Blackstone Secured Lending Fund (NYSE:BXSL) Q4 2023 Earnings Call Transcript

Blackstone Secured Lending Fund (NYSE:BXSL) Q4 2023 Earnings Call Transcript February 28, 2024

Blackstone Secured Lending Fund isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day and welcome to the Blackstone Secured Lending Fourth Quarter and Full Year 2023 Investor Call. Today’s conference is being recorded. [Operator Instructions]. At this time, I’d like to turn the conference over to Stacy Wang, Head of stakeholder relations. Please go ahead.

Stacy Wang: Thank you, Katie. Good morning and welcome to Blackstone Secured Lending fund’s fourth-quarter and full year. Earlier today, we issued a press release with the presentation of our results and filed our 10-K, both of which are available on the shareholders section of our website, www.bxsl.com. We will be referring to that presentation throughout today’s call. I’d like to remind you that this 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 in updating these statements. For some of the risks that could affect results, please see the risk factors section of our most recent annual report on Form 10-K filed earlier today. This audio cast is copyrighted material of Blackstone and may not be duplicated without consent. With that, I’d like to turn the call over to BXSL Co-Chief Executive Officer, Brad Marshall.

A professional banker meeting with a customer in her office to discuss his finances.

Brad Marshall: Thank you, Stacy, and good morning, everyone. Thanks for joining our call this morning. Also with me today our Co-CEO, Jon Bock; and our President, Carlos Whitaker; and our CFO, Teddy Desloge. Turning to this morning’s agenda, I will start with some high-level thoughts before Jon, Carlos, and Teddy to go into more details on our portfolio and fourth-quarter results. So just turning to the slide deck that we posted. And if we start on slide 4, the BXSL reported another strong quarter of results, including growth in net investment income, increased net asset value and continued solid credit performance. Several other key highlights in the quarter include the highest weighted average asset yield on the portfolio since inception at 12%, our second-best quarter of net investment income per share and the busiest deployment period in two years.

Net investment income or NII per share increased 1% quarter over quarter to $0.96 per share, which represented a 14.5% annualized return on equity. It’s important to note, along with strong earnings, the quality of our earnings remains high, the limited PIC payment, nonrecurring and fee driven income. In fact, interest income, excluding PIC, fees, and dividends represented 95% of our total investment income in the fourth quarter. BXSL maintained its dividend of $0.77 per share, representing an 11.6% annualized distribution yield, one of the highest among our traded BDC peers with as much of their portfolio in first-lien senior secured assets, while covering our fourth quarter dividend by 125%. We continue to focus on our mandate of protecting investors’ capital by constructing a portfolio of first-lien senior secured loans.

As of December 31, BXSL’s portfolio is 98.5% first-lien senior secured debt for the 48.2% average loan to value. We had strong credit performance, supported by minimal nonaccrual rate below 0.1% at both amortized cost and fair market value, lowest among our traded BDC peers, and approximately 1.5% of our debt investments as a percentage of total cost are most marked below 90. Turning now to page 5 of the presentation deck. In the fourth quarter, BXSL saw a meaningful increase in investment activity, ending the period with over $1 billion at par in new investment commitments and $874 million in new investment fundings. New investments fund in the quarter were over 98% first lien with a weighted average EBITDA of approximately $130 million and an average loan to value of 41.5%, reflecting our continued focus on what we believe are high quality investments.

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Q&A Session

In addition, the weighted average spread was approximately 580 basis points with an average OID of 1.7% and nearly two years on average of call protection. From a market activity’s perspective, we see strength building as fourth quarter M&A volume increased almost $400 billion, a 40% boost year over year. We expect M&A activity to continue to build and accelerate in 2024. This view is supported by our ongoing dialogues with the top financial sponsors that we cover as well as the sell-side advisers with whom we partner with. M&A activities expected to be largely driven by the buildup in record levels of private equity dry powder, large amounts of unsold assets that sponsors are sitting on, and older previous vintage funds, and the impact of lower M&A activity in 2023, 54% lower than the most recent peak in 2021.

This expected market activity can be sustained by the prospect of lower interest rates and continued narrowing of bid-ask spreads between buyers and sellers. In addition, the number of deals in the Blackstone credit and insurance pipeline doubled as of the end of the fourth quarter versus the end of the first quarter. These pipeline deals are predominantly first-lien senior secured exposure on companies, and historically recession resilient sectors we know very well. While we know every opportunity in BXSL’s pipeline, we’ll not convert into investments. And our underwriting bar remains high, the volume gives us a sense for the scale and presence that we believe we have as an institution to drive deal flow. BXSL’s origination pace benefits from the scale and platform Blackstone for BXSI, which is one of the world’s largest alternative credit managers with $319 billion in assets under management and over 500 investment professionals in 18 offices globally.

Our incumbency in over 4,500 corporate issuers allows us to see more deal flow, leverage our incumbency, and select into what we believe are the most attractive risk-adjusted assets. Further, BXSI has been the sole or lead lender in approximately 84% of BXSL’s direct lending transactions since inception. This quarter alone, 12 of 17 BXSL’s funded transactions were for deals Blackstone led, which allows us to be in a position to drive the negotiation of terms and documentation. During the quarter, we issued nearly $330 million of common shares through our ATM offering with additional equity and increased capacity for our debt, which has a weighted average cost of just over 5%. We remain very well positioned to take advantage of an improving M&A environment where we believe we can deploy capital and drive earnings for shareholders.

2023 was also our best year performance since inception with a 14.7% return on NAV basis and a lot of that return was supported by higher rates. We believe there are multiple drivers of returns that could work in our favor in 2024. These drivers include sustained elevated interest rates despite potential cuts later this year, tightening credit spreads, which could result in asset appreciation, and refinancings in our first-lien senior secured portfolio. And lastly, as I just mentioned, additional potential income driven by increased M&A activity, which we are starting to see as evidenced by our fourth quarter activity. So with that, I will turn it over to Jon Bocks.

Jonathan Bock: Thank you, Brad. And let’s turn to slide 6. We ended the quarter with $9.9 billion of investments, an increase from $9.5 billion in the third quarter. We also modestly de-levered and end the quarter at 1 times debt to equity averaging 1.05 times in the quarter. And we enhanced our liquidity position this quarter to $1.8 billion. That’s comprised of cash and available borrowing capacity across our revolving credit facilities, including ABLs, and that’s a lean into an expanded pipeline. And our weighted average yield on debt investments at fair value was 12% this quarter compared to 11.9% last quarter. New investments continue to be accretive to investment income. The yield on both new debt investment fundings and assets repaid during the quarter averaged around 11.7%.

And importantly, the weighted average base rate over the fourth quarter expanded approximately 120 basis points on our 98.9% floating rate debt portfolio compared to the same quarter in the prior year as rates remain elevated. Now let’s look at the portfolio in on slide 7. BXSL continue to focus on its defensive positioning in the current market environment. And this is reflected in our nonaccrual rate of less than 0.1% at cost and fair market value with no new nonaccruals in the quarter. As we look into 2024, we expect to see dispersion in performance across the market with defaults increasing in certain areas, particularly in smaller companies and businesses with cyclical and capital intensive profile, neither of which are within the BXSL’s investment focus.

In addition, we expect the underperforming businesses with upcoming maturities where sponsors have taken value out, could also face more challenges. And while we expect market defaults and non-accruals to pick up modestly, fewer than 10% of BSXL’s loans have maturities in the next 24 months, and liquidity profiles overall remain healthy, and further 9% of BXSL’s exposure to revolver credit facilities is drawn. And while we’re pleased with our non-accrual rate, we continue to monitor our portfolio companies very closely, leveraging our team of 84 professionals in Blackstone’s Credit and Insurance’s strategic investment office. Now over 98% of BXSL’s investments are in first-lien senior secured loans and 99% of those loans are to companies owned by private equity firms or other financial sponsors who generally have access to additional equity capital and equity owners of this type has historically shown a willingness to support borrowers.

These sponsors have significant equity value in these capital structures with an average loan-to-value of 48.2% in BXSL. And to complement healthy credit fundamentals and what could be a lower interest rate environment later this year, our portfolio also starts from a very strong EBITDA base. Taking a look at slide 8. You can see why we view larger companies as higher performing borrowers. Our portfolio companies generated an average of $192 million in LTM EBITDA, up from approximately $167 million at the end of the fourth quarter of 2022, and more than 2 times larger than the private credit market average. As we can see from the Lincoln International Private Market database, a market resource on private credit markets overall, larger companies of $100 million or higher in EBITDA have experienced nearly 4 times greater EBITDA growth and default nearly 5 times less than when compared to true middle market transactions.

And this is often said these companies are not simply good because they are big. We believe they are big because they are good. And with our extensive sourcing capabilities in origination engine, we have the ability to identify and choose a broad array of investments that are in our view, attractive risk-adjusted opportunities in a market environment where we’re anticipating increased activity as Brad outlined earlier. Now slide 9 focuses on our industry exposure. Another important part of our defensive positioning, where we like to focus on better investment neighborhoods. And this means focusing on key sectors with among other themes, lower default rates and lower CapEx requirements. This quarter, 30% of BXSL’s deals were closed in the software industry as we continued to focus on more historically lower default rate industries.

We increased the number of portfolio companies while maintaining nearly 90% invested at historically lower default rate industries, including software healthcare providers and services, professional services, and commercial services and supplies, which are some of the highest exposures and highest conviction themes across the portfolio. On slide 10, we can see BXSL’s portfolio company fundamentals compared to the private credit market as measured by Lincoln. And then relative to the private credit market, BXSL has approximately 2 times — our portfolio companies have approximately 2 times higher growth rate and generate nearly 15% higher profitability. Now, we continue to stress the importance of interest coverage. Average LTM EBITDA coverage of interest for BXSL portfolio companies over the last 12 months was 1.8 times in Q4, which again compares favorably to the Lincoln database for the private credit market at 1.4 times coverage in Q4.

As we always say, the tails here are key. And 6% of BSXL’s portfolio reflected interest coverage below 1 times compared to the market at 15% on an LTM basis. It is even more important to understand what’s driving these tails and which companies comprise them. If you’re looking at the market, looking at their tail below 1 times EBITDA coverage, more than 70% of the companies below 1 times interest coverage are small with less than $50 million in EBITDA. And for BXSL, the majority of these companies are associated with recurring revenue loans, which were underwritten as higher growth names with lower initial coverage ratios, and if you exclude recurring revenue loans from the analysis, BXSL’s share of the portfolio below 1 times interest coverage becomes less than 1% versus the market at 13%, especially relative to the broader private credit market, we’ve seen our portfolio companies continue to deliver strong fundamental performance.

Now looking ahead, the market’s expecting rates to begin fall this year. Current pricing implying an average SOFR rate in 2025 of 4.1%. Now as many of you know, lower interest rates effectively lower the interest burden that’s currently placed on our portfolio companies and that in turn allows more free cash flow to equity holding all else equal, whether this trend of free cash flow and interest payments, borrowers can reinvest excess cash into growth or prepare for sale or refinancing. And to illustrate this point, running at a 4.1% average base rate through BXSL’s portfolio as of Q4 2023, that imply a hypothetical increase in the portfolio’s interest coverage ratio from 1.8 times to 1.9 times holding other data constant. Now I’ll conclude with some points on our documents and recent amendment activity.

As Brad indicated, when we negotiate our credit agreement, especially when we’re the leading lender, we place significant focus on ensuring important protections are put in place. Nearly 100% of the Blackstone led deals held in BXSL, include certain protections against asset stripping and collateral release and have caps on add-backs to EBITDA. This is in stark contrast to the syndicated market where the majority of loans lack these kind of lender protections and which we believe have been a significant driver of depressed recoveries and liquid loans over the past year. Finally, amendment activity continues to be relatively benign. In the fourth quarter in BXSL there were 40 amendments. The vast majority of which were associated with add-ons, DDTL extensions, and other immaterial technical matter.

And there were two other amendments associated with providing additional PIC flexibility and one amendment associated with an underperforming investment. Among the two PIC amendments, one was associated with a significant equity infusion by the PE sponsor and the other was effectively extension on a PIC option provided at initial underwriting. Now when we extend the call, we also extend the call protection on one of the deals by two years. And for the underperforming investment, we proactively engaged the PE sponsor who also contributed new equity. And the amendments here was associated with recognizing additional equity in our covenant tests. With that, I’ll turn it over to Carlos.

Carlos Whitaker: Thanks, Jon. Turn to slide 11. BXSL maintained its dividend distribution of $0.77 per share, a 28% increase from Q4 of last year and a 45% increase since our IPO two years ago. As you can see, we have continued to focus on delivering high-quality yield to shareholders, building a level of confidence through steady regular dividends while also building NAV per share. We expect this approach to continue. As the economic environment shifts, it’s important to look at the market as a whole. We expect private credit spreads to tighten as M&A increases, a trend we began noticing in late 2023. To expand on Brad’s point regarding deal activity, we are optimistic about M&A volumes and the deployment picture for 2024. Valuation expectations have improved.

Record private equity dry powder of $1.5 trillion is on the sidelines. Economic sentiment is improving. Fundamentals remain healthy. And there is a new prospect for lower cost to capital if rates fall. All drivers for pent-up market activity. Given our broad origination platform and expansive credit footprint, we believe BXSL is well positioned to take advantage of this environment. Another benefit we offer is our scaled investment franchise, which allows us to drive investor returns. A main Blackstone focus. Recall, our value creation program, which all BXSL portfolio companies have access to. Seeks to assist our companies by lowering their expenses and creating cross-sell opportunities across the broader Blackstone portfolio. We have created an implied $3.5 billion plus of enterprise value for our BXCI companies, in addition to being their lender.

For example, we made over 20 introductions across the broader Blackstone ecosystem to a digital service provider and generated approximately $7 million in sales for this borrower. This included projects for enterprise architecture and enterprise resource planning selection, cloud optimization consulting and material requirements and planning, all directly with other Blackstone investments. We also worked with a management service provider for healthcare, to put together a request for proposals for medical consumables. The request contained over 1,000 SKUs. And through this process, saved the borrowers almost $2 million. And again, we are just the lender here. So to be able to provide such assistance is quite remarkable. It’s a point worth emphasizing, as we provide BXCI value creation services that aim to add value to our companies.

We offer our borrowers access to over 50 data scientists, over 90 senior advisers, and a team of cybersecurity experts, all of which we believe ultimately makes us an attractive manager to partner with. But all of this ties to our focus on shareholder experience and alignments. We built BXSL to help drive attractive risk-adjusted returns to shareholders with what we consider to be industry leading best practices. Even after the expiration of our fee waiver BXSL has among the lowest fee structures, expense ratios, and cost of debt relative to our peer set as a percentage of NAV and as of the end of Q4. This helps us to build a defensive portfolio and deliver returns to our investors. We have a three-year look-back for total return hurdle related to incentive fees on income and importantly, we amortize OID over the life of the loan and do that scrape upfront fees to the manager by passing on all of BXSL’s portion of investment related fees fully to the fund, another example of shareholder alignment and another way we aim to differentiate ourselves.

And with that, I’ll turn it over to Teddy.

Teddy Desloge: Thank you, Carlos. I’ll start with our operating results on slide 12. In the fourth quarter BXSL’s net investment income was $172 million, or $0.96 per share, representing the second highest NII quarterly performance since our IPO. GAAP net income in the quarter was $157 million or $0.88 per share, up 16% from a year ago. Our total investment income for the quarter was up $53 million or 21% year over year, driven by increased interest income, primarily due to higher rates. Payment in-kind or PIC income represented approximately 5% of total investment income during the quarter. We would also like to acknowledge that the fee waivers in place since our IPO expired near the end of October 2023. While this quarter included partial waivers for approximately one third of the period, future quarters will fully incorporate BXSL’s full management fee of 1% and its incentive fee of 17.5%.

The partial waivers added approximately $0.02 of NII per share to the quarter. Turning to the balance sheet on slide 13. We ended the quarter with $9.9 billion of total portfolio investments at fair value, less than $5 billion of outstanding debt and nearly $5 billion of total net assets. With our strong earnings in excess of the dividend in the quarter, NAV per share increased to $26.66, up from $26.54 last quarter. Next, slide 14 outlines our attractive and diverse liability profile, which includes 57% of drawn debt in unsecured bonds. These bonds have a weighted average fixed coupon of less than 3%, which we view as a key advantage in this elevated rate environment and contribute to an overall weighted average interest rate on our borrowings of just over 5%.

Again, this compares to a weighted average yield at fair value on our debt investments of 12%. Additionally, we have no maturities on our liabilities until 2026, and our funding facilities have an overall weighted average maturity of 3.4 years. As mentioned in our prior earnings call, BXSL was the first traded BDC to receive an improved outlook from Stable to Positive by Moody’s, and we continue to maintain our three investment grade corporate credit ratings. We ended the quarter with approximately $1.8 billion of liquidity in cash and undrawn debt available to borrow, providing us with significant capacity for continued portfolio growth. The fourth quarter of 2023 was our most active quarter since 2021 with BXSL committing to over $1 billion in investments in the quarter that have closed to date, plus an additional $221 million committed to BXSL as of December 31 that have yet — not yet closed.

As you heard from Brad, Jon, and Carlos, we believe deal activity will increase in 2024 and create new deployment opportunities we are seeing that play through our pipeline. We also have seen spreads tighten and activity rise in a syndicated loan market, generally a leading indicator for what we expect to see in the private side. As such, we are actively leveraging incumbency to retain exposure where capital structures were set up in a wider spread environment while company performance has remained strong, exceeding expectations. For example, in the fourth quarter, we redefined repricings in the portfolio in exchange for an average of nearly two years of additional call protection. We are also finding success offering private solutions that are differentiating versus what the syndicated market can offer, such as refresh DDTL capacity or modest PIC flexibility.

In conclusion, we remain positive about the year ahead, our competitive advantages in the market and robust performance in various metrics against our peer set. We believe the positive factors that have supported returns for investors remain in place, including portfolio positioning for a modestly lower, but still elevated rate environment, ample liquidity to deploy in what we believe will be a more robust deal environment and continued elevated earnings powered by low cost financing sources, all of which is backed by Blackstone’s platform advantages in scale and sourcing and our focus on protecting investors’ capital. With that I’ll ask the operator to open up for question. Thank you.