Good morning, and Welcome to Sixth Street Specialty Lending, Inc.'s Third Quarter Ended September 30th, 2021 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 fact 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 the number of factors, including those described from time to time in Sixth Street Specialty Lending, Inc.'s filings with the Securities and Exchange Commission. The company assumes no obligation to update any such forward-looking statements.
Yesterday, after the market closed, the company issued its earnings press release for the third quarter ended September 30th, 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, Inc.'s earnings release is also available on the company's website under the Investor Resources section. Unless noted otherwise, all performance figures mentioned in today's prepared remarks are as of and for the third quarter ended September 30th, 2021. As a reminder, this call is being recorded for replay purposes. I'll 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. For our call today, I will review this quarter's results and pass over to Bo to discuss this quarter's origination activities 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 close yesterday, we reported third quarter adjusted net investment income of $0.55 per share and adjusted net income of $0.80 per share. These results correspond to an annualized year-to-date return on equity on adjusted net investment income of 12.9% and an adjusted net income of 21.5%.
This quarter's robust net investment income was driven by higher fees from elevated repayment activity relative to the first half of the year. It was also supported by a robust level of interest income from the strength and the core earnings power of our portfolio. The difference between this quarter's net investment income and net income was due to the net unrealized and realized gains from portfolio company-specific events, which Bo and Ian will discuss later in the call. As a result of this quarter's net gains, we continue to accrue capital gains incentive fees, fee expenses totaling $0.05 per share, which we've excluded in the presentation for this quarter's adjusted results. Again, this is because we believe the expense accrual requirement creates noise around the fundamental earnings power of our business.
If the year were to have ended on September 30th, and we were to calculate the capital gains incentive fees that are actually payable to the advisor in cash, it would have been zero because the gains driving this fee accrual are unrealized. At quarter end, we had approximately $0.21 per share of cumulative accrued capital gain incentive fees on the balance sheet, and approximately half of these would be payable in cash if our entire portfolio will be realized at their quarter end mark in normal course. The rest of the accrued fees are tied to unrealized gains resulting from the valuation of our debt investments, inclusive of call protection, which, if prepaid, would result in a recognition of fees and investment income and trigger a reversal of previously accrued capital gain incentive fees related to these investments.
If we were to hold these debt investments to maturity, realizing them in normal course at par over time, there would be an uplift to our NAV of approximately $0.10 per share related to the reversal of accrued capital gain incentive fees. Returning to our Q3 results, the over-earning of our base dividend and net gains this quarter drove growth in our reported net asset value per share to a new high of $17.18. This represents a 2% increase from the prior quarter and is $0.02 per share in excess of our prior record high in Q4 2020 at $17.60. Recall that upon the release of our Q4 results in this February, our board declared a special dividend of $1.25 per share.
Since that time, we have fully rebuilt our net asset value per share, primarily through net gains in our portfolio that continued over-earning of our base dividend and the benefit of tightening credit spreads on the valuation of our investments. Over the trailing 12-month period, we've generated total shareholder economic return of 20% through dividends and growth in net asset value per share. Let me now provide an update on our convertible notes due in August 2022, of which $143 million principal value remained outstanding at quarter end. On September 30, these notes became eligible for early conversion, and holders of approximately $43 million principal value of notes opted to early convert subsequent to quarter end.
Based on the calculations laid out in the indenture, the nearly all-stock settlement we've elected to apply on this portion of the notes translate to approximately $0.04 per share of accretion in net asset value. To offset the deleveraging impact of the stock settlement, our board has declared a special cash dividend of $0.50 per share to shareholders of record as of December 7th, payable on December 20th. This special dividend also serves to enhance our capital efficiency by eliminating nearly all the excise tax drag on our spillover income, which is currently estimated to be $0.02 per share on an annualized basis. Given that the combination of these transactions is leverage neutral, the reduction in our excise tax burden will result in approximately 10 basis points of ROE uplift on an annualized basis.
Yesterday, our board also approved a base quarterly dividend of $0.41 per share to shareholders of record as of December 15th, payable on January 14th. Our board also declared a supplemental dividend of $0.07 per share based on Q3 adjusted net investment income to shareholders of record as of November 30th, payable on December 31st. Our ending net asset value per share, inclusive of the impact of the special and supplemental dividends that was declared yesterday, would be $16.61. With that, I'll now pass it over to Bo to discuss this quarter's origination activities and portfolio metrics.
Thanks, Josh. Let me first provide our thoughts on the current direct lending environment and how our business is positioned to serve borrowers and management teams as well as our stakeholders for the period ahead. It was 10 years ago when TSLX made its first direct lending investment, and the landscape of private credit has changed dramatically since then. In the last 10 years, private debt AUM has grown over threefold in what was a relatively niche asset class has become increasingly institutionalized, attracting new managers and investors into the space. The value proposition of private credit for borrowers over this time has remained constant. Speed and certainty of execution, documentation flexibility for management teams to achieve strategic goals, and the opportunity to work with value-added trusted financing partners. The pandemic-induced market volatility and growth trends in sponsor M&A have only underscored the value proposition of direct lenders.
More so than ever, we're seeing an increasing number of borrowers and sponsors turn to the direct lending market for larger financings instead of the traditional syndicated markets. We believe this broadening of the opportunity set is a net positive for our sector and specifically for our business and our stakeholders, given our ability to be solutions providers at scale through co-investment with our affiliated funds. While competition for direct lenders is likely to remain strong in both the larger cap and traditional mid-market for the foreseeable future, we believe that our thematic investment approach and differentiated underwriting capabilities will allow us to expand our borrower and sponsor relationships and continue generating attractive risk-adjusted returns for our shareholders. Moving now to this quarter's origination activity.
We funded five investments, including upsizes to our existing portfolio investments, totaling $105.4 million in commitments and $65.4 million in fundings. We mentioned on our last earnings call that we had a strong funding pipeline heading into the second half of the year. Given the timing of various M&A processes, our funding activity is now back-end weighted for the fourth quarter. Post-quarter end to date, we've already funded approximately $100 million of new investments, including one where we're the agent on a $975 million credit facility. Based on our current pipeline, we'd expect to fund another $150 million-$250 million of net investments by year-end, including what is funded to date.
Circling back to Q3 activity, a new investment this quarter was a $317 million TSLX-agented senior secured facility to support the sponsor acquisition of ExtraHop Networks, a provider of cloud-based cybersecurity solutions. We believe that the sponsor chose us to lead the financing as a result of our deep knowledge of the sector and our ability to be constructive early in our financing process. This, in turn, allowed us to structure attractive risk-adjusted returns to our security, approximately $50 million of which was held by TSLX at quarter end. Also this quarter, we in the Sixth Street platform completed $250 million term loan facility upsize for Biohaven, a biopharmaceutical company.
Our initial $500 million Biohaven term loan facility was completed in August of last year to support the company's commercialization of its FDA-approved migraine drug, which has had strong fundamental performance post our investment to date. The upsize facility, which generates an attractive blended yield to maturity of over 11% on our total investment, will be used to support the continued commercialization of this drug and the clinical development of the company's pipeline assets. We believe that ExtraHop and Biohaven are examples of how our platform's expertise across sectors and themes allows us to source and underwrite strong risk-adjusted returns across both sponsored and non-sponsored landscape. On the repayment side, after a quiet first half of the year, we fully realized six investments and partially sold one investment totaling $284 million in the third quarter.
Our full investment realizations were driven by a combination of company-specific M&A as well as a favorable refinancing environment. Through prepayment-related fees and equity upside that we structured into these fully realized investments, we generated a weighted average MOIC of approximately 1.2x based on our capital invested. From a portfolio yield perspective, funding and repayment activity this quarter had a slight positive impact for a weighted average yield on debt and income-producing securities at amortized costs. Yields increased from 10.1% to 10.2% quarter-over-quarter, and it is on par with what it was a year ago. The weighted average yield at amortized costs on new investments, including upsizes this quarter, was 11.7% compared to a yield of 9.5% on exited investments. Moving on to the portfolio composition and credit stats.
This quarter, our portfolio's equity concentration increased slightly from 6% to 7% on a fair value basis quarter-over-quarter, primarily driven by our increase in the fair value of our existing equity positions. The biggest driver was our IRG equity position, whose fair value at quarter end reflected the pending sale of certain of the company's assets at a contracted price meaningfully above what was implied by our prior quarter's fair value mark. The IRG sale process is expected to be completed in the first half of 2022. While we continue to be focused on investing at the top of the capital structure, with approximately 93% of our portfolio being first lien at quarter end, from time to time, we may look to selectively increase our junior capital exposure in sectors and companies that we believe have strong tailwinds and resilient business models.
Finally, the performance rating of our portfolio continues to be strong, with a weighted average rating of 1.12 on a scale of 1 to 5, with 1 being the strongest. We continue to have minimal non-accruals at less than 0.01% of the portfolio at fair value. With that, I'd like to turn it over to Ian to cover this quarter's financial results in more detail.
Thanks, Bo. To Q3, we generated adjusted net investment income per share of $0.55 and adjusted net income per share of $0.80. At quarter end, total investments were $2.4 billion, down from $2.6 billion in the prior quarter as a result of net repayment activity. Total principal debt outstanding at quarter end was $1.1 billion, and net assets were $1.3 billion or $17.18 per share prior to the impact of the special and supplemental dividends that were declared yesterday. Our average debt-to-equity ratio decreased slightly quarter-over-quarter from 1.07x to 1.01x, and our debt-to-equity ratio at September 30th was 0.9x.
As Bo previewed, the net funding activity we've experienced post-quarter and to date has brought our debt-to-equity ratio back to approximately 1x, and we expect to finish the quarter at 1.05x-1.15x leverage. Given that the size of the stock settlement on our convertible notes in Q4 will approximate our special dividend payment, there will be no material net impact from those two transactions on our financial leverage. As we head into year-end, our liquidity position remains robust, with over $1.3 billion of unfunded revolver capacity at quarter end against $122 million of unfunded portfolio company commitments eligible to be drawn. Note that during the quarter, we increased the size of our revolver by $25 million to $1.51 billion with the addition of a new lender.
We now have 21 lenders in our credit facility. Looking across our debt maturities, as Josh mentioned, we have approximately $100 million remaining principal value of 2022 convertible notes that will mature in August of next year. Similar to our approach on the early conversion on a portion of these notes this fall, we plan to settle our remaining convertible notes in either cash, stock, or a combination thereof as permitted by the indenture, depending on our balance sheet leverage and our investment opportunity set at the time any election is required. As you can expect, we will choose settlement methods that consider the overall impact of conversion on our NAV and ROE. We continue to believe that maintaining a strong balance sheet with diversified funding sources and well-staggered maturities is important to our ability to create value for our shareholders in any environment.
As such, we will continue to actively manage the right-hand side of our balance sheet to ensure we have appropriate funding mix diversity and remaining duration on our liabilities. Moving to our presentation materials. Slide 8 contains this quarter's NAV bridge. Walking through the main drivers of NAV growth, we added $0.55 per share from adjusted net investment income against our base dividend of $0.41 per share. As Josh mentioned at the beginning of this call, there was $0.05 per share of accrued capital gains incentive fee expenses related to this quarter's net realized and unrealized gains. The impact of tightening credit spreads on the valuation of our portfolio had a positive $0.02 per share impact, and there was a positive $0.39 per share impact from other changes, primarily net and unrealized gains on investments due to portfolio company-specific events of $0.34 per share.
A large portion of this was driven by our investment in IRG, which Bo mentioned earlier. Note that this quarter, there was a realized loss of $0.18 per share related to the sale of our pre-petition JCPenney term loan and secured notes. The recognition of this loss in our income statement corresponded with an unwind of prior period unrealized losses on our balance sheet, totaling the same amount, and therefore, the overall impact was NAV neutral. There was, however, a positive impact from the recognition of this loss in the form of a reduction to our excise tax accrual. For context, recall that last December, upon JCPenney's emergence from bankruptcy, our pre-petition term loan and notes were converted to non-interest paying instruments with rights to immediate and future distributions in cash and other instruments, including the exit term loan and earn-out and propco interests.
The combined value of these other instruments and cash distributions that we've received to date have far exceeded our total capital invested in the original JCPenney pre-petition securities. Through September 30th, we've generated an MOM of 1.23x and a gross unlevered IRR of 26% on our total capital invested. Moving on to our operating results detail on slide 9. Total investment income for the quarter was $71.2 million, compared to $62.8 million in the prior quarter. Walking through the components of income, interest and dividend income was $59.4 million, stable from the prior quarter. Other fees, representing prepayment fees and accelerated amortization of upfront fees from unscheduled pay downs, were $10 million, up from $2.2 million in the prior quarter due to higher portfolio repayment activity.
Other income was $1.8 million, up from $1.1 million in the prior quarter. Net expenses, excluding the impact of a non-cash accrual related to capital gains incentive fees, was $31.2 million, up slightly from $29.7 million in the prior quarter. This was primarily due to higher incentive fees as a result of this quarter's overearning. Due to the decrease in the effective LIBOR on our floating rate liability structure, our weighted average interest rate on debt outstanding decreased by approximately five basis points. Similar to Q2, we applied a fee waiver on base management fees related to the portion of average gross assets this quarter financed with greater than 1x leverage.
As Josh mentioned, through the first three quarters of the year, we've generated an annualized return on equity on adjusted net investment income of 12.9% and on adjusted net income of 21.5%. This quarter, an elevated level of portfolio repayments contributed to robust activity-related fees, and we expect this trend to continue through Q4. Dovetailing this with our active funding pipeline, we would expect to drive strong ROE results for Q4 through the combination of activity-related fees and an increase in our financial leverage. As a result, we would expect our full year 2021 adjusted net investment income to exceed $2 per share, which is above the upper end of our beginning year ROE target of 12% or $1.90 per share. With that, I'd like to turn it back to Josh for concluding remarks.
Thank you, Ian. With this being the 10-year anniversary of when we first began our investment activities, we think it's a good time to reflect on the basis of any success we've enjoyed to date. We think there are 2 root drivers for this. With the first being our one team culture. Our cultural philosophy of collaborating across platforms to harness best ideas and best practices allow us to continue to provide thoughtful solutions for our management teams and sponsors, while also creating strong outcomes for our shareholders. Examples of this include our thematic investing in retail ABL, financing pharma royalty streams, upstream E&P, and growth capital, which have all contributed in their own way to the alpha in our portfolio's performance to date. This one team culture extends to our capital base.
The power to co-invest with our affiliated funds, which in Q3 surpassed $9 billion in cumulative Sixth Street direct lending investments, has allowed us to expand our investment opportunity set and our relationships with sponsors and management teams. Our ability to scale up through co-investment, co-investing with affiliated funds continue to benefit TSLX shareholders as it allows us to size our funds appropriately to remain nimble in any environment while supporting middle market borrowers. The second driver of our success today, if any, we believe is simply our focus on doing good fundamental credit work. Our emphasis on first principles thinking and using tools to manage the inherent fragility of our credit assets are, in our view, the foundation of our strong track record to date.
Since inception, we've experienced an average annual gross realized loss rate on assets of 7 basis points or a net realized gain of 5 basis points. This compares to a net loss of 115 basis points across all private credit during this period, an outperformance of 120 basis points according to the Cliffwater Direct Lending Index. Given that BDCs are now levered approximately 1-to-1 debt to equity, this means in theory that we've generated an outperformance of 250 basis points on equity solely attributed to our credit selection. Looking ahead, we will continue to be focused on the shareholder experience.
As you can see, since the end of 2019, we've kept net asset value per share fairly stable while distributing a total of $5.42 per share in regular, supplemental, and special dividends. One final note. Yesterday, in consultation with our board, we decided to amend our existing $50 million stock repurchase program so we again will be purchasing shares automatically when our stock trades at prices starting at one penny below 105, our most recently reported pro forma net asset value per share instead of below one.
Given the strength in our earnings power of our portfolio on our ongoing cadence of supplemental and special dividends and our expectations of operating in a targeted debt-to-equity range, we believe that reinvesting our existing portfolio prices starting below 1.05x book value would be highly ROE accretive with a short payback period compared to any dilution in net asset value. At the end of the day, our goal is to make the optimal capital allocation choices for our shareholders independent of what it means for asset growth and implications for fee income for the manager. With that, thank you for your time today. Operator, please open the line for questions.
Certainly. Ladies and gentlemen, to ask a question, simply press star one on your telephone. To withdraw the question, press the pound or hash key. Again, that is star one to get in the queue. Please stand by while we compile the Q&A roster. First question comes from Devin Ryan with JMP Securities. Your line is open.
Good morning. This is Kevin Fultz on for Devin. First question-
Hi, Kevin.
Just looking at investment activity during the quarter, gross originations were fairly healthy at $572 million, but new investment commitments were fairly light at $105 million, which is more than 80% of originations were sold down. Just curious, given where leverage is at and the level of repayments, if that gross origination number was skewed by a large deal during the quarter, or if the small share that you retained was the result of origination investments that were less suitable for the portfolio.
Great question. That gross origination number, I think, is largely impacted by Biohaven, which we, you know, had capped out basically at our position size or risk appetite for the portfolio. The other thing I would note on origination activity in this quarter, there is a, as Ian noted, and Bo in their prepared comments, there was a timing issue, which is there's been a large net origination already in Q4, and we expect that to continue. You know, quarters are somewhat arbitrary, right? In the sense that they're a moment in time, they don't tell the entire story. I think this year, obviously the portfolio has grown significantly year-over-year.
Our expectation is it will, on a calendar year basis, experience net portfolio growth too. It just happens to be, you know, slipped into Q4.
Okay, that makes sense, Josh. Just on the repayment side, obviously repayment activity was elevated during the third quarter. Could you talk about how repayment activity has tracked quarter to date and your expectations for repayment activity through the end of the year?
Yeah. By the way, if I need you to take a step back and rewind, I know it's hard for people to rewind. If you talk about Q2, I think there was, like, very little repayment activity, and people were questioning what was happening with the investment income given that there was no activity-based fee. Again, you know, there happened to be something in Q3 which helped economics and helped earnings. I think in Q4, it feels like it's a pretty good mix. There will be most definitely repayment activity. One that's public is Moda will be taken out of Moda, which was a long-time client of ours, I think in the syndicated loan market. We also had an equity co-invest in Moda.
I would say generally the portfolio activity there, it's pretty balanced and kind of looks like historical between repayment, new activity and less repayments, but net portfolio growth. You know, that's how I would frame it. If that's helpful.
Okay. That's helpful, and thank you for taking my questions, and congratulations on a strong quarter.
Great. Thank you so much. Thanks.
Thank you. Our next question comes from Ryan Lynch with KBW. Your line is open.
Good morning, and thanks for taking my questions. First one I had was, Josh, do you or Sixth Street really have any high-level views on how the inflation picture will look over the coming quarters or even coming years? Are there any actions that you guys are taking within your portfolio companies, existing portfolio companies or potential new deals in how to prepare for this?
Yeah. It's a great question, Ryan. We most definitely have views. I would say they're informed. The reality is that it's a complicated issue, and I think there's, you know, divergent opinions in the firm. I'm not sure my opinion matters. I can tell you kind of the framework, how I think about the framework, and then I can tell you about how we position the portfolio. Look, obviously a lot of money printing, and, you know, if people talk about the, you know, inflation, they really point to that. If you really look at, there's still a decent amount of excess capacity, especially labor capacity, in the markets.
That labor capacity has been really sidelined given the stimulus, that and the residual stimulus from COVID. I think there's, you know, $13 trillion-$17 trillion of excess savings in the U.S. system. You saw this with household debt coming down and credit card balances coming down and, you know, those are starting to pick up. At some point, people are gonna have to go back to work once they've burned through the stimulus and the excess savings. I think we're getting close to an inflection point on that. I think there was a jobs number out today. There was a decent amount of jobs creation.
I think people are starting to come back to work given that they're burning through that stimulus. I think that will most definitely be a deflationary factor. Look, as people know, we've participated in the portfolio construction side. We've been an early investor in software and technology, you know, that industry sector is a massive exporter of deflation on a global basis. I think that is a deflationary factor. Surely, I think people need to take a step back and look at the world, and the world over the last 10-15 years, I think, or 20 years has been really deflationary, driven by, you know, globalization and technology, and demographics.
I think except for globalization, which we probably were at peak globalization part of the global financial crisis, those factors are actually gonna continue. I'm not as concerned about inflation as the average bear, so to speak. I think there's divergent views in our group. That being said, I think how we've set the portfolio, generally speaking, is we typically finance companies and like to finance companies that have a ton of pricing power, that live in ecosystems, that they have...
where pricing power exists and where they're not commodity, where they're not, you know, quote-unquote, "commodity providers." Our expectation of our portfolio, given the average EBITDA margin of our portfolio, I think is, you know, of the core portfolio is probably in the 30%, 35% or 40% range, which tells you they have pricing power, if inflation does come, they will be able to pass along. By the way, their cost structure is, you know, typically, you know, given its high margin, a high gross margin, they have. There's less impact on inflation, but they'll be able to pass along and have pricing power. From a portfolio construction standpoint, I think our portfolio is super robust from an inflation standpoint.
When you look at the behavior or the model for TSLX, there's a little bit of a pinch point between the floors if there is inflation between the floors. We have basically a floating rate capital structure, floating rate left-hand side of the balance sheet, floating rate right-hand side of the balance sheet. There will be EPS expansion once we get to our floors. There's a little pinch point on the floors. If there is inflation, my expectation is that we would kind of, you know, rip through those floors pretty quickly, and be in EPS expansion.
the kind of my framework for inflation, how the portfolio behaves in an inflationary environment, which I think is robust, and then the earnings power of TSLX in an inflationary environment. Does that help?
Yeah. That's a super comprehensive and very thoughtful response. I very much appreciate that. Kind of on the opposite end, more of just a technical question, I think for Ian. Can the convertible owners convert early or until the maturity in August 2022, or is that just like a one-time event that they only have the option to do it then and then they'll have to decide when it comes to maturity?
Hey, Ryan, I just want to point out that I can answer technical questions too, but we'll let Ian take that one.
We know, Josh. I just want to give Ian some air time.
I'm messing with you.
Oh, it's okay. Ryan, there's kind of two parts to that question. One depends on whether the early conversion triggers have been met prior to six months prior to maturity. Think of it as two periods. Prior to February 1 of next year, there has to be an early conversion trigger met. As of today, there's no early conversion triggers met. As of today, there's no more early conversion until we get to February 1, which is six months prior to maturity. Then the early conversion triggers are not applicable, and holders can convert early at their option.
Yeah. Let me color that up. That's Ian's right on. The early conversion trigger was a broker bid parity calculation. For some reason, in a moment in time, the broker bids were, you know, less than, I think 98% of
Parity
... of parity. That doesn't seem to exist today. It sometimes happens in high-paying dividend stocks. What I would say is we take another step back, is that there's two kinds of holders of the convertible bonds: hedged holders and non-hedged holders. The hedged holders, when the bonds get deeply in the money and like really deeply in the money and they delta-hedge the bonds, they basically are hedging the bonds on a one-to-one basis because they effectively just own the stock. Therefore, they're short the dividend of TSLX, and they only have 4.5 points on the coupon, and the dividend yield is much higher. They have a cash flow, so they really want to unwind the hedge, which is why that early...
You know, they can unwind the hedge basically through two things. One is either selling the bonds and unwinding the hedge or. The trigger exists that which is, if the bonds, for some reason, are trading below parity, that they have a liquidity option, so they can unwind the hedge. It has felt like all of the hedged buyers have exercised early conversion trigger, I mean, early conversion option. In addition to that, it feels like that environment of where the bonds trade at parity no longer exists. I would expect that we won't see that again.
That was a point in time given, you know, a little bit of a market dislocation on the price of the bonds, and then the nature of the holders are no longer hedged holders.
Okay. Yep, that makes sense. I understood the.
See-
the color behind that. Yeah.
Technical. Technical answer.
Yep. Got them both. All right. Well, I appreciate the time today, and nice quarter, guys.
Thanks.
Thank you. Our next question comes from Melissa Wedel with J.P. Morgan. Your line is open.
Good morning, everyone. Thanks for taking my questions today. Most of them have actually been either anticipated or already asked and answered.
Hey, Melissa, we can't hear you. Sorry, you're muffled.
Sorry about that. Hope that's better.
Perfect. Yeah. Yeah.
Okay. Wanted to clarify the $100 million in activity that you mentioned so far, quarter to date. Was that gross or net?
That was gross.
Okay, the $100-$150 of additional that you expected, that was a net number, correct?
That's a net. That's correct. That's a net number that's expected.
Just to round out that math a little bit, you also continue to expect elevated prepayment activity into 4Q?
Yeah, I think what Joshua said is, we expect normalized repayment activity in Q4 to what we've seen at typical levels. Combine that with a robust pipeline coming into Q4. We expect those net fundings between $150 million and $250 million.
Yeah, look, I think the math historically, and somebody can correct me if I'm wrong, typical average repayments tend to be, you know, $175 million-$250 million. Gross originations tend to be, you know, somewhere between $200 million and $275 million. I would expect that, you know, we're $100 million-$150 million net on the quarter up. Is that helpful Mo-
We may have lost her.
We lost her.
Okay.
If you can re-queue. Shall we continue with the next question, sir?
Sure, sure.
From Finian O'Shea with Wells Fargo. Your line is open.
Hey, everyone. Good morning. I guess first question for Josh or Bo on the ABL opportunity set high level. We haven't seen a new portfolio company too recently. Is this part of the private credit arena as Bo described, where you know, there's a lot of new entrants in terms of coming too much? Or are you just not seeing your style of opportunity, preferred opportunity there?
Yeah. Hey, Finian, good morning. Thanks for your question. Good question. Well, the good news is... Well, not the good news. There's one in Q4. We actually have one that we've committed to, that we've been actually earning a little bit of commitment fees along the way, over last quarter and this quarter, that's taken some time to get regulatory approval, but that should close early next week. That's, you know, consistent with what you've seen in the past. I would say it's not really a private credit competition issue. It's really a broader issue, which is when you look at pre-pandemic, what retail looked like was that you had foot traffic declining, and store-based retailers. You had...
It's a low barrier in this industry, so you had a lot of competition. You had share being taken away from physical stores, from omni-channel providers and from Amazon. You saw a lot of pressure on those business models, including on a gross margin basis and a discounting basis. The consumer was kind of stable down. When the pandemic hit, what you had was basically a culling of the herd of retailers, only the strong survived and got to reduce their footprint and rebase. They were themselves better positioned. There was less competition. Foot traffic has remained, you know, stable or slightly declining. Consumers are in much better shape, given excess savings.
You've had no discounting, you've had margin expansion. Retailers or generally those who survived are living in a slightly better environment with a better consumer. You know, my guess is the big secular will continue to play out. In this moment in time, you know, retail is relatively healthy.
Yeah, no, makes sense. Just a follow-up. We can call it technical or high level, but either way it goes to Ian. Is there a change in the supplemental dividend policy? I think you used to pay out about half of the NOI spillover. I know there's a few wrinkles going on this quarter with the big special and the preferred and everything, but are we seeing any change to what you pay out for-
No, no.
the supplemental?
No, Finian, it's the same formula. I think maybe what we didn't do as good a job of articulating, we're using the adjusted NII figure to calculate that, so it's the $0.55 less the base dividend of $0.41 and then 50% of that. That's how we got to the 7.
Because
Got it. Okay.
Because the part two in capital gains incentive fees are not paid in cash and are not expected to be paid in cash anytime soon.
Yeah.
That you have to make an adjustment to the adjusted net investment income number to get to the earnings power and the cash earnings power of the business.
Awesome. Thank you so much.
Thank you.
As a reminder, ladies and gentlemen, to get in the queue with your questions, simply press star one. Our next question is from Robert Dodd with Raymond James.
Hi, everyone. Excuse me, and congratulations on the quarter. For what it's worth, my questions are open. Anybody can answer them. I suspect I know who's going to answer this one. On the kind of portfolio mix going forward, I mean, as. I don't mean firstly and secondly, and I mean more by verticals. I mean, you addressed ABL, but you've got pharma royalties expertise. You've got a whole bunch of other expertise beyond just, you know, regular way LBO sponsor finance. You know, do you expect to shift the mix at all? I mean, as you point out, right, the regular way business seems to be getting more competitive. Big managers come in large pools of capital.
You've always run higher, typically higher IRRs, MOICs, whichever metric you wanna look at, you know, because of those more niche verticals that a lot of big players don't participate in. Should we expect the kind of number of verticals you're willing or want to operate in to increase or expand as a piece of the mix, the more vanilla ends of the market get increasingly competitive?
Yeah. That's a great question, and I'll let Fishie answer it. No, I'm just joking. Fishie is here. He can hop in. I like your approach to who you direct the question at. I'll take a shot at it, then Bo and everybody else. First of all, look, I think you're right. We try to be very thoughtful in the sectors and lanes that we've operated in. Quite frankly, there is inefficiencies where we operate. What you find over the ten-year anniversary of the business, you found us having higher IRRs or higher ROAs or, you know, higher spreads and less defaults, significantly less defaults, like actual, you know, net gains versus losses.
We've found lanes that offer higher risk-adjusted returns. That's the power of the Sixth Street platform. The power of the Sixth Street platform is we have, you know, 400 people now, and, you know, we have a whole bunch of people in sectors and hunting and thinking about what's happening in those individual ecosystems and where we can, you know, have direct dialogue with companies and, you know, pick our lanes and pick them in a thoughtful way where we can find the balance of providing a tremendous amount of value to our issuers, but also value to our shareholders. You know, I think you will see us continue to evolve like, you know, this year retail was down.
My expectation is retail will come back when that industry is less healthy and the secular overrides the cyclical vis-a-vis the consumer. I think you'll see us do some energy stuff, you know, in the coming months, given the pullback of capital in that space. I think you'll see us attack, you know, software as we have. We have a little bit of an incumbency benefit there. I just think that, you know, on the pharma side, we'll continue to be a thoughtful investor there as well. I just think that, you know, given that Sixth Street Specialty Lending, Inc. is really focused on the middle market and focused on specialty verticals.
I think you'll continue to see us do our thing and, you know, across sectors when we find, you know, good relative value and good risk-adjusted returns and where we can provide value to our issuers. Fishie, you have anything to add? Fishie is, you know, just in the background, always judging, but he's here as well.
No. I think the only thing I would add is, you know, we say software, right? It's such a broad category and encompasses so much. I think one of the things we've done is kind of dig deeper. There's a lot of subverticals, whether it's, you know, healthcare IT or education or edtech or payments. I mean, we're developing, I guess, expertise I would call it in subverticals of something that's very, very broad. We're constantly looking for, you know, I would say a differentiated view in different areas, and just, I know we just throw around software a lot, so that's the only thing I would talk about.
Bo, anything to add?
No, no. I mean, I guess what I would add is when I look forward to the Q4 pipeline, it's across a number of themes and a good mix of both sponsored, non-sponsored deals. I think that has been the power of the platform that's constantly rotating thematic approach, where we have hundreds of investment professionals speaking directly to management teams, sponsors, intermediaries to find the best risk-adjusted return. I think that's gonna be represented in our Q4 results.
Yeah. Hey, then, Robert, I know you didn't ask this question, but I think it's worth saying. Look, we didn't get the spillover question. I wanna talk quickly about the spillover. Look, spillover, given the unrealized gains in the portfolio, spillover is gonna, you know, quickly increase again. That being said, I am, you know, not sure the value of keeping a whole bunch of spillover income in the system. Ultimately, what matters is the forward earnings power of the business and protecting the dividend vis-à-vis the forward earnings power of the business. We've tried to do a decent job of being thoughtful and appropriately, you know, choosing our capital structure and eliminating the excise tax, although that excise tax will probably build again, given as we convert the unrealized book to realized, we'll create more spillover income.
That being said, I think our philosophy is a little bit shifting, and we're using that as a lever to optimize our capital structure at any given time to create the right balance, to generate forward earnings of the power and earnings of the business and making sure that, you know, we keep, you know, ROEs in acceptable level. I wanted to hit that. The other thing I wanted to hit, you know, I think Ian's earnings estimate, which was in excess of $2 per share, I would probably slightly reframe that. It's probably gonna be well in excess of $2 per share, or, you know, you know, for Q4, my guess.
I, you know, I won't define well in excess, but it's gonna be, you know, it's gonna be it you know.
That was gonna be my next question.
Yeah. People shouldn't model $2 a share for the year. That would be wrong. Or I think it would be wrong. But then Robert, I'll find we can debate the spillover income piece because I think the spillover income concept was this idea of providing protection to the dividend. Ultimately, if you're paying the dividend through spillover income, you're reducing net asset value per share from that moment forward.
We're trying to really find that balance of, you know, kind of letting spillover income increase, which it will, and then using it as a kind of letting air out of the balloon to make sure we keep the optimal financial leverage and make sure that we don't have a drag on earnings through the excise tax.
I appreciate that, and you're not the only one whose view on spillover may be philosophically evolving as well. I look forward to that debate later. I appreciate that color from everybody. Thank you.
Okay, great. Thank you so much.
Thank you. This concludes our Q&A. I would like to turn the call back to Joshua Easterly for his final remarks.
So-
Any quest-
Thank you. Thanks for the time and attention and participation from everybody. What I would say is this time of the year always makes me feel a little bit sad because it's gonna be a longer period before we connect next. I think in February sometime, given the Q4 additional timing to facilitate the year-end audit. First I wanna wish people a happy Thanksgiving. A lot to be thankful for this year. You know, a lot to reflect on.
It's obviously been a difficult two years for people and given the pandemic and the uncertainty in the world and a lot of other issues, this diversity and equity issues that are real and affecting parts of our community. You know, we obviously have to deal with some, as a society deal, you know, with the reckoning of some of our history. You know, a lot to be thankful for. Thank you for your time and efforts. I deeply from our team hope people have a healthy holiday season and can take some time to spend with their family given the last two years. Thanks, everybody.
Thank you, ladies and gentlemen, for participating in today's conference, and you may now disconnect. Good day.