Nuveen Churchill Direct Lending Corp. (NYSE:NCDL) Q2 2024 Earnings Call Transcript

Nuveen Churchill Direct Lending Corp. (NYSE:NCDL) Q2 2024 Earnings Call Transcript August 11, 2024

Operator: Welcome to the Nuveen Churchill Direct Lending Corp. Second Quarter 2024 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the management team’s prepared remarks. [Operator Instructions] As a reminder, this conference call is being recorded for replay purposes. I’d like to turn the call over to Alona Gornick, Senior Investment Strategist at Churchill Asset Management. Alona, please go ahead.

Alona Gornick: Good morning, and welcome to Nuveen Churchill Direct Lending Corp. Second Quarter 2024 Earnings Call. Today, I’m joined by NCDL’s Chairman, President and CEO, Ken Kencel; and Chief Financial Officer and Treasurer, Shai Vichness; as well as Robert Paun, Head of Investor Relations for Retail & Wealth here at Churchill. Following our prepared remarks, we will be available to take your questions. Today’s call may include forward-looking statements. Such statements involve known and unknown risks uncertainties and other factors, and undue reliance should not be placed thereon. These forward-looking statements are not historical facts, but rather are based on current expectations, estimates and projections about the company, our current and prospective portfolio investments, our industry, our beliefs and opinions and our assumptions.

These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond our control and difficult to predict. Actual results may differ materially from those expressed or forecasted in the forward-looking statements. We ask that you refer to the company’s most recent filings with the SEC for important risk factors. Any forward-looking statements made today do not guarantee future performance and undue reliance should not be placed on them. The company assumes no obligation to update any forward-looking statements at any time. Our earnings release, 10-Q and supplemental earnings presentation are available on the Investor and News section of our website at ncdl.com. Now I’d like to turn the call over to Ken.

Kenneth Kencel: Thank you, Alona, and thank you, everyone, for joining us on the call today. I’d like to start by taking a few minutes to discuss NCDL’s results for the second quarter, and then I’ll provide some thoughts on the current market and economic environment and our outlook for the coming months. After that, I’ll hand — I’ll hand the call over to Shai for a more detailed discussion of our performance. Overall, I’m very pleased with the momentum we’ve maintained since our last call. Our performance continues to be strong as we delivered net investment income that exceeded both our regular quarterly distribution of $0.45 per share and our $0.10 per share special distribution. Investment activity picked up significantly during the second quarter with $360 million of new originations, over 95% of which were first lien senior secured loans, and we delivered an attractive 12.3% annualized dividend yield to shareholders.

Our investment portfolio performed well this quarter, largely due to the continued strength of our senior loan investments. Net asset value per share declined modestly quarter-over-quarter primarily driven by unrealized losses on two investments that we placed on nonaccrual, which we will speak about later on in the call. Looking ahead, we are optimistic about NCDL’s positioning as a leader in the core middle market, given our long-standing track record, deep network of sponsor relationships an extensive, strong LP commitments across the broader Churchill platform. Looking at the overall market. Credit quality remains strong despite the higher for longer rate environment and inflationary pressures on borrowers. While we are seeing modest spread compression during the first half of the year, we believe that our focus on the core middle market enables us to remain largely insulated from the pricing pressure, increased volatility and generally weaker terms we see in the broadly syndicated loan market.

As a result, we believe that the risk-adjusted returns available to scaled, highly selective managers like Churchill with deep, long-standing private equity relationships in the core middle market are among the most attractive in the private credit market today. The U.S. economic environment remains healthy and resilient, and we believe that will continue in the near term. We have yet to see evidence in our core middle market portfolio of an imminent recession or pullback in spending and CapEx investment. And our CFO confidence appears to remain high given the significant add-on M&A activity that we are seeing on a daily basis. We also monitor on a daily basis, the liquidity of borrowers in our portfolio and have been pleased to see how companies have generally navigated this higher rate environment quite well.

Moreover, we believe interest coverage is going to be a tailwind going into the back half of the year as we start to see the Fed move to reduce interest rates as inflation pressures subside. Our deep relationships in the middle market private equity community provide us with strong insights on potential headwinds. And while underwriting selectivity will always be at the forefront, we feel quite positive heading into the second half of the year with respect to both deal flow generation and the health of our underlying borrowers. When looking at the second quarter results, there are two factors that help bolster our performance. One was the level of deployment we experienced in the quarter. The other was our discipline in managing NCDL’s leverage profile, which Shai will discuss in more detail.

NCDL’s deployment of capital during the second quarter was very strong. This was a meaningful uplift compared to Q1. In fact, Q2 represented one of the strongest quarters in the history of our firm in terms of loan origination. And that resurgence of activity particularly in the senior lending area, which represented over 95% of our origination activity was responsible for much of our success. In fact, as a result of the strong level of senior lending activity, first lien senior loans increased to nearly 91% of the fair value of the overall portfolio, the highest level of spend in the past year. We will continue to prioritize opportunities to deploy capital in core middle market senior loan investments as we pursue portfolio growth and diversification as a public company.

We feel this asset class provides strong long-term risk mitigation characteristics, including floating rates, generally lower leverage and traditional financial covenants. Like I mentioned earlier, our credit quality remains strong and healthy. As Shai will cover later on in the call, our weighted average internal risk rating remains at 4.1 versus an original rating of 4.0 for all of our investments, and our watch list remains a very manageable level of 3.8% of fair value. Overall, we are pleased with the fundamentals across the portfolio with portfolio company net leverage of 4.8x, interest coverage of 2.2x on first lien loans and a weighted average asset yield of 11.4%. These metrics are a direct result of conservative structuring and relatively low attachment points that we target when underwriting new transactions.

his conservative approach has served us well in the elevated rate environment. That said, we did add two new nonaccruals this quarter. However, within our highly diversified portfolio of nearly 200 investments, nonaccruals represented just 0.49% of the fair value of the portfolio as of quarter end. We view these two new nonaccruals as idiosyncratic in nature, and we are in conversations with both companies and their private equity owners as we work toward a favorable outcome for our shareholders. As you heard at the top of the call, we generated record deployments in the quarter, which has resulted in continued improvement in the diversification of our portfolio. This has been achieved with continued selectivity facilitated by the significant proprietary deal flow, our sourcing engine is able to generate from the breadth and depth of our PE relationships.

We now have 198 companies in our portfolio, and our top 10 investments represent only 14.4% of the total portfolio. This diversification is critical as we seek to maintain exceptional credit quality and originate additional attractive investment opportunities. From a forward-looking perspective, we believe NCDL is well positioned for strong performance in the second half of 2024, particularly given our standing is one of the largest and most active BDCs focused on the core middle market. Our outlook is underpinned and enabled by NCDL’s approach to portfolio construction and management. Three key factors are worth highlighting. First, NCDL has a strong focus on a high level of portfolio diversification across a number of key metrics. We are not simply looking to diversify at the sector level.

We have constructed a defensive portfolio that is balanced across multiple measures, whether you’re looking at sponsor, position size, or industry. We’ve achieved this level of diversification across all our different vehicles across our investment platform, and it represents a consistent commitment embedded in Churchill’s DNA. It has been essential to our success throughout our history, and it is a key reason why I’m optimistic about NCDL’s longer-term prospects. Second, we have a rigorous investment process that puts credit quality above all else. As we look for opportunities to underwrite, we focus on high-quality, market-leading businesses that operate in recession-resistant industries with leading market positions and high barriers to entry backed by top-tier private equity sponsors.

Our strong deal flow and unique sourcing model enables us to maintain a rigorous investment process and maintain strong credit discipline. As an example, we do not invest in ARR loans, which we believe rely heavily on more volatile enterprise value multiples as well as business transition execution and less on underlying true cash flow, which is needed to ultimately service the debt. We’re also carefully attuned to the interest burden facing both our existing portfolio companies as well as new borrowers. This consideration influences our conservative approach to structuring new transactions with lower overall leverage and tighter covenant packages. This discipline is crucial, particularly in an environment where spreads are tighter in terms of more aggressive.

That is why we’re willing and able to walk away from certain deals that we assess as too risky. And this brings us to a very important third factor that is especially important. Our highly differentiated origination and sourcing model. We enjoy strong private equity LP relationships. Over nearly two decades, Churchill has worked with more than 280 middle market private equity firms. In fact, today, Churchill has commitments to over 300 leading U.S. middle market private equity funds and sits on over 240 advisory boards. We have been and continue to be a trusted and established investor in the core middle market with deep long-term relationships, which provides NCDL with a strong information and sourcing advantage. This advantage was very much evident during the past quarter that saw us generate record investment activity across our platform, and we believe we’ll continue to see similar dynamics as we move through the balance of the year.

Overall, we remain highly optimistic about NCDL’s longer-term outlook as we believe we are well positioned to take advantage of a growing private credit market opportunity. And now I’ll hand it over to Shai to discuss our financial results in more detail.

Shai Vichness: Thank you, Ken, and thank you all for joining us to review our second quarter results. For the quarter, we earned $0.57 of net investment income per share. And in July, we paid regular and special dividends of $0.45 and $0.10 per share, respectively. In aggregate, this $0.55 dividend equates to an annualized dividend yield of approximately 12.3% based on our quarter end NAV. As a reminder, the $0.10 special dividend that we paid in July is the first of 4 special dividends that we declared at the time of our IPO. The 3 remaining special dividends will be paid through the second quarter of 2025 to shareholders of record as of August 12 and November 11 of this year and February 12, 2025. As discussed previously, we intend to operate with a supplemental dividend program that sees us paying out a portion of the excess earnings over and above our regular dividend, allowing us to deliver the benefits of higher returns in the current environment to shareholders as well as grow our NAV.

Our total net income for the quarter was $0.37 per share, driven by $0.20 per share of net realized and unrealized losses. We generated approximately $0.02 per share of realized gains on repayments, which were offset by approximately $0.22 per share of unrealized losses, primarily on two underperforming investments that were placed on nonaccrual during the quarter. Our debt-to-equity ratio at the end of the quarter was 1.04x, which is consistent with the guidance we provided at the time of our IPO. We were pleased with our ability to deploy capital and utilize leverage during the quarter, and we remain on track to optimize leverage through the balance of the year with the goal of maintaining leverage within our target range of 1.0 to 1.25x.

Our net asset value per share decreased by approximately 1% to $18.03 per share. The decrease was attributable to the unrealized losses on two new nonaccruals during the quarter, offset by the excess earnings we generated in the quarter over and above the regular and special dividend that we paid. As Ken mentioned, the second quarter was a very strong one for us in terms of new origination. The fair value of our assets grew by approximately $196 million quarter-over-quarter. This increase was largely attributable to record high new originations, which accounted for 11 of the transactions done during the quarter totaling approximately $150 million. We continue to mine our portfolio for add-on financing opportunities, which allowed us to generate 25 deals in the form of incremental transactions for existing portfolio companies totaling approximately $130 million.

In addition, we saw drawdowns of roughly $26 million on our delayed draw term loans as our portfolio companies continue to be active in growing the acquisitions. Repayment activity significantly increased during the quarter, in line with the increase in volume that we saw both on new transactions as well as repricing and refinancing activity. We had full repayments on 8 deals totaling $80 million and partial prepayments for another $11 million. As the incumbent lender, we took advantage of our position, reinvesting in 4 of the 8 deals that fully repaid during the quarter. Repayments in the second quarter totaled 4.9%, a meaningful increase from the 2.2% we saw in the first quarter and in line with our long-range assumption of 5% per quarter.

Despite this uptick in repayment activity, our portfolio grew to 198 names as of quarter end and it remains highly diversified with the top 10 positions representing only 14.4% of the fair value of the portfolio and our largest exposure at only 1.6%. Our average position size is one half of 1%, which we see as a key risk mitigation tool. In terms of new originations, the second quarter was our strongest quarter ever, which highlights the strength and durability of our platform. As Ken mentioned, we saw volume grow year-over-year to $360 million in par amount of new originations across 36 investments from the $110 million we committed in the second quarter of 2023 and up sequentially from the $207 million of gross commitments in Q1. Looking at asset selection during the quarter, our new originations were heavily weighted towards the traditional middle market senior loans with only 16% of the investments made during the quarter going into the upper middle market.

This is consistent with the guidance that we gave last quarter and at the time of our IPO, when we communicated our expectation that we would allocate more readily initially to the upper middle market and then rotate that portion of the portfolio into the traditional middle market segment where spreads are meaningfully higher and documentation terms are tighter. This strategy is evident when looking at the weighted average interest rate on new debt investments made during the quarter, which was up 20 basis points from the prior quarter. As Ken mentioned, spreads tightened further in Q2, but our continued focus on the traditional middle market segment allowed us to deliver an increase in this metric quarter-over-quarter. We would expect that to continue as we execute on our rotation strategy and invest in our robust pipeline of traditional middle market deals.

The portfolio remains anchored in senior loans, which represented close to 91% of the portfolio at quarter end. The modest increase from the 89% senior loan allocation at the end of Q1 is consistent with the strategy that we laid out at the time of our IPO. We continue to opportunistically invest in junior debt and equity, which made up 4% and 1% of the investments made during the quarter and comprised 7.8% and 1.6% of the portfolio overall as of quarter end. We remain committed to the target allocations that we communicated at the time of our IPO with a target of 85% to 90% senior loans and the balance in junior debt and equity co-investments with equity staying in the low single-digit percentage range. In terms of the credit quality of the portfolio, our weighted average internal risk rating remained steady quarter-over-quarter at 4.1 despite the two new nonaccruals that I referenced earlier.

This brought the total number of nonaccrual assets at quarter end to 3, representing just 0.49% of the fair value of the portfolio. The number of names on our watch list increased by two as well as a result of 4 downgrades and two upgrades. However, our watch list remains at a historically low level at only 3.8% of the portfolio fair value. Turning to our leverage strategy, we continue to keep a close eye on the unsecured debt market as we evaluate our long-term capital structure and are encouraged by the trends that we see in that market with healthy levels of issuance activity over the first half of the year. We remain incredibly well positioned to take advantage of attractive investment opportunities and to fund our unfunded commitments and share repurchase program with over $360 million of liquidity available to us as of quarter end.

Further, we have no near-term maturities as we have constructed a diversified capital structure to date that is match funded to our floating rate assets. We have been using a modest amount of liquidity to fund our share repurchase program, which commenced 60 days after our IPO. Through July 31, we’ve utilized approximately $6.5 million, leaving approximately $92.8 million remaining under the program. We have now traded through our second lockup release, which saw 35% of the nonaffiliated pre-IPO shares released from lockup. As a reminder, at the time of our IPO, we put in place a thoughtful staggered lockup release schedule for our pre-IPO shareholders, coupled with the special dividends payable over 4 quarters that I mentioned earlier. Affiliated shareholders were locked up for a full year and nonaffiliated pre-IPO shareholders were locked up for 90, 180 and 270 days.

With the second lockup release on July 23, we have now nearly quadrupled our public float since the IPO. I’ll now turn it back to Ken for closing remarks.

Kenneth Kencel: Thank you, Shai. I want to conclude our prepared remarks today by acknowledging the efforts of our team here at Churchill. I am pleased with our results for the quarter and the momentum we have achieved since our IPO. We’re excited about the quarter ahead and our ability to deliver an attractive distribution yield to our NCDL shareholders. I will now turn the call over to the operator for Q&A.

Operator: [Operator Instructions] Our first question comes from Brian Mckenna with JMP Securities. Please state your question.

Q&A Session

Brian Mckenna : Bryan, thanks. Good morning, everyone. It was great to see the strong pickup in origination activity in the quarter, but there are significantly more add-on deals versus new investments. So what’s the outlook for new investments, specifically into the back half of the year? And then we’re more than 1 month into the third quarter here. So any early read on the quarter in terms of origination activity or even how the pipeline is refilling for activity post Labor Day?

Kenneth Kencel: Great. Thanks, Brian. It’s a great question. I guess I would make a couple of comments overall. One is that we continue to be extremely busy on the origination side. I can tell you that — normally, you get a bit of a slowdown in the summer months, particularly in August. That has not been the case this year. We continue to have a very, very deep backlog, and our pipeline is very robust and that continues as we look through — through August. And based upon what we’re hearing in terms of sale processes and companies being put up for sale, that pipeline looks quite robust as well. So we’re — we are quite optimistic about the balance of Q3 and then into Q4. I would say that we did see a lot of add-on activity.

Obviously, we have a very large portfolio across — across the firm if you look at both our senior lending, junior capital, equity co-invest in over 400 companies across the platform. So we are seeing a significant amount of add-on activity, which obviously, from our perspective, is a good thing since we know the companies. We know their performance and obviously, the sponsors as well. But I would — I would expect that new deal activity which was quite robust in the second quarter will continue to grow as a percentage of our overall investment activity as we balance out the third quarter and into the fourth quarter. So good new deal activity. Pipeline, obviously, kicking off a lot as well. As I mentioned earlier, we had a record quarter in Q2 in terms of investment activity, and that has not stopped.

We’re — we’re busy, and we’re seeing good quality and obviously remaining very selective.

Brian Mckenna : Okay. That’s great. And then just a bigger picture question. There’s clearly a lot of focus in the market today on the economic outlook into the back half of the year, specifically over the past several days. So it would be great just to get a little bit more detail on what you’re seeing across all of your portfolios at Churchill today, not just at NCDL and — really, what kind of revenue and EBITDA growth are you seeing across portfolio companies? And then are there any new or interesting trends going on? And it’s early, but anything just to know even over the past week or so.

Kenneth Kencel: Yes. Obviously, it’s a bit early to handicap the last few days in terms of assessing what that — what that will really mean longer term. But I can tell you that on a broader portfolio basis, we track the percentage of our portfolio companies showing revenue growth and EBITDA growth and those metrics remain quite positive. In fact, EBITDA growth across our portfolio, the percentage of company — portfolio companies, again, this is across all of our investments ticked up during — during the quarter. So we’re seeing the majority of those companies reporting growth in EBITDA and revenue. So from our perspective, we view it as a very, very positive sign. Health of the portfolio, as I mentioned, during our call remains very good.

All of our loans start out with a risk rating 4.0 and the overall portfolio right now at DLC is 4.1. So we continue to see good quality in the portfolio, good underlying growth, obviously, an emphasis and focus on strategic M&A add-on acquisitions as a way to enhance that. So we feel very good about — about those metrics, not just at the DLC level, but more broadly across our overall investment portfolio.

Operator: And our next question comes from Douglas Harter with UBS. Please state your question.

Douglas Harter: Hi, I just had two quick questions for you.. So one, you talked about nonaccruals — two nonaccruals. Do you have any possible insight into resolution for — for those or any of the nonaccruals that you have to have on your book?

Shai Vichness: Doug, it’s Shai. Thanks for the question. Yes. Is there more?

Douglas Harter: I mean in regard to like a — possible timeline for resolutions.

Shai Vichness: Yes. Look, I would say — thanks for the question and for joining. It’s obviously early in those processes. And as we often do, we get into the situations, we work very closely with the sponsor and the borrowers to get to an attractive resolution for our shareholders. We’ve spoken in the past about kind of our workout resources, which are robust and are obviously involved here and active in trying to get through resolution. So no specific comments on timeline. But as we always do, we’re working hard to — to try to maximize value on the two new nonaccruals and obviously, anything else in the portfolio that’s on that list.

Douglas Harter: Great. And just in regard to — do you have any insight in regards to the timeline or the pace of possibly rotating out of the upper middle market loans into the more traditional middle market loans?

Shai Vichness: Yes. I mean I think as you heard from Ken, both on the call and just in the last question, we continue to enjoy a very robust pipeline of traditional middle market opportunities that we’re seeing, obviously, are rotating from the upper middle market deals that we invested in immediately post IPO into the pipeline is market dependent. But based on how we’ve ramped in the most recent quarter and the pipeline that we’re seeing, we’re sort of well on our way with respect to that strategy. And you can see it in the numbers in terms of the new — the yield on the new investments that we made during the quarter. Those were much more heavily weighted towards the traditional middle market, and we would expect that to continue in the coming quarters.

Kenneth Kencel: Yes. And I would just add to that and — I agree with all of that. I would add to that, that as we look at the market environment today, we think that the fact that we are largely focused on the core middle market has enabled us to drive what we believe are the most attractive risk-adjusted returns. We’re talking about businesses where we get underlying financial covenants, generally lower leverage, pricing premium to be in that core middle market and obviously directly originating those deals. I think that what we continue to see in the second quarter on an ongoing basis is that our model of being a very large and significant LP in — as I mentioned during the call and over 300 private equity funds, 240-plus advisory board seats, it’s a tremendous dynamic that continues to show itself as we drive attractive deal flow.

And it’s a continuity that enables us to — to get a first look at transactions and in many cases, the last look. So it’s — I think the power of that very differentiated origination model continues to drive very attractive opportunities in the core middle market where we are directly originating and we’re seeing very good value.

Operator: [Operator Instructions] Our next question comes from Mark Hughes with Truist Securities. Please state your question.

Mark Hughes: Mark. Yeah, thanks. Good morning. You had pointed out that the overall portfolio you’re — you’re benefiting in terms of spread from that migration of the core middle market. But within the middle market, what are you seeing in terms of spreads, say, on kind of the same — same-store basis?

Kenneth Kencel: Yes. I would say if you look back over the last six to nine months, we’ve seen spreads come in a bit in the core middle market, nowhere near as much as we saw in the broadly syndicated market. You saw a much more significant spread compression in the BSL world. And that obviously was a direct result of funds flows into that BSL market and the reemergence really of the CLO market and the loan funds that caused spreads that have tightened quite dramatically in the BSL world. We’ve seen some more modest impact in our world, roughly 25 basis points quarter-over-quarter. And if you went back six months, I would say that’s probably more like 50 basis points. But that compares to a much more significant compression in the BSL world of, call it, 150 or even 200 basis points.

So modest compression, nowhere near what we saw in the BSL world, and I would say that quality in terms of new deal activity and certainly when you think — think through that relative to our level of selectivity, we’re very happy with the quality of what we’re seeing. And on a relative basis, I think the — the value of core middle market opportunities compared to BSL has become even more pronounced more recently. So we feel good about what we’re seeing and — and good about the overall underlying spread dynamics in — in the core middle market.

Mark Hughes: And — understood. Maybe a little pressure from the top down from the BSL market on the spreads, but obviously, you’re — you’re insulated as you described. How about competition from other direct lenders within the middle market? Is there more capacity out there, more — more dollars chasing those deals?

Kenneth Kencel: So it’s an interesting dynamic. And this — these are comments that I know have been echoed by a number of our peers. I think what we’re seeing is a dynamic where the largest scale players in the core middle market, and there are obviously 5 to 8 of us or so that — that really are playing and investing in this world for firms that can underwrite and hold upwards of $400 million, $500 million, $600 million per deal. We see the market right now is consolidating and that those firms — those handful of firms, of which Churchill is one, are benefiting from that consolidation. The new players firms that are raising $500 million, $1 billion fund, they’re not going to be able to issue commitment letters and to fund $300 million, $400 million, $500 million per deal.

So I think this is an environment that — that favors the established players with relationships. Obviously, we, along with that handful of firms compete for opportunities. But we have deep and long-standing relationships in the sponsor community, and that really has enabled us to — to be on the front line of that kind of — that quality deal flow. But new entrants are really not impacting in our world. I would say in the lower end of the middle market, that’s where you might see that impact where you have a new entrant. They really can’t do the larger core middle market deals, they’re really limited to more smaller middle market, smaller companies, maybe less established sponsors. So in the world, we plan, it’s — it’s a handful of firms that continue to raise significant capital.

We obviously continue to raise substantial capital at our platform. We feel very good about that. We had a very good first half of the year in terms of capital raising that enables us to stay in the mix with the larger core middle market deals, and we think that’s — that’s where things will play out through the balance of this year. So a smaller number of large-scale players getting access to the quality deals, newer entrants playing at the kind of smaller end of the market. And then you’ve got the larger end of the market where we generally see terms and structures less attractive to us. So we feel we’re in the right place in the market and driving what we believe are the best risk-adjusted returns.

Operator: [Operator Instructions] We’ll pause to see if there are any remaining questions. Thank you. At this time, we have reached the end of our question-and-answer session. I would now like to turn the floor back over to Ken Kencel for closing comments.

Kenneth Kencel: Thank you, everyone, for joining us on the call today. If you have any additional questions, please reach out to our Investor Relations team. I hope everyone enjoys the rest of the summer, and we look forward to speaking with you on our next earnings call. Thanks very much.

Operator: Thank you. And with that conclude today’s conference. All parties may disconnect. Have a good day.