Sixth Street Specialty Lending, Inc. Q2 FY2025 earnings call

Sector Trends - The sector is seeing a shift from credit quality to dividend coverage as portfolio yields decline. Credit issues are predominantly behind us, with an improvement in nonaccruals. - Sixth Street Specialty Lending's net asset value per share increased by 1.2% from Q4 2021 to Q2 2025, outperforming the average public BDC decline of 10.1% during the same period. ### Investment Activity - Q2 had $289 million in total commitments and $209 million in total fundings across 13 new investments and 4 upsizes. Approximately 30% of commitments were nonsponsored transactions, including a direct-to-company investment in Ingenovis Health. - Repayment activity was elevated for the third consecutive quarter, with $389 million in repayments, contributing to strong activity-based fee income. - Lithium Technologies, previously on nonaccrual, was removed from nonaccrual status following restructuring. ### Portfolio Metrics - The portfolio reflects disciplined capital allocation, with only 6.2% of investments by fair value having a contractual spread of 500 basis points or below. Nonaccruals decreased from 1.2% to 0.6% quarter-over-quarter. - Weighted average revenue and EBITDA of core portfolio companies were $377 million and $114 million, respectively.

In the second quarter ended June 30, 2025, Sixth Street Specialty Lending, Inc. reported adjusted net investment income per share of $0.56 and adjusted net income per share of $0.64. Net asset value per share was $17.17 as of June 30. Total investments were $3.3 billion, down slightly from the prior quarter due to net repayment activity. The company's adjusted net investment income exceeded the base dividend by 22%, and annualized return on equity was 13.1% for adjusted net investment income and 15.1% for adjusted net income.

- The company expects credit issues to continue improving, leading to a convergence between net investment income and net income for the sector. - Anticipates the focus shifting to dividend coverage as portfolio yields decline. - Estimates quarterly earnings power to exceed the base dividend level assuming stable credit, leverage in the target range, and conservative fee incurrence. - Anticipates generating a return on equity based on adjusted net investment income in the top half of the previously slated range of 11.5% to 12.5% for the full year, with potential to exceed the top end if activity-based fees remain elevated.

- Complacency in the sector driven by backward-looking focus on LTM metrics that may not reflect current investment landscape. - Potential for dividend cuts as portfolio yields decline and reinvestment spreads change. - Competitive market environment making it challenging to generate outsized returns. - Idiosyncratic credit risks that could impact portfolio performance if not managed properly.

Q: How does Sixth Street balance portfolio diversification and sizing positions based on conviction?

A: It's about idiosyncratic underwriting. The company has a strong track record of risk management, focusing on originating and underwriting credits with asymmetrical risk-reward profiles to minimize losses.

Q: What are the attractive themes and sectors Sixth Street is investing in?

A: More off-the-run nonsponsor stuff like spec pharma, asset-based lending, and energy, which are less picked over with less capital. The company also builds out sector capabilities across the platform.

Q: Is the process of nontraded BDCs and private credit funds pressuring loan spreads a secular trend?

A: There's complacency with backward-looking LTM metrics. The industry may see reallocation of capital to managers producing attractive ROE as the back book and spot forward hide economics. Liability and fee levers may not provide significant excess return, and capital could reallocate if ROE is not generated.

Q: Why did credit issues become idiosyncratic and likely behind us?

A: Credit issues were largely idiosyncratic, like the Lithium Technologies case which was specific to the business model and not due to general market factors. The lag in defaults from the rate hike cycle in 2022 is mostly played out.

Q: What's the outlook for Lane 2 or Lane 3 investments?

A: Activity is expected to be stronger in the second half, with a robust pipeline. The company is thoughtful in capital allocation but sees good demand across sponsor and nonsponsor activity.

Q: Thoughts on retirement vehicles opening to private investment assets?

A: Mixed feelings; concerned about individual investor protections and proper understanding of return types. The focus should be on providing value to clients.

Q: What drove higher other income this quarter?

A: Miscellaneous exit fees from transactions that paid off during the quarter. Fees are deferred and put in OID, so repayment activity and portfolio churn drive net investment income.

Q: Details on Lithium restructuring earn-out securities?

A: Split into an interest-earning debt security and an equity participation. The duration is about 3 years to realize value, with expectations of overperformance within that timeline.