Executive Summary / Key Takeaways

• Sixth Street Specialty Lending (TSLX) operates as a disciplined middle-market lender, leveraging the broader Sixth Street platform to source differentiated, often non-sponsored, investment opportunities that aim to generate returns exceeding its cost of equity.
• The company's focus on senior secured, floating-rate debt (93% first-lien, 97% floating-rate as of Q1 2025) with call protection provides portfolio stability and benefits from higher interest rates, contributing to robust net investment income.
• Recent financial performance, including Q1 2025 adjusted NII of $0.58/share and full-year 2024 adjusted NII of $2.33/share, demonstrates strong operating earnings, although net income has shown some dispersion due to credit-related unrealized losses and spread widening.
• TSLX maintains a strong liquidity position and proactively manages its balance sheet through debt issuances and credit facility amendments, providing flexibility to fund commitments and capitalize on opportunistic investments.
• Management guides for full-year 2025 adjusted NII ROE of 11.5% to 12.5%, reflecting expectations for portfolio spreads, leverage, and activity fees, while emphasizing that disciplined capital allocation in the current competitive environment is key to long-term shareholder value.

Sixth Street Specialty Lending: Capital Discipline in a Changing Market

Sixth Street Specialty Lending, Inc. (TSLX) is a business development company (BDC) established in 2010, specializing in providing financing solutions to U.S. middle-market companies. Operating within the expansive Sixth Street global investment platform, TSLX focuses primarily on originating senior secured loans, alongside select investments in mezzanine debt, corporate bonds, and equity securities. This strategic positioning allows TSLX to tap into a wide network and deep industry expertise, differentiating its approach in a competitive lending landscape. The company's history, marked by its 2014 IPO and subsequent growth, is fundamentally tied to its ability to act as a disciplined capital allocator, seeking opportunities that promise attractive risk-adjusted returns for its shareholders.

The current market environment presents a complex mix of dynamics. While higher interest rates have provided a tailwind for floating-rate portfolios like TSLX's, contributing to elevated operating earnings across the BDC sector, they have also introduced potential headwinds, including idiosyncratic credit deterioration in some portfolio "tails." Furthermore, significant capital inflows into the direct lending space, particularly from non-traded BDCs, have intensified competition and exerted downward pressure on new investment spreads. TSLX navigates this by emphasizing its differentiated sourcing channels and maintaining a selective investment posture, passing on deals where the economics do not align with its required return on equity.

TSLX's investment framework is built on four pillars: business and sector selection, investment structuring, deal dynamics, and risk mitigation. The company targets businesses with enterprise values typically between $50 million and $1 billion and EBITDA between $10 million and $250 million, favoring those with strong cash flow characteristics and sustainable competitive advantages. A core tenet of its strategy is investing high in the capital structure; as of March 31, 2025, 93% of the portfolio by fair value was in first-lien debt. This focus on senior secured positions, coupled with robust covenant packages and a preference for retaining effective voting control, aims to provide downside protection and opportunities for early intervention in challenging situations.

A key operational differentiator for TSLX is its ability to leverage the broader Sixth Street platform, which boasts over 650 investment and operating professionals, including 73 dedicated to direct lending. This extensive network and deep sector expertise enable TSLX to source a wide range of opportunities, including those outside the traditional, highly competitive sponsor-backed market. In Q1 2025, 84% of new fundings originated outside the sponsor channel, contributing to a weighted average spread over the reference rate of 700 basis points on new commitments, notably wider than the 541 basis points reported by public BDC peers in Q4 2024. This focus on non-sponsored deals, including specialized areas like Retail ABL, Energy, and Healthcare/Spec Pharma, allows TSLX to earn incremental spread while maintaining what it views as an appropriate risk-return profile. The company's track record in themes like Retail ABL, spanning over a decade, underscores its ability to create value through specialized underwriting predicated on collateral value.

Recent financial performance reflects the impact of the prevailing rate environment and the company's strategic execution. For the first quarter ended March 31, 2025, TSLX reported adjusted net investment income of $0.58 per share, translating to an annualized ROE of 13.5%. This follows a strong full year 2024, where adjusted NII reached $2.33 per share, resulting in an operating ROE of 13.8%. Interest income remains the primary driver, increasing slightly in Q1 2025 due to a larger average investment size, despite a decrease in PIK income. Interest expense saw a notable decrease in Q1 2025, falling from $39.0 million to $33.0 million quarter-over-quarter, primarily benefiting from a lower weighted average interest rate on debt outstanding (6.4% in Q1 2025 vs. 7.6% in Q1 2024). While operating earnings have been robust, net income has shown some variability. The $0.22 per share difference between adjusted NII and adjusted net income in Q1 2025 was largely attributable to credit-related markdowns on nonaccrual loans and the impact of widening credit spreads, alongside the movement of prior period unrealized gains into NII upon investment realization.

TSLX's competitive positioning is shaped by its disciplined approach and platform capabilities. While larger competitors like Ares Capital Corporation (ARCC) benefit from greater scale and market reach, enabling participation in larger syndicated deals, TSLX differentiates itself through its selective focus and ability to source opportunities in less-trafficked segments. Compared to more sector-focused peers like Hercules Capital, Inc. (HTGC), TSLX's diversified portfolio across various end-markets offers broader exposure, although HTGC may hold an edge in processing speed within its tech niche. Against income-focused BDCs like Golub Capital BDC, Inc. (GBDC), TSLX's floating-rate exposure (97% of debt investments) provides a strong hedge against inflation and interest rate volatility, potentially offering better yield efficiency in a rising rate environment. While direct quantitative comparisons across all metrics can be challenging due to varying reporting focuses, TSLX's emphasis on senior secured lending and lower non-accrual rates (1.2% of portfolio fair value in Q1 2025) suggests a focus on credit quality that aims to translate into lower credit losses over the long term, a key differentiator cited by management.

Liquidity and balance sheet management are critical components of TSLX's strategy, providing the flexibility to fund commitments and pursue new investments. As of March 31, 2025, the company had $1.9 billion in total principal debt outstanding

and maintained approximately $1.0 billion of available capacity under its Revolving Credit Facility.

Recent financing activities, including the issuance of $300 million in unsecured notes due 2030 in February 2025 and the amendment of the Revolving Credit Facility in March 2025 to extend a significant portion of commitments to 2030, have further laddered maturities and enhanced funding flexibility. This proactive approach ensures TSLX is well-positioned to meet its unfunded commitments ($322.6 million as of Q1 2025) and capitalize on investment opportunities as they arise.

Looking ahead, management has provided guidance for full-year 2025 adjusted net investment income return on equity between 11.5% and 12.5%. This outlook is based on assumptions regarding the forward interest rate curve, prevailing spreads on new deals, targeted leverage levels, and expected activity-based fees. The company acknowledges potential headwinds, including the possibility of continued spread tightening in certain market segments and the realization of credit issues in older vintage assets ("tails"). However, management believes that the majority of credit issues are known and expects credit performance to be a relative strength. The disciplined approach to capital allocation, prioritizing investments that earn a return above the estimated cost of equity, remains central to the strategy, aiming to deliver sustainable shareholder value.

Conclusion

Sixth Street Specialty Lending operates with a clear and disciplined investment philosophy, leveraging the extensive resources and expertise of the Sixth Street platform to identify and execute on differentiated middle-market lending opportunities. The company's focus on senior secured, floating-rate debt provides a resilient income stream in the current interest rate environment, while its selective approach to originations, particularly in the non-sponsored channel, aims to capture wider spreads and better terms than those available in more competitive segments. Despite potential market headwinds such as spread compression and idiosyncratic credit challenges, TSLX's strong liquidity, proactive balance sheet management, and commitment to investing above its cost of equity position it to navigate the evolving landscape. The company's guidance for 2025 reflects confidence in its ability to continue generating attractive returns for shareholders, underpinned by a strategy focused on long-term value creation through disciplined capital allocation and differentiated sourcing capabilities.