Sixth Street Specialty Lending, Inc. (TSLX) Q2 2021 Earnings Call Transcript

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Sixth Street Specialty Lending, Inc. (TSLX -0.05%)
Q2 2021 Earnings Call
Aug 4, 2021, 8:30 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to Sixth Street Specialty Lending. Inc. Second Quarter ended June 30, 2021 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 Sixth Street Specialty Lending. Inc. 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 second quarter ended June 30, 2021, and posted a presentation to the Investor Resources section of its website, www.sixthstreetspecialtylending.com. The presentation should be reviewed in conjunction with the company's Form 10-Q filed yesterday with the SEC. Sixth Street 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 for the second quarter ended June 30, 2021. [Operator Instructions].

I will now turn the call over to Joshua Easterly, Chief Executive Officer of Sixth Street Specialty Lending. Inc.

Joshua Easterly -- Chief Executive Officer, Director and Chairman of the Board and Risk Management Committee, Co-Chief

Thank you. Good morning, everyone, and thank you for joining us. As usual, with me today is my partner and our President, Bo Stanley; and our CFO, Ian Simmonds. For our call today, I will review this quarter's results and then pass it over to Bo to discuss this quarter's originations activity and portfolio. Ian will review our quarterly financial results in more detail, and I will conclude with final remarks before opening up the call to Q&A.

After market closed yesterday, we reported second quarter adjusted net investment income per share of $0.46, exceeding our quarterly base dividend per share of $0.41. This corresponds to an annualized return on equity of 11%. Adjusted net income per share for the quarter was $0.88, which corresponds to an annualized return on equity of 21.4%. Year-to-date, our annualized return on equity on adjusted net investment income is 12.4%, ahead of our full year target of 11.5% to 12%, and return on equity on adjusted net income was 22.2%.

This quarter's net investment income reflects continued strength in our core earnings power of our portfolio, and the difference between this quarter's net investment income and net income was due to significantly net realized and unrealized gains on our investments, which Bo will cover. Since these gains resulted in accrued capital gains incentive fees, we have adjusted this quarter's results exclude the impact of this noncash expense, which was approximately $0.08 per share.

There's a few -- there are a few reasons to do this. To start, the accrual for capital gains incentive fee is a GAAP requirement and quarters where cumulative gains exceed cumulative losses, less previously paid capital gains incentive fees. The rationale is that when these gains become realized, they would be subject to capital gains incentive fees. Note, however, that only a portion of our cumulative unrealized gains at quarter end would actually be subject to a capital gains incentive fee if our entire portfolio will be realized in normal course at the June 30 mark.

The rest of the cumulative unrealized gains are related to the evaluation of our debt investments, inclusive of call protection, which if prepaid will result in the recognition of fees and investment income and trigger a reversal of previously accrued capital gains incentive fees related to these investments. At quarter end, we had approximately $0.16 per share of cumulative accrued capital gains incentive fees on our balance sheet, but only $0.04 per share would actually be payable in cash if our entire portfolio would be realized at the quarter end mark in normal course.

A reminder that the calculation of accrued capital gains incentive fees has actually payable to the advisor is done annually at quarter -- at calendar year-end. Capital gains incentive fees would only be payable to extend our cumulative net realized gains exceed our cumulative net realized and unrealized losses on an inception-to-date basis, less any previously paid fees. All cumulative unrealized gains are disregarded for this calculation since the gains must be realized in order for us to be eligible to receive fees.

Therefore, illustratively, if we were at year-end today and calculating the capital gains incentive fees payable based on our Q2 financials, none of our cumulative accrued capital gains incentive fees would be actually payable. Given the capital gains incentive fee accrual creates noise around the fundamental earnings power of our business, we've adjusted our results to exclude this line item.

Continuing with this quarter's results. Gains on investments drove strong net asset value per share, growth of 2.7% quarter-over-quarter to $16.85, up $0.44 per share from Q1's pro forma net asset value per share of $16.41. If we were to look at the growth in our net asset value since the onset of COVID through today, which would require adjusting for the impact of special and supplemental dividends, we've grown net asset value per share by 12.2% since year-end 2019. From a total economic return perspective, which would factor in the benefit of our quarterly base dividends as well, we've generated a return of 26.8% for our shareholders over this time.

While we think the challenges of COVID are far from over, we believe our strong results to date demonstrate the robustness of our business model and ability to create value across uncertain market environments. Yesterday, our Board approved a base quarterly dividend of $0.41 per share to shareholders of record as of September 15, payable on October 15. Our Board also declared a supplemental dividend of $0.02 per share based on our Q2 adjusted net investment income to shareholders of record as of August 31, payable on September 30.

Pro forma for the impact of the Q2 supplemental dividend, our quarterly quarter net end -- net asset value per share was $16.83. Reviewing our first half progress, we continue to generate attractive risk-adjusted returns by focusing on segments of the market where we believe we have the highest value proposition for our portfolio of companies, management teams and sponsors.

After experiencing elevated portfolio turnover in 2020 and faced with reinvestment headwinds from falling credit risk premiums in the broader loan market, we were able to grow our portfolio while maintaining stable portfolio yields and portfolio credit metrics, which Bo will cover in more detail. By remaining disciplined to our specialty lending focus and drawing on the breadth and depth of Sixth Street platform, we are able to find opportunities where our deep sector knowledge and structural capabilities allowed us to generate our target levels of returns for our investors.

With that, I'll now pass it over to Bo to discuss our Q2 originations activity and portfolio metrics.

Robert J. Stanley -- President

Thanks, Josh. We had a very active quarter, supported by a robust dealmaking environment. And against the improving macro backdrop, transaction levels were elevated as sellers look to capitalize on attractive valuation environment and buyers look to accelerate growth through strategic acquisition. Meanwhile, sponsors with record levels of dry powder continue to focus on buying and building portfolio of companies.

With the busy activity levels for the first half of this year, our thematic approach and scale and resource benefits of being part of the $50 billion plus Sixth Street platform continued to serve as an important competitive advantage. Of thematic playbook allowed our team to efficiently focus on transactions where we have the expertise and the capital base to provide financing solutions that few other competitors could replicate.

In addition, the market insights and resources across the Sixth Street platform, which allow us to provide value beyond capital, became an important consideration for our management teams sponsors looking to successfully navigate today's complex and evolving market dynamics. In addition to the strong originations activity we had in Q2, we also have a strong backlog for the second half of this year, including agent roles on three large financings that total over $1.5 billion in facility size.

As you can expect, we are partnering with our affiliated funds and other managers on these transactions, which provides us the flexibility to determine the optimal final hold sizes for TSLX. This quarter, we had $303 million of commitments and $265 million of fundings across seven new investments and upsizes to eight existing portfolio companies. As an illustration of the power of the platform, the majority of our new investments were completed in collaboration with funds across the Sixth Street platform.

Perhaps reflective of broader market trends, all of our new investments this quarter were financing to support acquisitions or growth, and six of the seven of these were backed by financial sponsors. We continue to execute on our educational technology theme with new first lien term loan investments in EXonify and Modern Campus. Given that we were one of the first lenders to market on this theme and have significant familiarity with the business model and market dynamics, we are able to provide speed of execution and a level of deal structure customization that set us apart from our competition.

As for our other new investments this quarter, they all had the hallmarks of our focus on well-managed businesses with mission-critical, deeply embedded tech-enabled solutions, and they were all sourced through our proprietary origination channels. On the repayment front, activity continued to be relatively muted this quarter at $108 million across two full pay-downs and one sell-down, which partly reflects the more recent vintage of our portfolio as we began the year. This resulted in net funding activity of $157 million for Q2.

The two pay-downs this quarter were both M&A driven, and the sell-down was our small Neeman equity position at a price above our cost basis, as mentioned on our last earnings call in May. During the quarter, a few of our portfolio companies were in the press following certain milestone events, a couple of which I'll touch upon here. In May, Caris completed a growth equity round at nearly $8 billion post-money valuation led by Sixth Street's Health Care and Life Sciences team. Since 2018, TSLX has made a relatively small investment in the company's capital structure alongside our affiliated funds and received warrants as part of these transactions.

Based on the valuation of Caris' latest financing round, the fair value of our junior debt warrant and preferred equity positions increased significantly quarter-over-quarter contributing to this quarter's unrealized gain. Sprinklr, another one of our portfolio companies and a provider of customer experience management solutions, completed its IPO on June 23. We made a small investment in Sprinklr's convertible notes alongside affiliated funds last May and upon completion of the IPO, our notes automatically converted into common equity.

The quarter-end fair value mark of our equity position reflects a discount to the company's June 30 closing share price given the trading restrictions on our equity security, but still represents a 2.5 times MOM on our capital invested. Driven primarily by the unrealized gains and the debt-to-equity conversion of certain investments upon milestone events this quarter, our portfolio's equity concentration increased slightly from 4% to 6% on a fair value basis.

We continue to be focused on investing at the top of the capital structure, and our portfolio remains predominantly first lien oriented with 94% first lien at quarter end.

As Josh alluded to, the credit quality of our portfolio remains robust with minimal changes in our credit metrics compared to the prior quarter. The weighted average EBITDA of our core borrowers this quarter was steady at $41 million, and our portfolio's average attachment and detachment points remained stable at 0.4 times and 4.2 times, respectively. The average interest coverage on the core borders improved slightly from 3.2 times to 3.4 times quarter-over-quarter.

Our investments on nonaccrual status remains minimal at 0.02% of the portfolio at fair value, representing our restructured subnotes and American achievement as discussed on our call in May. Our portfolio's weighted average yield on debt and income producing securities at amortized cost continues to be steady. This quarter's yield was 10.1%, same as the prior quarter and approximately 10 basis points higher than what it was a year ago. The yield impact on new versus exited investments this quarter was minimal. The weighted average yield at amortized cost of new investments this quarter was 10% compared to a yield of 9.5% on exited investments.

With that, I'd like to turn it over to Ian.

Ian Simmonds -- Chief Financial Officer, Chief Compliance Officer and Secretary

Thanks, Bo. Reviewing the headline results, for Q2, we generated adjusted net investment income per share of $0.46 and adjusted net income per share of $0.88. Quarter-over-quarter, total investments at fair value grew by approximately 8% to $2.6 billion, driven by net funding activity and the positive impact of valuations on the fair value of our portfolio. Total principal debt outstanding at quarter end was $1.3 billion and net assets were $1.2 billion or $16.85 per share, which is prior to the impact of the supplemental dividend that was declared yesterday.

This quarter's average debt-to-equity ratio increased to 1.07 times compared to 0.93 times in the prior quarter as a result of net funding activity as well as the payment of our $1.25 per share special dividend in April. Our debt-to-equity ratio at June 30 was 1.08 times. We continued to have ample liquidity with $1.1 billion of unfunded revolver capacity against $121 million of unfunded portfolio company commitments eligible to be drawn. At quarter end, we remained match-funded with 4.1 years of weighted average remaining time to maturity on our debt liabilities against 2.4 years of weighted average remaining life of investments funded by debt.

Our next debt maturity is approximately a year away, in August 2022, on $143 million remaining power value of convertible notes. This quarter, the average share price of our stock continued to exceed the adjusted conversion price on these notes. As we've mentioned previously, we have the flexibility under the indenture to settle the aggregate value of these notes in either cash, stock or a combination thereof.

The triggers for early conversion have not been met, and we will make a determination on the most efficient settlement method when the time comes based on our then balance sheet leverage and investment opportunity set, so that we can manage the impact on NAV per share and ROEs. A reminder that per our early adoption of ASU 2020-06 last quarter, the diluted EPS in our financial statement uses the if converted method, which shows the maximum dilution effect of our convertible notes to common stockholders regardless of how the conversion can actually occur.

Moving back to our presentation materials. Slide eight contains this quarter's NAV bridge. Walking through the notable drivers of NAV growth, we added $0.46 per share from adjusted net investment income against our base dividend of $0.41 per share. As Josh mentioned, there were $0.08 per share of accrued capital gains incentive fees related to this quarter's net realized and unrealized gains. The impact of tightening credit spreads on the valuation of our portfolio had a positive $0.04 per share impact, and there was a positive $0.51 per share impact from other changes, primarily net unrealized gains on investments of $0.43 per share due to portfolio company-specific events, which Bo provided some examples of earlier.

Moving on to our operating results detailed on Slide nine. Total investment income for the quarter was $62.8 million compared to $66.2 million in the prior quarter. Walking through the components of income, interest and dividend income was $59.4 million, up $3.5 million from the prior quarter, primarily as a result of an increase in the average size of our portfolio. Other fees representing prepayment fees and accelerated amortization of upfront fees from unscheduled paydowns were $2.2 million compared to $8 million in the prior quarter.

Other income was $1.1 million compared to $2.3 million in the prior quarter. In summary, the slowdown in portfolio turnover this quarter and net portfolio growth allowed us to generate a higher quality of earnings from interest income. For reference, 95% of this quarter's total investment income was generated through interest and dividend income compared to 79% across 2020 and 88% across 2019. Net expenses, excluding the impact of the noncash accrual related to capital gains incentive fees, were $29.7 million, up slightly from $29 million in the prior quarter.

This was primarily due to higher interest expense from an increase in our average debt outstanding. Our weighted average interest rate on debt outstanding decreased slightly quarter-over-quarter by four basis points to 2.26% as a result of a funding mix shift to greater usage of our secured revolver. Lastly, on expenses. You'll notice that we applied for the first time, a fee waiver on base management fees related to this quarter's portion of average gross assets financed with greater than one times leverage.

Above that leverage level, base management fees are reduced to an annualized level of 1%. This is the first time since our stockholders approved the application of a 150% minimum asset coverage ratio in 2018 that we have reached this threshold. For the year-to-date period, we've generated an annualized return on equity on adjusted net investment income of 12.4% and on adjusted net income of 22.2%. Our net income has benefited from both net realized and unrealized gains on investments from company-specific events as well as the positive valuation impact of tightening risk premiums across asset classes.

As portfolio repayments moderated in the first half of the year, we've been able to generate greater interest income from investments while increasing our balance sheet leverage to support our ROEs. In the second half, we expect some rebound in portfolio repayment activity, which would drive a more normalized level of activity-related fees for our business. Based on where we stand today, we believe we are on track to meet the high end or exceed our previously stated guidance range of $1.82 to $1.90 of adjusted NII per share for full year 2021, which corresponds to a return on equity of 11.5% to 12%.

With that, I'd like to turn it back to Josh for concluding remarks.

Joshua Easterly -- Chief Executive Officer, Director and Chairman of the Board and Risk Management Committee, Co-Chief

Thank you, Ian. In the first half of the year, the broader market sentiment has been mostly positive given the vaccine rollout, economic reopenings and the promise of continued accommodative Fed. Given the health of the consumer and health of financials, the aforementioned accommodative Fed, we remain constructive on the U.S. economy. Although we do believe there's a myriad of factors, including the impact of the Delta variant, the debate around transitory versus non-transitory inflation that could create periods of volatility.

As always, we've positioned our balance sheet funding liquidity such that we've been ready to operate across varying market environments. As of 2020 has shown, in periods of uncertainty, we are a proven source of stability of capital for new and existing clients, while being a provider of strong risk-adjusted returns for our investors. To ensure that Sixth Street platform continues to be a leading solutions provider and deliver superior results for our shareholders and LPs, we are working hard to expand our capabilities.

Over the past 1.5 years, Sixth Street has a focus on growing our capabilities in healthcare, growth and energy, among other business verticals and have grown our team by approximately 80 people, including 30 investment professionals across sectors and disciplines. Today, Sixth Street has more than 320 team members, including over 145 investment professionals operating across nine collaborative investment platforms from nine locations around the world.

We believe that the scale and resources of our platform allow our business to be well positioned and nimble across business cycles and market environments, which is ultimately -- which ultimately benefits the TSRX shareholder.

With that, thank you for your time today. Operator, please open up the line for questions.

Questions and Answers:

Operator

Thank you. [Operator Instructions] And our first question comes from the line of Devin Ryan with JMP Securities. Your line is open. Please go ahead.

Devin Ryan -- JMP Securities -- Analyst

Okay. Great. Good morning, everyone.

Joshua Easterly -- Chief Executive Officer, Director and Chairman of the Board and Risk Management Committee, Co-Chief

Good morning, Devin.

Devin Ryan -- JMP Securities -- Analyst

First question here. Just given the strong economic backdrop and elevated transaction activity, coupled with your meaningful available liquidity, just curious how you're thinking about leverage -- your current leverage 1.08 times. Do you see an opportunity to take that higher in the current environment? And how should we think about the trajectory there, if anything you can share? Thanks.

Joshua Easterly -- Chief Executive Officer, Director and Chairman of the Board and Risk Management Committee, Co-Chief

Yes. Great. That's a good question, Devin. Look, I think this quarter was a quarter where it was very -- showed up in our P&L, very low kind of activity-related fees. That being said, I'll get to your question, I think this is our highest quarter on a per share basis by a long shot on interest income, and that was primarily driven by us slugging into our balance sheet leverage. So put it in perspective, I think on average, true interest income per share has ranged about $0.81.

This quarter, it was $0.89. But activity fees were typically $0.10 or $0.03 this quarter. So -- and that was all driven by financial leverage. I would expect that we continue to leg into our financial leverage. We're kind of in the low end to low-ish the middle of our financial leverage range. I would expect activity levels to -- activity level fees and some portfolio turnover in the second half of the year. And so we're going to work hard to continue to stay kind of in the one-plus range, and we'll -- given the economic backdrop, I think we're willing to take it up to 1.15 to 1.25 in this environment.

So I hope I answered your question, but we most definitely, given the economic backdrop and the activity levels, will most definitely continue. We think there's a path to put out capital, but there's going to be more activity in our portfolio, I think, in the second half of the year on the repayment side.

Devin Ryan -- JMP Securities -- Analyst

Okay. That's perfect. Thank you. And then just a follow-up, Josh. The competitive environment for capital allocation, how would you compare today versus other periods of your career, what you've seen? And clearly, there's a lot of deal flow right now, and so that's good. How do you think that might evolve if deal flow slows from here?

Joshua Easterly -- Chief Executive Officer, Director and Chairman of the Board and Risk Management Committee, Co-Chief

Yes. So look, I think -- I would frame it this way. I think this is probably one of the most competitive environments we've seen. And there's been -- the space that's been gentrified for sure. There's capital flow into the space, both in the -- in a fund format, in the BDC format and I would call in the gray market for BDC. So definitely this is probably one of the most competitive markets. That being said, from a risk-adjusted return perspective, it's a pretty good environment to put capital out. I would expect default rates to be low going forward. Corporates are in pretty good shape.

And so although it's competitive, I think overall risk-adjusted returns given where we are in the economic cycle, which feels like it got reset, we're in the first to second inning, there's some small corner cases, but it feels like we're in the first or second inning. You feel like default rates are -- and losses given defaults would be pretty high in this environment. So I think there continues to be a path to generate strong risk-adjusted returns for shareholders in this environment. Bo, anything to add?

Robert J. Stanley -- President

No. The only thing I'd add is that while competition is intense, it's stable. It is not -- it's been stable the last couple of quarters, and it doesn't seem to be intensifying. And I think the risk-adjusted return, to Josh's point, is compelling given the economic backdrop.

Devin Ryan -- JMP Securities -- Analyst

Okay. Great. Very helpful. Thank you, guys.

Robert J. Stanley -- President

Thanks, Devin.

Operator

Thank you. Our next question comes from the line of Finian O'Shea with Wells Fargo. Your line is open. Please go ahead.

Finian O'Shea -- Wells Fargo -- Analyst

Hey, everyone. Good morning. First question, in the line of the competition discussion as well, but more toward venture, which it looks like you've been doing a -- growing cadence of over time. Can you kind of explain the perhaps pros and cons of, let's say, dabbling in venture where that market seems to be typically reserved for the dedicated crowd? Just give us a feel of how -- what the challenge is in getting good quality deals when you're not full time in that market?

Joshua Easterly -- Chief Executive Officer, Director and Chairman of the Board and Risk Management Committee, Co-Chief

Yes, Fin, so I appreciate your question. I know this has been a little bit of a theme for you this quarter. I would argue with your premise. We don't do Venture that. And so when I think about venture, and I think on the spectrum of -- and kind of investment strategies, Venture is typically investing in companies that have unknown or highly speculative business models that are either pre-revenue or not scaled businesses. That we do zero. And I'll say it again, we do zero of that.

On occasion, which we've been a leader in and we've done for 20 years, we've financed companies with known business models, no unit economics, very diverse customer base that are growing, that are reinvesting in their business. And so I would juxtapose that against the Venture debt model where there is an unknown business model, a large TAM, but unknown business model, unknown unit economics or if it's post revenue, there's a highly concentrated revenue. And so we do zero of what you would think of or what the market would think of Venture debt. I don't know, Bo or Fishy, do you have anything to add there?

Robert J. Stanley -- President

No. I was just going to reiterate that the late-stage growth market that we play in, which is characterized by -- with companies that have underwritten -- business models that you can underwrite downside protection, secondary forms of repayment, we've been doing that for 20-plus years. And is that theme expanding over time as you're seeing the digitization of the economy and more businesses fall into that late-stage market? Yes, I think that is a fair statement, but we've never done Venture in the late-stage growth lending, something we've been doing for 20-plus years.

Ian Simmonds -- Chief Financial Officer, Chief Compliance Officer and Secretary

Yes. And even the earlier stage recurring revenue deals we do are tied directly to very high gross margin, recurring revenues that throw up cash flow at the marginal line just reinvesting those cash flows.

Joshua Easterly -- Chief Executive Officer, Director and Chairman of the Board and Risk Management Committee, Co-Chief

You have scaled businesses with revenue, no customer concentration. So I would argue the premise now. There might be, in the case of Passport, which is a company that has -- went from a Venture debt provider to a company that has now grown up and has real diversified contracts with municipalities, and they're in the payments business. And for municipalities and parking lot owners, that has transitioned as a credit and as a business model. But that's how I'd frame it for you.

Finian O'Shea -- Wells Fargo -- Analyst

Yes. That's very helpful. And then I guess sort of a related question on -- I think, Ian, you mentioned there's an impact of yields coming down from the competition and such. There's obviously not a large pool of rescue or special or oriented deals right now. Do you have any like strategy to stay increase your equity co-invest or engage in -- or I'll just leave it at that. Anything to help sustain just the baseline yields you've been getting? I know you'll get some pickup, you said from normalized activity. But if this environment is protracted, what do you think on that matter?

Joshua Easterly -- Chief Executive Officer, Director and Chairman of the Board and Risk Management Committee, Co-Chief

Yes. So I'll hand it over to you. I just want to, again, frame it up a little bit, which is yield -- when you look at our yields, if you look at June 30, 2020, our yields and amortized costs are up 10 basis points year-over-year. So I'm not sure we said anywhere that yields were coming down. Just to frame it, I think our Q2 2021 yields on new investments were basically at our average yield. And so -- and I think that exceeded loans slightly that paid off.

So I think, again, a little bit of the -- maybe this is a theme in this space, but we haven't really seen yield compression in our book. We actually picked up net interest margin when LIBOR went from, whatever, 2.5 down to 20 basis points. We picked up net interest margin, and yields have been to stable to slightly increasing actually year-over-year. And yields on new investments equal yields on the total book. So I don't think -- I think that's a little bit of the benefit of being small, nimble, having the benefit of the Sixth Street platform, having 150 people getting up and thinking about, among other things, that direct lending and how to solve an issuer's problem and being nimble across sectors to a lesser extent geographies.

And so I like -- again, I think the premise is maybe something that's thematically happy in the space. I don't think it's happening to Sixth Street Specialty Lending. Ian, do you have anything to add?

Ian Simmonds -- Chief Financial Officer, Chief Compliance Officer and Secretary

No. Was the second part of your question, Fin, also getting to whether where we're seeing more opportunity on equity co-invest? Is that where you're going with that?

Finian O'Shea -- Wells Fargo -- Analyst

Yes, and your plans to engage in it as well, I suppose.

Joshua Easterly -- Chief Executive Officer, Director and Chairman of the Board and Risk Management Committee, Co-Chief

We've always been opportunistic about our equity co-invest program. I think over time, we've invested -- just to put this in perspective, we've invested about -- I'm trying to -- we've invested -- I'll give you the math. We've invested about $160 million of equity over time, and we're currently at like 1.7 times MOM, and I guess that will grow because we have a whole bunch of stuff in the books still. And so it's been a decent source of returns. I think the average return on fully realized has been in the 40% range. So we'll continue to take our shots.

I would say that it's very specific. So we're not asking for -- or equity co-invest program is not asking for equity co-invest in every deal. We have a -- if it fits into a sector, we have a deep fundamental view of that -- of the business. And I think there are -- the prospects are good and the valuation is good, we'll ask for it, but it's more rifle than a shotgun. And it's more, I would say, actively managed versus kind of a passive strategy of equity co-invest in taking kind of private equity returns across the cycle. We're pretty specific and thoughtful what we do given the capabilities of the platform.

Finian O'Shea -- Wells Fargo -- Analyst

Got it. Thanks so much.

Joshua Easterly -- Chief Executive Officer, Director and Chairman of the Board and Risk Management Committee, Co-Chief

Thanks, Fin.

Operator

Thank you. And our next question comes from the line of Robert Dodd with Raymond James. Your line is open. Please go ahead.

Robert Dodd -- Raymond James -- Analyst

Hi, guys. First, a follow-up to Devin's question. Obviously, you gave kind of an indication that you may be able to get toward the higher end leverage range by year-end, maybe. If that path kind of plays out, and there's a lot of variables understood, would that change your bias on what to do with the convert in terms of how much cash, how much debt, how much equity as we go into next year? I mean is that the convert strategy a function of where leverage ends up at the end of the year? Is that a good way to put it?

Joshua Easterly -- Chief Executive Officer, Director and Chairman of the Board and Risk Management Committee, Co-Chief

Yes. Robert, you're -- first of all, I just want to be clear. Like, I think we have given the convert and our ability to settle that in all equity. And -- like we are most definitely willing. I'm not sure we'll be able to willing to run "harder" on debt to equity, and that will give us flexibility, and that is most definitely a consideration in the convert. So I think that there's going to be -- I think the market environment. And as one consideration, which we're very constructive on the U.S. economy, which allows you to be -- use -- lean into your financial leverage a little bit more in that we have effectively can settle the convert with equity allows us flexibility as well, and that's most definitely a consideration.

Robert Dodd -- Raymond James -- Analyst

Got it. Got it. Thank you. And then one more, if I could. You mentioned, Josh, in the prepared remarks, I think, adding expertise, I think, more at the payer, the manager, obviously, in energy. Obviously, energy is everything from oil and gas E&P to solar panels, right? Could you give us -- two parts. One, where you're adding the expertise? But more to the point, should we expect energy exposure to go up at the BDC? And if so, could you maybe narrow down what kind of energy verticals you find to attract?

Joshua Easterly -- Chief Executive Officer, Director and Chairman of the Board and Risk Management Committee, Co-Chief

Yes. So it's a great question. So we've got expertise both on, what I would call, infrastructure and distributed energy, so solar, wind, etc., on the platform. We're -- people know this, I think we're one of the largest owners of solar and some of our private funds and -- have also made investments in wind, etc. And then on the -- typically on traditional, we've been really everywhere from far upstream to midstream. We've done stuff and made investments historically.

So I think it's wide open. We haven't really seen a ton of opportunities, I would say, in the all energy space for lending, maybe that changes, but we most definitely have the expertise and we've added to that expertise. We have been relatively active and the -- in the space. For example, we bought a group of -- this is publicly bought by group of RBO loans with a partner that was exiting the business.

Obviously, we have an ESG framework and committed to that ESG framework. But I would expect us to be active across the complex and be opportunistic in that. I think the max exposure was -- and our energy in the BDC was about 10%. And most of that was in the form of a reserve-based lending on hedged proven collateral. I'm not sure we ever get back up to 10%.

But we most definitely, when we see opportunities, we'll be -- we're willing to add risk there and be opportunistic, but it has to fit into the portfolio construction, it has to be assets we like that are low on the cost curve where there's no development risk and where we are -- where they're hedging the commodity price. We've done actually a pretty good job, I think, over time in that space. We have positive P&L. Mississippi was the one mistake, I'd say, relatively small. But across the investments, we've done a pretty good job and -- so we'll still be active in it.

Robert Dodd -- Raymond James -- Analyst

Got it. Thank you.

Operator

Thank you. And our next question comes from the line of Kenneth Lee with RBC Capital Markets. Your line is open. Please go ahead.

Kenneth Lee -- RBC Capital Markets -- Analyst

Hi. Thanks for taking my question. Just one on the Sixth Street platform on a broader level. Wondering if you could expand upon your expectations for the platform's potential contribution to originations over the near term?

Joshua Easterly -- Chief Executive Officer, Director and Chairman of the Board and Risk Management Committee, Co-Chief

Yes. So we've touched on this a couple of times. But look, we -- sorry, is the question the contribution of originations to the platform? Or is it just where we're adding expertise, sorry?

Kenneth Lee -- RBC Capital Markets -- Analyst

Just the first part, just a contribution to potential originations and any

Joshua Easterly -- Chief Executive Officer, Director and Chairman of the Board and Risk Management Committee, Co-Chief

I don't know if we track it specifically because we kind of have -- we kind of go out as a one team like mentality, I would say, in the ebbs and flows. So for example, just a call -- technically, the healthcare team doesn't sit inside the direct lending platform, but my guess is like 50% of their activities are direct lending related. And so they really own all of our activities in biotech land. And that -- so -- and that -- for example, in that space, I think we've invested a couple of hundred million dollars, if not more, maybe $0.5 billion or half yard.

So -- but I don't think we -- given the culture of the platform, which is really 145, 150 investment professionals getting up every day and thinking about how to be a solution provider for our clients and how to be -- and protect our investors' capital, I don't think we track it, but it's ebbed and flowed. And the one thing that pops out to me is on the healthcare that technically sits not within the direct lending team, but has contributed a decent amount to the success for SLX shareholders.

Kenneth Lee -- RBC Capital Markets -- Analyst

Got you. Very helpful. And just one follow-up, if I may, and this is related to the previous question about equity co-investments. Wondering if you could just refine your comments. Would it be fair to say that the philosophy around equity co-investments is more around potential upside versus mitigating potential losses over the cycle? Thanks.

Joshua Easterly -- Chief Executive Officer, Director and Chairman of the Board and Risk Management Committee, Co-Chief

Yes. Look -- so the question is, is our equity co-investment program effectively the way to mitigate credit losses over the cycle versus -- and the answer is no, in the sense that we're trying to -- if you look at historically, we're in a -- obviously, you see this with the accrued capital gains fee. We're in a -- we've basically had positive net gains across the book and haven't really experienced massive credits, any really credit -- significant credit losses over a long period of time. I think the one is Mississippi, but it's been offset by a whole bunch of other stuff.

So for us, it's -- I would say it's a more offensive strategy where companies and where we can partner with people, where we have the expertise to make an educated investment decision and complete and educated underwriting versus taking a portfolio approach and trying to offset, give you long private capital/private equity beta to offset losses in the credit book. That is not our approach. Our approach is be specific, be good partner, have a thesis to be able to underwrite and be offensive when we think there's an opportunity based on a sector or a company, a management team and evaluation we like. Bo, anything to add there?

Robert J. Stanley -- President

I think [Indecipherable]

Kenneth Lee -- RBC Capital Markets -- Analyst

Great. That is very helpful. Thank you.

Operator

Thank you. And our next question comes from the line of Ryan Lynch with KBW. Your line is open. Please go ahead.

Ryan Lynch -- KBW -- Analyst

Hey. Good morning. Thanks for taking my questions. You guys have always been a big investor into the software space. It feels like over the last several years and really after -- in really the last several quarters, kind of post COVID, it feels like everybody, all the direct lenders are really piling into the software space as that sector performed fantastic overall during COVID.

And so I'm just wondering as we sit here today and as you guys evaluate new opportunities, what are the biggest risks you all see today in the software lending space? Is it elevated multiples? Is it risky end markets? Technology risk? And really, how are you guys navigating that sector, given the amount of capital flowing into it and given the focus that you guys have had in the past as part of your portfolio?

Joshua Easterly -- Chief Executive Officer, Director and Chairman of the Board and Risk Management Committee, Co-Chief

Yes, it's a good question. I'll start and then I'll turn it over to Bo. First of all, I think the -- most definitely, there's a greater focus on the software space. That being said, there's a larger universe as well. Software over the last 10 years to quote somebody smarter than all of us or at least me, it's kind of eating the world. And so the base -- the digitization or the software is in our life in both companies and consumers is very large, and there's -- the opportunities has grown along with the capital that is looking at. So it's not like -- I'm not deeply concerned in the sense that the opportunities that -- stay the same.

We got smaller and there's a whole bunch of more eyeballs on it. They kind of had a step function together. So I just want to level set there. That being said, we do think we have a unique lens and expertise and can bring the Sixth Street platform to think about not only end markets, but technology -- any technology risk, secular trends in technology. But -- and -- but we have a pretty good -- we have a framework we like we're already thinking about where we're focused on companies that are highly embedded, that are super capital efficient. And we have a framework on how to determine how capital efficient they are? That's been around for 20 years. I mean we've adjusted it. But Bo, I don't know if anything to add.

Robert J. Stanley -- President

Look, the one thing I'd add is we don't think of software as an industry. It's ubiquitous. We get very nuanced within technology itself and have sub themes that we focus on. And I think part of your question was like with everybody piling into the sector, is there concerns about certain business models, etc.? I think that's right. I think all business models within software are not created equally. All businesses aren't created equally. And you have to be very nuanced in your underwrite.

I think the 20 years of pattern recognition that we have along the sector and seeing it evolve has allowed us to get very nuanced and -- to attack subsectors what we think return on invested capital is going to remain strong, and the durability of those business models remain strong. So that's how we combat it. We're very nuanced. We're very thematic focused and continue to see very interesting opportunities in the sector. But without a doubt, is it more crowded? For sure. And -- but I do think there are folks that are being indiscriminate on how they look at businesses.

Joshua Easterly -- Chief Executive Officer, Director and Chairman of the Board and Risk Management Committee, Co-Chief

Yes, to put a fine point on indiscriminate. Look, not every dollar of "recurring revenue" is credit equal. And not every dollar of marketing spend is efficient. And so depending on customer life gross margin how embedded, do they control the customer, how stable the end markets, we continue to be very discriminating as the investments we make in the space. And we always made same underwriting.

Ryan Lynch -- KBW -- Analyst

That's really helpful color until we understand not every software deal is created equal. The other question that I had was, obviously, the direct lending space and the borrowers have been growing significantly over the last several years. Maybe just curious, you guys have -- on Slide number six, you guys showed the average loan commitment that you guys are making.

And over the last several quarters, it's in the $30 million to kind of $40 million commitment range at TSLX. I'm just curious, what would you say is the average commitment if you guys are holding $30 million to $40 million at TSLX? What is the average commitment that you guys are making kind of across the Sixth Street platform? And where would you guys feel kind of on a max level feel comfortable committing?

Because today, you're seeing multibillion-dollar direct lending deals that are clubbed up, but still. I'm just trying to get a sense of where you guys could kind of sit and play on the upper end in the direct lending market today, given the growth of your platform? [Indecipherable]

Joshua Easterly -- Chief Executive Officer, Director and Chairman of the Board and Risk Management Committee, Co-Chief

Look -- yes. So you pointed out, and I appreciate it. I would not complete with TSLX whole size with our ability to scale our capital. And so they're -- being part of Sixth Street allows us and the what allows us to move upmarket. I think Bo mentioned in the prepared remarks, there's three deals were agents on that total over $1.5 billion of capital. And so I think those range from like $300 million -- $950 million. So they -- we most definitely will pick our spots up market on -- in kind of the Sixth Street way, which is here where we can move fast and be a value partner to our responser or the issuer.

And so we'll come back to you on the exact commitment sizes across the platform and how those change over time. The -- I would say my intuition is that they've got bigger, although we've continued to keep portfolio sizes pretty granular in TSLX so that we can continue to -- where our shareholders can get the value of some diversification if we're not always going to be right. And so I don't know if that's helpful. But if you look at the back half pipeline, we're an agent on a $900 million or $800 million deal. We're an agent on a couple of $350 million deals. And so we're continuing to move up market where our capital can be value add.

And again, we are -- PDC is generally setting the cost curve. You got to -- you have to provide -- you have to understand where are you in the cost curve, your cost of capital to make sure you provide value, finding that place where there's overlap where you're providing value to your clients and value to your shareholders. You can't just be a substitute to the high-yield market and leverage loan market and have fees that are four to six times higher. It just doesn't work as an endurance of business model.

Ryan Lynch -- KBW -- Analyst

Okay. Understood. That is helpful. I appreciate the time this morning.

Joshua Easterly -- Chief Executive Officer, Director and Chairman of the Board and Risk Management Committee, Co-Chief

Thanks, Ryan.

Robert J. Stanley -- President

Thanks, Ryan.

Operator

Thank you. And our next question comes from the line of Melissa Wedel with JPMorgan. Your line is open. Please go ahead.

Melissa Wedel -- JPMorgan -- Analyst

Thanks. Good morning. I think most of them have been asked, but I have a follow-up

Robert J. Stanley -- President

Sorry, Melissa, we've lost you.

Melissa Wedel -- JPMorgan -- Analyst

Sorry, can you [Technical Issues]

Robert J. Stanley -- President

You're breaking up.

Joshua Easterly -- Chief Executive Officer, Director and Chairman of the Board and Risk Management Committee, Co-Chief

Melissa, we can't hear you. You want to try to get into a better zone and we'll -- obviously, we want everybody to get the benefit of your question and be able to answer your question, but we can't hear you at the moment.

Operator

Our next question is going to be from the line of Mickey Schleien with Ladenburg. Your line is open. Please go ahead.

Mickey Schleien -- Ladenburg -- Analyst

Good morning, everyone. I hope you are well. Josh, you have been historically very successful using a thematic investment thesis in your portfolio management. And if we look back at 2020 and this year, I'd like to ask how has the pandemic affected the themes that you're pursuing, if there's been any change?

Joshua Easterly -- Chief Executive Officer, Director and Chairman of the Board and Risk Management Committee, Co-Chief

Yes. Look, I would say -- thank you, Mickey, by way. I think -- I appreciate the attribution to Josh, but it's really the platform and the people around the platform. But I think most definitely it seems come in and out of vogue. I would say one thing that's coming out of vogue for us is retail on the margin. Kind of the pandemic washed out -- by the way, generally, I think capitalism does a lot of the heavy lifting for society. So typically, you have an economic downturn. It gets rid of all the companies that are high on the cost curve, that are inefficient uses of resources.

And I'm not sure the pandemic did that except for the retail. And so you surely had that done in retail, and that was happening before with Amazon, direct-to-consumer. And so people who don't have a rule omnichannel model, we're going away. And that being said, I think the pandemic accelerated that cleansing of retail. Now the retailers left overlaid with a really, really healthy consumer is -- I would say, it's in really good shape and probably peakish earnings across the sector are going to be peakish earnings across the sector.

And so I think we're probably less bullish about in the short term, the -- given that the health of the U.S. consumer, there's, I think, $1.7 trillion of excess savings across the U.S. economy that the retailers left has a better value proposition. And so I think that's surely one thing that's come out of vogue for us. Payments continue to be invoked for us. And so Passport fits into the software kind of where it meets payment ecosystem.

And so -- but it constantly changes. Some parts of healthcare, we think are really interesting and others not. And so we continue -- this is the thing as a platform we continue to always talk about and spend our time as a group and the partners talk about. Bo Or Fish, anything to add?

Robert J. Stanley -- President

No. What I would add is for direct lending, there's generally 15 to 20 themes where we are actively pursuing at any one time, that's constantly rotating. We spend a lot of time. We have weekly meetings, talking about thematic, research and testing ideas and pressure testing certain themes, and that's constantly rotating. That's been a practice since we started. We'll continue to do that. In periods of dislocation in -- at the beginning or end of the cycles, we see that rotation generally speed up. So to your point, I think we've had a pretty healthy rotation of the themes that we're pursuing post COVID. But that will continue as long as we're here managing money.

Ian Simmonds -- Chief Financial Officer, Chief Compliance Officer and Secretary

I'd say we also look at on software recurring revenue, the sub themes would be the end markets that they're related to. So we spend a lot of time thinking about that. As we said before, not every recurring revenue deal or software deal is the same. And those that focus on specific sectors themselves, we have to look at that as effectively a subsector of our theme.

Mickey Schleien -- Ladenburg -- Analyst

Josh, on the back of that, then I haven't done the math, but if you were to look at the IRRs on some of your distressed retail deals, they were pretty exceptional, if I'm not mistaken. Is there a new theme that can sort of replace that? Or when you and the Board think about sort of target ROEs, do you -- are you considering a lower ROE target going forward if there's no theme that can replace that distressed retail opportunity?

Joshua Easterly -- Chief Executive Officer, Director and Chairman of the Board and Risk Management Committee, Co-Chief

Yes. Thanks. So obviously, that's been a theme for us. The other themes will pop up. I would -- we've been pretty clear. Portfolio yields have remained pretty constant. And I think our ROEs are going to be at the high end of our -- when you think about the exceptional value proposition for SLX shareholder, I think what we said today was our average ROE is a bit about -- over time, I think, about 12%. It's going to be about 12 -- we think it's going to be 12% plus this year on a net investment income basis.

Obviously, there's been a huge uplift on a net income basis. In a rate environment, that's 200 basis points less than what we've lived in. We think there is -- that's a -- on a risk-adjusted basis, we're actually doing more for our shareholders. And I don't think ROE targets have moved down. I think we're doing more for our shareholders. That's a little bit of financial leverage, but that's us being able to hold portfolio yields.

And so I think this has been one of our and will continue to be one of our best years given the interest rate environment to create -- to provide value for our shareholders. And you see that across not only the net investment income line, but the net income line and how capital efficient we are.

Mickey Schleien -- Ladenburg -- Analyst

I appreciate that, Josh. Just one sort of more housekeeping sort of question. I realize it's a small portion of the portfolio. But could you review why you've invested in CLO debt instead of CLO equity given that CLO equity estimated yields are so much higher and their cash flows have been really exceptional, pretty much since the second half of last year?

Joshua Easterly -- Chief Executive Officer, Director and Chairman of the Board and Risk Management Committee, Co-Chief

Yes. Look, I would say, first of all, CLO equity -- we invested in the CLO debt, I think, in the middle of the -- of COVID where there was -- where -- as you know, we don't try to lose capital where there was a decent amount of uncertainty on defaults and recoveries, and it wasn't clear that CLO equity is going to make the other side. We haven't added any new CLO debt positions in the book. I generally think that, to your point, the CLO equity is a decent -- it has a decent value proposition at the moment, although it's highly volatile.

And I would say, as you know, you've lived through, and we've seen across the space, there is a significant difference between cash-on-cash returns and ultimate IRRs. And so current cash-on-cash returns in CLN is not only net interest margin, but it's a return of -- not only return on capital, but return of capital when you look at an entire kind of of the CLO investment. And so I wouldn't disagree that it has worked at the time where we made investments in structured credit was -- and we haven't made it since COVID, it was in a very different time with a whole defaults and losses. And given the nature of CLO, is massively levered, we didn't think it was appropriate for the BDC.

Mickey Schleien -- Ladenburg -- Analyst

Okay, I understand. That is it for me this morning. I appreciate your time. Thank you.

Operator

And I'm showing no further questions at this time. And I would like to turn the conference back over to Joshua Easterly for any further remarks.

Joshua Easterly -- Chief Executive Officer, Director and Chairman of the Board and Risk Management Committee, Co-Chief

Great. Great. Thank you so much for people's interest and time. We look forward to chatting in the fall. I hope people have an easy and healthy rest of summer, and enjoy your Labor Day. Thanks.

Operator

[Operator Closing Remarks]

Duration: 65 minutes

Call participants:

Joshua Easterly -- Chief Executive Officer, Director and Chairman of the Board and Risk Management Committee, Co-Chief

Robert J. Stanley -- President

Ian Simmonds -- Chief Financial Officer, Chief Compliance Officer and Secretary

Devin Ryan -- JMP Securities -- Analyst

Finian O'Shea -- Wells Fargo -- Analyst

Robert Dodd -- Raymond James -- Analyst

Kenneth Lee -- RBC Capital Markets -- Analyst

Ryan Lynch -- KBW -- Analyst

Melissa Wedel -- JPMorgan -- Analyst

Mickey Schleien -- Ladenburg -- Analyst

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