TSLX

Business Context and Reporting Period

Sixth Street Specialty Lending, Inc. (TSLX) is an externally managed, closed-end, non-diversified management investment company regulated as a Business Development Company (BDC) and a Regulated Investment Company (RIC). The company focuses on lending to U.S.-domiciled middle-market companies, primarily through direct originations of senior secured loans. The reporting period covers the fiscal year ended December 31, 2020.

As of December 31, 2020, the company held investments in 70 portfolio companies with an aggregate fair value of $2,298.9 million. The portfolio is heavily weighted toward first-lien debt (95.6% of fair value), with the largest industry exposures being business services (22.2%) and financial services (15.7%).

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total investment income increased 7.4% to $270.0 million, driven primarily by higher prepayment fees ($21.5 million vs. $12.0 million) and accelerated amortization of upfront fees ($14.0 million vs. $6.7 million) due to increased paydowns.
• Expense Reduction: Total interest expense decreased significantly to $39.4 million from $49.1 million, primarily due to a lower average interest rate (3.0% vs. 4.4%) resulting from the decline in LIBOR and a change in the mix of debt financing.
• Portfolio Composition: The portfolio grew to 70 companies from 63. First-lien debt remained the dominant asset class at 95.6% of fair value. Non-accrual investments represented 0.9% of the portfolio fair value ($21.6 million), an increase from 0% in 2019.
• Capital Structure: The company repurchased $29.7 million of its 2022 Convertible Notes and $2.5 million of its 2024 Notes during the year. The revolving credit facility had $862.7 million available.

Guidance, Outlook, and Risks

Management Commentary: Management noted that the COVID-19 pandemic has materially and adversely affected portfolio companies and the broader economy. Despite this, the company maintained strong asset coverage and liquidity. The weighted average yield on debt investments at fair value was 10.0% as of year-end 2020.

Risks and Contingencies:

• LIBOR Transition: The company faces uncertainty regarding the transition away from LIBOR, which is used as a reference rate for the majority of its debt investments and borrowings. This could impact interest income and borrowing costs.
• Credit Risk: Economic downturns could impair portfolio companies' ability to service debt, leading to increased defaults. The company holds 0.9% of its portfolio on non-accrual status.
• Leverage: The company utilizes leverage to enhance returns, which magnifies both gains and losses. The asset coverage ratio of 204.5% provides a buffer above the 150% regulatory minimum.
• Adviser Dependency: The company is dependent on Sixth Street Specialty Lending Advisers, LLC for investment management. The Investment Advisory Agreement may be terminated on 60 days' notice.

Investor Verification Checklist

• Verify the impact of the LIBOR phase-out on the company's floating-rate asset yield and liability costs.
• Monitor the non-accrual portfolio ($21.6 million) and potential credit deterioration in the business services and financial services sectors.
• Review the company's ability to maintain RIC status and avoid corporate-level taxes given the excise tax expense of $5.8 million recorded in 2020.
• Assess the sustainability of the 10.0% weighted average yield in a low-interest-rate environment.
• Confirm the status of the $192.8 million in unfunded portfolio company commitments and the company's liquidity to fund them.