Sixth Street Specialty Lending(TSLX) - 2021 Q3 - Quarterly Report

PART I Financial Statements This section presents the unaudited consolidated financial statements for Sixth Street Specialty Lending, Inc. as of September 30, 2021, covering balance sheets, operations, and cash flows with accompanying notes Consolidated Balance Sheets As of September 30, 2021, total assets were $2.44 billion, up from $2.34 billion at December 31, 2020, driven by a rise in the fair value of investments to $2.41 billion, leading to an increase in total net assets to $1.25 billion Consolidated Balance Sheet Highlights (in thousands) | Metric | Sep 30, 2021 | Dec 31, 2020 | | :--- | :--- | :--- | | Total Investments at Fair Value | $2,406,465 | $2,298,870 | | Total Assets | $2,438,474 | $2,338,593 | | Total Debt (net) | $1,103,114 | $1,110,363 | | Total Liabilities | $1,186,629 | $1,177,278 | | Total Net Assets | $1,251,845 | $1,161,315 | | Net Asset Value Per Share | $17.18 | $17.16 | Consolidated Statements of Operations For Q3 2021, total investment income was $71.2 million, with net investment income decreasing to $36.5 million due to higher expenses, resulting in a $55.0 million increase in net assets from operations and basic EPS of $0.75 Q3 2021 vs Q3 2020 Performance (in thousands, except per share data) | Metric | Q3 2021 | Q3 2020 | | :--- | :--- | :--- | | Total Investment Income | $71,200 | $71,316 | | Net Expenses | $34,626 | $28,212 | | Net Investment Income | $36,470 | $41,104 | | Net Unrealized and Realized Gains | $18,486 | $40,753 | | Increase in Net Assets | $54,956 | $81,857 | | Earnings Per Share (Basic) | $0.75 | $1.21 | Nine Months Ended Performance (in thousands, except per share data) | Metric | Nine Months 2021 | Nine Months 2020 | | :--- | :--- | :--- | | Total Investment Income | $200,269 | $207,819 | | Net Expenses | $103,373 | $89,575 | | Net Investment Income | $96,167 | $114,234 | | Net Unrealized and Realized Gains | $73,795 | $10,394 | | Increase in Net Assets | $169,962 | $124,628 | | Earnings Per Share (Basic) | $2.37 | $1.86 | Consolidated Schedules of Investments As of September 30, 2021, total investments at fair value were $2.41 billion, primarily concentrated in debt investments (93.2%) with Business Services as the largest industry concentration at 21.3% Portfolio Composition by Investment Type (Sep 30, 2021) | Investment Type | Fair Value (in thousands) | % of Net Assets | | :--- | :--- | :--- | | Debt Investments | $2,242,484 | 179.1% | | Equity and Other Investments | $163,981 | 13.1% | | Total Investments | $2,406,465 | 192.2% | Top 5 Industry Concentrations by Fair Value (Sep 30, 2021) | Industry | % of Total Investments | | :--- | :--- | | Business services | 21.3% | | Financial services | 14.4% | | Human resource support services | 11.2% | | Education | 9.6% | | Retail and consumer products | 9.6% | - As of September 30, 2021, two investments were on non-accrual status: Mississippi Resources, LLC and a subordinated note in American Achievement, Corp[35] Consolidated Statements of Changes in Net Assets For the nine months ended September 30, 2021, net assets increased by $90.5 million to $1.25 billion, driven by operations and stock issuance, partially offset by dividends Changes in Net Assets (Nine Months Ended Sep 30, 2021, in thousands) | Description | Amount | | :--- | :--- | | Balance at Dec 31, 2020 | $1,161,315 | | Net Increase from Operations | $169,962 | | Issuance of Common Stock, net | $85,945 | | Dividend Reinvestment Plan | $23,403 | | Dividends Declared | ($188,454) | | Other Adjustments | ($285) | | Balance at Sep 30, 2021 | $1,251,845 | Consolidated Statements of Cash Flows For the nine months ended September 30, 2021, net cash provided by operating activities significantly decreased to $75.9 million, while net cash used in financing activities was $70.9 million, resulting in a $5.0 million net increase in cash Cash Flow Summary (Nine Months Ended, in thousands) | Cash Flow Category | Sep 30, 2021 | Sep 30, 2020 | | :--- | :--- | :--- | | Net Cash Provided by Operating Activities | $75,911 | $289,022 | | Net Cash Used in Financing Activities | ($70,923) | ($287,505) | | Net Increase in Cash | $4,988 | $1,517 | | Cash, End of Period | $18,262 | $15,660 | Notes to Consolidated Financial Statements The notes provide detailed information on the company's organization, accounting policies, investment valuation, debt obligations, and unfunded commitments, including the adoption of new accounting guidance - The company is managed by Sixth Street Specialty Lending Advisers, LLC, which provides investment advisory and administrative services, earning a base management fee of 1.5% on average gross assets and a two-part incentive fee based on net investment income and capital gains[108][114][118] - Substantially all investments are valued at fair value using significant unobservable inputs (Level 3), with $2.36 billion of the $2.41 billion total investment portfolio classified as Level 3 as of September 30, 2021[75][139] - The company utilizes a $1.51 billion Revolving Credit Facility and several series of unsecured notes for leverage, with total debt outstanding of $1.12 billion and an asset coverage ratio of 211.6% as of September 30, 2021, well above the 150% regulatory requirement[152][153] - As of September 30, 2021, the company had $191.3 million in unfunded commitments to fund investments in current portfolio companies, primarily in the form of delayed draw term loans and revolvers[192] Management's Discussion and Analysis of Financial Condition and Results of Operations Management discusses the company's performance, investment strategy, and financial condition, highlighting its focus on direct origination of senior secured loans to U.S. middle-market companies and its strong liquidity position Overview and Investment Framework The company is a specialty finance BDC focused on lending to U.S. middle-market companies, employing a four-tiered investment strategy emphasizing secured, floating-rate debt and leveraging its relationship with Sixth Street - The company focuses on lending to middle-market companies with annual EBITDA of $10 million to $250 million[213] - As of September 30, 2021, 92.5% of the portfolio was invested in secured debt, and 98.9% of debt investments bore floating interest rates (including hedges)[220][222] - The company benefits from its relationship with Sixth Street, a global investment firm with over $50 billion AUM, which provides extensive resources and deal flow[223][224] Portfolio and Investment Activity As of September 30, 2021, the portfolio's fair value was $2.41 billion across 67 companies, with a weighted average total yield of 9.9%, and non-accrual investments significantly decreased to 0.0% of the portfolio Investment Activity (Q3 2021 vs Q3 2020, in millions) | Activity | Q3 2021 | Q3 2020 | | :--- | :--- | :--- | | Total New Investment Commitments | $105.4 | $435.5 | | Principal Amount Funded | $65.4 | $332.3 | | Principal Amount Sold/Repaid | $283.7 | $253.1 | Portfolio Quality by Fair Value | Metric | Sep 30, 2021 | Dec 31, 2020 | | :--- | :--- | :--- | | Performing Investments | 100.0% | 99.1% | | Non-Accrual Investments | 0.0% | 0.9% | | Investments Rated 1 or 2 | 96.5% | 97.5% | Results of Operations For Q3 2021, total investment income remained stable at $71.2 million, but net investment income decreased to $36.5 million due to lower other income and higher expenses, while exited investments have generated a 19.1% gross IRR since inception - Q3 2021 interest income increased to $68.6 million from $62.8 million in Q3 2020, driven by a larger average portfolio and higher prepayment fees, though other income fell sharply from $8.1 million to $1.8 million[260] - Net expenses rose to $34.6 million in Q3 2021 from $28.2 million in Q3 2020, primarily due to higher management fees on a larger asset base and incentive fees accrued on unrealized gains[262] - Since inception through September 30, 2021, the company's exited investments have generated an average realized gross internal rate of return (IRR) of 19.1% on $5.4 billion of invested capital[281] Financial Condition, Liquidity and Capital Resources The company maintains strong liquidity with $18.3 million in cash and $1.3 billion available on its Revolving Credit Facility, supported by an asset coverage ratio of 211.6%, well above regulatory requirements - As of September 30, 2021, the company had $1.3 billion of availability on its Revolving Credit Facility, subject to borrowing base and asset coverage limitations[293] Debt Obligations as of Sep 30, 2021 (in millions) | Debt Instrument | Outstanding Principal | Carrying Value | | :--- | :--- | :--- | | Revolving Credit Facility | $184.2 | $171.7 | | 2022 Convertible Notes | $142.8 | $142.2 | | 2023 Notes | $150.0 | $149.1 | | 2024 Notes | $347.5 | $352.7 | | 2026 Notes | $300.0 | $287.4 | | Total Debt | $1,124.5 | $1,103.1 | - The company's asset coverage ratio was 211.6% as of September 30, 2021, exceeding the 150% minimum required by the 1940 Act[291] Quantitative and Qualitative Disclosures About Market Risk The company is subject to valuation, interest rate, and currency risks, with 98.9% of debt investments at floating rates, and hypothetical interest rate changes would result in varying impacts on annual net interest income due to interest rate floors - The company's primary market risks are valuation risk for its illiquid private securities, interest rate risk due to the difference between investment yields and borrowing costs, and currency risk from foreign-denominated investments[346] Annualized Impact of Hypothetical Interest Rate Changes (in millions) | Basis Point Change | Net Interest Income Change | | :--- | :--- | | Up 300 basis points | $11.4 | | Up 200 basis points | $0.7 | | Up 100 basis points | ($8.4) | | Down 50 basis points | $5.0 | - The company hedges foreign currency exposure primarily by borrowing in the same local currency under its Revolving Credit Facility to create a natural hedge[354] Controls and Procedures Management, including the CEO and CFO, concluded that the company's disclosure controls and procedures were effective as of the end of the period, with no material changes to internal control over financial reporting during the quarter - The CEO and CFO concluded that the company's disclosure controls and procedures were effective as of September 30, 2021[356] - There were no material changes in internal control over financial reporting during the most recently completed fiscal quarter[357] PART II. OTHER INFORMATION Legal Proceedings The company is not currently subject to any material legal proceedings, nor is it aware of any material legal proceedings being threatened against it - As of the report date, the company is not a party to any material legal proceedings[359] Risk Factors This section highlights key risks, emphasizing those associated with the company's use of leverage, BDC regulatory constraints, potential dilution from stock issuances, and conflicts of interest related to the Adviser's fee structure - The company operates under an SEC-approved 150% minimum asset coverage ratio, permitting higher leverage (up to 2:1 debt-to-equity), which increases investment risk and magnifies potential gains or losses for stockholders[363][373] - BDC regulations constrain operations, including a requirement to invest at least 70% of assets in qualifying U.S. companies and limitations on raising capital, which may hinder the ability to seize attractive opportunities[365][367] - The Adviser's management fee is based on gross assets (including leverage), and the incentive fee structure could create an incentive to make riskier investments or use more leverage, which may not always align with stockholder interests[381][382][385] Unregistered Sales of Equity Securities and Use of Proceeds There were no unregistered sales of equity securities during the period - None[387] Defaults Upon Senior Securities Not applicable - Not applicable[388] Mine Safety Disclosures Not applicable - Not applicable[389] Other Information Not applicable - Not applicable[390] Exhibits This section lists the exhibits filed with the report, including the CEO and CFO certifications pursuant to the Sarbanes-Oxley Act of 2002 (Sections 302 and 906) - Exhibits filed include CEO and CFO certifications under Sarbanes-Oxley Sections 302 and 906[392]