OREANDA-NEWS. Fitch Ratings has affirmed the Long-term Issuer Default Rating (IDR), secured debt and unsecured debt ratings for TPG Specialty Lending, Inc. (TSLX) at 'BBB-'. The Rating Outlook is Stable. Today's rating actions have been taken as part of Fitch's periodic peer review of Business Development Companies (BDCs), which encompasses 10 publicly rated firms.

BDC INDUSTRY OUTLOOK

Fitch's outlook for the BDC sector is negative; reflecting competitive underwriting conditions, earnings pressure, underperforming energy investments, unsustainable asset quality metrics, increased activist pressure, and limited access to growth capital. While some firms are better positioned, given their more conservative financial profiles and portfolio characteristics, others are likely to see rating pressure over the outlook horizon.

BDCs are heavily dependent on the equity markets to fund portfolio growth, but access to the market has been almost non-existent over the last 18 months as share prices continue to trade at steep discounts to net asset value (NAV). At March 7, 2016, rated BDCs were trading at an 18.3% average discount to NAV, thus preventing most from issuing stock without significantly diluting existing shareholders. While the reduction in portfolio growth is viewed favorably by Fitch, given tough underwriting conditions, some firms may struggle to close the trading gap, leaving them at a competitive disadvantage if and when investment opportunities arise.

The decline in commodity prices has yielded the first notable crack in asset quality performance for BDCs. More broadly, asset quality metrics remain at unsustainably low levels, in Fitch's opinion. While strong portfolio company performance has been supported by an improving economic environment, low interest rates are likely masking some potential underlying company-specific issues, as issuers have been able to refinance themselves out of trouble rather easily in recent years. Fitch believes asset quality metrics are likely to deteriorate over the near term; however, the pace of deterioration will be somewhat dependent upon the rate of change in interest rates, the backdrop of the broader economic environment, differing sector exposures, and the integrity of individual firms' underwriting.

Fitch has not observed a marked increase in leverage levels for the sector, with average leverage for investment grade-rated BDCs of 0.74x at year-end 2015 compared to 0.60x at year-end 2014. However, there is a wide dispersion of leverage around the average, and those with the most energy exposure often also have the highest leverage ratios. Share repurchase activity has also increased in the sector in recent quarters, which could inflate leverage ratios further. Fitch believes that BDCs heavily focused on maximizing leverage run the risk of having less dry powder to deploy if and when underwriting conditions improve, thus weakening earnings upside.

KEY RATING DRIVERS

IDRs AND SENIOR DEBT

The rating affirmations reflect a lower risk profile relative to peer-BDCs given TSLX's senior lending focus and lower underlying portfolio company leverage, strong asset quality performance, lower historical average leverage, solid liquidity, strong dividend coverage and the strength of TSLX's relationship with TPG Special Situation Partners (TSSP) and TPG Global (TPG) as well as its affiliates, which provide enhanced access to deal flow and investment resources. Fitch also views positively TSLX's demonstrated access to the debt and equity markets, as well as its strong alignment of interest between TPG and TSLX, which is evidenced by its shared brand and meaningful ownership interest of the BDC's common shares by TPG and its partners and employees.

Primary rating constraints include the current challenging market backdrop, as well as the capital markets impact on leverage, given the need to fair value the portfolio each quarter, dependence on the capital markets to fund portfolio growth, and a limited ability to retain capital due to dividend distribution requirements. Constraints specific to TSLX include its relatively short operating history as a BDC, given its inception after the onset of the financial crisis, modest portfolio concentrations, and a largely secured funding profile.

The Stable Rating Outlook reflects Fitch's expectations for continued operating consistency, relatively stable portfolio yields, given the firm's focus on direct originations, and the maintenance of good asset quality performance, appropriate leverage, sufficient liquidity with demonstrated access to equity capital and strong dividend coverage.

Leverage, as measured by total debt to equity, amounted to 0.80x as of Dec. 31, 2015, which is modestly higher than the peer average of 0.64x. Longer-term, TSLX targets leverage between 0.75x and 0.85x, which is on the higher end of the range compared to peers, but Fitch views to be appropriate given the firm's senior lending strategy. Fitch expects leverage will remain within the lower end of the targeted range over the near-term to provide a cushion for potential valuation movements, given current market trends.

On March 3, 2016, TSLX priced its offering of 5.0 million shares of common stock. TSLX expects to receive $78.4 million of net proceeds from the offering, which will be used to repay outstanding borrowings under its revolving credit facility. Proforma, leverage will decrease to 0.69x following the paydown, which is below the leverage target. However, TSLX expects to make new investments consistent with their investment objectives and strategies, and expect leverage to fall within their targeted range over time through additional borrowings under their revolver. Fitch views positively TSLX's ability to access the equity markets in the current environment, which speaks to the strength of its franchise relative to peers.

In February 2016, the board authorized an extension to TSLX's programmatic 10b5-1 share repurchase plan to acquire up to $50 million of its common stock at prices below NAV until Aug. 31, 2016. In 2015, the firm repurchased 2,000 shares at a weighted average price of $14.44 per share during a period in August 2015 when the stock was trading at prices below NAV. As of March 2, 2016, TSLX was trading at $16.84 per share, representing an 11% premium to the December 2015 quarter-end NAV of $15.15 per share, unique among its peers in the current environment where BDC shares have been trading at an average discount of 18.3% to NAV. Fitch views positively TSLX's programmatic share repurchase program as it provides more flexible terms and fewer blackout periods than management-led repurchases, which further aligns management's interest with those of its shareholders. Fitch believes TSLX will look to extend the program when it expires in August 2016.

TSLX's investment portfolio is somewhat more concentrated than peers, as TSLX generally takes larger positions in portfolio companies given its focus on direct originations and control lending. As of December 31, 2015, the top 10 investments accounted for 40.5% of total assets and 74.9% of equity. Management represented that they target no single investment to comprise more than 5% of the portfolio and Fitch expects that issuer concentrations will continue to decline as the portfolio grows, and the order for exemptive relief from the SEC will provide TSLX with an opportunity to invest in larger transactions and increase the diversification of its investment portfolio.

Asset quality performance has been strong since inception and no investments were on non-accrual status, as of December 31, 2015. However, TSLX's operating history is relatively short, having begun investing in 2011. Consequently, portfolio performance has not been observed through a credit cycle and has been supported, in part, by favorable market conditions over the last several years.

However, TSLX continues to focus on the senior-most part of the capital structure with first-lien loans, including last out first-lien loans, representing 88.2% of the total investment portfolio at fair value. In aggregate, senior debt (inclusive of second-lien loans) represented 96.3% of the total portfolio at fair value, which compares favorably to the peer average of 71.8%. Exposure to equity and other investments, which can experience meaningful valuation volatility, amounted to 1.8% of the total portfolio at fair value, as of Dec. 31, 2015.

Oil, gas and consumable fuel investments accounted for 3.2% of the portfolio at fair value, as of Dec. 31, 2015. Fitch conducted a stress test on the firm's exposure along with the rest of the peer group, and views the valuation declines on the firm's overall leverage profile to be manageable.

Net investment income (NII) was modestly lower year-over-year in 2015, adjusting for the GAAP accrual of incentive income, as a 6.2% increase in investment income was outpaced by 27.7% growth in total expenses during the period, driven primarily by an increase in borrowings and expenses due to investment portfolio growth and other one-time charges, including the acceleration of deferred financing costs associated with the termination of the SPV facility and expenses related to involvement with TICC. While Fitch believes there is some upside to interest income in 2016, particularly if spreads widen, fee income is expected to decline due to the lower pace of refinancing activity, given a modest increase in interest rates.

TSLX's funding profile remains primarily secured, representing 82.5% of total outstanding debt. The firm has accessed the unsecured market once, issuing $115.0 million of convertible notes in June 2014. The company has no debt maturities until 2019. Fitch believes TSLX will look to access the unsecured debt markets to improve funding flexibility, if market conditions are supportive. Fitch views positively TSLX's ability to recently refinance its revolver at favorable economic terms.

Fitch considers TSLX's liquidity profile as solid, with $2.4 million in balance sheet cash and $280.9 million of available capacity under its corporate revolver, subject to borrowing base requirements and prior to the inclusion of additional proceeds from the March equity raise. The revolver has an accordion feature expandable to allow up to $1.25 billion of borrowings, providing additional contingent liquidity. Cash flows from investment repayments and exits amounted to $513.6 million in 2015, a 28.8% reduction compared to the year-prior due to lower refinancing and prepayment volume. Fitch believes the pace of repayment could slow further in 2016, particularly if loan yields increase.

NII coverage of the dividend, which adjusts for non-cash incentive payment accruals, net paid-in-kind income, was strong, amounting to 134.1% in 2015. Since 2012, dividend coverage has averaged 107.4%, which compares favorably relative to peer BDCs. The dividend is also further supported by the presence of spillover income of approximately $0.71 per share, which Fitch believes provides further stability to the dividend in the medium-term.

On Feb. 4, 2016, TSLX renewed its activist campaign against TICC Capital (TICC), seeking to elect a new independent candidate to its board and to terminate the investment advisory agreement with TICC's external manager at the 2016 meeting of shareholders. This follows TSLX's prior campaign urging TICC's shareholders to vote against its external manager's sale to Benefit Street Partners and agree to TSLX's offer to purchase the BDC at 90% of to TICC's NAV as of the signing of a definitive agreement. Based on the proxies submitted, TICC shareholders did not ultimately approve the sale and the existing advisory agreement remains. As of Dec. 31, 2015, TSLX owned approximately 1.6 million shares, or 3% of TICC.

Fitch views TSLX's activist campaign as neutral to its overall financial profile. The firm announced that it will voluntarily waive fees attributed to the firm's ownership of TICC shares. In 2015, the fee waivers amounted to $0.2 million, immaterial relative to management and incentive fees of $41.5 million, in aggregate, during the period. Generally speaking, activist campaigns associated with Fitch-rated entities do not have a rating impact, unless it has a material adverse impact to creditors. Fitch believes that not all activist activities have weakened credit profiles, as some may be neutral to mildly positive.

RATING SENSITIVITIES

IDRs AND SENIOR DEBT

Positive rating actions for TSLX could be driven by measured portfolio growth over time and successful navigation of the current challenging environment as evidenced by strong and differentiated credit performance of recent vintages. 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. The maintenance of sufficient liquidity and relatively low leverage and an improvement in funding flexibility over time would also be viewed positively by Fitch.

Conversely, negative rating actions could be driven by a material change in the firm's risk profile, resulting from higher leverage, a decline in first-lien positions or a meaningful increase in equity investments without a commensurate decline in leverage. A spike in non-accrual levels, decline in operating performance, outsized fees, or expenses attributable to the TICC campaign, as well as weaker cash dividend coverage would also be viewed negatively from a ratings perspective.

TSLX is an externally managed BDC, organized in July 2010 and commencing investment activities in July 2011. As of December 31, 2015, the company had investments totaling approximately $1.5 billion. TSLX trades on the NYSE under the ticker, 'TSLX'.

Fitch has affirmed the following ratings:

TPG Specialty Lending, Inc.
--Long-term IDR at 'BBB-';
--Senior secured debt at 'BBB-'
--Senior unsecured debt at 'BBB-'.

The Rating Outlook is Stable.