Sixth Street Specialty Lending, Inc. (TSLX) Q3 2021 Earnings Call Transcript

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Sixth Street Specialty Lending, Inc. (TSLX -0.28%)
Q3 2021 Earnings Call
Nov 3, 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. Third Quarter ended September 30, 2021 Earnings Conference Call. Before we begin today's call. [Operator Instructions]

Statements other than statements of historical facts made during this call may constitute forward-looking statements and are not guarantees of the 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 the number of factors including those described from time to time in Sixth Street 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, 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 third quarter ended September 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 and Co-Chief Investment Officer

Thank you. Good morning, everyone and thank you for joining us. 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 origination activities and portfolio metrics. Ian will review our quarterly financial results in more detail and I will conclude with final remarks before opening the call to Q&A. After market closed yesterday, we reported third quarter adjusted net investment income of $0.55 per share and adjusted net income of $0.80 per share. This result correspond to an annualized year-to-date return on equity on adjusted net investment income of 12.9% and in an adjusted net income of 21.5%. This quarter's robust net investment income was driven by higher fees from elevated repayment activity relative to the first half of the year. It was also supported by a robust level of interest income from the strength in the core earnings power of our portfolio.

The difference between this quarter's net investment income and net income was due to the net unrealized and realized gains from portfolio company-specific events which Bo and Ian will discuss later in the call. As a result of this quarter's net gains, we continue to accrue capital gain and incentive fee expenses totaling $0.05 per share which we've excluded in presentation for this quarter's adjusted results. Again, this is because we believe the expense accrual requirement creates noise around the fundamental earnings power of our business. As the year have ended on September 30 and we were to calculate the capital gains incentive fees that are actually payable to the advisor in cash it would be -- it would be -- it would have been zero because the games driving this fee accrual are unrealized.

At quarter end, we had approximately $0.21 per share of cumulative accrued capital gains, incentive fees on the balance sheet and cash -- and approximately half of these would be payable in cash if our entire portfolio will be realized at the quarter end mark in normal course. The rest of the accrued fees are tied to unrealized gains resulting from the valuation of our debt investments inclusive of call protection which if prepaid will result in a recognition of fees and investment income and trigger a reversal of previously accrued capital gains and the fees related to these investments. If we were to hold these debt investments to maturity, realizing them in normal course at par over time there will be an uplift to our NAV of approximately $0.10 per share related to the reversal of accrued capital gain incentive fees. Returning to our Q3 results. The over-earning of our base dividend and net gains this quarter drove growth in our reported net asset value per share to a new high of 17/18. This results -- this represents a 2% increase from the prior quarter and is $0.02 per share in excess of our prior record high in Q4, 2020 of 17/16.

Recall that upon the release of our Q4 results in this February, our Board declared a special dividend of $1.25 per share. Since that time we have fully rebuilt our net asset value per share, primarily through net gains in our portfolio that continued overearning of our base dividend and the benefit of tightening credit spreads and the valuation of our investments. Over the trailing 12-month period, we generated total shareholder economic return of 20% through dividends and growth in net asset value per share. Let me now provide an update on our convertible notes due in August 2022, of which $143 million principal value remain outstanding at quarter end. On September 30, these notes became eligible for early conversion and holders of approximately $43 million principal value of notes opted to early convert subsequent to quarter end.

Based on the calculations laid on indenture, the nearly all stock settlement, we've elected to apply on this portion of the notes translate to approximately $0.04 per share of accretion in net asset value. To offset the deleveraging impact of the stock settlement, our Board has declared a special cash dividend of $0.50 per share to shareholders of record as of December 7, payable on December 20. This special dividend also serves to enhance our capital efficiency by eliminating nearly all of the excise tax drag on our spillover income, which is currently estimated to be $0.02 per share on an annualized basis. Given that the combination of these transactions is leverage neutral, the reduction in our excise tax burden will result in approximately 10 basis points of ROE uplift on an annualized basis.

Yesterday, our Board also approved a base quarterly dividend of $0.41 per share to shareholders of record as of December 15 payable on January 14. Our Board also declared a supplemental dividend of $0.07 per share based on Q3 adjusted net investment income to shareholders of record as of November 30, payable on December 31 -- or any net asset value per share inclusive of the impact of the special and supplemental dividends that was declared yesterday would be $16.61.

With that I'll now pass it over to Bo to discuss this quarter's origination activities and portfolio metrics.

Robert (Bo) Stanley -- President

Thanks, Josh. Let me first provide our thoughts on the current direct lending environment and how our business is positioned to serve borrowers and management teams as well as our stakeholders for the period ahead. It was 10 years ago when TSLX made its first direct lending investment and the landscape of private credit has streamed dramatically since then. In the last 10 years private debt AUM has grown over threefold, in what was a relatively niche asset class has become increasingly institutionalized, attracting new managers and investors into the space. The value proposition of private credit for borrowers over this time has remained constant. Speed and certainty of execution, documentation flexibility for management teams to achieve strategic goals and the opportunity to work with value-added trusted financing partners.

The pandemic-induced market volatility and growth trends in sponsor M&A have only underscored the value proposition of direct lenders. More so than ever, we're seeing an increasing number of borrowers and sponsors turn to the direct lending market for larger financings instead of the traditional syndicated markets. We believe this broadening of the opportunity set is a net positive for our sector and specifically for our business and our stakeholders, given our ability to be solutions providers at scale through co-investment with our affiliated funds. While competition for direct lenders is likely to remain strong in both the larger cap and traditional mid-market for the foreseeable future, we believe that our thematic investment approach and differentiated underwriting capabilities will allow us to expand our borrower and sponsor relationships and continue generating attractive risk-adjusted returns for our shareholders.

Moving now to this quarter's origination activity. We funded five investments including upsizes to our existing portfolio of investments, totaling $105.4 million in commitments and $65.4 million in fundings. We mentioned on our last earnings call that we had a strong funding pipeline heading into the second half of the year. Given the timing of various M&A processes, our funding activity is now back-end weighted for the fourth quarter. Post quarter end-to-date, we've already funded approximately $100 million of new investments including one where we have an agent on a $975 million credit facility. Based on our current pipeline, we'd expect to fund another $150 million to $250 million of net investments by year-end included what is funded to date.

Circling back to Q3 activity, a new investment this quarter was a $317 million TSLX agent in its senior secured facility to support the sponsor acquisition of ExtraHop Networks, a provider of cloud-based cybersecurity solutions. We believe that the sponsor chose us to lead the financing as a result of our deep knowledge of the sector and our ability to be constructive early in our financing process. This in turn allowed us to structure attractive risk-adjusted returns to our security, approximately $50 million of which was held by TSLX at quarter end. Also this quarter we in the Sixth Street platform completed $250 million term loan facility upsize for Biohaven, a biopharmaceutical company. Our initial $500 million Biohaven term loan facility was completed in August of last year to support the company's commercialization of its FDA-approved migraine drug, which has had strong fundamental performance post our investment to-date.

The upside facility which generates an attractive blended yield to maturity of over 11% on our total investment will be used to support the continued commercialization of this drug and the clinical development of the company's pipeline assets. We believe that ExtraHop and Biohaven are examples of how our platform's expertise across sectors and themes allows us to source and underwrite strong risk-adjusted returns across both sponsored and non-sponsored landscape. On the repayment side, after a quiet first half of the year, we fully realized six investments and partially sold one investment totaling $284 million in the third quarter. Our full investment realizations were driven by a combination of company-specific M&A as well as a favorable refinancing environment.

Through prepayment-related fees and equity upside that we structured into these fully realized investments, we generated a weighted average MOM of approximately 1.2x based on our capital invested. From a portfolio yield perspective, funding and repayment activity this quarter had a slight positive impact to our weighted average yield on debt and producing securities at amortized cost. Yields increased from 10.1% to 10.2% quarter-over-quarter and is on par with what it was a year ago. The weighted average yield at amortized cost on new investments including upsizes this quarter was 11.7% compared to a yield of 9.5% on exited investments.

Moving on to the portfolio composition and credit stats. This quarter our portfolio's equity concentration increased slightly from 6% to 7% on a fair value basis quarter-over-quarter, primarily driven by an increase in the fair value of our existing equity positions. The biggest driver was our IRG equity position whose fair value at quarter end reflected the pending sale of certain of the company's assets at a contracted price meaningfully above what was implied by our prior quarter's fair value mark. The IRG sale process is expected to be completed in the first half of 2022, while we continue to be focused on investing at the top of the capital structure with approximately 93% of our portfolio being first lien at quarter end from time-to-time, you may like to selectively increase our junior capital exposure in sectors and companies that we believe have strong tailwinds and resilient business models.

Finally, the performance rating of our portfolio continues to be strong with a weighted average rating of 1.12 on a scale of one to five with one being the strongest. We continue to have minimal non-accruals at less than 0.01% of the portfolio at fair value.

With that I'd like to turn it over to Ian to cover this quarter's financial results in more detail.

Ian Simmonds -- Chief Financial Officer

Thanks Bo. For Q3, we generated adjusted net investment income per share of $0.55 and adjusted net income per share of $0.80. At quarter end, total investments were $2.4 billion, down from $2.6 billion in the prior quarter as a result of net repayment activity. Total principal debt outstanding at quarter end was $1.1 billion and net assets were $1.3 billion or $17.18 per share prior to the impact of the special and supplemental dividends that were declared yesterday. Our average debt-to-equity ratio decreased slightly quarter-over-quarter from 1.07 times to 1.01 times and our debt-to-equity ratio at September 30 was 0.9 times. As Bo previewed, the net funding activity we've experienced post quarter end to-date has brought our debt-to-equity ratio back to approximately one times and we expect to finish the quarter at 1.05 times to 1.15 times leverage.

Given that the size of the stock settlement on our convertible notes in Q4 will approximate our special dividend payment, there will be no material net impact from those two transactions on our financial leverage. As we head into year end, our liquidity position remains robust with over $1.3 billion of unfunded revolver capacity at quarter end against $122 million of unfunded portfolio company commitments eligible to be drawn. Note that during the quarter, we increased the size of our revolver by $25 million to $1.51 billion with the addition of a new lender. We now have 21 lenders in our credit facility. Looking across our debt maturities as Josh mentioned, we have approximately $100 million remaining principal value of 2022 convertible notes that will mature in August of next year. Similar to our approach on the early conversion on a portion of these notes this fall, we plan to settle our remaining convertible notes in either cash stock or a combination, thereof, as permitted by the indenture depending on our balance sheet leverage and our investment opportunity set at the time any election is required.

As you can expect, we will choose settlement methods that consider the overall impact of conversion on our NAV and ROE. We continue to believe that maintaining a strong balance sheet with diversified funding sources and well-staggered maturities is important to our ability to create value for our shareholders in any environment. As such, we will continue to actively manage the right-hand side of our balance sheet to ensure we have appropriate funding mix diversity and remaining duration on our liabilities. Moving to our presentation materials. Slide eight contains this quarter's NAV bridge. Walking through the main drivers of NAV growth, we added $0.55 per share from adjusted net investment income against our base dividend of $0.41 per share. As Josh mentioned at the beginning of this call there was $0.05 per share of accrued capital gains incentive fee expenses 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 $0.02 per share impact and there was a positive $0.39 per share impact from other changes, primarily net unrealized gains on investments due to portfolio company specific events of $0.34 per share. A large portion of this was driven by our investment in IRG, which Bo mentioned earlier. Note that this quarter there was a realized loss of $0.18 per share related to the sale of our pre-petition JCPenney term loan and secured notes. The recognition of this loss in our income statement corresponded with an unwind of prior period unrealized losses on our balance sheet, totaling the same amount and therefore the overall impact was NAV neutral. There was, however, a positive impact from the recognition of this loss in the form of a reduction to our excise tax accrual.

For context, recall that last December upon JCPenney's emergence from bankruptcy, our pre-petition term loan and notes were converted to non-interest paying instruments with rights to immediate and future distributions in cash and other instruments including the exit term loan and earn-out and PropCo interests. The combined value of these other instruments and cash distributions that we've received to date have far exceeded our total capital invested in the original JCPenney pre-petition securities. Through September 30, we've generated an MOM of 1.23 times and a gross unlevered IRR of 26% on our total capital invested. Moving on to our operating results detailed on slide nine. Total investment income for the quarter was $71.2 million compared to $62.8 million in the prior quarter. Walking through the components of income interest and dividend income was $59.4 million stable from the prior quarter. Other fees, representing prepayment fees and accelerated amortization of upfront fees from unscheduled paydowns were $10 million, up from $2.2 million in the prior quarter due to higher portfolio repayment activity. Other income was $1.8 million, up from $1.1 million in the prior quarter.

Net expenses excluding the impact of the non-cash accrual related to capital gains incentive fees was $31.2 million, up slightly from $29.7 million in the prior quarter. This was primarily due to higher incentive fees as a result of this quarter's over earning. Due to the decrease in the effective LIBOR on our floating rate liability structure, our weighted average interest rate on debt outstanding decreased by approximately five basis points. Similar to Q2, we applied a fee waiver on base management fees related to the portion of average gross assets this quarter financed with greater than one times leverage. As Josh mentioned, through the first three quarters of the year, we've generated an annualized return on equity on adjusted net investment income of 12.9% and on adjusted net income of 21.5%. This quarter an elevated level of portfolio repayments contributed to robust activity-related fees and we expect this trend to continue through Q4.

Dovetailing this with our active funding pipeline, we would expect to drive strong ROE results for Q4 through the combination of activity-related fees and an increase in our financial leverage. As a result we would expect our full year 2021 adjusted net investment income to exceed $2 per share, which is above the upper end of our beginning year ROE target of 12% or $1.90 per share.

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

Joshua Easterly -- Chief Executive Officer and Co-Chief Investment Officer

Thank you, Ian. With this being the 10-year anniversary of when we first began our investment activities, we think it's a good time to reflect on the basis of any success we've enjoyed to date. We think there are two drivers for this, with the first being our one team culture. Our cultural philosophy of collaborating across platforms to harness best ideas and best practices, allow us to continue to provide thoughtful solutions for our management teams and sponsors, will also create strong outcomes for our shareholders.

Examples of this include a thematic investing in retail ABL, financing former royalty streams, upstream E&P and growth capital, which have all contributed in their own way to be also in our portfolio's performance to date. This one team culture extends to our capital base. The power to co-invest with our affiliated funds, which in Q3 surpassed $9 billion in cumulative Sixth Street direct lending investments, has allowed us to expand our investment opportunity set and our relationships with sponsors and management teams.

Our ability to scale up through co-investment -- co-investing with affiliated funds continue to benefit TSLX shareholders, as it allows us to size our funds appropriately to remain nimble in any environment for supporting middle-market borrowers. The second driver of our success to date, if any, we believe is simply our focus on doing good fundamental credit work. Our emphasis on first principles thinking and using tools to manage the inherent fragility of our credit assets or in our view, the foundation of our strong track record to date.

Since inception, we've experienced an annual -- experienced an average annual gross realized loss rate on assets of seven basis points, or a net realized gain of five basis points. This compares to a net loss of 115 basis points across all private credit during this period, an outperformance of 120 basis points according to the Cliffwater Direct Lending Index. Given that BDCs are now levered approximately 1:1 debt to equity, this means in theory that we've generated an outperformance of 250 basis points on equity, solely attributed to our credit selection. Looking ahead, we will continue to be focused on the shareholder experience.

As you can see, since around -- since the end of 2019 we've kept net asset value per share fairly stable, while distributing a total of $5.42 per share in regular, supplemental and special dividends. One final note. Yesterday, in consultation with our Board, we decided to amend our existing $50 million stock repurchase program. So we again would be purchasing shares automatically when our stock trades at prices starting at $0.01 below $1.05, our most recently reported pro forma net asset value per share, instead of below $1.

Given the strength in our -- in earnings power of our portfolio, on our ongoing cadence of supplemental and special dividends and our expectations of operating in a targeted debt-to-equity range, we believe that reinvesting in our existing portfolio of prices starting below 1.05 times book value would be highly ROE accretive with a short payback period compared to any solution and net asset value. At the end of the day, our goal is to make the optimal capital allocation choices for our shareholders and dependent on what it means for asset growth and implications for fee income for the manager.

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

Questions and Answers:

Operator

Certainly. [Operator Instructions] First question comes from Devin Ryan with JMP Securities. Your line is open.

Kevin Fultz -- JMP Securities -- Analyst

Good morning. This is Kevin Fultz on for Devin.

Joshua Easterly -- Chief Executive Officer and Co-Chief Investment Officer

Hi, Kevin. Yes.

Kevin Fultz -- JMP Securities -- Analyst

First question. Just looking at investment activity during the quarter, gross originations were fairly healthy at $572 million, but new investment covenants were fairly light at $105 million, which is similar to 80% of originations were sold down. Just curious given where leverage is at a level of repayments if that gross origination over was skewed by a larger deal during the quarter? Or if the small share that you retained was the result of raising investments that were less suitable for that portfolio?

Joshua Easterly -- Chief Executive Officer and Co-Chief Investment Officer

Yes. Great question. So that gross origination number I think is largely impacted by Biohaven which we had capped out basically at our position size -- risk position size or risk appetite for the portfolio. The other thing I would note on origination activity in this quarter there is a -- as Ian noted and Bo in their prepared comments there was a timing issue which is there's been a large net origination already in Q4 and we expect that to continue.

And so, quarter was somewhat arbitrary right? In the sense that there are a moment in time they don't tell the entire story. I think this year obviously the portfolio has grown significantly year-over-year. Our expectation is it will on a calendar year basis experience net portfolio growth too. It just happens to be subsequent into Q4.

Kevin Fultz -- JMP Securities -- Analyst

Okay. That makes sense Josh. And then just on the repayment side obviously repayment activity was elevated during the third quarter. Could you talk about how your payment activity has tracked quarter-to-date and your expectations for repayment activity through the end of the year?

Joshua Easterly -- Chief Executive Officer and Co-Chief Investment Officer

Yes. So -- by the way if in just to take a step back and we wind I know is hard for people to rewind. If you talk about Q2, I think there was like very little repayment activity and people were questioning what was happening with the investment income given that there was no activity-based fees. So again, there happen to be some in Q3 which helped economics and helped earnings. I think in Q4, it feels like it's a pretty good mix which there will be most definitely repayment activity. One that's public is Motus.

We're being taken out of Motus which was a longtime client of ours I think in the syndicated loan market. We also had an equity co-investment in Motus. And so I would say generally the portfolio activity it's pretty balanced and kind of looks like historical between repayment -- new activity and less repayments, but net portfolio growth. So that's how I would frame it if that's helpful?

Kevin Fultz -- JMP Securities -- Analyst

Okay. That's helpful and thanks for taking my question and congratulations on a strong quarter.

Joshua Easterly -- Chief Executive Officer and Co-Chief Investment Officer

Thank you so much.

Operator

Our next question comes from Ryan Lynch with KBW. Your line is open.

Ryan Lynch -- KBW -- Analyst

Good morning and thanks for taking my question. First one I had was, Josh do you or Sixth Street really have any high-level views on how the inflation picture will look over the coming quarters or even coming years? And are there any actions that you guys are taking within your portfolio of companies -- existing portfolio of companies or potential new deals and how to prepare for this?

Joshua Easterly -- Chief Executive Officer and Co-Chief Investment Officer

Yes. It's a great question Ryan. We most definitely have views and I would say they're informed. The reality is, is that, it's a complicated issue and I think there's divergent opinions in the firm. I'm not sure my opinion matters. But I can tell you kind of the framework, how I think about the framework. And then I could tell you about how we position the portfolio. Look so, obviously a lot of money printing. And if you talk -- if people talk about the inflation they really point to that. If you really look at -- there's still a decent amount of excess capacity, especially labor capacity in the markets. That labor capacity has been really sidelined given the stimulus that -- in the residual stimulus from COVID. And so, I think there's $13 billion to $17 billion of -- or $13 billion to $17 trillion of excess savings in the US system. You saw this with household debt coming down and credit card balances coming down and those are starting to pick up.

And so at some point people are going to have to go back to work once they've burned through the stimulus and the excess savings. And I think we're getting close to an inflection point on that. I think there was a job number out today so there was a decent amount of job creation. So I think people are starting to come back to work, given that they're bringing through that stimulus. So I think that will most definitely -- that's a deflationary factor. Look as people know and we participated in the portfolio construction side, we've been an early investor in software and technology. And that industry and sector is a massive exporter of deflation on a global basis. And so I think that is a -- that surely -- I think people needed to take a step back and look at the world and the world over the last 10 to 15 years I think or 20 years has been really deflationary, driven by globalization and technology and demographics. And I think except for globalization, which we probably were a peak globalization part of the global financial crisis, those factors are actually going to continue.

So I'm not as concerned about inflation as the average bearer so to speak. I think there's divergent views in our -- divergent views in our group. That being said, I think how we've set the portfolio, generally speaking is we typically finance companies and like to finance companies that have a ton of pricing power that live in ecosystems that they have -- where they where pricing power exists and where they're not commodity -- or they're not "commodity providers." And so our expectation of our portfolio given the average EBITDA margin of our portfolio I think is the core portfolio is probably in the 30%, 35% or 40% range is that -- which tells you that pricing power that if inflation does come they will be able to pass along. And by the way, their cost structure is typically given its high margin, high gross margin -- they have -- there's less impact on inflation but they'll be able to pass along and have pricing power.

So from a portfolio construction standpoint I think our portfolio is super robust from an inflation standpoint. And then when you look at our -- when you look at the behavior or the model for TSLX is that we have a little bit -- there's a little bit of a pinch point between -- if there is inflation between the floors, we have basically a floating-rate capital structure, floating rate left-hand side of the balance sheet, floating rate right hand of side of balance sheet. There will be EPS expansion once we get through our floors, there's a little pinch point on the floors. But if there is inflation my expectation is that we would kind of ripped through those floors pretty quickly and be in EPS expansion. So kind of my framework for inflation, how the portfolio behaves in an inflationary environment, which is I think robust and then the earnings power of TSLX in an inflationary environment. Is that helpful?

Ryan Lynch -- KBW -- Analyst

Yes, that's a super comprehensive and very thoughtful response. I very much appreciate that. Kind of on the opposite and more just a technical question I think for Ian. Can the convertible owners, can they continue to convert early until the maturity in August 2022? Or is that just like a one-time effect at that and the option to do it then and then they'll have to decide when it comes to maturity?

Joshua Easterly -- Chief Executive Officer and Co-Chief Investment Officer

Hey, Ryan I just want to point out that I can answer technical questions too but I will let you -- will let Ian take that.

Ian Simmonds -- Chief Financial Officer

Ryan, there's kind of two parts to that question. One depends on whether the early conversion triggers have been met prior to six months prior to maturity. So think of it as two periods, prior to February 1 of next year, there has to be an early conversion trigger met. As of today, there's no early conversion triggers met. So as of today, there's no more early conversion. Until we get to February 1, which is six months prior to maturity and then the early conversion triggers are not applicable and holders can convert early at their option.

Joshua Easterly -- Chief Executive Officer and Co-Chief Investment Officer

Yes let me color that up. So the -- that's the -- Ian's right on. The early conversion trigger was a broker bid parity calculation. And for some reason in a moment in time, the broker bids were less than I think 98% of parity. That doesn't seem to exist today. It sometimes happens in high paying dividend stocks. And what I would say is we take another step back is that there's two basically -- there's two kind of holders of the convertible bonds hedge holders and non-hedge holders. And the hedge holders when the bonds get deeply in the money and like really deeply in the money and the delta hedge the bonds they're basically hedging the bonds on a one-to-one basis because they're effectively just own the stock, and therefore they're short the dividend of SLX and they only have 4.5 points on the coupon and the dividend yield is much higher. And so they have a cash flow.

So they really want to issue so they really want to unwind the hedge, which is why that early -- and they can unwind their hedge basically through two things. One is either selling the bonds and unwinding the hedge or -- and so the trigger exists that, which is if the bonds for some reason are trading below parity that they have a liquidity option so they can unwind the hedge. It has felt like all of the hedged buyers have exercised early conversion trigger -- I mean early conversion option. In addition to that it feels like that environment of where the bonds trade at parity no longer exist. And so I would expect that we won't see that again. That was a point in time given a little bit of a market dislocation on the price of the bonds and then the nature of the holders, and the nature of the holders are no longer hedged holders.

Ryan Lynch -- KBW -- Analyst

Okay. Yeah. That makes sense. I understood the color behind that.

Joshua Easterly -- Chief Executive Officer and Co-Chief Investment Officer

Technical answer.

Ryan Lynch -- KBW -- Analyst

Well, I appreciate the time today, and nice quarter guys.

Joshua Easterly -- Chief Executive Officer and Co-Chief Investment Officer

Thanks.

Operator

Thank you. Our next question comes from Melissa Wedel with JPMorgan. Your line is open.

Melissa Wedel -- JPMorgan -- Analyst

Good morning, everyone. Thank you for taking my questions today. Most of them have actually been anticipated or already asked and answered...

Joshua Easterly -- Chief Executive Officer and Co-Chief Investment Officer

Melissa, we can't hear you. Sorry you're muffled.

Melissa Wedel -- JPMorgan -- Analyst

Sorry about that. I hope that's better.

Ian Simmonds -- Chief Financial Officer

Perfect.

Joshua Easterly -- Chief Executive Officer and Co-Chief Investment Officer

Yeah, yeah.

Melissa Wedel -- JPMorgan -- Analyst

Okay. I wanted to clarify the $100 million in activity that you mentioned so far quarter-to-date. Was that gross or net?

Ian Simmonds -- Chief Financial Officer

That was gross.

Melissa Wedel -- JPMorgan -- Analyst

Gross? Okay. And then the $100 million to $150 million of additional that you expected that was a net number correct?

Ian Simmonds -- Chief Financial Officer

That's correct. That's a net number that's expected.

Melissa Wedel -- JPMorgan -- Analyst

Okay. And then just to round out that mass a little bit you also continue to expect elevated prepayment activity into 4Q?

Ian Simmonds -- Chief Financial Officer

Yeah, I think what Josh said is we expect normalized repayment activity in Q4 to what we've seen at typical levels and combine that with a robust pipeline coming into Q4, we expect those net funding is between $150 million and $250 million.

Joshua Easterly -- Chief Executive Officer and Co-Chief Investment Officer

Yeah. Look I think the math historically and somebody can correct me if I'm wrong typical average repayments tend to be $200 million, $175 million to $250 million and then gross originations seem to be somewhere between $200 million and $275 million. And I would expect that we're $150 million -- $100 million to $150 million net on the quarter up. Is that helpful? We may have lost her.

Operator

We lost her. If you can requeue. Shall we continue with the next question sir?

Joshua Easterly -- Chief Executive Officer and Co-Chief Investment Officer

Sure, sure.

Operator

From Finian O'Shea with Wells Fargo. Your line is open.

Finian O'Shea -- Wells Fargo -- Analyst

Hi, everyone. Good morning. I guess, first question for Josh or Bo on the ABL opportunity set high level. We haven't seen a new portfolio company too recently. Is this part of the private credit arena as Bo described where there's a lot of new entrants in terms of coming too much? Or are you just not seeing your style of opportunity -- preferred opportunity there?

Joshua Easterly -- Chief Executive Officer and Co-Chief Investment Officer

Yes, good morning. So, thanks for your question. Good question. So, the good news is not to go there is one -- we actually have one that we've committed to that we've been actually earning a little bit of commitment fees along the way over last quarter and this quarter that's taken some time to get regulatory approval, but that should close early next week consistent with what you've seen in the past. I would say it's not really a private credit competition issue, it's really a broader issue which is when you look at pre-pandemic what retail look liked was that you had foot traffic declining and store-based retailers. You had -- it's a low barrier industry, so you got a lot of competition.

You had share being taken from being taken away from physical stores from omni channel providers and from Amazon. And so you saw a lot of pressure on those business models including on a gross margin basis and a discounting basis. And then the consumer was kind of stable or down. And then when the pandemic hit what you had was you had basically a culling of the herd. Retailers only the strong survive and got to reduce our footprint and rebase. So, they were themselves better positioned. There was less competition. Foot traffic has remained stable or slightly declining.

Consumers are in much better shape given excess savings and so you've had no discounting, you've had margin expansion and retailers are generally those who survived are living in a slightly better environment with a better consumer. My guess is the big secular will continue to play out. But in this moment in time, retail is relatively healthy.

Finian O'Shea -- Wells Fargo -- Analyst

Yes. No, makes sense. Just a follow-up. We can call it technical or high level but either way it goes to Ian. Is there a change in the supplemental dividend policy? I think you used to pay out about half of the NOI spillover. I know there's a few wrinkles going on this quarter with the big special on the preferred and everything. But are we seeing any change to what you pay out for the quarter supplemental?

Ian Simmonds -- Chief Financial Officer

No, Finian, it's the same formula. I think maybe what we didn't do as good a job of articulating. We're using the adjusted NII figure to calculate that. So, it's the $0.55 less the base dividend of $0.41 and then 50% of that, so that's how we got to the seven.

Joshua Easterly -- Chief Executive Officer and Co-Chief Investment Officer

Because the part two in capital gains incentive fees are not paid in cash and are not expected to be paid in cash any time soon that you have to make an adjustment to the adjusted net investment income number to get to the power and the cash earnings part of the business.

Finian O'Shea -- Wells Fargo -- Analyst

Awesome. Thank you so much.

Joshua Easterly -- Chief Executive Officer and Co-Chief Investment Officer

Thank you.

Operator

[Operator Instructions] Our next question is from Robert Dodd with Raymond James.

Robert Dodd -- Raymond James -- Analyst

Hi everyone. Congratulations on the quarter for what it's worth. My questions are -- anybody can answer them. So, on the -- I suspect I know who's going to answer this. On the kind of portfolio mix going forward I mean and I don't mean first lien second lien, I mean more by verticals. I mean you addressed ABL, but you've got pharma royalty expertise. You've got a whole bunch of other expertise beyond just regular way LBO sponsor finance. Do you expect to shift the mix at all? I mean as you pointed out right?

The regular way business seems to be getting more competitive, big managers coming in large pools of capital. You've always run higher -- typically higher IRRs, MOIs, whichever metric you want to look at. Because of those more niche verticals where a lot of big players don't participating in, so should we expect the kind of -- the number of verticals you're willing or want to operate in to increase or expand as a piece of the mix, as the more vanilla ends of the market get increasingly competitive?

Joshua Easterly -- Chief Executive Officer and Co-Chief Investment Officer

Yes. So, it's a great question. And I'll let Fishy answer it. No, I'm just joking. But Fishy is here, he can hop in. And I like your approach to who you direct the question at, but I'll take a shot, then Bo and everybody else. First of all, look, I think you're right. We try to be very thoughtful in the sectors and lanes that we've operated in. And quite frankly, there is inefficiencies where we operate. What you find over now in the 10-year anniversary of the business, you found us having higher IRRs or higher ROAs or higher spreads and less defaults, significantly less defaults, like actual net gains versus losses.

And so, we've found lanes that offer higher risk-adjusted returns. That's the power of the Sixth Street platform. The power of the Sixth Street platform, as we have 400 people now and we have a whole bunch of people in sectors and hunting and thinking about what's happening in those individual ecosystems and where we can have direct dialogue with companies and picker lanes and pick them in a thoughtful way, where we can find the balance of providing a tremendous amount of value to our issuers, but also value to our shareholders.

I think you will see us continue to evolve -- this year retail was down. My expectation is, retail will come back when that industry is less healthy in the secular overrides the cyclical, vis-a-vis the consumer. I think you'll see us do some energy stuff in the coming moment, given the pullback of capital in that space. I think you'll continue to see us still attack software as we have and we have a little bit of an incumbency benefit there.

And so I just think that there is -- on the pharma side, we'll continue to be a thoughtful investor there as well. So I just think that there were -- given that Sixth Street Specialty line is, we really focus on the middle market and focus on specialty verticals, I think you'll continue us to do -- see us do our thing and across sectors when we find good relative value and good risk-adjusted returns and where we can provide value to our issuers. Fishy, do you have anything to add. Fishy just as a background always judging, but he's here as well.

Michael Fishman -- Vice President and Director

I think the only thing I would add is, we say software, right? It's such a broad category and encompasses so much. I think one of the things we've done is, kind of, dig deeper. And there's a lot of sub verticals, whether it's healthcare, IT or education, or EdTech or payments.

I mean there's such a -- we're developing, I guess, expertise, I would call it, in subverticals of something that's very, very broad. So we're constantly looking for, I would say, a differentiated view in different areas. And just -- I know, we just throw around software. So that's the only thing we've talked about.

Joshua Easterly -- Chief Executive Officer and Co-Chief Investment Officer

Bo, anything to add?

Robert (Bo) Stanley -- President

No. I mean, I guess, what I would add is, when I look forward at the Q4 pipeline, it's across a number of themes and a good mix of both sponsor and nonsponsor deals. I think that has been the power of the platform that's constantly rotating thematic approach, where we have hundreds of investment professionals speaking directly to management teams, sponsors, intermediaries to find the best risk-adjusted return. So that's -- and I think that's going to be represented in our Q4 results.

Joshua Easterly -- Chief Executive Officer and Co-Chief Investment Officer

Yes. Hey. And then -- Bo I know you didn't ask this question, but I think it's worth saying. Look, we didn't get the spillover question and I want to talk quickly about the spillover, look, spillover given the unrealized gains in the portfolio, spillover is going to quickly increase again. That being said, I am not sure the value of keeping always a spillover income in the system. Ultimately, what matters is the forward earnings power of the business and protecting the dividend vis-a-vis the forward earnings power of the business. And so we've tried to do a decent job of being thoughtful and appropriately choosing our capital structure and eliminating the excise tax, although that excess tax will probably build again, given as we convert the unrealized book to realize will create more spillover income.

That being said, I think our philosophy is a little bit shifting. And we're using that as a lever to optimize our capital structure at any given time to create the right balance to generate forward earnings in the power and earnings of the business and making sure that we keep ROEs in an acceptable level. So I wanted to hit that. The other thing I wanted to hit I think Ian's earnings estimate, which was in excess of $2 per share I would probably slightly reframe that. It's probably going to be well in excess of $2 per share -- for Q4 my guess. And so I won't define well in excess but it's going to be...

Robert Dodd -- Raymond James -- Analyst

That was going to be next question.

Joshua Easterly -- Chief Executive Officer and Co-Chief Investment Officer

Yes. People should model $2 a share for the year that would be wrong. So -- or I think would be wrong. But -- and then Robert, offline we could debate the spillover income piece because I think the sole over income concept was this idea of providing protection to the dividend. Ultimately, if you're paying the dividend through spillover income you're reducing net asset value per share from that moment forward. So we're trying to really find that balance of kind of letting go over income increase, which it will and then using it as a kind of letting their out of balloon to make sure we keep the optimal financial leverage and make sure that we don't have a drag on our use of the excise tax.

Robert Dodd -- Raymond James -- Analyst

I appreciate that and you're not the only one whose view on spillover maybe philosophically evolving as well. So I look forward to that topic later. I appreciate those -- that follow-up from everybody. Thank you.

Joshua Easterly -- Chief Executive Officer and Co-Chief Investment Officer

Okay. Great.

Ian Simmonds -- Chief Financial Officer

Thank you so much.

Operator

Thank you. And this concludes our Q&A.

I would like to turn the call back to Joshua Easterly for his final remarks.

Joshua Easterly -- Chief Executive Officer and Co-Chief Investment Officer

So thank you. Thanks for the time and attention and participation from everybody. What I would say is, this year -- this time of the year always makes you a little bit sad because it's not going to be for -- it's going to be a longer period before we connect next. I think in February, sometime, given the Q4 additional timing to facilitate the year-end audit. So first, I want to wish people a happy Thanksgiving, a lot to be thankful for this year and a lot to reflect on. It's obviously been a difficult two years for people and given the pandemic and the uncertainty in the world and a lot of other issues of the diverse equity issues that are real and affecting parts of our communities.

So -- and we obviously have to deal with them as a society deal with the reckoning of some of our history. And so -- but a lot to be thankful for. So thank you for your time and efforts. And I deep believe from our team, I hope people have a healthy holiday season and can take some time to sit with their family, given the last two years.

Ian Simmonds -- Chief Financial Officer

Thanks, everybody.

Operator

[Operator Closing Remarks]

Duration: 54 minutes

Call participants:

Joshua Easterly -- Chief Executive Officer and Co-Chief Investment Officer

Robert (Bo) Stanley -- President

Ian Simmonds -- Chief Financial Officer

Michael Fishman -- Vice President and Director

Kevin Fultz -- JMP Securities -- Analyst

Ryan Lynch -- KBW -- Analyst

Melissa Wedel -- JPMorgan -- Analyst

Finian O'Shea -- Wells Fargo -- Analyst

Robert Dodd -- Raymond James -- Analyst

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