Sixth Street Specialty Lending, Inc. — 2022 Form 10-K
Reporting period: Fiscal year ended December 31, 2022. Sixth Street Specialty Lending is an externally managed business development company (BDC) focused mainly on directly originating senior secured loans to U.S. middle-market companies. Unless noted, financial amounts are in U.S. dollars.
Business context and portfolio
- At year-end, investments had a fair value of $2.788 billion across 121 portfolio company investments, including 43 structured-credit investments. The portfolio’s largest individual investment was 2.8% of total investment fair value.
- By fair value, the portfolio was 90.3% first-lien debt, 1.5% second-lien debt, 0.4% mezzanine debt, 6.0% equity and other investments, and 1.8% structured credit. Business Services (14.4%) and Internet Services (13.9%) were the largest industries.
- 98.9% of debt investments were floating-rate; all of those had interest-rate floors. Management reported a 13.5% weighted-average total yield on debt and income-producing securities at fair value, compared with 10.0% a year earlier.
Key financial results and liquidity
| Metric | 2022 | 2021 |
|---|---|---|
| Total investment income | $309.3 million | $278.6 million |
| Net investment income | $166.3 million | $142.4 million |
| Net increase in net assets from operations | $108.1 million | $211.8 million |
| Basic earnings per share | $1.38 | $2.93 |
| Net asset value per share at year-end | $16.48 | $16.84 |
| Investments at fair value | $2.788 billion | $2.522 billion |
- Net investment income was $168.9 million before $2.6 million of income and excise taxes. The filing reports net expenses of $140.4 million, including $63.0 million of interest expense and $39.5 million of management fees net of waivers.
- Net realized gains were $16.7 million, while the net change in unrealized gains and losses was a loss of $74.9 million. The unrealized investment loss was principally associated with negative valuation and credit-related adjustments, reversals of prior gains on realizations, and changes in credit spreads.
- Cash and cash equivalents were $25.6 million, including $15.4 million restricted as swap collateral. Operating activities used $224.5 million of cash, primarily reflecting investment funding; financing activities provided $234.2 million.
- Outstanding debt principal was $1.517 billion. Revolver commitments totaled $1.585 billion, with $865.7 million shown as available, subject to borrowing-base and asset-coverage limits. Asset coverage was 188.6%, down from 205.4%.
- Average debt outstanding was $1.342 billion and the weighted-average interest rate was 3.9%, compared with $1.223 billion and 2.3% in 2021. Interest expense rose to $63.0 million from $38.8 million.
- Declared dividends totaled $1.84 per share in 2022, versus $3.59 in 2021, which included special dividends. The filing does not provide a specific future earnings or dividend forecast.
Material changes versus 2021
- Investment income increased 11.0% and net investment income increased 16.8%, reflecting higher interest rates and greater average assets. The weighted-average total yield at fair value rose to 13.5% from 10.0%.
- Higher borrowing costs partly offset investment-income growth: interest expense increased by $24.2 million as average debt and its average rate both rose.
- Operations declined to $108.1 million from $211.8 million. The change chiefly reflects the shift from a $40.5 million net unrealized gain in 2021 to a $74.9 million net unrealized loss in 2022, and lower realized gains.
- Investments at fair value increased by $266.3 million. New investments funded were $864.0 million, below $1.117 billion in 2021; exits and repayments were $653.8 million, versus $1.005 billion. New investment commitments, net of syndications and sell-downs, were $1.084 billion.
- Portfolio risk ratings were mixed: investments rated 2 increased to 10.5% of portfolio fair value from 7.0%, while rating 3 investments decreased to 0.8% from 3.2%. Rating 5 exposure was approximately 0.0% by fair value; reported non-accrual investments had $0.2 million fair value.
- The 2022 Convertible Notes matured in August. Holders converted $79.2 million of principal through combination settlement, and the Company issued 4.36 million shares valued at $77.6 million; the remaining balance was settled with cash resources, including revolver borrowing.
Outlook, commentary, risks and unusual items
- Management described higher interest rates, inflation, market volatility and uncertain economic conditions as risks to both borrowers and the Company’s financing costs and access to capital. Floating-rate assets can benefit from rising rates, but higher borrower payments may weaken portfolio company performance; the Company’s own floating-rate borrowings also become more expensive.
- The filing gives no quantitative earnings, originations, NAV or dividend guidance. Management said middle-market lending supply-and-demand dynamics may create attractive opportunities, while noting that market disruption could constrain funding and investment activity.
- Key risks include borrower defaults and weaker collateral values; illiquid investments and subjective fair-value estimates; leverage and refinancing needs; concentration in selected industries; conflicts and fee incentives associated with the external adviser; and the transition from LIBOR to replacement rates. Substantially all investments were Level 3 fair value measurements; the auditor identified fair value assessment as a critical audit matter.
- The Company recorded a $74.9 million net unrealized loss for 2022 and a $2.6 million income-tax and excise-tax expense. It retained approximately $63 million of taxable income and capital gains and recorded approximately $2.2 million of U.S. federal excise tax related to retained amounts.
- Management reported compliance with debt covenants at year-end and no material pending or threatened litigation requiring financial-statement recognition or disclosure. The auditor gave unqualified opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- Review the Level 3 valuation assumptions and the drivers of 2022 unrealized losses, particularly market yields, borrower credit changes and equity valuation multiples.
- Assess borrower performance and migration in risk ratings, including the increased share rated 2, and confirm the status and recovery prospects of non-accrual exposures.
- Reconcile available revolver capacity with borrowing-base and asset-coverage constraints, upcoming debt maturities, and the effect of higher rates on both asset income and financing costs.
- Confirm the cash-flow and funding implications of $338.0 million in unfunded commitments to existing portfolio companies and the Company’s dividend and RIC distribution requirements.
- Evaluate the significance of the 2022 convertible-note share issuance, the decline in NAV per share, and the reduction in declared dividends compared with 2021.