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, 2020.

Key Financial Metrics

Material Changes vs. Prior Period

• Investment Income: Total investment income increased slightly for the three months ended September 30, 2020 ($71.3 million) compared to the same period in 2019 ($70.1 million), driven by a significant increase in "Other income" (amendment and fees) which offset a decline in interest income due to lower LIBOR rates. For the nine-month period, investment income rose to $207.8 million from $185.0 million in 2019.
• Expenses: Net expenses decreased for the quarter to $28.2 million from $31.8 million in 2019, primarily due to lower interest expense resulting from decreased LIBOR rates. For the nine-month period, expenses increased slightly to $89.6 million from $87.6 million.
• Realized and Unrealized Gains: The company reported a net realized gain of $11.0 million for the quarter, compared to $5.1 million in the prior year. Net unrealized gains were $29.8 million for the quarter, a significant improvement from a loss of $11.5 million in the prior year, attributed to tightening credit spreads and positive portfolio adjustments.
• Portfolio Composition: As of September 30, 2020, 95.0% of the portfolio consisted of first-lien debt investments. Non-accrual investments represented 0.9% of the portfolio by fair value ($19.7 million), up from 0% at year-end 2019.

Guidance, Outlook, and Risks

• Management Commentary: Management noted that the weighted average total yield of debt and income-producing securities at fair value was 10.1% as of September 30, 2020. The company continues to originate new investments, funding $332.3 million in principal during the quarter.
• Dividends: The company declared total dividends of $1.79 per share for the nine months ended September 30, 2020. A dividend reinvestment plan is in effect.
• Risks and Contingencies:
  • COVID-19 Impact: The filing highlights that the pandemic has materially and adversely affected portfolio companies, potentially leading to increased defaults, requests for amendments, and difficulty in refinancing.
  • Interest Rate Risk: While 98.9% of debt investments bear floating rates, the company uses interest rate swaps to hedge fixed-rate debt. A hypothetical 100 basis point increase in rates would decrease net interest income by $5.3 million annually, while a 25 basis point decrease would increase it by $2.0 million.
  • Liquidity: The company has approximately $1.0 billion of availability on its Revolving Credit Facility, subject to asset coverage limitations.

Investor Verification Checklist

• Non-Accrual Status: Verify the specific portfolio companies contributing to the $19.7 million in non-accrual investments and the likelihood of recovery.
• Debt Repurchase Activity: Review the details of the $29.7 million repurchase of 2022 Convertible Notes and the resulting gain on extinguishment.
• Commitments: Assess the $250.0 million in unfunded commitments to current portfolio companies and the impact on future liquidity.
• Valuation Methodology: Confirm the fair value of Level 3 investments, which constitute the vast majority of the portfolio, given the reliance on unobservable inputs.
• Dividend Sustainability: Analyze the source of dividends (net investment income vs. return of capital) given the company's RIC status requirements.