Carlyle Secured Lending, Inc. (CGBD) Q2 2021 Earnings Report, Transcript and Summary

Thank you for standing by, and welcome to TCG BDC's Second Quarter 2021 Earnings Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference maybe recorded. [Operator Instructions] I would now like to hand the conference over to your host, Head of Investor Relations, Allison Rudary.

Good morning, and welcome to TCG BDC's second 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 they 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. And with that, I'll 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 second quarter 2021 results. Joining me on the call today is our Chief Investment Officer, Taylor Boswell; and our Chief Financial Officer, Tom Hennigan. I want to focus my remarks on three areas. First, I'll touch on a few portfolio highlights. Second, I'll provide a review of our second quarter results. And third, I'll share some thoughts on the current market environment. Let me start by highlighting our portfolio activity and current credit position for the quarter. As we previewed last quarter, our deal activity in the second quarter was extremely robust, outpacing even the volume of the fourth quarter. We originated over $213 million of loans across a diverse array of new borrowers and add-ons for existing portfolio companies. Overall, the portfolio is sitting at just under $1.9 billion and we continue to find ample attractive new deployment opportunities in today's market. We're pleased to report that credit performance continues to strengthen alongside the macro-economic recovery. Over the past several quarters, we've seen tangible evidence of cyclical recovery across the portfolio, including those names most impacted by COVID. Fundamental performance is solid, our watchlist continues to trend down as a percent of the portfolio, and our portfolio internal risk rating continued to improve. Importantly, we have seen no new non-accruals in the last year and we're confident in the trajectory and progress we're making in each of our four non-accrual names. We're proud of the performance of the portfolio through COVID. And most importantly, we see the current trajectory of improving performance and solid credit continuing on its current upward path. I'd like to turn now to the financial highlights of the quarter, we generated net investment income of $0.38 per common share, and declared a total dividend of $0.38. This includes a base dividend of $0.32 and a $0.06 supplemental dividend in line with our policy of regularly distributing substantially all of the excess income earned over our base dividend. As Tom will detail later, we see earnings continuing in the context of $0.36 to $0.37, as we've reported over the last several quarters, which remains comfortably in excess of our $0.32 base dividend. Net asset value per share increased 2.8% or $0.44 from $15.70 to $16.14 while improving market yields drove some of this increase, NAV was substantially bolstered by stronger overall credit performance, particularly in those names impacted by COVID. We've taken an appropriately conservative approach to valuation through this cycle and we expect continued underlying fundamental improvement to drive positive NAV migration in the coming quarters. Additionally, we repurchased $8 million of our common stock, resulting in $0.02 of accretion to net asset value. We care deeply about our shareholders total return experience, and at our stock's current valuation, we'll continue to be consistent active repurchasers of our shares. Turning to the investment environment. Investment activity across our business footprint in the second quarter was amongst the highest on record reflective of the active transaction environment and consistent with the trends in private equity and broadly syndicated loan markets. We view the investment opportunity set in our market as highly attractive, especially on a relative risk reward basis, and are actively deploying capital into those transactions we regard as most compelling. At the same time as you would expect, we remain highly selective investors, vigilant on risk and thoughtful in portfolio construction. With this backdrop, we're confident in our ability to continue to generate and sustain attractive and stable income for our shareholders. Finally, I'd like to take a moment to welcome Aren LeeKong who joined our board of directors in June as an independent director. Aren brings a great deal of expertise in both leveraged finance and middle market private equity to our board. We're pleased to have the benefit of his counsel and experience. I'd like to now hand the call over to our Chief Investment Officer, Taylor Boswell.

Thanks, Linda. As usual, I'll begin with Carlyle's macroeconomic perspectives. And then I'll share thoughts on our investment approach to stay as highly active and competitive market. Global growth accelerated in the second quarter as vaccine distribution progressed, health restrictions ease and economies reopened. U.S. GDP grew at an annualized 6.5% in the first quarter, while the Eurozone and Chinese economies expanded at 8% and 5% respectively. Most strikingly, households in the U.S. continued to spend freely and we have seen a 20% year-to-date increase in our discretionary spending index relative to 2019. This year's acceleration in economic activity, paired with the pandemic related disruptions in the last year caused headline Q2 inflation to reach levels not seen in over a decade. Recently realized inflation remains concentrated in certain supply constrained sectors, such as autos, materials and energy. We expect many of these pressures to ease in coming quarters as capacity expands and consumer spending patterns revert. One place we're keeping a close eye on is the labor market, where we see more risk as the year progresses, given continued tight labor availability. Despite these pressures, corporate profits are expanding across many sectors, thanks to significant productivity improvements, including a broad base increase in the adoption of technology. In total, we judge the macro backdrop to be highly supportive of continued credit performance, both generally and in CGBD's portfolio. The velocity with which our markets have recovered after 2020 severe shock is remarkable. Like 2019, we're again in a very robust transaction environment and the key metrics in our industry spreads fees leverage and the like are now broadly in line with the pre-COVID period. We've come full circle and the operative question for today's market is the same one as 2019. How will you drive out performance in a competitive environment? Across our platform, we have windows into the vast majority of credit risk markets and we can report with high confidence that there is no avoiding competition, non-sponsor finance, non-technology lending, not in ABL, not in liquid markets, not in any investment market of reasonable depth or scale. Yes, there are varying degrees of competition for any given deal. But as it relates to building diversified credit portfolios, the last decade central bank policies have made obsolete the question of how do you avoid competition? Rather, the right question is how do you win in the face of competition? Here's how we do it at Carlyle. First, we leverage our leadership position in middle market sponsor finance to win the deals we want to win, and in so doing avoid adverse credit selection. We accomplish this by maintaining a heavy investment in direct origination, offering a complete leverage finance product set at scale, possessing underwriting and execution expertise to move with speed and conviction and delivering value to borrowers beyond our capital in as many ways as possible. In short, we use Carlyle's platform to create an extremely broad investment funnel and we pair it to the highly relevant solution set for potential borrowers, allowing us to be both highly credit selective and trusted partners for financial sponsors. It's critical to remember, we're operating in a market where demand for capital is growing at least as strongly as the supply of capital and a market with an extremely fragmented competitive set. Our platforms competitive advantages are real and sustainable, and stand in stark contrast to the average player in the market. Where deal sourcing and relevance of offering maybe more constraints. We're comfortably on the right side of the competitive landscape and fortunate to operate in a market, which offers extremely strong relative investment value. Second, we complement our first dollars sponsor finance business with additive private credit assets were Carlyle possesses similarly deep expertise, such as asset-backed, non-sponsor and recurring revenue lending. The value in this exercise is not that these markets are categorically better or worse than our core market. Rather, the value is that they are fundamentally different than our core assets, allowing us to diversify risk factors in our book. Tactically assess relative value deal-by-deal and be even more credit selective. We are confident that complementing our core with these other safe and defensive private credit profiles will result in better portfolio construction, and investment results on a through cycle basis. Finally, we are intensely focused on deploying the advantages of the Carlyle platform against every investment opportunity and every aspect of our operations. From origination to diligence, to execution to portfolio management, we understand our edge, apply it with rigor, and seek to extend it in all possible ways. At Carlyle, we sit alongside hundreds of talented investment professionals with specific expertise across sectors, geographies and asset classes, from which we can derive investment insights to both capture opportunities and avoid mistakes. In addition, we leverage fully staffed and highly capable teams in capital markets workout, liability management, and ESG to name just a few. When properly applied, it's hard to overstate the extent to which these capabilities create and sustain edge for CGBD. In summary, our market offers a highly attractive investment opportunity characterized by growing demand for capital, high current income, and significant downside protection. It makes all the sense in the world that people want exposure to it, and that there would be ample competition. At Carlyle, our platform equips us to win the business we want to win in competitive markets and across cycles. Harnessing these competitive advantages has been exactly what Linda, Tom and I have been focused on these past two years. And we're confident that it will continue to produce strong investment results. As always, thank you for your continuing support. I'll now hand the call over to our CFO, Tom Hennigan.

Thank you, Taylor. Today I will begin with a review of our second quarter earnings that I'll provide further detail on the portfolio and our balance sheet positioning. As Linda previewed, we had another very solid quarter on the earnings front. Total investment income for the second quarter was $43 million that's up from $41 million in the prior quarter, primarily due to two main factors. First, higher core interest income on our investment book and second, higher amendment and underwriting fees. Both OID accretion from repayments and income from the 2 JVs were flat versus prior quarter. Total expenses were $21 million in the quarter up modestly from $20 million last quarter. The result was net investment income for the quarter of $21 million or $0.38 cents per common share, exceeding the general guidance we've been providing during recent earnings calls. On August 2, our Board of Directors declared the dividends for the third quarter of 2021 at a total level of $0.38 per share that comprises the $0.32 base dividend, plus a $0.06 supplemental, which is payable to shareholders of record as of the close of business on September 30. Similar to prior quarters as we look forward to the rest of 2021 and beyond, we remain very confident in our ability to comfortably deliver the $0.32 base dividend plus continue the sizable supplemental dividends in line with the $0.45 we've been paying the last few quarters. Moving on to the performance of our 2 JVs. Total dividend income was 7.5 million in line with last quarter. On a combined basis, our dividend yield from the JVs inched up from 10% closer to a 11%. Given we're able to make return of capital at MMCF 1 following a recent favorable amendment under our primary credit facility. Total assets at the JVs increased from $1.2 billion to $1.3 billion reversing the recent trend of declines that have been driven by repayment headwinds. Linda noted the robust due originations across our direct lending platform. This was particularly evident in the MMCF 1 portfolio with fair value increasing by over 10% in the second quarter. Going forward, we continue to expect stable dividend generation from the 2 JVs similar to this quarter's results. On evaluations our total aggregate realized and unrealized net gain was $21 million for the quarter. The fifth consecutive quarter of positive performance following the drop in March 2020. Using the same buckets I've outlined in prior quarters, we again saw improvement across the board. First, performing lower COVID-impacted names plus our equity investments in the JVs, which accounts for combined 70% of the portfolio increased in value about $8 million compared to 3/31. Second, the assets that have been underperforming pre-pandemic, so which have COVID exposure were up $4 million, marking the fifth consecutive quarter of stability or improvement. This included in exit at par of our investment in Plano Molding. The final category is the moderate to heavier COVID-impacted gains. We continue to see improvement in fundamentals and recovery prospects for these investments. Collectively they experienced a net $9 million increase in value. I'll 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 this was the fourth consecutive quarter with no new additional non-accruals. Similar to last quarter, we don't see any additional loans at risk of non-accrual. As Linda noted, we also see potential for improvement in the level of non-accruals over the next 12 months. The total fair value of transactions risk rated 3% to 5%, indicating some level of downgrade since we made the investment improved again this quarter by $14 million in the aggregate. While over $15 million in transactions experienced some level of upgrade. While there remain some unfinished work, we're very pleased with the continued positive momentum and the performance of the overall portfolio. I'll finish with a review of our financing facilities and leverage. We continue to be very well positioned with the right side of our balance sheet. Statutory leverage was again stable at about 1.2x, while net financial leverage, which as soon as the preferred is converted in a risk metric we used to manage the business was again right around one turn of leverage. So we're sitting close to the lower end of our target range of 1.0x to 1.4x giving us flexibility to invest prudently in the current robust field environment. And regarding the preferred equity issuance for May 2020. I'll reiterate again, this instrument was a strong sign of support by Carlyle during the darkest days of the global pandemic. And it continues to be a long-term investment by Carlyle in our BDC. So currently, there is no intention to convert. With that, back over to Linda for some closing remarks.

Thanks, Tom. Before turning to your questions, I'd like to conclude by noting that we are very pleased with the current momentum embedded in our business. The engines we have in place, mainly the talent and hard work of our team here and throughout Carlisle are driving attractive and sustainable returns for our shareholders. And let's enjoy the remaining weeks of summer. And with that, I'd like to now turn the call back over to the operator to take your questions.

Thank you. [Operator Instructions]. Our first question comes from the line of Ryan Lynch of KBW. Your line is open.

Hey, good morning. Thanks for taking my questions. But first one you were talking about the competitive environment that that's out there today in the Direct Lending market, which has been very clear to us. And you talked about how you guys are coming to the market and how you guys can hopefully win deals. And I was hoping to get is they get a little more background on where you guys stand as a direct lending platform. I'd love to hear what sort of AUM you guys can currently come to the market that's currently dedicated to the Direct Lending space across the Carlyle platform and obviously CGBD can participate with. And what sort of commitment sizes you all can make across the platform, because that's obviously one way to help win deals is to be able to commit to larger hold sizes, able to offer fuller solutions. And as we've seen the direct lending market grow and grow, we've seen larger solutions becoming a competitive advantage. So I just would love to hear an update on where you guys stand there from a platform standpoint?

Yes, sure. Thanks Ryan, it's Taylor and happy to pick up that question. So just to provide a couple of points of context around that, Carlyle's overall global credit business is about $60 billion of AUM and so while CGBD is a really important vehicle, and flagship vehicle for us at $1.9 billion of AUM, it does represent a small portion of our total capital base aligned against these markets. And what I would say also about that $60 billion of AUM at Carlyle is we really have built a credit business that focuses down on core corporate leveraged finance markets. So the vast majority of that AUM is targeted right in the places where you think Carlyle would be good, corporate levered credit, private transactional levered credit, and the like. And so collectively, that does give us a very full product suite, to deliver to the marketplace, which really enhances our relevance in the marketplace as well as our hold sizes to get specifically into illiquid credit, which you can kind of shorthand as a direct lending business or the relevant private corporate credit markets, we managed about $15 billion in capital across the platform in those strategies, and so we have a very material footprint. Specifically around hold sizes, we've done transactions on our platform as large as $750 million in total commitment size. Now obviously, individual positions that flow into CGBD end up being smaller, but it's a material market presence. One thing, I will call out for you though, is unlike some players in the market, we really remain focused on the core middle market, that $20 million to $75 million EBITDA business, and a lot of the very large transactions that are printing in the Unitranche market and appropriately getting significant headlines, those are far larger borrowers where the competitive set is competing with traditional leveraged finance markets, broadly syndicated loans and high yield markets and the like. So, our capital base is very relevant, very scaled, but you're less likely to see us competing head-to-head in large cap markets against broadly syndicated and high yield, and more likely to see us kind of sticking to that middle market knitting where you don't have to go head-to-head with both private credit and traditional liquid market financing sources. So sorry, for the long answer. I hope that's broadly responsive to the question.

Nope, that's very helpful, very good context and color on your overall platform, good to hear. The other question that I had, which you guys have kind of talked about in the past and reiterated it, but you talked about the convertible preferred stock being kind of a long-term financing solution which you guys intend to hold and I think you said, you view that as an attractive source today, I mean you guys have been able to issue liability, unsecured notes recently at 4.5%. I wouldn't be surprised if you could do something less than that in today's market. So why is paying 7% cash on a convertible preferred, an attractive source of financing when you're able to tap unsecured notes at 4.5% and then depending on your answer that we can get into converting that, what does that look like? How does that look like from a manager converting at a sizable discount, the external manager converting and having and making a sizable profit from supporting the BDC, I don't know if that's a great look either, but I just don't understand that comment why paying 7% is attractive source when you guys are issuing debt for significantly below that.

Yes. Hi, Ryan, it's Linda. I'll start and then maybe turn it over to Tom. So just to kind of reiterate if you recall, when we put the convert in place, life was pretty dire, right our stock price was half of what it is today, we're in the middle of the pandemic, we're looking at really how to make sure our balance sheet was strong and defensible during a time that was - just an enormous amount of uncertainty. And Carlyle coming in and doing the preferred was a really great testament not only to their support of our business, but also to just really help us achieve the goals that we wanted to achieve at that point in time. So, I'd like really people to kind of just put all of this in context. For Carlyle, it's a great show support, but let's not forget it, it is $50 million for Carlyle, and it's $50 million for our balance sheets. So it's relatively small, and Carlyle, this is strategic right they're not looking to convert this anytime soon, it's here to support the business, and we really look at this as equity. So, compared to our dividend yield on our common stock, this is paying 7%, which is we think, actually a pretty attractive piece of equity for our balance sheet. And converting it is just not really in the cards. So I would just encourage people to think of this really as permanent equity, which you may view as expensive, but we actually view as pretty, pretty cheap. And know that this is not something that is going to dilute our current shareholders really in the foreseeable future that that we can tell. So and we're pretty conscious of that, when back when we issued this, we didn't want to dilute shareholders especially back in the Spring of 2020 and that's still our view now, there's no reason to dilute current shareholders, not when Carlyle is standing behind the business like it is. Tom, maybe you could kind of talk about our unsecured, and then just the rest of the balance sheet and how we're thinking about that?

Yes, sure. I will just add, I think we have the best performance, we have the financial flexibility, effectively equity, we manage the business as if it's equity, we get credit under our leverage facilities as if it's equity. So certainly from the financial flexibility perspective, we think it's well priced equity. So managing the business would mean we have to have this in the capital structure, we would have better capital structure. We've got diversified funding sources of our traditional corporate rollover with very attractive CLO vehicle that's got north of two years left under its investment period and that's obviously well suited for primarily first-lien book. And then, of course we have our two tranches of unsecured notes. And one or two of those unsecured notes priced a little bit high compared to current market standards, but it's a couple of charges they mature in a few years, they actually a very favorable call features as well. So we look down the road in terms of a traditional bond deal that has effectively form a call, we've got some flexibility in the capital structure with those bonds depending on the…

The only thing that I would just add though is, one of the issues we've looking have to preferred as equity is that, as I sit here today from a regulatory standpoint accounts of leverage. So it's counting towards your leverage calculation as it sits here today not as an equity tranche. And so that's one of the issues from [indiscernible] point I would just say. If it does convert at its current price, I mean one of the things that CGBD is known for having a large successful big class or backing in Carlyle through the external manager. And so I don't know if it's a great work, when it does convert to have the manager making a large profit via from the BDC shareholders from making an investment into it at a rough time in the market. And then again, I don't think necessarily having a 7% cost of capital out there, which right now counts its leverage is a great option we've here.

Yes, I think we'll be cautious of that how that that could look and would look. But what I would tell you now is two things and Tom correct me if I'm wrong on this, but just also keep in mind that our financing facilities do not look at this as leverage, right? They, so it's not restraining our flexibility, these will be the rest of the liabilities on the balance sheet. And just I know, you're keeping it in the back of your mind is that, what happens when and if this converts. But again, I would just reiterate, there's no plan to convert it. And at sometimes I think the focus on this $50 million preferred gets lost and overshadows. I think what we would like people to really feel like, what is the focus of our story, which is over the past two years the management team particularly Taylor, and Tom and the rest of the team have just really been working super hard to get us through COVID. Get us out of the cup program. Put in place processes and procedures that strengthen the balance sheet, that strengthen the portfolio. And we've made such great progress over the past couple of years, that I cringe a little bit that that the $50 million preferred that is support from our parents kind of overshadows that message. So maybe a little bit of advertisement here from me, but I guess as the CEO, that is part of my job. But, so we're happy to keep talking about it each quarter. But I would just ask let's not lose sight of also, I think kind of the bigger picture that that we're trying to show to you and to our investors. And keep in mind that Carlyle has, I think Carlyle and up here at CGBD we pride ourselves on having a really strong reputation for taking care of our shareholders. And it's - it would - it's not our intent to change that that way of operating.

That's a fair point. And I do want to say that this was a really nice quarter kind of all around. So keep up the good work on that front. That's all for me. I appreciate the discussion today.

Thanks, Ryan.

Thank you. [Operator Instructions]. Our next question comes from Finian O'Shea of Wells Fargo. Please go ahead.

Hi, everyone. Just a follow-up on Ryan's question, sorry to do that. I was listening to some of your comments, Linda I agree that life was pretty dire when the parents stepped up in during COVID. But it was also rather bright and sunny in say 2018 when the BDC lost a lot of money and was paying the parent a full incentive fee. So I guess the question is, against your opening remarks about caring deeply about the shareholders total return. Do you perhaps care more deeply about the advisor or should something give - like, should there be sort of pick one between the convert and not having a credit look back?

Thanks, Fin for that question. I think I've kind of addressed the convert issue in talking about our look back and our management fee. We do believe that Carlyle, Carlyle has a very fair and balanced management fee structure. We think that in the shareholders are getting a lot of value for that. Keep in mind that, we do manage the JVs and don't take a fee for that. So sometimes, I think that gets a little bit lost when people look at our overall fee structure. So we're kind of getting the management the JVs at a very nice discount on the management fee. And one of the other kind of topics I think that Taylor really discussed on the call and one that we'd like to further emphasize is. All of the resources that Carlyle brings to the table just away from just the core team that's supporting the CGBD and the rest of Direct Lending is there for investors as well. So our management fee and not having a look back, I'm not really sure that that is what is going to be driving our stock price higher, it's really, we've got to continue on this straightforward consistent performance get our non-accruals down, which is looking better and better. And really keep our shareholders satisfied by knowing that we can generate our dividends, perform well on credits. And ultimately, we think that will get our stock price up. I'm not sure our management fee is really the issue.

Okay. It makes sense. That's all for me. Thank you.

Thank you, and there appear to be no further questions in queue on the phone lines at this time. At this time, I'd like to turn it back over for closing remarks.

This is Linda. I want to thank everybody for joining us on our call today.

And this concludes today's conference call. Thank you for participating. You may now disconnect.