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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning and welcome to TPG Specialty Lending Inc's September 30, 2018 Quarterly Earnings Conference Call. Before we begin today's call, I would like to remind our listeners that remarks made during the call may contain forward-looking statements. Statements other than statements of historical facts made during this call may constitute forward-looking statements and are not guarantees of future performance or results and involve a number of risks and uncertainties. Actual results may differ materially from those in the forward-looking statements as a result of a number of factors, including those described from time to time in TPG Specialty Lending Inc's filings with the Securities and Exchange Commission. The company assumes no obligation to update any such forward-looking statements.
Yesterday, after the market closed, the company issued its earnings press release for the third quarter ended September 30, 2018, and posted a presentation to the Investor Resources section of its website, www.tpgspecialtylending.com. The presentation should be reviewed in conjunction with the Company's Form 10-Q filed yesterday with the SEC. TPG Specialty Lending Inc's earnings release is also available on the Company's website under the Investor Resources section. Unless noted otherwise, all performance figures mentioned in today's prepared remarks are as of and for the third quarter ended September 30, 2018. As a reminder, this conference call is being recorded for replay purposes.
I will now turn the call over to Josh Easterly, Chief Executive Officer of TPG Specialty Lending Inc.
Thank you. Good morning everyone and thank you for joining us. I will start with an overview of our quarterly results and hand it off to our President, and my partner Bo Stanley to discuss origination and portfolio metrics for the third quarter. Our CFO, Ian Simmonds, will review our financial results in more detail and I will conclude with our final remarks before opening the call to Q&A.
After market closed yesterday, we reported strong third quarter financial results with net investment income per share of $0.50 and net income per share at $0.57, both which exceed our third quarter base dividend per share of $0.39. Our Q3 results imply an annualized return on equity on net investment income and net income of 12.2% and 14.1% respectively.
Reported net asset value per share at quarter-end was $16.47, an increase of $0.19 compared to the prior quarter after giving effect to the impact of the Q2 supplemental dividend, which was paid during Q3. Net asset value movement during Q3 was primarily driven by the over earning of our base dividend, the positive impact of net unrealized gains specific to certain portfolio companies and tightening of credit spreads quarter-over-quarter.
Yesterday our Board announced a fourth quarter dividend of $0.39 per share to shareholders of record as of December 14 payable on January 15. Our Board also declared a Q3 supplemental dividend of $0.05 per share to shareholders of record of November 30 payable December 31. Over the trailing 12 months period, we declared a total of $0.22 in supplemental dividends, while increasing net asset per share pro forma for the impact of supplemental dividends from $16.03 to $16.42. This represents an increase in total dividends declared over the base dividend level of 14.1%, an increase of net asset value per share of 2.4% over the same period.
We continue to assess the appropriateness of our base dividend level in context of the underlining earning power – earnings power of our business to ensure we're optimizing cash distributions and satisfying requirements, while preserving the stability of net asset value. Post quarter end, we have received shareholder approval to reduce our minimum asset coverage ratio from 200% to 150% or to say another way to increase our maximum debt to equity limit from one to two times. Of the TSLX shareholders who voted approximately 99% voted in favor of the proposal. We are humbled by the continued support of our shareholder base.
As announced yesterday, we have also completed all necessary amendments to our revolving credit facility to allow us access to regulatory relief provided by the Small Business Credit Availability Act, Ian will discuss this in more detail. We believe regulatory relief provided through a reduced asset coverage requirement is beneficial for all of our stakeholders. Investment environment permitting, we will look to use incremental leverage through modestly revised financial policy to drive incremental return on equity for our shareholders.
On the portfolio side let me provide an update on two names highlighted in our last call: iHeart and Rex Energy. You may recall that we have made specific income reserves in Q2 related to these two investments totaling approximately $0.06 per share given the lack of visibility at the time on bankruptcy related outcomes.
During the quarter upon completion of Rex Asset sale to a strategic buyer, we received full cash payment of a debtor-in-possession loan along with accrued interest and fees earned in Q2 upon the Company’s Chapter 11 filing. As a result, we released 2.875 million of reserves established in the prior quarter into this quarter's income. On iHeart, we call that we reserved $592,000 of certain interest income we received during Q2 in connection with the repayment of our loan principal upon the funding of the company’s new debtor-in-possession financing.
We created this reserve as a result of an objection filed iHeart’s unsecured creditors committee in July on certain portions of our income related – received by the ABL lenders. The UCC now supports a plan of reorganization that removes this prior objection to the ABL claims and we expect to release this income reserve during the fourth quarter.
On October 15 whenever ABL our portfolio companies Sears filed voluntary petition for relief under Chapter 11 of the bankruptcy code. The company intends to pursue a store rationalization and going concern sale for all of the remaining assets. Our $17.3 million par value first-lien ABL loan is expected to be rolled out in the first-lien debtor-in-possession financing, which calls for mandatory repayments from the cash proceeds of sale – of asset sales.
We believe our investments well secured by the company’s working capital assets and additionally for the company’s additional real estate collateral which was pledged. Given the milestones in the bankruptcy case, we expect to be fully repaid on our principal investment within the first half of 2018. With that I'd like to turn the call over to Bo, who will walk you through our quarterly originations and portfolio metrics in more detail.
Thanks, Josh. The direct lending environment in Q3 continues to be highly competitive. In response, we stayed focused on late-cycle capital structure and sector selection has maintained their high degree of investment discipline. During the third quarter, we generated gross originations of $317 million across four new investments and upsizes to two existing portfolio companies. Of the $317 million of gross originations, $175 million were allocated to affiliated funds and $8 million consisted of unfunded commitments.
On the repayments front, there were three full realizations totaling $119 million aggregate principal amount resulting in net portfolio fundings of $15 million for the quarter. We continue to be thematic in our originations approach focusing on opportunities that correspond to our platform sector expertise and relationships. Three out of the four new investments this quarter were software technology businesses that have uncorrelated revenue characteristics, high quality customer bases and strong returns on invested capital.
While the direct lending to software technology companies has become increasingly competitive, we have been able to differentiate ourselves through our deep sector knowledge ability to move quickly and to make large scale commitments given the capabilities across the TSSP platform. One of our investment strategies continues to be opportunistic capital deployment in dislocations as a way to generate excess returns across our portfolio. Upstream EMP, one of our opportunistic themes since late 2015, has been a sector we've been able to generate strong risk adjusted returns most recently with our loan investments in Rex in northern oil.
The Rex pay down this quarter, which Josh discussed resulted in a gross unlevered IRR on our investment of 34% and post quarter-end we realized on our $58.5 million par value alone investment in Northern Oil in connection with a refinancing.
Since, the refinancing was announced prior to quarter-end the Q3 fair value mark of our loan reflects a scenario where we would earn a make whole premium. The net proceeds we received upon the closing of the transaction in October exceeded what was implied by our Q3 mark on the loan, resulting on a gross realized unlevered IRR on our debt investment of approximately 36%.
Since inception through September 30, we've invested approximately $340 million in the energy sector and generated a P&L of $47 million across the current and fully realized energy investments. We’ll continue to be opportunistic in this sector given our platform's expertise and ability to drive high risk adjusted returns.
Across our portfolio since inception through September 30. We've generated growth unlevered IRR of 18.8% on a fully realized investments totaling $3 billion of cash invested.
Turning now to our portfolio metrics and yields at quarter-end we had effective voting control on 86% of our debt investment on an average 2.2 financial covenants per debt investment consistent with historical levels. As for mitigating prepayment risk the fair value of our portfolio as a percentage of call protection a quarter end was 95.8%. This metric means that we have protection in the form of additional economics should our portfolio get repaid in the near-term.
Our direct origination strategy has allowed us to structuring meaningful downside protection features into our portfolio despite the competitive lending environment. At quarter end 99% of our portfolio by fair value continue to be sourced through non-intermediated channels.
At September 30, the weighted average total yield on our debt and income-producing securities at amortized cost was 11.3% compared to 11.4% at June 30. This slight decrease was due to the impact of new versus exited debt investments. Regarding asset mix 94% of our investments at quarter-end were first-lien on a fair value basis consistent with our defensive approach.
Our portfolio is well diversified across 49 portfolio companies in 17 industries. Our largest industry exposure continues to be business services at 19.5% of portfolio at fair value followed by financial services at 15.6% of portfolio at fair value. Note the vast majority of our financial services portfolio companies are B2B integrated software payment businesses with limited financial leverage and underlying bank regulatory risk.
At quarter-end our cyclical exposure excluding energy was at an all time low of 3.5% of the portfolio at fair value. Our energy exposure at quarter-end represented 4.9% of the portfolio at fair value or 1.3% adjusted for the pay-down of Northern Oil alone post quarter-end. From a portfolio quality perspective, there were no investments on non-accrual status at quarter-end.
Overall portfolio performance has trended well quarter-over-quarter improvement from 1.24 to 1.19 based on our assessment scale of 1 to 5 with 1 being the highest. With that I'd like to turn it over Ian.
Thank you, Bo. We ended the third quarter with total investments of $1.98 billion, total debt outstanding of $893 million and net assets of $1.07 billion or $16.47 per share, which is prior to the impact of $0.05 per share supplemental dividend that will be paid in Q4.
As Josh mentioned our net investment income was $0.50 per share and our net income was $0.57 per share. Average debt-to-equity during the quarter was 0.91 times compared to 0.89 times in the prior quarter. Given our visibility into the late quarter timing of certain repayments, we chose to operate at higher leverage levels during Q3 and ended quarter with debt-to-equity of 0.83 times, inside the top-end of our historical target range.
At quarter end, we had significant liquidity, with $483 million of undrawn revolver capacity. In conjunction with yesterday's earnings release, we also announced an amendment to our revolving credit agreement to reduce the Company's minimum asset coverage ratio covenant from 200% to 150%. This accomplishes two things. First, we now have access to regulatory relief provided by the SBCAA to operate with a significantly expanded regulatory limit cushion.
Second, we now have flexibility to execute on our revised financial policy of 0.9 to 1.25 times debt to equity by selectively growing assets over time and increasing the fundamental earnings power of the business. We appreciate the support from our existing lenders on this process.
In addition, Moody's Investors Services has assigned TSLX an investment grade rating of Baa3 with a stable outlook following a review of our investment strategy, track record capital structure and liquidity profile. We are pleased to add the Moody's rating to our existing investment grade ratings profile from S&P, Fitch and Kroll.
Moving back to our presentation materials Slide 8, contains an NAV bridge for the quarter, walking through the various components we added $0.50 per share from net investment income against the base dividend of $0.39 per share. There was a $0.06 per share reduction to NAV as we reversed net unrealized gains from full investment realizations on the balance sheet and took their respective accelerated OID and/or prepayment fees through investment income.
This quarter the marginal tightening of credit spreads led to a positive $0.08 per share impact on the valuation of our portfolio, which was partially offset by $0.03 per share negative impact to NAV from unrealized mark-to-market losses related to interest rate swaps. Other changes of $0.09 per share primarily includes unrealized gains from our investment in Northern Oil that Bo referenced earlier.
As a reminder given our risk management practice of implementing fixed to floating swaps on all of our fixed rate liabilities to match the floating rate nature of our assets. Any upward movements in the shape of the forward LIBOR curve since the inception date to their outstanding swaps either through a shift or through steepening have the effect of creating unrealized mark-to-market losses.
Our NAV per share at the end of Q3 included $0.14 of cumulative swap related unrealized losses that will unwind over time as we approach the maturity date on each swap instrument.
Moving to the income statement on Slide 10, total investment income for the first quarter was $63 million down $3.4 million from the previous quarter. Breaking down the components of income interest and dividend income was $56.7 up $1.1 million from the previous quarter given the slight increase in the average size of our investment portfolio.
Other fees, which consist of prepayment fees an accelerated amortization of upfront fees from unscheduled pay downs were $5.2 million for the quarter compared to $7.6 million in the prior quarter. Other income was $1.2 million for the quarter a decrease of $2.1 million from the prior quarter given syndication fees earned during Q2.
Net expenses for the quarter were $30.1 million up from $29.2 million in the prior quarter primarily due to higher interest expense. This was due to an increase in the average debt outstanding as well as an increase in the effective LIBOR rate on our outstanding debt weighted average interest rate on average debt outstanding increased by 18 basis points quarter-over-quarter, primarily due to the increase in effective LIBOR across our debt instruments.
Note that other operating expenses this quarter includes non-recurring professional fees related to the reduction in our asset coverage requirement.
Before passing it back to Josh. I wanted to provide an update on the unit economics of our business. Year-to-date we've generated strong annualized ROEs based on both net investment income and net income of 13.7% and 14.4% respectively. This was the result of robust all in asset yields and an expansion of balance sheet leverage.
Since year-end 2017 our average quarterly leverage ratio increased from 0.72 times to 0.91 times. And our quarterly investment income yield on average assets increased from 12% to 12.8%. Our all in cost of debt over this period increased from 4.9% to 5.3% largely a result of the increase in LIBOR. By maintaining our investment grade ratings profile, our hope is that the spread on our cost of debt over LIBOR does not materially increase overtime.
Given our capital deployment discipline, which we believe is especially important in today’s competitive and late cycle environment, we may from time to time operate below our revised target leverage range of 0.9 to 1.25. As we said in the past, in periods where we see a decrease in our financial leverage, we would expect elevated levels of other fees from repayment activity to support our ROEs. We believe our revised financial policy will allow us to drive incremental ROEs for our shareholders as we reached the higher end of our leverage target, which again could take some time to achieve, given our selective and disciplined approach to growth.
At the beginning of the year we had set our 2018 earnings guidance based on our prior target ROE range of 10.5% to 11.5%, which corresponded to a full year NII range of $1.69 to $1.85, based on beginning pro forma NAV of $16.06 per share.
Last quarter, based on year-to-date results, we updated the upper end of our full year guidance from $1.85 to $2 per share. Given our Q3 performance and the fee income associated with the repayment of our Northern Oil loan post quarter end, we are revising our full year NII per share guidance to a range of $2.7 to $2.12, which implies an ROE range of 12.9% to 13.2% for 2018.
With that I'd like to turn it back to Josh for concluding remarks.
Thank you, Ian. We are pleased to have delivered another strong quarter resulting in incremental dividends to our shareholders. As I shared in my opening remarks, the goal of our dividend framework is to maximize distributions to our shareholders base on underlying earnings power of our business, while maintaining the subordinate asset value.
Going forward, as the market opportunity that allows us to operate with higher balance sheet leverage within our new targeted range and increase return on equity for the business, we would look to resize our base dividend accordingly. Our practices has set our dividend at a level where we believe we can be consistently earned over the intermediate term and therefore we'd only take action if we believe there's a sustainable increase in earnings power of the business.
In periods of tight risk premiums, we believe our undrawn capital is our most valuable asset. When the market doesn't offer appropriate risk adjusted returns, we’ll be slow to deploy – we’ll be slow to deploy capital, given the high opportunity cost of doing so, that is for growing our ability to deploy that same capital during more attractive investment environments and do attractive risk-adjusted return opportunities that drive return on equity.
We believe our stakeholders support in providing us with immediate access to leverage flexibility. We flex our focus on optimal capital allocation and put an approach to growth. We continue to be long-term oriented and work hard to deliver an attractive risk adjusted returns for our shareholders.
With that, I like to thank you for your continued interest and for your time today. Operator, please open line for questions.
Thank you. [Operator Instructions] And our first question comes from Rick Shane of JPMorgan. Your line is now open.
Good morning guys. Thanks for taking my questions. Look, the industry is about to experience essentially an influx of liquidity. So the supply of capital is going to increase demand for capital probably won't increase as much. As we enter that environment, it kind of feels like everybody needs to gain market share, which is obviously impossible. How concerned are you about pricing and how concerned are you about the further erosion of deal terms?
Hey Rick, it's Josh. I think we've spoke at length about this. We share your concerns. Look, the industry has under earned this cost of equity for a long, long period of time. So I think since the four years we've been public, the average ROE is between 5.5% and 6.5%, which quite frankly is under earning is cost of equity is why the industry is trading below book value.
So the idea that there is excess supply in the industry already and you can see that because of not earning as cost of capital and that you will have additional capacity, the change in the Small Business Credit Availability Act, I think, is deeply concerning to us.
That being said, we’re not focused on market share. We've never been focused on market share. We're focused on providing high risk adjusted returns on capital to our shareholders at the same time protecting other stakeholders, including our creditors. So I am deeply concerned that more supply in industry is oversupplied and the incentives that people have operated under which I would argue is the long-term incentives, will create an environment for worse deal terms.
That being said, I have hundred percent confidence in our ability to manage through that. And quite frankly, we've managed that over the last four years given, the industry has been over supplied. So I share your concerns. I would suspect and I would hope that the industry participants would act rational and deploy capital slowly. Obviously that hasn't always been the case. And growth is the enemy of returns for finance companies and the enemy of quality. And so we share your concern.
Again that being said, I don't share your – I am not concerned about our ability to manage through that.
Yes, fair enough. We appreciate the discipline and we also appreciate the – I mean look, you can't get it right unless you view the world in the right way. And we share your concerns about what's going to happen in the next six months to twelve months, just in terms of influx of capital. Thanks guys for taking the questions.
Thanks.
Thank you. And our next question comes from Ryan Lynch of KBW. Your line is now open.
Hey, good morning guys and thanks for taking my question. The first one, last week I was reading a Wall Street journal article and they were talking about with some volatility in the equity markets has actually created some volatility in the bond market, the speculative grade bond market. And you talked about three recent bond sales that were recently polled and couldn't get done. I was just wondering, I know you guys have been, very opportunistic in the past and been able to be very creative, flexible and fast.
Are you guys seeing any sort of disruption in the bond markets? And does that present any sort of opportunity for you guys to be opportunistic in that at all?
Yes, so great question. So you saw some volatility in the bond market, mostly driven by the high yield outflows – retail outflows. And that was driven a) by retail and b) concern over overrates and that's a fixed rate market. On the leverage loan side, which is quite frankly less – is more stable that capital base is 60% CLOs you did not see much volatility. You might have seen bids back off in eight, three eight on loans, but low supply. And so you haven't seen that volatility kind of move into other areas of the credit spectrum. So our hope is that you will see that. Our business model is long-haul. As we talked about in my, closing remarks, right – our undrawn capital is our biggest asset because that allows us to attack volatility end markets.
We did that in Q4 of 2015, Q1 of 2016. I think at our high point there might have been 20% of our book was in Level 2 names. And today it's basically zero. But you haven't seen it creep in yet. You got to be careful what you ask for a little bit in that year long, we'll long a whole bunch of assets, but we feel good about those assets. But we're also long a whole bunch of dry powder so we think we're well positioned, but you haven't seen it yet.
Yes, that's helpful color. And actually in the article also talk about one of those deals that couldn't get done at the high yield bond market actually, the tailwind will then move over and get done in the leverage loan market. So that makes sense about not having the same volatility there. I wanted to talk about your guys' leveraged range. The 0.9 to 1.25, that’s a pretty wide range that you guys have disclosed and it's not unusual, other BDCs have a similar range. But I just wanted to kind of get more commentary on what factors you guys consider that would have you operate in the lower end of the range versus the upper end of the range?
I mean, what are you looking at – you guys looking at the pulse of the economy or competition, private middle market credit or quality or quantity of deal flow in. And given those factors, did you guys evaluate and where we are today, do you think it makes more sense to operate towards the lower end, the upper end or kind of right in the middle?
Yes. So that is a super insightful question. So the range is wide. The range is wide for a reason because we don't know what the environment is going to afford us. In an environment where you have – the market is offering you high risk adjusted returns on capital, you would expect us operate at the high end of that range. In a market where we're in today, where we think that, risk adjusted returns are fair to slightly expensive, right. Surely the market's not cheap. You would expect us to operate at the lower end of that range.
And quite frankly, it's going to take us even if we were constructive on the market, given that growth as the enemy of underwriting standards and process is going to take us a while to kind of leg into that leverage. Obviously that leverage is a big driver of, kind of, the earnings power of the business or at least a part of it. And so when you think about what we've told the market is you can expect, ROEs, our guidance this year was I think 10.5% to 11.5% at 0.75 to 0.85 debt-to-equity. We've done significantly better than that.
If you think we're operating at 1x to 1.2x with our same asset level yields, those ROEs are significantly better than that so call it kind of a 11% to 13% depending on credit losses, which are – well, obviously you can back into the envelope on what EPS is by just taking those ROEs times it by the most recent NAV and we'll get you kind of the expected range of GAAP ROE, I mean GAAP EPS.
And so the answer is we don't, we don't know. And so if a wait and see approach and the emphasis, surely where we are in the economic cycle. What does the market providing us on a risk adjusted return basis.
Okay. That’s helpful and that makes sense. And then just one last one, it sounds like you guys are maybe potentially, kind of evaluating the core dividend and may do something with that in the future. Just kind of wondering what are you guys are looking at I mean, you guys are significantly around the core dividend through NII you guys significantly over run the dividend through the core plus a special dividend or variable dividend. On top of that, I understand you don't want to get over your skis, and raise the dividend, the core dividend.
And so just what are you looking at? You're looking at kind of your NII coverage of the core dividend, having a certain percentage above that or are you guys looking at some sort of like downside scenario of spreads compress and non-accruals increase that we can still earn it before we would potentially raise that? What do you guys kind of look at evaluating?
Let me tell you that one of the things that the first and foremost is we want to be RIC compliant. And so this is not an earnings estimate, but let me give you the math. At 50 basis points of credit loss, 1.25x leverage with a LIBOR curve, EPS is $2.30 to $2.35 a share. And obviously, if you have to distribute 90% of your income at our formula plus our base dividends, we do not meet the RIC requirements. But the math is that simple. So you could do the math, which is 2.33 minus 1.56 divided by 2 plus the 1.56 compared to 233 times 90%. I think we fall short. And so obviously the RIC compliance is a piece of it.
The second piece of it is, is that under a stress scenario where losses increase, we want to be able to cover the core dividend and have GAAP NII ROEs cover the core dividend. And so that's the second piece of it. The third piece of it, which is kind of the lowest priority, but still a priority is we prefer to get as much cash back to shareholders while preserving net asset value because that's kind of the product we offer.
What that does for investors is it gives them the option to reinvest in the DRIP program, with the DRIP program they could buy shares at a discount to the price, which creates value or they could make other investments or fund retirements, et cetera. And so if the combination of those types of things, I think what we're signaling is in the event we're able to slowly increase financial leverage.
We will have to increase our base dividend given not only RIC but given that the earnings power will given not only the RIC considerations but that we want to optimize cash back to shareholders.
And again the 2:33 was not a earnings estimate. The 233 was a extreme case to show you the RIC compliance issue that we would borne if we did not adjust our base dividend accordingly.
Yes, that's helpful insight, Josh. That's all my questions. I appreciate the time today.
Thank you. And our next question comes from Mickey Schleien of Ladenburg. Your line is now open.
Yes, Good morning everyone. Josh, just a couple of questions. We're seeing companies in the middle market doing – really think exceptionally well this year. And I'm interested in understanding whether at least in terms of your portfolio, are you seeing their EBITDA grow fast enough to sustain their fixed charge coverage ratios as interest rates have been climbing?
Sure. Yes. So, Mickey, that’s a good question. I think the answer is most definitely yes. If you think about the world and kind of status quo, continue to grow. The good news is that most of our companies are business services, software. We do not have a heavy manufacturing base. We don’t have input. They don’t have input price issues regarding kind of the environment we are in related to the trade war.
And so earnings momentum has been positive. Our companies have on average 3 times interest coverage with growing earnings. And so I think in this environment you should continue to see – you should continue to be constructive on credit. That being said, there are tail risks where this environment is not sustainable, and including increasing interest rates not only as it relates to increasing fixed charge coverage, but as rates increase, hurdle rates where investments go up, which slows the economy, consumer spending goes down, which slows the economy. And so you clearly have tail risk including rising rates that are – that impacts not only corporate credit and interest coverage, but impacts the general economic environment.
I would say, that's a big portion of our portfolio. Obviously, we have some – we have Cardillo and niche [ph] doing stress financings in retail. Retail comps are actually pretty good. I would expect them not to be good going into Q4, or comps be okay, margins I think will be relatively poor given they won't be able to pass on price increases given and that they will have issues with wage inflation. I think the bottom decile worker is getting most of the wage gains which are seasonal workers for retail.
So I would expect, as you know, we underwrite that portfolio on a liquidation basis, so we feel very good about the underlying credit quality of that portfolio, although I would expect to see some pressure on retail earnings in Q4 and going forward. And so I just wanted to kind of bifurcate our book between kind of the performing stuff versus the stress stuff. In the stress stuff where we underwrite to some type of an event or a secondary source of repayment based on asset value, they will probably continue to have some issues on the earning side.
That's helpful, Josh. And in terms of tail risk, it's been a long time since we've seen the fed goes through a tightening cycle. And some folks will argue that, there was too much tightening last time and that precipitated or helped precipitate the downturn. So now we're in a new tightening cycle and I'm interested in understanding when you underwrite your deals, particularly, second liens, and I know you don't do a lot of second lien, but how much stress do you assume in EBITDA and in those fixed charge coverage ratios to make you comfortable going into what appears to be late in the cycle?
Yes, that's predominantly why we don't do second liens.
I get it. Yes, I understand.
Look, generally, not generally, we always use the LIBOR curve as it relates to when we underwrite our investments. We also obviously stress and empowers the business both growth – depending on what the key drivers of the business are, wage inflation on the cost side, so we – sensitize the gross margins, EBITDA margins and sales.
The challenge is given that you are financing relatively high earnings compared to the trough at peak leverage ratios has led to not allocate capital to second liens for that exact reason. The two updates I'd give you as it relates to our second lien book; one is public, AFS, which we owned equity, own effectively the business, and had a second lien was recently sold/recapitalized. We kept a small piece of the common equity to – and we sold that to a private equity book – private equity sponsor basically at our market called Symphony. We continue to finance that basis on a first name basis, so we've moved up the capital structure. And my guess is that Vertellus at some point, which is our other second lien, will actually refi as well, refi well in short order.
So we continue – that's not saying we'll never do a second lien. We look at on good businesses depending on the attachment points and how strong we think the earnings power of the businesses both in the secular basis and to withstand cyclical headwinds, you could see us participate. I can tell you our second liens are basically going to be at zero, so you can't get less than zero. And so we've continually tried to move up the capital structure given where we are in a risk adjusted return basis, weight cycle earnings and peak leverage.
That's very helpful, Josh. I appreciate your time. That's it for me this morning.
Thanks, Mickey.
Thank you. And our next question comes from Leslie Vandegrift of Raymond James. Your line is now open.
Hi, good morning. Thank you for taking my questions. Quick question on the Moody's upgrade, that upgrade this morning, had a very good wording and talking about the portfolio and security similar to the S&P a couple months ago, I guess now. But given that you now have Moody's and S&P on the investment grade as well as others, do you feel that your debt cost of capital going forward could get cheaper?
Yes. So I'll let Ian answer. What I’d say is that clarify, it wasn't really an upgrade, it was an initiation. So we weren't covered by Moody's originally, but I’ll let Ian give you a little color on the Moody's.
Yes. I think part of the strategy was how do we go about expanding the universe of investors that we can speak to on the investment grade side, Moody’s obviously comes with a certain perception in the marketplace. And so the first part of it was how do we get a broader investor universe. And then if that allows us to help keep our funding cost down and that would be a good byproduct of having attracted those that broader universe.
Yes. Ian, that’s exactly. The only thing I would add is that I think people know this is not going to be a surprise and which is the fixed income market for BDCs is relatively shallow. And for whatever reason, that that includes partly because Moody’s hasn’t probably been constructive on it given that they thought the biggest constraint was the lack of regulatory cushion. And so our belief is that if we can continue to create optionality and continue to validate the space, which – and broaden the rating agencies support that, that market over time we’ll get a less shallow. I’m not sure, well ever be deep, but less shallow. Although I think generally I think that market for the ratings provide very good risk adjusted returns, but it will give – could be less shallow and that we will get longer-term funding where that is beneficial to not only to the sector, but to TSLX.
Perfect. Thank you. And on fee income in the quarter, you touched on the prepared mark, there is a little bit lower core recorder, because it tends to be lumpy there, but the $2.8 million from Rex, that was in topline interest income, correct?
Yes.
Okay. And then for the fourth quarter, I look so far on this fee income broken outline. Given Northern Oil and any other that you have for the quarter. Do you think that’s going to be kind of run rate like this quarter or one of the higher quarters again?
I’m sorry, Leslie. I lost the question.
I think the question was Northern Oil.
Fourth quarter outlook for fee, yes.
Fourth quarter outlook for payment fee, so there’s a large payment fee on Northern Oil that that position was marked at – I’ll use the estimate, but that position was marked at 1.13 on – 1.13 at quarter end, which was in how much in equate a dollar, 1.13 a quarter, I’ll just use 1.13, we ended up collecting more than the price. And so you can impute that, that there will be a decent amount of prepayment income in Q3, I mean Q4. As Ian said, I think our estimates for Q4, if you just isolate Q4 on NII basis are between Ian, $0.50 and $0.55.
That’s right.
Okay, perfect. And Vertellus, last quarter, the first line was marked as due in August of this year, it’s marked as due in October of this year. Is there an update there?
Yes. So there is a basically committed financing that we are not going to participate in, but it was slow to close. And so the existing bank group did a one or two month extension to facilitate that committed financing, but there is committed financing provided by a backstop of existing lenders. We had the option to actually put our existing position to the backstop parties. We decide not to do that, because why not, knowing that it’s committed, why not collect the extra interest income.
Okay. And on Ferrellgas the large investment right now on the portfolio was marked up in the quarter and just was looking for an update on that investment.
I think Ferrell – let me get you the exact number. I think Ferrell was relatively maybe on, because it’s a large position, but on a price, sorry, it was more from – sorry. Ferrell has marked up a quarter basis point I think. So the 6.30 mark was a 100 spot quarter, the 9.30 mark was a 150. So the – that’s a reflection of where other parts of the capital – that discount rate and where other parts of the capital structure a trade the company continues to perform as expected. And there’s a – and quite frankly there was a small change in markets spreads a quarter-over-quarter as well.
All right. Thank you. And lastly, just the modeling question, what was this deliver income level again?
Sure. Leslie, it’s a $1.01 share.
Perfect. Thank you for taking my questions this morning.
Thanks.
Thanks, Leslie.
Thank you. And our next question comes from Chris York of JMP Securities. Your line is now open.
Good morning, guys, and thanks for taking my questions. So just a couple modeling questions. How much professional fees were non-recurring as a result of the pursuit of the SBCAA?
Chris, great question. Ian will dive into that. The SBCAA was expensive this quarter between the special meeting and rating agencies, but Ianwill dive into that.
Yes. I would use a number of about $500,000, Chris, and that’s a combination of legal fees. We paid for a solicitation agent on the special meeting and we had some incremental fees from rating agencies. So $500,000 is a good estimate for non-recurring element out of that.
And she paid for regulatory relief, but good question, Chris.
Thank you. And then you also have some nice equity appreciation or couple of portfolio companies. You have co-investments. So well, I presume your ability to influence monetization are limited, are there any investments that appear more likely to result in any near-term exit?
Yes. Look, we’ve truly control NOG, because that’s public equity, a post us feeling comfortable in an NMPI basis that were cleansed. So we clearly can control that. And then I think the largest one probably is swift, which is a neat and little company that's doing very, very well. We have a co-invest, we have the typical rights including preemptive rights, but we don't control the monetization of that, but the company has done very well. And so we don't really have a view. It wouldn't be my place to speculate. Right.
Got it. And then, if you did exit NOG or swift there. Any other company at a realized gain, how would move this increment factor thinking on dividend distributions and then being comply.
I don't think it would – I don't make their material enough to change. The change our distribution policy, I think what's more material as it relates to our distribution policy is what we think the core earnings of the businesses. And so I don't think that those materially change the policy and surely, are not material to make it compliant versus noncompliant.
Got it. On a recommend – shifting maybe, Josh or Bo, so even lending the SaaS and software companies for a long time. In this quarter you had some origination activities skewed there. But I think I've noticed a fair amount of expansion in lending software companies from other large alternative affenpinschers. So the question is twofold. One, have you noticed any marginal competition and/or deterioration in the quality of deal flow? And then two, what does the pipeline look like for SaaS or software companies?
Well, sure, I'll take that.
You can add to it. Exactly, I think for sure there has been an increase of competition in the space over the last two to three years. As people move into these assets that they believe are more and more resilient than some of the manufacturing, day cyclical businesses. So we've certainly seen an influx, I think for us, um, having been a long-term investor in this space 20 plus years, if you count our partner Mike Fishman, who's on the call with us, can add some color as well. We continue to stay to be too dramatic within technology originations and focus on areas, I'm there, where we see strong secular growth within technology and software. And where business models aren't as understood and we can actually provide value and insight to those processes.
And where the exemptive relief provide a balance sheet uncertainty and transactions. So the competitive environment has increased, I think our opportunity set has remained pretty solid and we continue to see, opportunities in the space in quarter. We're seeing that as well. And Mike, do you want to add anything to it?
Just going back to address it. I mean, we're not interested in market share even in this segment. So we see a fair amount of opportunities and we just continue to be selective in part, because what you said is true, which is – there is increased competition in this space and the risk returns we're seeing on a number of investments that we're looking at just don't hurdle for us. So we continue to expect to do a to make investments in this space, but be much more selective.
It’s very helpful. And then I mean staying on the topic with expansion leverage and then potential for a bigger balance sheet. And therefore, lending to larger companies. Could you use your software and your, your expertise in that area to lend to public companies when maybe the broadly syndicated market gets disrupted?
Yes. So Chris, I would not draw a line between bigger balance sheet lending the bigger companies. I mean, our strategy has always been try to stay right under – and there's always exceptions and NOG, Ferrell, where there was some idiosyncratic things happened in that business, but stay right under where the broadly syndicated market or the leverage loan market operate. We think those are very efficient mediums of capital to companies who have access to it. And so I don't – as if we are in this same environment and without massive volatility, I don't think our core portfolio changes and I don't think we start doing massively bigger deals and with bigger companies given, I think that those companies have access to much cheaper capital in the CLO market and the high yield market.
That being said, well, you will see us move up market is today our average EBITDA is slightly moved up. The core EBITDA of our book is about $37.5 million, and so slightly moved up. But if you look back in 2013 when the markets were closed, the weighted average EBITDA was like $42 and new investments for like $60. And so what I do think is, as you see volatility and the high yield market and our leverage loan market shut down, you will see us clearly go up market.
Yes, exactly. Yes, makes a lot of sense. And then last year, pivoting a little bit on the topic of second liens, have you had to turn off any distributions to any Obligors in your investment portfolio to second lien lenders that may be behind your position today?
Yes, that's a good question. So the answer is no. We've seen some, we have a JV outside of TSLX and our private credit firm was CIT. We have as a senior lending portfolio as a LIBOR $400. It's not a problem for TSLX. We have seen some payment blockage as it relates to sub debt negotiated second lien payments being deferred. Those companies tend to be more manufacturing-oriented and having some gross margin issues or wage inflation issues. But we have not seen that in our book. If you look at for example, Ferrellgas, which is publicly traded have unsecured bonds, none of those are subordinated, we don’t have payment blockage right. Our perspective is levered free cash flow, neutral deposit with a lot of liquidity. And so, the company is very well positioned to services debt. I have not seen – there’s not an instance in the TSLX book, we’ve seen a couple instances in a broader kind of credit book or senior lender, but nothing at TSLX.
Great. That’s it for me. Thanks for taking my questions and congrats on a good quarter.
Great. Thanks Chris.
Thank you. And our next question comes from Christopher Testa of National Securities. Your line is now open.
Hi, good morning. Thanks for taking my questions. I just wanted to talk about – you guys discussing obviously the reduced asset coverage and increasing the size of the balance sheet. Have you guys evaluated the securitization market instead of potentially raising the revolver capacity or issuing another bond?
Yes. So let me start. Let me frame it and then Ian will hop in. So the answer is all capital markets transactions on our table. Our preference would be the straight bond market. Outside of – our first preference is obviously increasing the revolver. That revolver has our low funding costs. We’ve committed to have a funding mix between secured and unsecured. And so if you think about on an unsecured basis, we think our preference would be the straight unsecured market.
The convert market may or may not be attractive over periods of time. What I would say is that when you look at generally the convert market it’s been 98% bond math for BDC’s and convert investors. That has been at work because there has been the convert market basic we had priced that paper looking at historical val, which coming out of the crisis was higher than val, which provided BDCs access a cheaper capital.
Today going forward, my guess is val in the space if you think there’s going to be increased earnings power is actually going to be higher than 10% to 15% val where it is now. And so that makes it probably less attractive on the margin. Again, if you look at our convert on our 22’s is that, what’s the strike price Ian?
Effectively now it’s $20.96 less the supplemental today, so $20.91.
$20.91, and so that paper is going to be – if we are able to increase financial leverage and continue to control credit costs, that is going to – there’s a lot of value in that option and quite frankly, when we originally did that deal, we didn’t think there was value in that option or as much value as there is. And so, given what our view on core earnings power of the business going forward, that would probably be lower in the list. As it relates to the securitization market, the pluses and minuses of that market is a secured financing, it’s not as attractive as secured financing as our secured revolver although the term financing, the weighted average life tends to be shorter than you think it is, which when you think about the upfront cost increase, increase the actual costs over the – what appears on a spread basis when you execute those liabilities.
So revolver, unsecured, convert securitization probably is the order, but we’re open, we’re opportunistic. The good news is we have $450 million of liquidity, so we’re able to with no near-term maturities, the near-term maturity is the 19th, which is 115. And so we’re able to be opportunistic. I’m not sitting here thinking to myself, oh my god, I took everything from Ian. I don’t know if you have anything to add?
Nothing more to add.
I think you nailed everything on that Josh. And just touching on your comment on potentially raising the dividend. If you were to increase the base rate of the dividend, would that philosophically change how you guys look at the supplemental? Would you still be declaring those on a quarterly basis or would you want some more cushion after you decide to take the leap and increase the base?
I think given kind of our risk adverse nature, our framework would be as follows, which is we would increase the dividend and where we think we can earn it in a variety of cases at two to three standard deviation of confidence. And therefore given that – most definitely going to be continued to be supplementals and so we would keep the formula in place to optimize return of cash to our shareholders.
So I don’t think you will see us get out way over our skis. I think we liked our framework because it make sure that we protect the dividend and protect NAV at the same time. So I don’t think you see us getting out over our skis on increasing the dividend. But look, it’s a lot – I guess we’ve paid in the last 12 months, $0.22 of supplemental dividends that means, we’ve over earned it by $0.44. And so, we’ll keep that framework because I think it allows us to make sure we – people view that dividends rock solid and hope hopefully lowers our cost of equity. Ian anything to add on that?
I think that’s right. You did a good job.
Okay, got it. That’s a good color. And just on the Caris Chapter 11, just wondering, A, if you guys are going to potentially maybe upsize this after this has been rolled up into a DIP loan, if there was a potential to upsize. And what the prepayment fee is likely to be on that when it repays in the first half of 2019.
No, I think it’s outsized as prepayment.
Okay.
I think that the loan today trades at $100 million spot one-on-one. It trades there, because you have the ability to put in additional dollar and if you own the term loan, you were able to – or own that revolving commitment, you were able to put more dollars to the depth, which has decent terms. I don't expect us to upsize. We would love to upsize outside of our pro rata. I don't expect us to do so, as currently contemplated, you only get to roll up your prepetition if you participate in the upsize. So I doubt anybody would leave their prepetition behind. And so I doubt there will be an opportunity to upsize outside our pro rata, which is relatively, I think it's like $5 million bucks or something.
Okay, all right. Got it. And last one for me, I know you guys have opportunistically and successfully been investing in E&P space. I'm just wondering how the kind of pipeline for opportunities looks there, oil has been relatively stable to up a bit. Just curious kind of how you're looking at the opportunity set going forward.
Yeah. So I think we will – I would expect that's not, again, zero kind of an absolute number. We basically have zero outside of the – I guess at 1.3% of fair market value of our book and energy. I would expect us to be opportunistic and continued to increase there do things or do things on an opportunistic basis. And the pipeline, we have – platform has a dedicated team in Houston, which is A-plus team. And we'll – I think we'll continue to find track of things.
Okay, got it. Those are all my questions. Thanks for your time today.
Thank you. [Operator Instructions] And our next question comes from Fin O'Shea of Wells Fargo Securities. Your line is now open.
Hi guys, thanks so much for taking my question. Just a small one on Caris Life Sciences, seeing this is a pretty small hold and delayed draw as well. Is this an allocation or participation from another vertical? Or is this a – sorry, go ahead.
Yeah, that's a good question. So we – TSL, along with affiliate funds, closed $150 million financing for Caris, which included a $50 million term loan, $50 million delayed draw term loan and $50 million of unsecured convertible notes. We acted as agent given the exemptive relief order. We, we get our first bite. Caris is a little bit further out on the risk curve, which drove the sizing. They were warrants related to the term loan and the DTL and the unsecured notes or convertible. And so we – the use of proceeds were to expand the salesforce, expand laboratory capacity, and to advance R&D. If they privately held sequencing diagnostics business, we think they are well positioned but clearly further out on the risk curve which drove our sizing of the position. We think that the company has – and so it was much more kind of biotech techie versus our typical biopharma, which has in-place loyalties.
And so again, that the exemptive relief allow TSL exercises its position. What it wants first? The sizing of that position was given kind of the risk, the kind of work down the risk curve. And it didn't look as asymmetric and both the right tail and the left tail that are typical credit investments do which we have really no left – which we'd like to think we have limited left tail risk.
Sure. I appreciate that. And then just bring that into the context of a gross originations verse commitments this quarter. I know you talked a bit about leverage but would have expected your commitments or fundings to be a little higher as a percent, given they were low this quarter. Is that mostly due to Caris?
That's Caris. Yes, out of the $317 million, $150 million was Caris.
So if it was a more suitable deal for TSLX, you would have had a higher funding. Okay, that makes sense.
Exactly.
Thanks so much guys.
Thank you.
Thank you. And that concludes our question-and-answer session. I'd like to turn the conference back over to Josh Easterly for closing remarks.
Great. So thank you. A lot of good questions. We look forward to hope everybody has a good holiday season and good new year. We look forward. We're always available both myself, Mike Fishman and Bo, and Ian and Lucy. And we hope you people have a great holiday season and a great new year. And we'll talk to people next quarter if not sooner.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.