Fitch Ratings has assigned 'BBB-' expected ratings to Sixth Street Lending Partners' (SSLP) Long-Term Issuer Default Rating (IDR), senior secured debt and the proposed senior unsecured debt issuance.

The Rating Outlook is Stable.

Key Rating Drivers

The expected ratings reflect SSLP's affiliation with Sixth Street Partners, LLC, strong management team, focus on first lien investments, appropriate leverage target, solid liquidity given undrawn capital commitments and Fitch's expectations that unsecured debt will increase to at least 20% of total debt with the proposed issuance and to at least 35% over the Outlook horizon. Fitch believes SSLP's franchise and competitive positioning benefit from management's track record in other funds, including Sixth Street Specialty Lending, Inc. (TSLX; BBB/Stable).

Rating constraints include SSLP's rapid growth over a short operating history, which has resulted in elevated portfolio concentrations, the below-average proportion of unsecured funding following the proposed issuance and lack of public equity markets access, although this is mitigated by SSLP's ability to draw on capital commitments in the near term.

Rating constraints for business development companies (BDCs) include the market impact on leverage, given the need to fair-value the portfolio quarterly, dependence on access to the capital markets to fund portfolio growth and a limited ability to retain capital given distribution requirements. Additionally, Fitch believes BDCs will face weaker asset quality metrics in 2024, given the challenging economic backdrop and elevated interest rates.

Fitch views SSLP's focus on first lien debt investments, which comprised 92% of the portfolio at fair value at YE23, favorably. SSLP's portfolio has been ramping since August 2022 and grew to $3.0 billion at cost at YE23 from $809.0 million at YE22. As a result, the portfolio is heavily concentrated in recent vintages, which were originated in a favorable underwriting environment for middle market lenders as evidenced by wider spreads, tighter covenants and lower underlying leverage than in prior years.

Fitch believes SSLP's access to growth capital could be a competitive advantage if new origination opportunities are attractive, but increased competition has started to pressure middle market deal terms in early 2024.

SSLP did not have any non-accrual investments at YE23. Fitch believes current credit metrics are unsustainable over cycles, but asset quality metrics will benefit from SSLP's focus on first lien investments in larger companies within the middle market. SSLP's portfolio companies had a weighted average annual EBITDA of $170.8 million at YE23, which compares favorably to peers. TSLX, which has the same management team and investment professionals as SSLP, has demonstrated strong credit performance since its inception with better-than-peer realized gain/loss rates. SSLP has moderate portfolio concentrations, but concentrations will decline as uncalled capital is invested.

Net investment income (NII), adjusted for non-cash accruals of capital gains incentive fees, amounted to 7% of SSLP's average portfolio at cost in 2023. Fitch believes the calculated NII yield is understated given meaningful portfolio growth in 4Q23. The annualized NII yield in 4Q23 was 8%, which was above-average. SSLP's debt portfolio yield (13.7% at YE23) is above-average, which Fitch believes is driven by the concentration in recent vintage investments with wider spreads. SSLP's earnings could face some pressure in 2024 from higher non-accruals, tighter spreads and potential rate cuts, but will continue to benefit from its below-average management fee rate prior to a public listing.

SSLP's leverage (par debt-to-equity) was 0.69x at YE23, below the firm's targeted range of 0.90x-1.25x. The leverage ratio implied an asset coverage cushion of 38.9%, which is at the low end of Fitch's 'a' category benchmark range of 33%-60%. Fitch believes leverage will rise as SSLP funds additional portfolio growth, but views SSLP's ability to draw on $5.7 billion of capital commitments to manage leverage favorably.

SSLP's debt funding was fully secured at YE23, but will increase to over 20% of total debt outstanding, pro forma for the proposed issuance, which is expected to be at least $300 million in size, and repayment of borrowings under the revolver. SSLP's secured debt at YE23 amounted to 39.8% of its assets and would improve to 30.2% pro forma for a $300 million issuance. The unsecured funding mix could tick down if SSLP draws on secured credit facilities to fund new investments, but the accompanying asset growth would limit meaningful increases in secured debt as a percentage of total assets. Fitch expects SSLP will continue to access the unsecured market to bring unsecured debt-to-total debt within Fitch's 'bbb' category benchmark range of 35%-100% for BDCs over the Rating Outlook horizon. Failure to do so could result in negative rating action.

Longer term, Fitch believes SSLP's growth could be constrained if it is unable to access the public equity markets. The undrawn committed capital commitments currently serve as an offset, but Fitch would view a public listing favorably.

Adjusted NII amounted to 126.2% of dividends declared in 2023. Adjusting for non-cash income and expenses, dividend coverage was 106.6%, but improves meaningfully to 147.1% if further adjusted for participation in the dividend reinvestment plan. Paid-in-kind income represented 6.1% of interest and dividend income in 2023, which was below-average.

The Stable Rating Outlook reflects Fitch's expectations that SSLP will increase unsecured debt to at least 35% of total debt over the Outlook horizon, manage leverage within its targeted range, continue to focus on first lien investments, demonstrate solid asset quality metrics, maintain sufficient liquidity and solid dividend coverage.

RATING SENSITIVITIES

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

Upon execution of an unsecured debt issuance which brings unsecured debt to at least 20% of total debt, pro forma, Fitch would expect to convert SSLP's expected IDR to a final IDR of 'BBB-' and expected debt ratings to final ratings.

An inability to improve funding flexibility, such that unsecured debt was sustained below 35% of total debt; a sustained increase in leverage above the targeted range; deterioration of the portfolio risk profile, such that first lien positions declined materially as a proportion of the overall portfolio, without a commensurate decline in leverage; a sustained meaningful increase in non-accrual levels; meaningful realized or unrealized losses; weaker cash-based NII coverage of the dividend; or an impairment of the firm's liquidity profile could result in negative rating action.

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

SSLP's short operating history and the potential that the firm will be unable to access the equity markets for capital barring a public listing limits the likelihood of positive rating momentum over the medium term.

If SSLP gained access to the public equity markets, factors that could, individually or collectively, lead to positive rating action/upgrade over time include strong and differentiated credit performance and demonstrated economic access to unsecured funding that results in unsecured debt increasing to over 40% of total debt. An upgrade would also be conditioned upon the maintenance of leverage within or below the targeted range, enhanced portfolio diversity, solid liquidity, strong cash earnings coverage of the dividend and consistent core operating performance.

DEBT AND OTHER INSTRUMENT RATINGS: KEY RATING DRIVERS

The alignment of the expected secured and unsecured debt ratings with the expected Long-Term IDR reflect Fitch's expectations for solid collateral coverage for all debt classes since SSLP is subject to a 150% asset coverage requirement. The expected unsecured debt rating reflects management's representation that the initial issuance would bring unsecured debt to at least 20% of total debt, combined with Fitch's expectation that unsecured debt will increase to at least 35% of debt.

DEBT AND OTHER INSTRUMENT RATINGS: RATING SENSITIVITIES

If the expected ratings assigned to the secured and unsecured debt were converted to final ratings, they would thereafter be sensitive to changes in the Long-Term IDR and the firm's funding mix.

ADJUSTMENTS

The Capitalization & Leverage score has been assigned below the implied score due to the following adjustment reason(s): Historical and future metrics (negative).

The Funding, Liquidity & Coverage score has been assigned above the implied score due to the following adjustment reasons: Historical and future metrics (positive), Liquidity coverage (positive).

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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