Carlyle Secured Lending, Inc.
Q1 2020 Earnings Call Transcript

Published: 6 May 2020

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to TCG BDC's First Quarter 2020 Earnings Call. [Operator Instructions]. I would now like to hand the conference over to your host, Head of Investor Relations, Daniel Harris. Sir, please go ahead.

[Daniel Harris:]

Thank you, Operator. Good morning, and welcome to TCG BDC's First Quarter 2020 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 any forward-looking statements at any time.With that, I'll turn the call over to our Chief Executive Officer, Linda Pace.

[Linda Pace:]

Thank you, Dan. Good morning, everyone, and thank you for joining us on our call this morning to discuss our first quarter 2020 results. Joining me on the call today is our Chief Investment Officer, Taylor Boswell; and our Chief Financial Officer, Tom Hennigan.The current global health and economic crisis is unprecedented and before we focus on our business, I want to start by thanking all of the frontline workers, health care and EMS professionals for keeping us safe and our communities operating.Our thoughts are with all of the people and families across the globe that have been impacted by this health crisis. Our priority has been and remains the health and safety of our investment and operating teams at Carlyle. And equally as important, our focus remains on supporting our portfolio of companies. I'd like to focus my remarks today across 3 areas

[Taylor Boswell:]

Thank you, Linda, and thanks to everyone on the call this morning for their interest in and support of CGBD. Our last earnings call was in late February. And what a difference 2 months has made. At that time, COVID-19 was a vastly underestimated health and economic threat, and credit markets were at their tightest in years. Now we are experiencing the largest economic shock in 70 years, accompanied by the second largest selloff in the history of leveraged credit markets. The severity of this crisis has been compounded by its suddenness, with a sharp reversal from an up into the right world to today's contractionary economic environment. Despite a rapid recovery in asset values in recent weeks, we remain cautious at Carlyle on the trajectory of the fundamental economy. As we are seeing not only significant disruption to the earnings power of corporations directly impacted by this crisis, but also the beginning of downstream impacts across the broader economy.Immense uncertainty remains. But from what Carlyle can see, it is our expectation that the recovery will progress in fits and starts and take longer than we all would hope. In credit, while March's liquid market selloff was by any measure severe, markets function reasonably well throughout, characterized by orderly concern but not panic. With economic uncertainty and deeply discounted secondary trading levels, March primary deal volumes in both liquid and private credit markets effectively came to a standstill.In April, we have seen early signs of healing in primary markets and emerging demand for private credit solutions. While traditional M&A financing will likely slow, significant capital will be required across the economy to allow borrowers to bridge through the COVID-19 environment. We see a compelling investment opportunity forming. At the same time and perhaps most consequentially for our business, competition has thinned as for a variety of reasons, a significant number of competitors have been forced to pull back from the market. This supply/demand imbalance will accrue to the benefit of competitively advantaged platforms with staying power, and we expect CGBD shareholders to benefit materially from the same. As regards the crisis impact on existing private credit portfolios, we expect it will have 3 distinct stages

[Thomas Hennigan:]

Thank you, Taylor. Today, I'll begin with a review of first quarter earnings, then drill deeper into 3 important topics. The portfolio, valuations and our balance sheet positioning. As Linda previewed, we had another solid quarter of total income generation. Total investment income for the first quarter was $50.5 million, down from $53.5 million in the prior quarter. The decrease was driven by a few factors

[Linda Pace:]

Thank you, Tom. I'd like to conclude by thanking each of you for joining our call this morning. We at Carlyle truly hope you and your families are healthy and doing well. Without a doubt, these are uncertain times. But our goal at TCG BDC is to work hard to ensure our portfolio and balance sheet are as well positioned as possible to manage through future volatility and take advantage of opportunities to deliver shareholder value.With that, we're pleased to take your questions.

[Operator:]

[Operator Instructions]. Our first question comes from the line of Rick Shane of JPMorgan.

[Richard Shane:]

Look, the transaction -- the convert transaction is a very interesting transaction. It's a -- obviously, from a capital perspective and a period of uncertainty, very positive to have a capital infusion, even if it is at a cost, I think there's a benefit to buying insurance in this tape. It's also a very good signal that your affiliate committed and sees the value in the entity. But I am curious, from a governance perspective, how you thought about pricing both on the coupon and on the convert?

[Taylor Boswell:]

Rick, it's Taylor Boswell. Thanks for the question. We really are held to a standard that we transact on a very fair basis of the vehicle. And it's a standard that we take very seriously as both a company and a manager. And I'll tell you that we went through a very thorough process over the course of the month of April. And we looked at a lot of options, reviewing them in-depth with our Board.And at the end of the day, everyone felt very comfortable that the capital that was being offered was on superior terms to what was otherwise available in the market. And what we did specifically is we took both reverse inquiry and sought feedback on what terms might look like for various other terms of financing, whether it be unsecured debt, convertible debt, rights offerings or otherwise. And ultimately, the Board concluded that this instrument was most favorable because it achieves the flexibility impacts you mentioned before, but also comes with a relatively low cost.So if you compare it up against other alternatives, it's structurally attractive, meaning it has a PIK option for payment. It has no covenants. It has a long duration. Those characteristics not generally available in the other financings offered in this market. And then economically attractive with a dividend rate well inside of the common and a strike price up 30% versus the last close and over 50% versus the VWAP. And so ultimately, we think the construction of the instrument really demonstrates plainly that it's conducted on a favorable basis for CGBD shareholders relative to other financing alternatives.

[Richard Shane:]

Yes. Look, I think that's all totally fair. And there's one thing I hadn't even thought about until you started answering the question, which is that having a transaction executed without any perceived overhang in the market in a period of volatility is another advantage as well in terms of being able to do that with a higher degree of secrecy.

[Taylor Boswell:]

Yes. I mean, we really spent a lot of time, as I said, chasing all the alternatives we've seen, unsecured debt, rights offerings and the like. And really, in terms of flexibility and nothing matches an equity instrument, ultimately, and the dilutive impact of this transaction is far less than the other equity raise alternatives that are available in this market. So I think it became pretty clear for our Board and the independent members of our Board as we work through the process that this would hit the flexibility goal and sort of be an optimal economic outcome for the shareholders.

[Operator:]

Our next question comes from Arren Cyganovich of Citi.

[Arren Cyganovich:]

I was wondering if you could talk a little bit about how portfolio companies performed in April, end of March, obviously, it's quite a bit different than the end of April. And whether or not you've had any chance to look at the financial performance and the ability for them to pay at this point in the quarter?

[Thomas Hennigan:]

Arren, it's Tom. So far, it's a little early in terms of receiving any second quarter results. What we can say is we're in very close dialogue with our borrowers and our sponsors regarding their liquidity forecasts. And in most cases, I'd say that the initial blush from the sponsors and companies in a lot of cases is, hey, here's our liquidity forecast. A lot of those cases, as we receive subsequent updates, those forecasts are looking better as the company is really focus on the liquidity positions. In terms of actual financial performance, it's a little bit early. I think we're going to get a more significant round of -- we'll get the March financials for many borrowers in the next week. And I think it's a little bit early in terms of April results. But I think that our borrowers are very much focused on liquidity.And so far, I think they're making good strides to manage costs, to manage liquidity. And we certainly anticipate that in terms of ASKS, we had a limited number of amendments at the end of the first quarter. We anticipate that that's going to likely accelerate in the next 6 weeks as we head into the June time frame and borrowers, even if they have liquidity, they may be looking for some relief to create additional liquidity to get through the current market environment.

[Arren Cyganovich:]

And what type of amendments are you willing and able to provide to the company? We -- I cover a pretty broad cross-section of companies and consumer finance, obviously, are giving a lot of deferrals in moratoriums and payments, commercial is a little bit more focused on the individual opportunities, but there's still banks are giving deferrals as well. What's your ability to work with the borrowers to help provide some relief?

[Thomas Hennigan:]

Yes. We have, I'd say, significant flexibility to work with our borrowers. And certainly, we're shoring up our liquidity position capital structure. In the last month, we were even better. We went from a good position to an even better position, not knowing to what extent our borrowers are going to ask for amendments, whether it be for PIK amendments or covenant relief, so what we're looking for in our amendment conversations is a fair deal. And for example, if a private equity sponsor is going to write a significant check to support liquidity, then we'll obviously be more likely to offer or to be agreeable to a PIK amendment where, let's say, for a short amount of time, we will convert some of our cash interest into PIK. And then that's the way we see some of these liquidity situations where companies are more strained. Where if the sponsor is going to support the business, we think the lenders should be part of the solution, and we're certainly willing, capable and have the flexibility to offer an amendment where we would take some of our interest in PIK.

[Arren Cyganovich:]

And how do you treat that from a nonaccrual perspective, if you give them an amendment to change to PIK for a short period of time that doesn't put that particular loan on nonaccrual status?

[Thomas Hennigan:]

That's correct. It would be situation by situation, but certainly, to the extent we have a private equity sponsor who's supporting the business, that's putting a stake in the ground in terms of where they see equity value where we see equity value in the business. And it will also factor in as we look at those situations as what's our long-term view of the business. And if we're current on payments, there's no payment default. And we believe that we will have full recovery on the loan. And that's a situation where those loans would -- irrespective of the PIK status, those would not be on nonaccrual.

[Operator:]

[Operator Instructions]. Our next question comes from the line of Finian O'Shea of Wells Fargo Securities.

[Finian O'Shea:]

I hope everyone is doing well. I first want to go back to the convert. Forgive me, I missed the beginning of the call. And appreciating that the terms are better than market terms out there for sure. I'm -- what's curious to me is the conversion premium, how you arrived to that? Is this based on any sort of market rate? Or is it balanced in conjunction with the terms and spread? Or just any color you'd give on why -- I think it was a 57% average premium you used.

[Taylor Boswell:]

Fin, it's Taylor. Really, we pulled through a lot of comparable transaction work, whether they be corporate converts, financial converts and we've received some indications over the course of the month of April of where people would be willing to transact from a conversion premium perspective. And without digging too far into the details, what I would say is as comp versus financial converts, BDC converts and what we were able to see as indicative terms over the last month, these conversion premiums are well outside of what the market would have otherwise asked for. So I think we feel pretty comfortable with this level. And to your point, to the prior point, I mean I think embedded in here is, hopefully, a strong message for the shareholders of both the support of Carlyle of the vehicle, but also Carlyle's view of value ultimately in the stock.

[Finian O'Shea:]

I appreciate that. And on the case where you don't reach that share price, would you plan to deleverage, to redeem that? Or is there any other sort of scenarios that you're able to work with between the BDC and the parent if it comes time? And do you think you'll still want to maintain that capital, prolong it or pay it down?

[Taylor Boswell:]

Our intention here is for this to be a long-term investment in the vehicle. And you'll see when you peel into the details of the instrument, that it has a put right in year 7. So it is well outside of our other financing maturities and the like. And what you'll also see is that put right is settleable and likely to be settled in the form of equity. And so that's one of the key reasons that underpins what Tom referenced before, which is our view is that really, this is an equity instrument in the capital structure. And while the '40 Act considers this as leverage under that definition, pretty much by any other standard, it's an equity instrument that we expect to be settled with equity. So that's how it's constructed in that respect, Fin, but a long-term investment in the vehicle and that is the intention and the structure.

[Finian O'Shea:]

Got it. I appreciate it. I didn't catch that earlier. Just another -- just one more for Tom. The SPV balance had come down a little. Are you able to give any color on how that came about? Was it a repay? Or did you pay down with cash?

[Thomas Hennigan:]

I think it was a combination. I don't think it was a decided markdown or sorry, pay down in that position. Yes. And that balance, I think it was a combination of repayments or loans just in managing our balance sheet amongst our various credit facilities kind of loans moving in and out of that vehicle. Overall -- on the total outstanding size.

[Finian O'Shea:]

Okay. And then just one final one, if I may. I apologize if I missed this as well. The middle market MMLC, any -- it seems like you're keeping the dividend at a reasonably consistent range, a little bit down. Any -- is it -- just looking in the surface, they were both pretty much equity positions, the mezz loan and the sub and interest. Does this materially short -- I assume this was in some respect a conservative move, right? Can you tell us like what that does for the BDC or the MMLC?

[Thomas Hennigan:]

Yes. What you see, this is similar to what we did at the end of 2018 when the market dislocated to a lesser extent. We opted to run the vehicle at a lower leverage level. So effectively with the materially lower leverage level, you're right, the total investment is the same, but we really -- there's a higher level of equity and lower mezzanine, so that's why you'll see beginning in the second quarter kind of a flip where the mezzanine, which is pay down 0 will be much lower income, but you'll see the dividend from the JV be higher as it just -- as there's more income, but on a higher equity base, and that's why you see that the yield that we've had in the 13% range will now be a lower yield percentage but a higher dollar number for the dividend yield.In the aggregate, we see the dollar amount coming down somewhat. And one of the things with the JV earnings, at least in the near-term is for the most part, our liabilities are tied to 90-day LIBOR. And just based on some anomalies in that market, the resets on a lot of our contracts in early April time frame were at higher level than where LIBOR is today. So we'll see a little bit of pressure, particularly based on LIBOR, more pressure than the simple rates would dictate the market, the rates having down in the market, just based on the timing when we reset some of our rates, you'll see a little bit of depressed earnings, particularly in the second quarter that'll contribute to overall lower JV income for the second quarter.

[Finian O'Shea:]

And does your -- when you pay down, sort of say, pay down the MMLC, the mezz you provide is a form of a revolver, right? And we're just looking at the language there. Does that automatically convert to sub interest? Or do you sort of have a choice there? Or do you get what I'm asking?

[Thomas Hennigan:]

The calling equity is a Board decision, so it's a 50-50 vote between the 2 members of the JV. Our BDC and PSP.

[Operator:]

Our next question comes from Ryan Lynch of KBW.

[Ryan Lynch:]

And I hope you guys all are doing well. Apologize if I missed this in the beginning, I hopped on a little late. But can you speak to both the securitization that you guys have on your balance sheet as well as the securitizations in your middle market credit fund regarding your comfort with some of the covenants of those, specifically the CCC bucket or the OC cushion given the dramatic kind of swings we've recently had in the market?

[Thomas Hennigan:]

Sure, Ryan. It's Tom. First, I'll start with the one -- the vehicles at the JV. Those are easier. Those are both static CLOs. So no issues at all with those vehicles in terms of various tests just based on the static nature. On the BDC's on balance sheet CLO, key points on that vehicle is, given that's a traditional middle market CLO, you have much higher CCC baskets, it's about 17.5% versus your regular broadly syndicated deal that would have 7.5%.So no doubt, we're seeing CCC sensitivity just like the broader market, but we've got such a much larger bucket and we have much more insulation from CCC issues because it's a traditional middle market CLO. And then from an OC test perspective, we've got -- we've run some sensitivities on that. We have significant cushion before we have to worry about any OC or other key covenant tests.

[Taylor Boswell:]

And I think, Ryan, it's Taylor. What I might just layer in is we've chosen to run our balance sheet with a very diversified funding structure, so sort of using each of the tools available to us. And we've liked that mix very much. And it's performed very well for us through this crisis and continues to perform. So hopefully, what you're also hearing from us on this call is we do have a view that the world is very uncertain. And we have a -- we're really prioritizing, we're moving downside over the alternative of trying to pin a base case and absolutely optimize. And so you've seen us take these actions over the course of the last month with some selective asset sales, with the convert raise to really take what was a very good position from a liquidity perspective, and fortify it and drive ourselves back into our target leverage range, which we're happy to be at right now. And also have a bunch of flexibility to accommodate for any number of scenarios that might play out from here. So I guess that's a long way of saying, "We're not seeing those kinds of issues in our financing vehicles today. We're not anticipating them with what we see, but we are making sure all of our bases are covered given the absolute level of uncertainty in the marketplace."

[Ryan Lynch:]

Okay. And then with your preferred that you issued, I believe it has a 7% coupon in cash or 9% of coupon in PIK. Have you guys determined or maybe you said this and I missed it, have you guys determined whether you guys are going to pay that in cash? Or do the 9% PIK yet?

[Thomas Hennigan:]

The Board hasn't made a determination yet for the coming quarter.

[Ryan Lynch:]

Okay. And then on the asset sales that you made, in April, I think you said over $150 million. I guess, how is that determined of what assets you were going to sell? Were those more liquid loans? And then also, I would think that the loans if you're getting attractive prices to exit those on, some of the stronger ones that are closer to par, are going to be some of the more well established, better performing recession-resistant loans in this environment. And if that's the case, then you're kind of selling off some of your best assets and I believe in some, I think, the -- I know it's a small portion, but some of the more troubled assets on your book. So can you just talk about the 150 -- over $150 million of asset sales, how were those selected and I guess, how those assets were selected?

[Taylor Boswell:]

Yes. It's Taylor again. The assets we sold were representative assets amongst our first lien book, I would say, in the portfolio, in line from a leverage yield perspective and generally pretty diversified by sector. So I don't think that the net result of those $150 million of sales out of the $2 billion portfolio is any sort of significant skewing in the risk factors in the book. And they weren't actually, the preponderance of them were not liquid loans or BSL loans. They were mainly traditional middle market credits, which we're really, really pleased by and we've got a well-developed capital markets capability at Carlyle credit and it lets us find liquidity and good bids, even in very challenging markets. So those assets that we did sell some a shade below, some a shade above our 331 marks. But generally, in line and attractive. So I think we feel good about that activity and don't feel like we either priced a significant amount of NAV or skewed the risk in the book as a result of those actions. Okay.

[Operator:]

At this time, I'd like to turn the call over to Dan Harris for closing remarks. Sir?

[Daniel Harris:]

Thank you, all. We appreciate your time and attention this morning, and we hope you and your families stay safe and happy. Please call Investor Relations directly or we will contact you after the call with any follow-up questions.Thank you very much. We look forward to talking to you next quarter.

[Operator:]

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.