 billion.
Great. Very thoughtful answer with contact the multiple topics of thank you. Last one just considering that Mike's role has evolved internally and there appears to be some attractive direct lending opportunities from banks in Europe. Are there any discussions internally maybe teams or investment opportunities in Europe that could result investments in your portfolio?
Yes. So look Mike is – hopeful Mike being next of today shows you the Mike full haven't changed that much, it same much more time as Europe. We have a dedicated direct lending fund in Europe. It's not super tax efficient quite frankly for our foreign shareholders, and the U.S. BDC to have non-qualifying assets, including European assets in the BDC. Given that there are withholding taxes on dividends given the extended legislation for foreign shareholders except for non-qualifying assets. And so it's not, we would expect not to do a lot of European stuff. Given we have a direct lending fund and it's not super careful efficient for non-U.S. shareholders of the BDC given the withholding tax. You had anything to add there.
Great. Well that’s it for me. Thanks guys.
Thank you and I'm showing there for the questions in the queue at this time. So it's my pleasure to hand the conference over to Mr. Joshua Easterly, Chief Executive Officer, Director and Chairman of the Board for some closing comments and remarks. Sir.
So look we appreciate everybody taking the time, I thought one of the longest Q&A session. So we're as people know we're really happy to engage about our business and what we think about the market and there are a lot of great questions. We also wish people a happy spring, looks spring coming early and you know Happy Passover and Easter at the beginning of April and late March for people family and the team is always available. And so thanks for your time today. Thanks everyone.
Ladies and gentlemen, thank you for your participation on today's conference. This does conclude our program. And you may all disconnect. Everybody have a wonderful day.