TSLX

Business Context and Reporting Period

Sixth Street Specialty Lending, Inc. (TSLX) is a Delaware corporation regulated as a Business Development Company (BDC) and a Regulated Investment Company (RIC). The company focuses on lending to middle-market companies in the United States, primarily through direct originations of senior secured loans. This report covers the quarterly period ended September 30, 2021.

Key Financial Metrics

Material Changes vs. Prior Period

• Investment Income: Total investment income remained relatively flat on a quarterly basis ($71.2M vs $71.3M in Q3 2020) but decreased year-to-date ($200.3M vs $207.8M). The YTD decrease was driven by lower prepayment fees and accelerated amortization of upfront fees compared to the prior year, partially offset by a larger average portfolio size.
• Net Investment Income: Decreased for the nine months ended September 30, 2021, compared to the same period in 2020, primarily due to the reduction in other income (amendment and other fees) and lower prepayment fees.
• Realized Gains/Losses: The company reported a net realized loss of $10.5 million in Q3 2021, contrasting with a gain of $11.0 million in Q3 2020. Year-to-date, the company reported a net realized gain of $6.1 million.
• Unrealized Gains: Significant unrealized gains were recorded in Q3 2021 ($29.0M) and YTD 2021 ($67.7M), driven by tightening credit spreads and positive portfolio company developments. This contrasts with minimal unrealized gains in the prior year YTD ($2.3M).
• Debt and Liquidity: The company issued $300 million in 2026 Notes in February 2021 and raised approximately $86 million in equity in February 2021. Proceeds were used to pay down the Revolving Credit Facility, reducing outstanding principal on the facility from $472.3 million (Dec 31, 2020) to $184.2 million (Sep 30, 2021).

Guidance, Outlook, and Risks

• Portfolio Composition: As of September 30, 2021, 92.5% of the portfolio consisted of first-lien debt investments. 98.9% of debt investments bore interest at floating rates, with 99.4% subject to interest rate floors.
• Capital Markets: The company increased its Revolving Credit Facility commitments to $1.51 billion and utilized an accordion feature. It maintains significant borrowing capacity ($1.3 billion available) subject to asset coverage limitations.
• Dividends: The company declared total dividends of $2.61 per share for the nine months ended September 30, 2021, compared to $1.79 per share in the prior year period. This includes base, supplemental, and special dividends.
• Risks:
  • Interest Rate Risk: While the portfolio is largely floating-rate, the company uses interest rate swaps to hedge fixed-rate debt. A 100 basis point increase in rates would increase net interest income by $11.4 million annually, while a 50 basis point decrease would increase it by $5.0 million (due to floors).
  • Leverage: The company operates with leverage, which magnifies returns but also increases the risk of loss. The asset coverage ratio is 211.6%, well above the 150% minimum requirement.
  • Convertible Notes: The 2022 Convertible Notes became eligible for conversion in Q3 2021. Approximately $42.8 million in principal was surrendered for conversion during the period.

Investor Verification Checklist

• Verify the impact of the $42.8 million conversion of 2022 Convertible Notes on future cash flows and share count dilution.
• Review the composition of the $191.3 million in unfunded portfolio commitments to assess future capital deployment needs.
• Monitor the asset coverage ratio to ensure compliance with the 150% minimum requirement under the 1940 Act, especially given the high level of leverage.
• Assess the sustainability of dividend payouts given the decrease in net investment income year-to-date compared to 2020.
• Examine the specific portfolio companies contributing to the $10.5 million realized loss in Q3 2021 to understand credit quality trends.