Carlyle Secured Lending, Inc. (NASDAQ:CGBD) Q4 2023 Earnings Call Transcript

Carlyle Secured Lending, Inc. (NASDAQ:CGBD) Q4 2023 Earnings Call Transcript February 27, 2024

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

Operator: Thank you for standing by, and welcome to the Carlyle Secured Lending, Inc. Fourth Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] As a reminder, today’s program is being recorded. And now I’d like to introduce your host for today’s program, Daniel Hahn, Shareholder Relations. Please go ahead, sir.

Daniel Hahn: Good morning, and welcome to Carlyle Secured Lending’s fourth quarter 2023 earnings call. With me on the call this morning is Aren LeeKong, our Chief Executive Officer; and Tom Hennigan, our Financial Officer. Last night, we filed our Form 10-K and issued a press release with the presentation of our results, which are available on the Investor Relations section of our 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 any 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.

These risks and uncertainties could cause actual results to differ materially from those indicated. Carlyle Secured Lending assumes no obligation to update any forward-looking statements at any time. With that, I’ll turn the call over to Aren.

Aren LeeKong: Thanks, Dan. Good morning, everyone, and thank you all for joining. As has become custom, I will focus my remarks on three topics for today’s call. First, I’ll provide an overview of the fourth quarter and full-year 2023 financial results. Next, I’ll touch on the current market environment. And finally, I’ll conclude with a few comments on the quarter’s investment activity and portfolio positioning. Starting off with earnings. We continue to see our financial performance benefit from the higher base rate environment. In the fourth quarter, we generated net investment income of $0.56 per share, which is an increase of 8% from the prior quarter and represents an annual yield of 13% based on 12/31 NAV. This continues to trend upward from last quarter and the LTM period.

As a result of our continued execution of our strategy, the quality of our portfolio and our confidence in the future, beginning this quarter, we are increasing the base dividend by $0.03 from $0.37 to $0.40 per share. Our Board of Directors declared a total first quarter dividend of $0.48 per share, consisting of our new base dividend of $0.40 plus an $0.08 supplemental, a total increase of 9% compared to the prior quarter and an increase of 8% on the base dividend. Our net asset value as of December 31 was $16.99 per share. That’s up $0.13 or approximately 1% from the September 30 period, primarily as a result of our Q4 earnings outpacing our dividend. Turning now to the market environment. 2023 was defined by market volatility, slow private equity capital formation and muted M&A activity for most of the year.

For context, private equity deal activity and M&A activity were down significantly in ’23 compared to ’22 and ’21, though there was a pickup in M&A activity in the fourth quarter. With this backdrop throughout the year, our investment team leveraged the breadth and depth of the One Carlyle platform to drive value in the evolving market environment by generating significant volume across our existing portfolio of borrowers and Carlyle’s broad sourcing network. Leveraging our incumbencies allowed us to source transactions where we had diligence and information advantages, and existing portfolio companies accounted for approximately half of our deal closings during the year. Our flexible origination capabilities enabled us to source transactions from the lower end of the middle market at $25 million of EBITDA and opportunistically all the way up to $450 million of EBITDA in the last year.

That includes sponsored and non-sponsored companies across North America and Europe. Outside of our core middle market strategy, we leveraged the One Carlyle network to source complementary, differentiated specialty lending transactions within the asset-based and recurring revenue markets. These trends were evident throughout the year and continue with fourth quarter origination activity. We continue to be pleased with the overall credit performance of our existing portfolio, with revenue and EBITDA up quarter-over-quarter and since inception. Compared to the prior year, portfolio company revenue and EBITDA both expanded by an average of approximately 13% and compared to the prior quarter, 1% and 3%, respectively. Non-accruals were stable in the fourth quarter.

And as Tom will discuss in detail later, we expect these levels to improve in the coming quarter. Tactical origination activity, strong credit fundamentals and the current rate environment drove record income for CGBD. Despite the rising base rate environment over the last two years, we have been intentionally conservative with our dividend through the cycle. In our view, our new dividend policy, which Tom will expand upon later, provides a sustainable base dividend along with a transparent framework for supplemental dividends that will enable investors to better anchor their expectations. Lastly, I’d like to spend a few minutes on current positioning. Our portfolio remains highly diversified and is comprised of 173 investments in 128 companies across over 25 industries.

The median EBITDA across our portfolio at the end of the quarter was $76 million. The average exposure in any single portfolio company is less than 1%, and 95% of our investments are in senior secured loans. I will now hand the call over to our CFO, Tom Hennigan.

Tom Hennigan: Thanks, Aren. Today, I’ll begin with a review of our fourth quarter earnings, then I’ll discuss portfolio performance, and I’ll complete with detail on our balance sheet positioning. As Aren previewed, we had another strong quarter on the earnings front. Total investment income for the fourth quarter was $63 million, up about $2 million from the prior quarter. This increase will be driven by the continued positive impact of base rates and an increase in both other income and OID acceleration, which were aided by prepayment activity. Total expenses of $34 million were flat versus prior quarter. Of note, total interest expense was up modestly as base rates stabilized during the quarter. The result was net investment income for the fourth quarter of $28 million or $0.56 per share, up nearly 8% from the prior quarter.

And this level represents an all-time high for core NII in any quarter. Our Board of Directors declared the dividends for the first quarter of 2024 at a total level of $0.48 per share. That’s comprised of the new $0.40 base dividend plus an $0.08 supplemental, which is payable to shareholders of record as of the close of business on March 29. This total dividend level reflects an increase of 9% over the previous $0.44 per share and reflects the earnings power and stability of our portfolio despite a complex macroeconomic environment. Our base dividend coverage of 140% for the quarter remains above the BDC peer set average. And we’ve grown the base dividend by 25% since 2022. At the same time, the total dividend level also represents an attractive yield of over 12% based on the recent share price.

In terms of the forward outlook for earnings for the rest of 2024, we see stability at this $0.50 plus level based on the latest interest rate curves and our current conservative positioning on leverage. Despite rising rates, we’ve maintained a conservative, disciplined approach that we believe will enable us to continue consistent dividend payout in a variety of rate environments, included when rates normalize. So we remain highly confident in our ability to comfortably meet and exceed our new $0.40 base dividend and continue paying out supplemental dividends each quarter. And going forward, we’re going to shift to a floating supplemental dividend construct and target paying out at least 50% of excess earnings through the supplemental dividend, which will allow us to be flexible as the portfolio evolves and base rates fluctuate.

On valuations, our total aggregate realized and unrealized net gain was about $0.5 million for the quarter, supported by a slight net positive movement in valuations. This increase in valuations combined with Q4 earnings exceeding the dividend resulted in our NAV increasing from $16.86 to $16.99 per share. Turning to the portfolio. We continue to see overall stability in credit quality across the book. Similar to last quarter, there were no new non-accruals and no additions to our watch list, which are deals with risk ratings 4 or 5. Total non-accruals were effectively flat quarter-over-quarter, and we’re very pleased to report that Dermatology Associates was successfully recapitalized in early February with the lenders taking equity control.

So we expect an improvement in non-accruals when we report March results. We continue to proactively manage the portfolio and are working with sponsors to ensure borrowers have adequate liquidity. You’ll see that PIK interest ticked up over the course of 2023. In almost all cases, when we provided PIK relief for existing borrowers, that was accompanied by significant equity support from the sponsor. I’ll finish by touching on our financing facilities and leverage. We continue to be well positioned on the right side of our balance sheet. Leverage is down quarter-over-quarter, and we’re intentionally running leverage conservatively at the lower end of our target range to maintain the flexibility to invest in attractive opportunities. Statutory leverage was about 1.2x, and net financial leverage ended the quarter modestly lower, right about one turn, the lowest level since early 2022.

This positioning allows us to remain opportunistic as the macroeconomic environment evolves and deal activity looks to pick up in 2024. With that, I’ll turn it back to Aren.

Aren LeeKong: Thanks, Tom. I would like to finish by highlighting the consistency of our investment approach and reiterate our overall investment strategy. We are primarily focused on making senior secured floating rate investments to U.S. companies backed by high-quality sponsors primarily in the mid-market. Market demand for private credit remains high. And we continue to focus on sourcing transactions with significant equity cushions, attractive leverage levels, strong documentation and attractive spreads relative to not only the current market but also historical originations through our disciplined underwriting, prudent portfolio construction and conservative approach to risk management. With attractive new originations, a stable portfolio and reduced non-accruals, we benefited from continued execution of our strategy in 2023 and remain committed to delivering a non-volatile cash flow stream to our investors through consistent income and solid credit performance.

I’d like to now hand the call over to the operator to take your questions, and thank you so much.

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Q&A Session

Operator: [Operator Instructions] And our first question comes from the line of Bryce Rowe from B. Riley.

Bryce Rowe: Wanted to maybe piggyback on some of the prepared comments there around potential pickup in activity. We’ve heard that from other BDCs. And if you could kind of just help us think about what that might look like, especially relative to the leverage profile of your balance sheet at this point. I mean you’ve noted that you’re at one of the lowest leverage points in quite a while. So just kind of want to understand how that could evolve over the course of ’24.

Aren LeeKong: Yes. So — and as usual, you asked a question probably has multifacet. So when we think of leverage, I’ll just start there, that’s — and Tom then should hop in a bit like, but that is a sort of multivariable topic. So one, we’re able to, in today’s market, originate loans that at S plus 6 plus. I think last year, the average loan in CGBD was probably around S plus 650. The team here will tell me if I’m off by a few basis points. You’re able to actually pay out that sustainable and non-volatile cash flow stream, which is actually the ultimate product of any BDC without being overlevered. And Bryce, you and I and the team have talked about this behind closed doors many times. The goal here isn’t to run hot just for the sake of being the best, but the goal here is to pay out that non-volatile cash flow stream.

So for us, the leverage is really just a function of the rest of the strategy. So the — in terms of a pickup in — and I’m just going to the fourth quarter. So there was a pickup in transactions in the fourth quarter, and the first quarter has actually been stable to the fourth quarter. The reality though is our first question isn’t, hey, how do we do 10 more deals? Our first question is, is the incremental transaction that we’re doing — right, you and I have talked about this behind closed doors, is it going to improve the current portfolio, period. So when we think about whether we have to take up leverage, we think about how an uptick in volume impacts the fund. The first question isn’t, oh, how many more deals can we do? The first question is, how do we actually create the cleanest, most non-volatile cash flow streams that we can?

So that can — is leverage going to stay down at one turn forever? No, we don’t mean it to, but in this market based on our current base returns, we actually have the benefit of being able to do that. And same token that I’m sorry for — if this doesn’t perfectly get your question, hopefully, it’s getting around it. Even if deal flow picks up, effectively that I’d rather the biggest funnel to be able to choose the best deal. So I’d rather always see more deals, but just because originations and see more transactions has picked up, again, my product and our team’s product to you and the Street, and this is kind of the strategy we try to execute is how do you create a clean portfolio that kicks off the cash flows that you all can predict. Is that helpful?

Bryce Rowe: Yes, for sure. Appreciate it. Definitely gets to the meat of the question. And maybe a follow-up for Tom, since you talked about it in the prepared remarks, the Dermatology Associates investment crystallized here in February, as you noted. Can you talk about what the mechanics of that might look like in the first quarter, given that you were actually carrying at a fair value mark above cost?

Tom Hennigan: Right. So the new capital structure, like the similar structure, is going to have two tranches of debt, the first debt and the last debt. And then you’ll see there will be a new equity tranche on our SOI. One important note is, in the aggregate, our total fair value will be, a crystal ball, that’s roughly unchanged. So total fair value is not going to change very much. It’s just there’ll be different instruments, and there’ll be more value moving from what is now our last out on non-accrual to an equity tranche and then there’ll be more debt on accrual status in those new tranches. So net-net, positive impact on a quarterly but full quarter basis of about $0.01 per share.

Bryce Rowe: Okay.

Tom Hennigan: No impact on fair value, but — and non-accruals going down materially with that transaction, and the aggregate being removed from non-accrual stats.

Bryce Rowe: Yes. Okay. Got it. And then maybe last one for me. You all have swapped out the fixed rate for a floating rate on the baby bonds. Maybe an obvious answer from you all, but just any thought around why do that as opposed to just keeping a fixed rate there?