Carlyle Secured Lending, Inc.
Q1 2021 Earnings Call Transcript

Published: 5 May 2021

[Operator:]

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

[Allison Rudary:]

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.

[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.

[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.

[Tom Hennigan:]

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

[Linda Pace:]

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:]

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

[Melissa Wedel:]

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.

[Taylor Boswell:]

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?

[Melissa Wedel:]

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.

[Linda Pace:]

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.

[Melissa Wedel:]

Thank you, Linda.

[Linda Pace:]

You’re welcome.

[Operator:]

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

[Paul Johnson:]

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?

[Tom Hennigan:]

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.

[Paul Johnson:]

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?

[Tom Hennigan:]

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.

[Paul Johnson:]

Okay.

[Taylor Boswell:]

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.

[Paul Johnson:]

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?

[Tom Hennigan:]

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.

[Paul Johnson:]

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

[Operator:]

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.

[Linda Pace:]

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.

[Operator:]

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