Sixth Street Specialty Lending, Inc. — Q3 2023 Form 10-Q
Reporting period: Three and nine months ended September 30, 2023. Sixth Street Specialty Lending is an externally managed business development company (BDC) and regulated investment company (RIC), focused primarily on lending to U.S. middle-market companies. Amounts below are U.S. dollars; financial statement amounts are rounded to millions.
Financial results and portfolio
- Investment income: Q3 total investment income was $114.4 million, up from $77.8 million in Q3 2022. Nine-month income was $318.5 million, versus $209.2 million. Most income came from interest on investments.
- Net investment income (NII): Q3 NII was $50.0 million ($0.57 per weighted-average share, calculated from reported NII and shares), compared with $37.2 million in the prior-year quarter. For nine months, NII was $141.7 million, or $1.68 per share, versus $113.7 million, or $1.47 per share.
- Operating results: Increase in net assets from operations was $64.8 million in Q3, versus $34.4 million; nine-month results were $170.9 million, versus $61.8 million. Reported earnings per share were $0.74 and $0.43 for the respective Q3 periods, and $2.03 and $0.80 for the nine-month periods. Results include realized and unrealized investment gains and losses, not just recurring income.
- Expenses and interest costs: Q3 net expenses rose to $64.0 million from $40.3 million; nine-month net expenses rose to $175.1 million from $94.0 million. Interest expense was $35.0 million in Q3 and $96.0 million for nine months, up from $18.9 million and $40.4 million, respectively. Management attributed the increase primarily to higher average borrowing rates and debt balances. Average debt cost was 7.5% in Q3 2023 versus 4.4% a year earlier.
- Portfolio and yields: Investments at fair value totaled $3.113 billion at September 30, up from $2.788 billion at year-end 2022. First-lien loans represented 91.0% of portfolio fair value; 99.7% of debt investments were floating-rate, all with floors. Weighted-average yield on debt and income-producing securities at fair value was 14.2%, versus 13.5% at year-end.
- Credit quality: Non-accrual investments were 0.7% of portfolio fair value ($20.7 million), compared with less than 0.1% at year-end. Investments rated risk category 3 increased to 3.2% of portfolio fair value from 0.8%; no investments were rated category 4. The filing identifies American Achievement as on non-accrual.
- Liquidity and debt: Cash and cash equivalents were $29.9 million, including $26.9 million restricted as derivative collateral. Debt outstanding at principal was $1.706 billion; carrying value was $1.623 billion. The revolving facility had $951.6 million of stated availability, subject to borrowing-base and asset-coverage limits. Asset coverage was 187.3%, compared with 188.6% at year-end; the company reported compliance with its debt covenants.
- Cash flows: Nine-month operating cash flow was negative $149.9 million, largely reflecting $634.9 million of investment purchases and originations, partly offset by $360.3 million of investment proceeds and repayments. Financing cash flow was positive $154.2 million, including $89.2 million net proceeds from a common-stock offering; debt repayments and dividends were significant uses of financing cash.
- Dividends and NAV: Dividends declared for the first nine months totaled $1.57 per share, including base and supplemental dividends. NAV per share was $16.97 at September 30, compared with $16.48 at December 31, 2022.
Material changes versus comparable periods
- Higher reference rates and a larger average investment portfolio drove much of the increase in investment interest income; the company also reported higher fee income in Q3, while nine-month prepayment fees were lower than in 2022.
- Borrowing costs rose sharply as both average debt and its average interest rate increased. NII still grew, but the rise in financing costs is an important countertrend to stronger portfolio income.
- Net unrealized gains were $9.7 million in Q3 2023, compared with $5.1 million of net unrealized losses in Q3 2022. For the first nine months, net unrealized gains were $17.3 million, compared with $68.4 million of losses in 2022. Management cited tighter credit spreads and positive company-specific developments among the drivers of 2023 gains.
- The company issued $300 million of 6.95% notes due 2028 in August 2023 and used the proceeds to repay revolving-facility borrowings. It also increased revolving-facility commitments from $1.585 billion to $1.710 billion in June.
- A May 2023 equity offering and overallotment raised $89.3 million net. Shares outstanding increased to 87.5 million at September 30 from 81.4 million at year-end.
Outlook, risks and unusual items
- The filing provides no formal earnings or dividend guidance. Management stated that cash and expected borrowing availability should be sufficient for near-term investing and operations, while noting that future funding access depends on market conditions and applicable limits.
- Management described middle-market lending opportunities as supported by demand for debt capital and limited traditional-bank lending, but these are forward-looking views, not guarantees. The filing highlights risks from economic downturns, inflation, portfolio-company performance, funding-market access, leverage, interest rates, and foreign-currency movements.
- Interest-rate sensitivity analysis estimates that a 100-basis-point increase in base rates would increase annualized net interest income by $12.5 million, while a 50-basis-point decline would reduce it by $6.3 million, assuming the September 30 balance sheet remained unchanged. Actual results may differ.
- Portfolio-company funding commitments totaled $327.2 million, plus a €0.9 million commitment to a prospective borrower. Derivative collateral requirements can vary, and a failure to meet a collateral call could trigger default.
- Most investments are valued using Level 3 inputs, requiring significant judgment; realized proceeds may differ materially from reported fair values. Some loans include payment-in-kind (PIK) interest: PIK represented 4.5% of Q3 investment income and 4.0% for the nine-month period.
- The company accrued $5.1 million of capital-gains incentive fees for the nine months; these amounts were not contractually payable to the Adviser as of September 30. The filing reports no material pending or threatened litigation and no material subsequent events requiring disclosure.
Key facts for investors to verify
- Whether investment income and dividend coverage remain resilient as borrowing costs rise, including the effect of rate changes and the company’s interest-rate swaps.
- Developments in non-accrual and watch-list credit quality, especially the rise in category 3 exposures and the recoverability of non-accrual investments.
- Actual usable revolving-facility capacity after borrowing-base and asset-coverage restrictions, and the company’s ability to meet unfunded commitments and derivative collateral calls.
- The assumptions behind Level 3 investment valuations and whether reported unrealized gains are subsequently realized.
- The effect of leverage, future share issuance, dividends, and debt maturities on NAV per share and shareholder returns.