NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned an initial long-term Issuer Default Rating (IDR), a secured debt rating and an unsecured debt rating of 'BBB-' to TPG Specialty Lending, Inc. (TSLX). The Rating Outlook is Stable.
KEY RATING DRIVERS - IDR and Senior Debt
The ratings reflect the strength of TSLX's relationship with TPG Special Situations Partners, and TPG Global, LLC (TPG) and its affiliates, which provide enhanced access to deal flow and investment resources, a relatively lower risk profile than peer Business Development Companies (BDCs), strong asset quality, appropriate leverage, strong dividend coverage, limited interest rate sensitivity and solid liquidity.
Fitch's favorable view of TSLX's risk profile, relative to peer BDCs, is based on the senior lending focus, strong call protections, lower underlying portfolio company leverage and limited exposure to equity investments. Fitch also views positively TSLX's recent listing and unsecured debt issuance, which enhance its funding diversity and access to liquidity, as well as strong alignment of interest between TPG and TSLX, which is evidenced by its shared brand and the meaningful ownership interest of the BDC's common shares by TPG and its partners and employees.
Rating constraints include TSLX's relatively short operating history, which makes it difficult to assess the company's middle market underwriting acumen through a credit cycle. Fitch acknowledges management's strong and established record in credit, although the unique operating constraints of the BDC construct modestly limit the transferability of this track record. Other TSLX-specific constraints include modest portfolio concentration and a largely secured funding profile. Rating constraints that are applicable to the BDC sector more broadly include the valuation impact of portfolio investments on balance sheet leverage and the inability to retain capital due to distribution requirements.
Leverage, as measured by debt to equity, amounted to 0.50 times (x) at March 31, 2014, or 0.46x net of cash, which is consistent with the long-run average of 0.42x. Fitch believes leverage remained largely consistent following the recent senior convertible debt issuance, as proceeds were used to repay a portion of outstanding borrowings under its secured credit facilities. Fitch views TSLX's current and targeted leverage of 0.65x to 0.75x as appropriate, especially given the company's senior lending focus.
Asset quality trends have been strong since inception and no investments were on non-accrual status at March 31, 2014. TSLX continues to focus on the senior part of the capital structure, with first and second lien senior debt and senior bonds accounting for 99.4% of the investment portfolio at first quarter-end 2014 (1Q'14), compared to a rated peer average of 62.7%. TSLX is meaningfully invested at the senior-most part of the capital structure, with first lien debt, including first lien last-out debt, representing 82.4% of the investment portfolio at 1Q'14. Exposure to equity investments, which can experience meaningful valuation volatility, was very low, representing only 0.2% at 1Q'14, compared to a rated peer average of 18.6%.
The investment portfolio was relatively more concentrated than peers from an investment perspective, as TSLX generally takes larger positions in portfolio companies relative to peer BDCs given its focus on direct originations. However, this is expected to change modestly over time with portfolio growth. The top 10 portfolio companies accounted for 47.6% of assets and 74% of equity, as of March 31, 2014. Fitch expects that with portfolio and earnings growth, portfolio concentrations will decrease modestly over time.
TSLX's operating history is relatively short, having begun investing in 2011, but earnings yields have improved meaningfully over the last several years, as the firm has gained scale. Net investment income grew 98.9% in 2013, adjusting for non-cash incentive accruals and management fees waived, as a 54.8% increase in the average portfolio, at amortized cost, and a more-than-doubling in fee income combined to offset a 10 basis point decline in the portfolio yield. The revenue yield on the portfolio was 11.3% for the year, which is modestly lower than the peer average of about 12.2%, given the firm's senior focus. Still, yield compression has been less significant than peers, due to the firm's strong call protection on a relative basis, which has limited refinancing volume to some extent. As of March 31, 2014, TSLX had call protection on 94.9% of its debt investments, with weighted average call prices of 107%, 103.3% and 101.3%, for the first, second and third year from the initial date of investment, respectively.
TSLX's funding profile is largely secured, consisting of a $781.3 million corporate revolver and a $175 million special purpose vehicle (SPV). The maturity profile is well laddered with the next debt maturity coming due in February 2019. TSLX recently expanded the borrowing capacity on its corporate revolver and SPV facility, as well as executed on its inaugural unsecured debt issuance at attractive economic terms. Fitch would view TSLX's continued access to the unsecured debt markets favorably and expects the company to extend debt maturities opportunistically over time.
TSLX's liquidity profile is considered solid with $28.8 million of balance sheet cash, and $535.9 million of borrowing availability on its various secured funding facilities, subject to borrowing base requirements as of March 31, 2014, pro forma for the upsize of the credit facility. Cash flows from repayments and proceeds from investments were significant, amounting to $153.6 million in 1Q'14, while the use of cash for new investments was $325.3 million. The high level of cash used for investment activity reflects the continued ramp-up of the investment portfolio, as well as modest portfolio turnover.
Cash earnings dividend coverage, which adjusts for non-cash incentive payment accruals, was solid, amounting to 108.9% in 1Q'14. The dividend is further supported by the presence of spillover income, which Fitch believes provides further stability to the dividend over the medium term, particularly in an origination environment characterized by tighter spreads.
The Stable Outlook reflects Fitch's expectations for continued operating consistency, relatively stable earnings yields, given the focus on less-liquid direct originations, and the maintenance of good asset quality, appropriate leverage, and strong dividend coverage.
However, Fitch sees a number of emerging industry challenges that could pressure ratings, or at least increase rating differentiation amongst BDCs over a longer-term horizon. These challenges include a potential increase in regulatory leverage limits and increased competition, which are yielding tighter market spreads and looser underwriting terms, including higher underlying portfolio company leverage and weaker covenant packages. Should competition continue to intensify, market yields could decline further, which would reduce earnings generation and pressure dividend coverage for the space.
RATING SENSITIVITIES - IDR and Senior Debt
Positive rating momentum for TSLX could develop over time provided the company continues to demonstrate measured portfolio growth in the face of a competitive market environment. This will be evaluated in the context of the stability and consistency of TSLX's operating performance, asset quality, valuation and underlying portfolio metrics, including leverage and interest coverage. Specifically, increases in underlying portfolio leverage, and/or deterioration in portfolio company interest coverage or overall portfolio yields, could signal the potential for asset quality issues down the road, which could yield a revision in TSLX's Rating Outlook.
Conversely, negative rating actions could be driven by an extended increase in leverage above the targeted range of approximately 0.65x-0.75x, resulting from increased borrowings or material realized or unrealized depreciation, and/or a meaningful increase in the proportion of equity holdings without a commensurate decline in leverage. A spike in non-accrual levels, or weaker cash income dividend coverage would also be viewed unfavorably from a ratings perspective.
The equalization of the secured and unsecured debt ratings with that of the IDR reflects solid collateral coverage for all classes of debt, given the low leverage levels for the firm and the fact that BDCs are subject to a 200% asset coverage rule, which enforces a high level of collateralization for debt holders. Consequently, the debt ratings are sensitive to changes in the IDR, as well as to changes in collateral values and advance rates under the borrowing facilities, which ultimately impact the level of available asset coverage.
TSLX is an externally managed BDC, organized in July 2010 and commencing investment operations in July 2011. As of March 31, 2014, the company had investments in 30 portfolio companies amounting to approximately $1.2 billion.
Fitch has assigned the following ratings with a Stable Outlook:
TPG Specialty Lending, Inc.
--Long-term IDR of 'BBB-';
--Senior secured debt rating of 'BBB-';
--Senior unsecured debt rating of 'BBB-'.
Additional information is available at 'www.fitchratings.com'
Applicable Criteria and Related Research:
--'Global Financial Institutions Criteria' (January 2014);
--'Investment Manager and Alternative Funds Criteria' (December 2013).
Applicable Criteria and Related Research:
Global Financial Institutions Rating Criteria
Investment Manager and Alternative Funds Criteria