Blackstone Secured Lending Fund (NYSE:BXSL) Q1 2023 Earnings Call Transcript May 10, 2023

Operator: Good day, and welcome to the Blackstone Secured Lending’s First Quarter 2023 Investor Call. Today’s conference is being recorded. [Operator Instructions] All participants are in listen-only mode. We will conduct a question and answer session after our prepared remarks. [Operator Instructions] At this time, I would like to turn the conference over to Weston Tucker, Head of Blackstone Shareholder Relations. Please go ahead.

Weston Tucker: Thank you, Katie, and good morning and welcome to Blackstone Secured Lendings’ first quarter call. Earlier today, we issued a press release with a presentation of our results and filed our 10-Q, both of which are available on the shareholder section of our website www.bxsl.com. We will be referring to that presentation throughout today’s call. I would like to remind you that today’s call may include Forward-Looking Statements which are uncertain and outside of the firm’s control and may differ materially from actual results. We do not undertake any duty to update these statements. For some of the risks that could affect results, please see the risk factors section of our most recent Form 10-K. This audio cast is copyrighted material of Blackstone and may not be duplicated without consent. With that, I will turn the call over to BXSL’s co-Chief Executive Officer, Brad Marshall.

Brad Marshall: Thank you, Weston, and good morning everyone. With me today is John Bock, Co-Chief Executive Officer, and we are excited to be joined by Teddy Desloge, our newly appointed Chief Financial Officer, effective as of close of business today. Many of you know Teddy as he has been with Blackstone credit since 2015, first on the direct lending investing team and then in a portfolio manager capacity for our direct lending business. We are excited to have him officially joined BXSL Management team. Turning to this morning’s agenda, I would like to start with some high level perspective before John and Teddy go into the detail of our portfolio and first quarter results. Turning to Slide 4, the BXSL reported another strong quarter with significant growth in net investment income, higher net asset value, and strong credit performance all in a period that was marked by meaningful uncertainty ranging from commercial bank failures to stubbornly high core inflation.

Net investment income or NII increased 3% quarter-over-quarter to $0.93 per share, which represented a 14% annualized return on equity and our highest NII per quarter since inception, primarily driven by rising interest rates that have increased the average yield on our debt investments from 10.7% last quarter to 11.4% at quarter end. This earning power further reflects the quality and strength of a well-sourced portfolio, which as of March 31st was 98% senior secured first lien, 45.2% loan to value, using cost basis to measure less than 0.14% of the investments are a non-accrual or 0.07% on a fair market value basis, and less than 2% of our assets are marked below 90 at cost. Our net asset value per share, which increased 0.7% to $26.10 from $25.93 the previous quarter further reflects portfolio stability.

Earnings power again exceeded our quarterly dividend of $0.70 per share, which was increased 17% last quarter and has increased over 30% since the fund’s IPO in late 2021. Our current dividend represents a 10.7% annualized yield for shareholders based on the higher first quarter NAV of $26.10 per share. We believe this represents the highest dividend yield for any listed BDC with as much of its portfolio invested in first lien senior secured assets. Slide 5 provides additional highlights on our portfolio activity in stability in our liquidity position. First quarter sales and repayments were $109 million matched by $108 million in new investment commitments. The result of lower net origination was tied to both a seasonally slow period for new deal activity, as well as a lower — overall level of deal volume as private equity sponsors selectively adjust to the new market and rate dynamics.

That said, we are beginning to see more market activity, which may lead to an increase in portfolio turnover. Subsequent to quarter end, we realize our debt and equity investments in Westland, the impact of which we expect to be accretive to NII by more than $0.05 per share. In terms of our balance sheet, we also believe we remain well positioned for both defense and continued growth with 1.2 billion of liquidity from cash and our undrawn lending lines. Our lending lines were set up two-years ago at what are now below market prices with high quality counterparties. We had zero direct exposure to Silicon Valley Bank, Signature Bank and First Republic Bank, and we have less than 1% of all secure debt commitments from regional banks in general.

Turning to Slide 6, we ended the quarter with 9.6 billion of investments and leverage of 1.31 times, which is down from 1.34 times the previous quarter. Importantly, the ending yield of our portfolio, which is 98% floating rate, debt expanded over 400 basis points over the last 12 months. Taking a moment on this slide, I want to outline that each quarter the market continues to witness increased earnings power associated with floating rate nature of our loans, and the attractive fixed rate liabilities. However, I believe that there is a growing demand for BXSL due to its defensive positioning during these more volatile times. In fact, if you look at senior secure debt, which is 98% of BXSL’s portfolio composition, the private credit asset class as measured by Cliffwater Direct Lending Index has generated consistent returns ranking as the top first or second performer in fixed income in 13 over the past 18-years since Blackstone, then GSO launches private credit strategy, and only one down year, which was during the great financial crisis.

And prior to the GFC, the average loan to value is 66% versus 57% in 2022 and 45% in BXSL. Part of the focus on limiting risk in our portfolio is to focus on larger deals. Our leadership in large private credit transactions, where we have led or been the sole lender in approximately 50% of the one billion plus direct lending deals is important as we have control over the outcome in these deals that focus on building right lending to the right businesses, which some may consider to be a first line of defense, continues to generate solid returns for BXSL shareholders. Comparing our NAV returns to public market benchmarks, BXSL generated a total return of 3.4% in the quarter compared to 3.2% for leverage loans, 3.6% for high yield bonds, and 3% for investment grade balance.

John will speak more to the portfolio later in the call. Additionally, there is a second line of defense to protect capital, often just as important as the first, but goes less recognized by investors. That is the potential value add a manager can bring to the portfolio after investments are made. Many of you have heard us outline the benefits of Blackstone credit value team, formally Blackstone Credit Advantage, but I would like to put a few numbers behind this value add. Recall, we have an internal Blackstone team of 109 professionals who work with our portfolio companies, including over 20 professionals in Blackstone Credit. This team offers the scale and operating capabilities of the Blackstone Network to our portfolio companies that drive both revenue and cost synergies to the benefit of the portfolio company and the private equity sponsor.

We believe these benefits are unique to Blackstone Credit and they provide substantial value to our shareholders. Let me share some detail with two examples where we held the equity. Last summer, we realized our position in a company called Data Site, a leading provider of Virtual Data Room, or VDR, services in which BXSL had invested in equity and warrants alongside the debt commitment, which was never called. Recall VDR are independent platforms used to host and share highly confidential files and manage workflows. By leveraging the Blackstone Value Creation team and the broader Blackstone Network, we were able to identify and help data site execute on meaningful cross-sell opportunities and cost savings. One important element to assist data site was Blackstone’s over 93 introductions across the Blackstone ecosystem, including Blackstone’s internal teams, the Blackstone portfolio companies, advisors, and private equity partners.

Subsequent to quarter end, as I mentioned earlier, we realized our investment in Westland, a Canadian insurance brokerage business in its sale of Broad Street Partners. We first invest in Westland in 2021 and have provided a combination of debt and equity based growth capital that helped turn them from a regional broker into a national scale player with nearly twice the operating profit. With the help of our advisor expertise, we provided support on their IT transformation to support growth culminating and a payoff that we expect to be accretive to NII by more than $0.05 a share. Across these two investments BXSL invested $207 million and received $265 million in proceeds on the sales, a 28% increase on our initial investment in addition the $28 million of interest we received during our hold period.

Remember, we offer cross sale, cost saving, and advisory opportunities to all of our boards at no additional fee, because we understand the end benefits of the investment portfolio. And while, we are a lender first with a portfolio overwhelmingly invest in first lien senior insured loans, our operating platform allows us to realize additional equity upside or help de-risk our debt investments, status site investment are two very recent and successful case studies of how truly unique our platform and our capital can be for the companies that we partner with. Generally, across our direct lending business, a substantial majority of the portfolio companies that are introduced to the valuation creation team actively participate in the program. And while we have a large portfolio monitoring team is one of the largest in the world in private credit, we go beyond that with our own resources and infrastructure to drive outcomes.

That benefit not only our portfolio companies, but also our shareholders in real tangible ways. With that, I will turn it over to Jon to speak about the portfolio.

Jonathan Bock: Thank you, Brad. And echoing your comments on strength and periods of uncertainty, let’s again see what a defensive portfolio looks like. So jump to Slide 7. Let’s start with seniority, up to 98% of BXSL investments are in first lean senior secured loans and over 95% of those are two companies owned by private equity firms or other financial sponsors who have access to additional equity capital to support their companies. The portfolio is highly equitized with an average loan-to-value of 45%. But it is not just that we are senior in the capital structure. More importantly, we are focused on seniority with companies of the right size and in the right industries. Focusing on size, our portfolio companies have a weighted average EBITDA of 179 million relative to 128 million as of the first quarter of 2022, as we continue to orient the portfolio to larger, more durable businesses.

Let’s jump to Slide 8. Our focus on the upper end of the middle market is rooted in our belief that this area provides compelling value opportunity, and the data bears this out. Note that recent data from Lincoln suggests that upper middle market companies with greater than a 100 million of EBITDA maintain a similar credit spread per unit of leverage compared to middle market businesses. But larger companies grew more than twice the rate of smaller companies in 2022 and have had substantially lower default rates since 2018. And for reference, BXSL had less than 2% of its portfolios in companies earning less than 30 million of EBITDA, which have historically had those higher covenant default rates. Now, many of you know Lincoln is a leading valuation provider to private credit in the BDC space as they value and review over 4,000 private credit investments each quarter.

Now, Slide 9 focuses on our industry exposure, where we believe investing in better companies in better neighborhoods drives sustained returns over time. This means focusing on key sectors with low default rates, low CapEx requirements, such as software, healthcare providers and services and professional services, which account for over 35% of the investment portfolio. Now diving into the portfolio quality further jump to Slide 10. Here we compare the BXSL portfolio to the Lincoln International Private Market database, and you can see that our weighted average EBITDA 179 million is more than double the market average of 80 million. Last 12 months EBITDA growth for our portfolio companies was nearly triple that of the benchmark, and importantly, on profitability, our portfolio companies have EBITDA margins that are 25% higher.

Now, let’s talk interest coverage. As mentioned last quarter, this is a stat that gets widely shared on other listed BDC earnings calls, but as we have mentioned previously, the way it is calculated by BDC managers varies widely. In some cases, certain sectors or types of loans are excluded in other cases, managers exclude negative EBITDA companies, both decisions that obscure the averages and leave investors looking for better transparency. So, when we calculate interest coverage, we include all private companies EBITDA, including companies that have borrowed on a recurring revenue loan and companies that may have amended some of their interest obligations to pick after initial underwriting. Next, we compare our portfolio to the Lincoln database, which we believe is a representative proxy for that entire credit market.

While we currently sit at last 12-months average interest coverage of 2.1 times today, which is slightly higher than the market average of 1.8 via Lincoln. This difference remains resilient when we run interest rates at 5% through the portfolio, which brings our average interest coverage to 1.7 times compared to the market at 1.4. And we attribute this stability to our focus on larger, more profitable higher growth businesses. Yet, we also hear from investors and other market participants that it is less about averages, particularly the averages that are obscured by exclusions and much more about the tails, namely the percent of one’s portfolio below an interest coverage ratio of one times on a forward basis using higher base rates. If we flow through 5% interest rates reflecting the lower end of the Fed funds target range today, we can see that BXSL would’ve had roughly 7% of its portfolio with an ICR below one compared to the private credit database or market, which is approximately twice that amount.

And in the 5% interest rates, example of that, estimated 7% of our portfolio below a 1% or one times interest coverage, 3% is related to a single transaction that we initially structured with a low ICR given the anticipated ramp of the EBITDA generation that company continues to perform and expand its profit margin. So discerning investors will be right, averages will not tell the story of direct lending performance, the tails will, and we seek to limit our tail risk with a focus on larger, better businesses and more stable sectors. And we continue to see favorable results. Blackstone still is conservative credit culture on a foundation of structural protection for investor capital. And we do this always while focusing on larger transactions.

Note that when Blackstone leads or co-leads the vast majority of our deals, they have structural protections against asset stripping, collateral lease to prevent any shifting of assets out of our collateral package. And almost none allow for uncapped EBITDA add backs all materially better than when compared to the leverage loan market. Now let’s just turn to amendments for a moment. We work with our companies constructively in the regular course to provide an idea scope. And so of the 45 amendment requests that we have received this quarter, 98% were related to M&A add-on activity and other benign technical amendments such as SOFR rate hedging or reporting. We did not have any situations where we provided immediate pick flexibility due to the inability to pay interest or principle.

Now turn to Slide 11, sorry about that. As Brad mentioned, we increased our dividend distribution to $0.70 a share with the current dividend yield at NAV approximately 10.7% and that was up 17% from the last quarter. And it has increased over 30% to be clear last quarter, two quarters ago in relative to the fund’s IPO in late 2021. So importantly, we believe this 10.7% dividend yield at NAV is supported by a high margin of safety, when you compare it to BXSL net income yield of 14%. And it further reflects our view that the best dividend policy can support both a steady and stable distribution and long-term NAV growth. And with that, I will turn it over to Teddy.

Teddy Desloge: Thanks, John, and thanks for the introduction, Brad. I’m excited to be part of the management team and look forward to spending more time with folks here on the phone in the coming months. I will spend a few minutes on our operating results, summarize our investment activity, and give some color into the pipeline activity we see on the ground today. I will start with our operating results on Slide 12. In the first quarter of 2023, we generated our highest quarterly net invested income to-date of $149 million or $0.93 per share, which was up 45% year-over-year, as we continued to see the benefit of higher base rates flow through earnings on a predominantly floating rate first lien portfolio. Our net investment income yield in the quarter was 14%.

Total investment income was up $79 million or approximately 43% year-over-year to $265 million in the first quarter. Importantly, we maintain a policy by which no origination fees are paid to the manager mitigating conflicts associated with originating any particular transaction. In addition, a 100% of upfront origination fees are amortized over the life of our loan. This results in a more stable income picture versus recognizing fees upfront, particularly in an environment where origination and repayment activity is lower. To that end fee income was less than $1 million in the first quarter due to below average repayment volume of $109 million. Yet we still generated earnings that represented 133% coverage to our dividend. Payment In Kind or PIK income was about flat quarter-over-quarter and represented less than 4% of total investment income.

As John mentioned, we are encouraged by our borrower’s ability thus far to manage through higher financing costs at higher base rates and we had no new amendments in the quarter providing for PIK flexibility. Moving down the P&L, net expenses were up 33 million compared to last year’s first quarter, driven primarily by higher interest expense. GAAP net income in the quarter was 139 million or $0.86 per share up from $0.63 per share a year-ago. Unrealized markdowns of approximately 15 million in the quarter were the primary driver of a $2 million capital gains incentive fee reversal or approximately $0.01 per share benefit to net investment income. Turning to the balance sheet on Slide 13. The end of the first quarter with 9.6 billion of total portfolio investments of which approximately 98%, our floating rate loans with a weighted average yield of 11.4%.

This compares to 5.5 billion of outstanding debt with a weighted average cost of just 4.68%. This spread between our floating rate assets and low cost mostly fixed rate liabilities has helped offset the impact of rising rates on our average cost of debt. As Brad previously mentioned, sales and repayment volume of 109 million was matched by new investment activity of 108 million, 90% of which was related to portfolio activity where we have incumbency. To give some context for the pipeline, we have seen an increasing activity in recent weeks, both as it relates to new opportunities and portfolio activity where we retain incumbency, which represents a significant competitive advantage from our scale and presence in the market. We believe this represents a strong foundation for new originations for BXSL to the extent capacity increases from repayment volume or new share issuance.

Lastly, as a result of strong earnings in excess of the dividend in the first quarter, NAV per share increased to $26.10 up from $25.93 last quarter. Next, Slide 14 outlines our attractive and diverse liability profile, which includes 58% of drawn debt in unsecured bonds and an average fixed rate of less than 3%, which we view as having been a key advantage while the Fed increased its policy rate by 500 basis points since the beginning of 2022. Additionally, BXSL ended the quarter with 1.2 billion of liquidity and cash and immediately available, but undrawn secured leverage capacity. Our debt to equity ratio was 1.31 times down from 1.34 times last quarter. Additional repayments realize subsequent to quarter ends will help support deleveraging towards our target approximately one in a quarter times.

Importantly, we ended the quarter with a 0.14% non-accrual rate at cost versus the BDC market average of 2.2% as of March 31, and we maintain our three investment grade corporate credit ratings. Additionally, we have a low level of near-term debt maturities with just 6% of commitments maturing within the next two-years and an overall weighted average maturity of 3.6 years. To that end, in March, we amended our 500 million Big Sky facility with Bank of America, which further expanded our revolving period by two-years with no pricing step up until September, 2024. Importantly, BXSL’s model is very different from some of the regional banks that have had issues. We do not hold deposits. We run a little over one turn of leverage. While banks typically run above 10 turns of leverage, we do not hold fixed rate liquid assets to cover funding obligations, and we manage the duration of our liabilities to match or exceed the expected duration of our assets.

As mentioned, we have available liquidity of 1.2 billion at quarter end, which we believe is sufficient to repay the $400 million bond maturing in July of this year. Should we choose to do so, this will maintain ample pro forward leverage capacity for unfunded commitments, which at quarter end totaled approximately $600 million with over 40% expiring by the end of this year if unused. We continue to balance the attractiveness of the market opportunity today, indirect lending and quality of our pipeline with our focus on managing the balance sheet toward our target of approximately one and a quarter times leverage. We may see additional repayments materialized beyond the approximately 200 million realized subsequent to the end of the first quarter, which would further support deleveraging and capacity for new deployment.

With that, I will pass it at back over to Brad.

Brad Marshall: Thanks. Teddy. Blackstone has been investing in cycles for over 37 years, and Blackstone credit and private credit for 17-years. Since the very beginning, our investment committee has been working together, navigating through cycles, and we have delivered a 12 basis points annualized realized loss rate in direct lending through our track record as of March 31st. We have 100 specialized industry advisors that support our underwriting. We cover over 3000 companies across private and liquid credit strategies, and we have 300 investment professionals globally across 17 offices. And what we believe to one of the largest teams in the industry at 57 in our CIO office specialized in active portfolio management. While we remain highly disciplined in an uncertain macro environment, we believe the dynamics at play create a once in a generation opportunity for direct lending and remain positive about the outlook for BXSL shareholders as a result.

And with that, I will ask the operator to open it up for questions. Thank you.

Q&A Session

Operator: Thank you. [Operator Instructions] We will take our first question from Finian O’Shea with Wells Fargo.

Operator: Thank you. We will take our next question from Casey Alexander with Compass Point.

Operator: We will take our next question from Ken Lee with RBC.

Operator: We will go next to Robert Dodd with Raymond James.

Operator: We will take our next question from Ryan Lynch with KBW.

Operator: We will take our last question from Melissa Wedel with JP Morgan.

Operator: That will conclude our question and answer session. At this time, I would like to turn the call back over to Mr. Tucker for any additional or closing remarks.

Weston Tucker: Great. Thanks everyone for joining us today and the team is available after the call for any follow-up questions. Have a good day.

Operator: That will conclude today’s call. We appreciate your participation.