Owl Rock Capital Corporation (NYSE:ORCC) Q1 2023 Earnings Call Transcript

Owl Rock Capital Corporation (NYSE:ORCC) Q1 2023 Earnings Call Transcript May 11, 2023

Operator: Good morning, and welcome to the Owl Rock Capital Corporation First Quarter 2023 Earnings Conference Call. . Please note, this conference is being recorded. I will now turn the conference over to our host, Dana Sclafani, Head of IR. Thank you. You may begin.

Dana Sclafani: Thank you, operator. Good morning, everyone, and welcome to Owl Rock Capital Corporation’s first quarter earnings call. Joining me this morning are our Chief Executive Officer, Craig Packer; our Chief Financial Officer and Chief Operating Officer, Jonathan Lam; and other members of our senior management team. I’d like to remind our listeners that remarks made during today’s call may contain forward-looking statements, which are not a guarantee of future performance or results and involve a number of risks and uncertainties that are outside the company’s control. Actual results may differ materially from those in the forward-looking statements as a result of a number of factors, including those described in ORCC’s filings with the SEC.

The company assumes no obligation to update any forward-looking statements. Certain information discussed on this call and in our earnings materials, including information related to portfolio companies, was derived from third-party sources and has not been independently verified. The company makes no such representations or warranties with respect to this information. ORCC’s earnings release, 10-Q and supplemental earnings presentation are available on the Investor Relations section of our website at owlrockcapitalcorporation.com. With that, I’ll turn the call over to Craig.

Craig Packer: Thanks, Dana. Good morning, everyone, and thank you all for joining us today. We are pleased to report another quarter of very strong results, driven by continued growth in earnings and strong credit performance. Our net investment income for the first quarter was $0.45 per share, a $0.04 increase from the prior quarter and a $0.14 increase compared to a year ago. This is a new record quarterly NII for the company. I want to start by putting this strong quarter in context. Going into the third quarter of last year, we were confident that rising rates and continued credit performance were going to drive significant improvement in earnings. As a result, we increased our regular dividend by $0.02 and added a formulaic supplemental dividend to our quarterly dividend structure.

We recognized that we would significantly outperform the regular dividends in a rising rate environment and wanted to create a predictable mechanism to share that upside with shareholders. Compared to the second quarter of 2022, the average base rate in the portfolio increased roughly 300 basis points and the NII has grown by over 40%, which has driven the growth in our supplemental dividend. For the first quarter, our Board approved a supplemental dividend of $0.06 per share, which is an increase of $0.02 from the prior quarter. This is in addition to our previously declared $0.33 regular dividend which results in total dividends of $0.39 for the quarter. In total, this represents an annualized dividend yield of over 12% based on the current share price, which we believe is very attractive in today’s market.

We also delivered an ROE of 12.1% for the quarter, and we would expect to deliver an ROE in excess of 12% over the full year based on our current outlook for rates and credit performance. Our continued earnings growth is complemented by the strength of our portfolio. Net asset value per share increased to $15.15, up $0.16 or 1% from the fourth quarter. The majority was driven by over-earning our dividend by $0.08 and by roughly $0.08 of net realized and unrealized gains in the portfolio. The average mark on our debt positions this quarter increased to 97.6% from 97% last quarter. However, the primary driver of this change was the improved marks on certain debt investments which were restructured during the quarter. Excluding those, the average change in the mark on the remainder of the debt portfolio was roughly 15 basis points.

We also benefited from the increase of the mark in the equity investment in our senior loan fund, reflecting improved public market loan trading levels. In addition to higher rates, our results were driven by the strength of our credit quality, which is reflected in our very low nonaccrual rate, which stands at just 0.3% of the fair value of the portfolio with only 2 names on nonaccrual as of quarter end. We are very pleased with these results and believe we are in a position to maintain this level of earnings power and credit performance in today’s environment. That said, we continue to expect and are prepared for more challenging conditions in the back half of the year. Like many in the market, we have been anticipating a shift in consumer demand on the back of the higher rate environment and a subsequent contraction in the economy.

We remain vigilant and are proactively analyzing our portfolio. Similar to last quarter, we have not yet seen any early signs of challenges across our borrowers who continue to deliver stable operating performance. Revenue and EBITDA are growing at a modest, albeit slowing piece. Many of our borrowers are experiencing improved profitability as a result of receding supply chain disruptions and lower input costs. We also take comfort that our portfolio is primarily comprised of senior secured first lien investments with low loan-to-values across companies that have strong financial sponsor backing. We are closely monitoring the interest coverage levels of our borrowers. As we expected, reported interest coverage continued to decline, finishing the quarter with a weighted average coverage ratio of 2.2x.

We fully recognize that the current rate environment, as it works its way through borrowers’ financials, will reduce interest coverage levels over the course of the year. We believe average interest coverage on our portfolio will trough around 1.5x in the second half of this year. This will undoubtedly pressure liquidity at some borrowers more than others. However, we believe we have good visibility into the small number of borrowers, which could be most affected, and therefore, we think that these challenges will be manageable. Further, as we’ve said before, most of our borrowers benefit from financial and operational support from sophisticated financial sponsors. Sponsors are also preparing for a tougher environment later in the year, and we’ve seen sponsors positioning the companies more defensively.

This includes cutting costs, putting projects on hold and shoring up liquidity. Lastly, when these situations do get more stressed, we have the tools in place to ensure that we are in dialogue early and often with borrowers and their sponsors. This information flow and our strong documentation and covenant protections ensure that we have a seat at the table at the early signs of trouble. We can then work with the sponsors who are generally incentivized to put in additional capital to provide near-term support in order to protect the longer-term value of their investment. For these reasons, we believe we are well prepared for further challenges to come. As we said before, while we may see increased levels of stress, we believe defaults or potential losses will be manageable and will be more than offset by the continued strength of our earnings across the balance of the portfolio.

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We are proud of the highly diversified and well-insulated portfolio we have built. Our borrowers have the advantages of size, scale and sponsor support as we enter a potentially more challenged environment, and we believe this will serve us well. With that, I’ll turn it over to Jonathan to provide more detail on our financial results.

Jonathan Lam: Thanks, Craig. We ended the first quarter with total portfolio investments of $13.2 billion, outstanding debt of $7.4 billion and total net assets of $5.9 billion. Our NAV per share was $15.15, a 1% increase from our fourth quarter NAV of $14.99. This increase was driven by the continued strong performance of our borrowers and our continued over-earning of the dividend. We continue to see the impact of the broader slowdown in M&A and refinancing activity on new investment activity across the market. Funded activity for our portfolio remained modest at roughly $94 million, which reflects the low repayment activity we continue to see. Turning to the income statement. We are pleased with the continued strength of our earnings.

We believe this quarter’s NII represents a sustainable level in the current rate environment. We could see further upside if repayments pick up or dividend income from our strategic equity investments and the senior loan fund increase. Conversely, we could also see a decline in NII if rates drop or non-accruals increase, although we do not currently see evidence of either happening in the near term. As a result, we believe that we will be able to deliver ROE in excess of 12% for the year and provide attractive dividend income to our shareholders. We have also continued to work towards our previously announced repurchase target of $75 million through the combined buying power of the company’s share repurchase program and the Blue Owl employee investment vehicle.

As of May 10, an incremental $22 million of ORCC stock was purchased bringing total stock purchase to $74 million at an average price of $12.22, of which $49 million was repurchased by the company. For the second quarter of 2023, our Board has declared a $0.33 per share regular dividend, which will be paid on or before July 14 to shareholders of record as of June 30. Our Board also declared a supplemental dividend of $0.06 per share for the first quarter of 2023, which will be paid on June 15 to shareholders of record on May 31. As a reminder, we instituted a supplemental dividend on the back of our continued earnings momentum to ensure that our shareholders benefit from the higher rate environment. We expect to continue to evaluate our dividend policy going forward to ensure we are striking the optimal balance of sharing upside while also protecting the stability of the dividend across all market environments.

Additionally, we have a flexible balance sheet with a well-diversified financing structure. We ended the quarter with net leverage of 1.21x, largely unchanged from where we ended the prior quarter and within our target range. We also had liquidity of $1.7 billion, well in excess of our unfunded commitments of approximately $940 million. Lastly, this quarter, we saw some stress in the market as the banking sector crisis played out. In response, our financing team rigorously analyzed the impact of a number of potential outcomes on our liability structure. We found that we had no material exposure to the affected banks, and we saw no impact to our fund operations. We believe this highlights the quality of our balance sheet and the benefit of having diverse funding sources.

We deliberately built our balance sheet to have a significant amount of unsecured bonds. Over 50% of our liabilities today and our revolver is made up of a large diversified group of 19 lenders, led by large global banks. This allows us to have material over-collateralization on our secured facilities, and we have structured those facilities to have limited mark-to-market exposure. We have over 60 unique finance partners across our secured facilities. In addition, our weighted average cost of debt remains low at 5.2%, and we have no near-term maturities. For these reasons, we remain pleased with the strength of our liability structure and believe it will serve as a competitive advantage, providing the portfolio with flexibility and durability across market environments.

With that, I will turn it back to Craig for closing comments.

Craig Packer: Thanks, Jonathan. To close, I’d like to touch on the current market environment, which remains a very attractive one for direct lending. With the public market mostly unfavorable for new issuance, we continue to see direct lenders financing nearly all of the deals that are coming to market. These opportunities are attractive because they are for high-quality borrowers with enhanced spreads, documentation and leverage levels. As we’ve noted before, given continued low repayments, ORCC is currently benefiting from this environment, largely through amendments and other repricing events which continue to help increase the overall spread on our portfolio. Our growing incumbency positions are also helping to drive additional deal flow in a slower M&A environment.

More broadly, recent volatility in the credit markets and general capital constraints have underscored the benefit of scale for direct lending platforms. Given the potential challenges to come over the near to medium term, we believe that the market environment over the next couple of years will favor larger platforms like ours. Size and scale are increasingly important when it comes to fundraising, deal flow and access to financing as well as hiring and retaining top talent. And we believe that the strength of our platform will be even more apparent during this time. When conditions are more challenging, people naturally gravitate to the stability and security that larger platforms provide, and we expect to be a beneficiary of this dynamic.

Our competitive positioning today is as strong as it’s ever been because of our scale and deep relationships with sponsors. And we believe that sponsors and borrowers value our capital, look to us as a preferred partner for financing solutions. Before we open it up for questions, I want to spend a few minutes on our upcoming Investor Day on May 24. This is our first Investor Day, and we’re excited to have the opportunity to discuss ORCC as well as our other BDCs in more detail to highlight what differentiates our direct lending platform. We have a full day planned, including sessions with senior members of our investment team, discussing our approach to origination, underwriting and portfolio management to provide further insight into our disciplined approach and how we have built our exceptional track record.

We will also cover why we believe ORCC is well positioned to deliver attractive returns through various market cycles and how the stock offers a compelling total return opportunity. For those of you that are new to our story, ORCC trades around 85% of net asset value. And some of our most comparable peers trade around 100% of net asset value. So as a result, ORCC offers not only the opportunity for an attractive dividend yield but also the potential for capital appreciation to net asset value if the stock is able to trade in line with those peers over time. We believe the current environment is one where our portfolio will not just fare well but will outperform. As we’ve noted before, we are prepared for conditions to get tougher from here but remain firm in our belief that any challenges will be manageable.

This is because we have been extremely disciplined on credit selection and believe our portfolio will continue to perform very well and generate strong returns. We have also been proactive in fortifying ORCC’s balance sheet with diversified financing sources. We seek to maximize flexibility and have locked in low-cost debt with no meaningful near-term maturities. I look forward to seeing many of you at the upcoming Investor Day and hope that you will come away from the event as confident as we are in our process, our people and our strong credit performance. On behalf of our entire team, we look forward to sharing more on why we are so excited about the future of ORCC. With that, as always, thank you for your time today. And we will now open the line for questions.

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Q&A Session

Operator: . And our first question comes from Casey Alexander with Compass Point.

Casey Alexander: I have two questions. One, I heard your comment about expecting the interest coverage ratio to decline to 1.5x in the second half of the year. I didn’t hear what it is currently. And then the second part of my question is what are the inputs that went into that in terms of your assumptions? I mean how much of that is expected company performance versus how much of that is expected rate development?

Craig Packer: Sure, Casey. So it’s 2.2 reported, if you will, through the first quarter. We think it’s going to trough at 1.5 in the back half of this year. We did do some analysis around performance, and it does bake in the impact of a moderating economy. We expect the economy to weaken. And so we baked that into that number, but the most significant impact is higher rates. And so I don’t have a precise number for you, but if I had to guess, it’s 75% rate.

Casey Alexander: Okay. My second question is Walker Edison was restructured during the quarter and yet you chose to keep it on nonaccrual. I recognize that, at least based upon the way I read the schedule of investments, that it’s 100% PIK right now. But still, most of the time when something is restructured, we — usually, it comes off of nonaccrual. I’m curious at what your thinking was there.

Craig Packer: Yes. No, it’s a good observation. And when — and I think it speaks to we try to be very thoughtful about every decision and investment when we put it on nonaccrual and evaluate its prospects. And you’re right, we restructured this position. Typically, we will restructure a position such that the remaining debt will be a par instrument, if you will, and on accrual. In the case of Walker, as a reminder, this is a business that makes ready-to-assemble home furnishing. Think coffee tables. It was significantly benefited from COVID and stay-at-home and has seen that reverse post COVID. In addition, there have been some supply chain issues. The business, although we did restructure the debt and took a significant loss on the business, continues to face challenges.

And we felt at this point, given the challenges that it’s facing, that it was prudent to keep it on nonaccrual. This will be a longer road back than some of our — we haven’t had a lot of troubled investments, but the ones we’ve had have been quite quick to respond. This one is going to be longer. And we felt that the right — based on the — our judgment of where the company sits right now, it’s best to keep it on nonaccrual. We hope to see improved performance, and we’ll evaluate it quarter by quarter.

Operator: Our next question comes from Robert Dodd with Raymond James.

Robert Dodd: Congrats on the quarter. I mean, Jonathan mentioned the bank disruption and the fact that the liability side is . On the asset side, I mean, something like Wingspire, where you’ve been putting in more capital, obviously, they do working capital lines, they do equipment financing, all areas where regional banks are typically big players and maybe less so going forward. So should we expect a better performance from Wingspire and maybe an acceleration in capital invested in that vehicle given its target market seems to be moving in a favorable direction ?