Carlyle Secured Lending, Inc. (CGBD) Q1 2021 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the TCG BDC First Quarter 2021 Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to your speaker host, Allison Rudary. Please go ahead.

Good morning and welcome to TCG BDC’s first quarter 2021 earnings call. Last night, we issued an earnings press release and detailed earnings presentation with our quarterly results, a copy of which is available on TCG BDC’s Investor Relations website. Following our remarks today, we will hold a question-and-answer session for analysts and institutional investors. This call is being webcast and a replay will be available on our website. Any forward-looking statements made today do not guarantee future performance and undue reliance should not be placed on them. These statements are based on current management expectations and involve inherent risks and uncertainties, including those identified in the Risk Factors section of our Annual Report on Form 10-K that could cause actual results to differ materially from those indicated. TCG BDC assumes no obligation to update forward-looking statements at any time. With that, I will turn the call over to our Chief Executive Officer, Linda Pace.

Thank you, Allison. Good morning, everyone and thank you for joining us on our call this morning to discuss our first quarter 2021 results. Joining me on the call today is our Chief Investment Officer, Taylor Boswell and our Chief Financial Officer, Tom Hennigan. I would like to start by highlighting the continued strong momentum we have established in our business. Our financial results for the quarter, which Tom and I will detail later, were solid. And importantly, our portfolio’s credit profile continues to improve. Going forward, we expect that credit will continue to strengthen alongside the macroeconomic recovery as we move further away from the depths of the health crisis in the U.S. Overall, we are pleased with our current positioning and are confident in our ability to generate and sustain attractive income for our shareholders. I’d like to turn now to the financial highlights of the quarter. We generated net investment income of $0.36 per common share and declared a total dividend of $0.36. This includes the base dividend of $0.32 and a $0.04 supplemental dividend. As we have noted before, we expect earnings to continue to be well in excess of our $0.32 base dividend. We ended the quarter with net asset value per share of $15.70, up $0.31 from last quarter for an increase of 2%. Driving this increase was a combination of improving market yields and more importantly stronger overall credit performance. This marks our fourth consecutive quarter of NAV growth since the first quarter of 2020. And since then, net asset value has increased 11%. Additionally, we repurchased almost $6 million of our common stock at an average discount of 22% of our net asset value. This resulted in $0.03 of accretion to net asset value. We continue to be consistent active repurchasers of our shares. Turning to the investment environment as we look forward, the markets in which we operate continue to be very active. And broadly speaking, the economic environment is recovering rapidly from last year of sharp contraction. As Taylor will detail later, broadly syndicated markets experienced an exceptionally strong quarter, but our focus area in the middle markets still provide compelling relative value. And we continue to close on attractive investment opportunities. Despite a competitive landscape, our deal pipeline is robust, both in our core markets and those adjacent areas of the credit markets where we have deep expertise. We remain focused on leveraging the competitive advantages that accrue to us from the breadth of the Carlyle platform to originate differentiated new business. Our broad sourcing funnel allows us to be highly selective. And as always, we construct our portfolio to be defensive, high quality and diverse, the aim of which is predictable, stable income generation throughout all market cycles. I would also like to take a moment to welcome Billy Wright who joined our Board of Directors last quarter as an Independent Director. Billy brings a great deal of experience and credit to our board. We are glad to have the benefit of his expertise as we continue to deliver on our key objectives for our shareholders. I will now hand it over to our Chief Investment Officer, Taylor Boswell.

Thank you, Linda. As usual, I will begin with some quick comments on Carlyle’s current macroeconomic perspectives, which we develop based upon inputs from across our global footprint. Keeping with the themes of the last year, our proprietary data again show sharp divergence across economies. China, which grew 3% in 2020, is evidencing signs of decelerating, but still solidly positive growth as its post-pandemic catch up phase out. Conversely, European lockdowns have generated a second quarter of economic contraction. In the U.S. as we expected, the economy is accelerating significantly on the back of improved confidence in vaccine distribution, reopening and massive fiscal stimulus, the latter of which is expected to boost household income by 5% of GDP this year. Our data suggests significant growth versus both 2020 and 2019 in the most income sensitive spending categories. Of course, with a 91% U.S. based investment portfolio, this establishes a strong fundamental operating backdrop for the vast majority of our borrowers. As the year has progressed, we have seen increased incidences of inflation globally, often the result of understandable, but ultimately overly conservative management decisions to take capacity offline in 2020. These capacity constraints are combining with pent-up demand to generate pockets of price spikes and shortages, especially in the industrial sector. However, at this time, life policymakers, we also view most of these increases as transitory, with a low likelihood of long-term runaway inflation. In the portfolio, we are monitoring for the effectiveness of price pass-through mechanisms, input substitution, and other management actions, which we expect will support continued strong credit performance. Liquid leverage finance markets have remained extremely active year-to-date, with both the broadly syndicated balance and high yield markets posting their busiest new issue quarters on record, an astonishing fact. The reason is obvious to all here. In today’s low interest rate environment, the execution offered by these asset classes is extremely attractive to both borrowers and investors alike. While we do not see a near-term catalyst for these market conditions to change, we are not concerned about operating effectively if they prove persistent. In fact, we are pleased that our business is demonstrating sustainable performance through this period. In this environment, repayments across credit markets have picked up and will continue to occur as transaction velocity increases. This has been especially true in our MMCF 1 JV, as larger EBITDA borrowers are more susceptible to rotation into liquid markets. However, our core middle-market borrower base has seen a slower pace of repayment activity year-to-date. Many of these assets were priced in higher LIBOR environments and do not offer significant spread savings as well as often possessing strong fundamental reasons to remain in private credit markets. Meanwhile, we are, as a business, finding ample attractive new opportunities to deploy capital. After the remarkable return of deal activity in the fourth quarter, where pent-up transaction demand from COVID matched with owners’ desires to sell ahead of potential tax or regulatory changes, one might have expected a material slowdown in Q1. But in fact, we were extremely active on the originations front in the first quarter, employing 151 million across 10 borrowers at an 8.4% average yield. This activity again comfortably outpaced $73 million of repayments in the period. The remainder of our portfolio exits for tactical sales, taking advantage of robust secondary market prices as part of our active portfolio management strategy. All-in, the yield on our sales and repayments was approximately 7.8%. The core secular drivers of our asset class remain intact, while the breadth and quality of origination available to us from the Carlyle platform allow us to maintain and grow our portfolio as maybe required across the investment cycle. At the same time, you will see we posted another solid quarter of credit improvement in earnings generation. Whether from an asset base, income or credit perspective, we feel our business is on sound setting to deliver for shareholders in 2021. As always, thank you for your time and support. Tom?

Thank you, Taylor. So now, I begin with a review of our first quarter earnings then I will provide further detail on the portfolio and our balance sheet positioning. As Linda previewed, we had another stable quarter on the earnings front. Total investment income for the first quarter was $41 million, that’s down from $44 million in the prior quarter primarily due to two main factors: first, a full quarter impact of lower average loan balance following the closing of our second JV in November; and second, lower OID accretion and prepayment fees due to lower loan repayments in the first quarter. This was partially offset by an increase in total dividend income from the two JVs, which increased due to full quarter impact from MMCF 2. Total expenses were $20 million in the quarter, down from $22 million last quarter. The largest component of the decrease was lower credit facility fees. The result was net investment income for the quarter of $0.36 per common share, or $20 million, right in line with guidance we provided during the last quarter’s earnings call. On May 3, our Board of Directors declared the dividends for the second quarter of 2021 at a total level of $0.36 per share. That comprises the $0.32 regular dividend plus the $0.04 supplemental, which is payable to shareholders of record as of the close of business on June 30. Similar to last quarter, as we look forward to the rest of 2021, we remain very confident in our ability to comfortably deliver the $0.32 regular dividend, but continue the sizable supplemental dividends. In line with the $0.04 to $0.05 we have been paying the last few quarters. Moving on to the performance of our two JVs, total dividend income was $7.5 million, up from $6.5 million last quarter. The increase was due to a full quarter impact of MMCF 2. On a combined basis, our dividend yield in the JVs was about 10%, in line with the prior quarter. Total assets at the JVs were down from $1.3 billion to $1.2 billion due to another wave of repayments that occurred at MMCF 1s later in the quarter. However, we have had positive momentum with new originations for that vehicle early in the second quarter. So going forward, we expect stable aggregate assets yield and dividend generation from the two JVs similar to the first quarter’s results. On valuations, our total aggregate realized and unrealized net gain was $15 million for the quarter, the fourth consecutive quarter of positive performance following the drop in March of 2020. Similar to the last three quarters, we saw valuations increase based on the continued rebound in market yields, plus improving fundamental credits. Using the same bucket that’s outlined in prior quarters, we again saw improvement across the board. First, performing lower COVID impacted borrowers plus our equity investments in the JVs, which accounts for combined 70% of the portfolio increased in value about $4 million compared to 12/31. Second, the assets that have been underperforming pre-pandemic, so much of COVID exposure were up $5 million, marking the fourth consecutive quarter of stability for improvements for this group. The final category is the moderate to heavier COVID impacted names. We continue to see a rebound in actual results and improvement in recovery prospects for these investments. Collectively, they also experienced the net $5 million increase in value. Given we are still in the early days for a sustained recovery for some of these borrowers, we continue to be appropriately conservative in our assessment of these credits. I will turn next to the portfolio and related activity. We continue to see overall stability and improvement across the book. Total non-accruals were flat at 3.3 based on fair value. And as we sit here today, we don’t see any additional loans at risk of non-accrual. The total fair value of transactions risk rated 3% to 5%, indicating some level of downgrade since we made the original investment is down again this quarter by about $33 million in the aggregate. Total M&A activity slowed down meaningfully in the first quarter, as we expected. We have two material amendments that closed for borrowers specifically impacted by COVID. Important point to note is that in exchange for covenant relief, sponsors injected significant incremental dollars to support the liquidity needs of each business. I will finish with a review of our financing facilities and liquidity. We continue to be very well positioned with the right size of our balance sheet. That said, we are always exploring various alternatives in both the private and public markets, particularly given the current issue of friendly financing environment. Regarding 03/31 results, statutory leverage was stable at about 1.2x, more net financial leverage, which as soon as the preferred is converted into this metric we used to manage the business for the game right around one turn of leverage. So, we are sitting close to the lower end of our target range of 1.0x to 1.4x, giving us flexibility to invest prudently in new attractive opportunities. And regarding the preferred equity issuance for May 2020, our stock continues to trade well above the conversion price. But as we previously noted, this instrument remains a long-term investment by Carlyle and BDC. So, there currently is no intention to convert. With that, back over to Linda for some closing remarks.

Thank you, Tom. I will finish where I started and note the strong momentum and performance in our company that will continue to drive attractive and sustainable income generation for our shareholders. We appreciate your support. And thank you for your time this morning. I would like to now turn the call over to the operator to take your questions.

[Operator Instructions] And our first question is coming from the line of Melissa Wedel with JPMorgan. Your line is open.

Good morning, everyone. Thanks for taking my questions today. A couple of interesting things in this quarter. First of all, I was noticing that there is some second lien issuance that was a little bit elevated compared to prior quarters. Just wondering if you could elaborate on sort of the relative value that you are seeing up and down the capital structures? Thank you.

Hey, thank you so much, Melissa. It’s Taylor picking that one up. I think that, that doesn’t represent any significant change in terms of our approach to originations and balance of the portfolio over time. And maybe it’s just more reflective of the opportunities that we saw in light in this particular period. But what I would say to you is that in our business, whether it’s a sub-asset class or product category, or a sector, even when portions of the market might comprehensively offer better or worse, well, now, we are always really kind of looking for the individual credit investment and tend to find those that we like, given those verticals. So interestingly, while we have a little more second lien origination, we really like those credits that we booked. I think the second lien market right now is probably comprehensively not as much of a source of relative value of other aspects of the market. And so I wouldn’t read into that, that we are doing deals we don’t like, rather we are finding investment conviction in credits we know and like very much within those markets, even if the whole market has less the relative value construct right now for large second lien borrowers. At the same time, I think the core middle market senior product continues to offer great relative value across that entire asset base. So again, deals we like out of a very big origination funnel, not necessarily a reflection of a view that that’s where the best relative value is comprehensively in the market today. Is that responsive?

That’s really helpful. Thank you. Follow-up question on the repurchase activity, which obviously discontinue in the March quarter, but was a bit lower from 4Q level of repurchase. And I am just wondering if you could help us understand the framework that you use to think about the sizing and pace of repurchase from quarter-to-quarter. Thanks so much.

Sure, Melissa. Hi, it’s Linda. Thanks for the question. Well, I think the first thing to state and excuse me, allergies are kicking in here is that we are – we do think there is a lot of value in our stock. And we continue to be consistent re-purchasers of it, but we will obviously scale those who purchases based on how accretive they are overall, and that will fluctuate as our as our stock price fluctuates. So, it shouldn’t be a surprise that we purchased a bit less this quarter. Repurchasing our shares was a bit less accretive this quarter than it had been in prior quarters. But nevertheless, again we continue to see great value in our shares. So, you should continue to see repurchases at least in the near future. And we have just as a side note, we have plenty of room and plenty of time left on our repurchase authorization that the Board gives us each year.

Thank you, Linda.

You’re welcome.

And our next question is coming from the line of Paul Johnson with KBW. Your line is open.

Yes. Good morning, everybody. Thanks for taking my questions. I realize you have mentioned this at the end of your prepared remarks and this has also been asked on previous calls as well. But I am just wondering on the preferred equity piece in your capital structure, have you guys assessed any of the dilutive impact from a potential conversion or even just a pay-off of that investment? And then also on that investment, I am just also curious is this – is the preferred equity essentially controlled by the advisor itself, with discretion over the prepayment of that investment or is this something that’s fun that’s maybe outside of the control of the advisor?

Hey, good morning, Paul, it’s Tom. To hit the second point and last part in terms of the actual investment who holds it, it’s held by Carlyle, the advisor. So, it is obviously part of Carlyle. We look at it as clearly friendly money. And any decisions will certainly be made with our management team as well as with Carlyle, noting that whatever the – sometime down the road, the ultimate realization of that product, there are certain requirements for board approval as well in terms of the same way the liquidity will come from. So, we think it certainly is very much friendly paper it’s going to be long-term Carlyle’s investment and support for this business. And when the time is right, sometime down the road, a collective decision across both BDC, the BDC Board and Carlyle, the manager. In terms of the accretive effect, you could see we report, the fully diluted shares, it’s something to the tune of 5 million shares if and when converted and that would have the commensurate impact on earnings. Obviously, we would not be paying the prep dividend, which is roughly 900,000, the cash rate per quarter, which is 7% rate, but then we would be paying the common dividend. So, the net impact would be $0.02 or so per share per quarter.

Okay, okay. Thanks for that. And not to prolong that topic anymore, I guess, but as you say, it’s part of your long-term financing plan for the BDC. I am just curious how you balance that out in context of today’s capital markets, where obviously we see BDCs issue unsecured debt at much lower rates 3%, 4% handles, some even lower than that. How do you balance that out in terms of dealing a 7% piece of financing when you can issue potentially lower in the unsecured markets?

Sure. And from a broader capital structure perspective, we are very comfortable with our current balance sheet, well-positioned with our flexible corporate revolver with an attractive long-term CLO that’s well suited for our heavy first lien portfolio and of course, the unsecured debt that we raised the last 2 years. So they are well positioned. We are certainly looking at the current hot market whether it be for unsecured, whether it be the CLO market, obviously, a lot of moving pieces and we would certainly be factoring in the impact of a bond offering at a lower interest rate, but then offsetting would certainly be the dilutive impact of, let’s say, a conversion or a repayment of the press. So I think – but I think that our analysis would suggest that certainly, Carlyle was a long-term holder with that prep is that, that will remain a long-term part of the capital structure, no intention right now to convert, no intention to repay it.

Okay.

Hi, Paul. It’s Taylor. I do think it’s important in the context of the convert to go back to the circumstances in which we – there was putting the capital structure which was sort of in the depths of the coronavirus crisis last year. And so the firm really thought that, that was a strong statement of support for the company at the time. And that execution was done on terms that probably wouldn’t have been available in the market at those times. And then if you flash forward to today, I do think it’s also important to callout that many of the attributes of that security are not replicable in other respects for the company meaning it’s perpetual duration, it’s pick toggle option. There is a bunch of attractive features of that security still today for that instrument. And so we don’t have any intention to convert in the near-term as Tom said, but yes, we don’t feel like it is an inappropriate portion of our overall capital structure at $50 million in size.

Okay. Yes, thanks for that. Then my last question was just on the JVs, I know you’ve been de-leveraging slightly over well, quite a bit over the last couple of years in the market credit fund number one, your list has been declining obviously as kind of a result of that. I calculate roughly like a 9.3% yield or so annualized yield for that JV this quarter. I am curious is that kind of the yield that we should expect going forward just given all the de-leveraging that’s taking place there or could we expect maybe potentially a higher return if you are going to be placing more investments into the fund?

Hey, Paul. Yes, it’s Tom, again. When you think – when you compare the current status of that JV lower leverage and certainly as we look at new investments now, perhaps slightly higher yield from a spread perspective, relative to historically you’ve had higher leverage in the vehicle, but perhaps much lower yielding assets, more broadly syndicated assets that, let’s say, had a plus 400 handle, you will see some of those legacy investments still in the portfolio. So, as we look going forward, the leverage will certainly be – I think in the ballpark of where it is now perhaps a little bit higher, but we will be looking for higher yielding assets relative to where the portfolio is right now. So, I think that right now, I’d say that, that 9% is a range of let’s say, 9% to 10% or 11% is at the bottom end of our range. I think we will be comfortably in that range based on some recent enhancements to our main credit facility. We have potentially have an ability to achieve some higher yields, but I think we feel really comfortable with the 9% and based on both on the asset side and the liability side, a little bit of movement potentially to move that up. I think we are comfortable with kind of a 9% to 10% target and again, some potential upside based on our current assets, targets and also our some recent developments and then also closed at our main credit facility.

Thanks for that. That’s very helpful. Those are all my questions. Thanks a lot.

[Operator Instructions] And I am showing no further questions at this time. I would now like to turn the call back over to the speakers for closing remarks.

This is Linda. I want to thank everyone for joining us on our call today. And please follow-up with Allison if you have any other further questions. Have a great day. Thanks.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may now disconnect.