Carlyle Secured Lending : Q2 2023 Earnings Transcript

lower at 1.1 times, comfortably within our target range. This positioning allows us to effectively deploy capital, given the attractive yields and terms available for new investments in the current market.

With that, I'll turn it back to Aren.

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Aren LeeKong

President, Chief Executive Officer & Director, Carlyle Secured Lending, Inc

Thanks, Tom. I would like to finish by highlighting the consistency of our investment approach and reiterate our overall strategy. We are focused on primarily making investments to US companies, backed by high-quality sponsors in the middle market. The median EBITDA across our core portfolio at the end of the first quarter was $72 million. Our approach allows us to remain focused on disciplined underwriting, prudent portfolio construction, and conservative risk management. Our portfolio remains highly diversified and is comprised of over 170 investments in 130 companies across over 25 industries. The average exposure to any single portfolio company is less than 1% and 94% of our investments are in senior secured loans. So we feel very well-positioned in the current environment.

I'd like to now hand the call over to the operator to take your questions. Thank you.

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QUESTION AND ANSWER SECTION

Operator: Thank you. [Operator Instructions] One moment while we compile the Q&A roster. And our first question comes from the line of Melissa Wedel with JPMorgan. Please proceed.

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Hey. This is AJ on for Melissa. I have a question on capital returns. First, how are you all thinking about share repurchase going forward? And then, given that you're out earning the dividend, could we see a special dividend at the end of the year?

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Good morning. Hi, it's Tom. On the share repurchases, we take a close look at where our current trading price is, and that's certainly a big factor in evaluating the level of repurchases. You can see this last quarter, we're trading up in the 90%, 95% of NAV territory. We've stated in the past, if we get that level, we'd certainly look to curtail the buybacks. And that's really what you saw this past quarter. We'll continue to evaluate, where the stock is trading, as well as looking importantly at our overall float. That's something we keep a close eye on, and we want to be mindful of.

When we talk to investors, some of them say, [indiscernible] (00:12:44) those buybacks, yes, depending on the level of accretion, but we also want to make sure we've got good float in that stock. So historically, we've purchased over $150 million. We've been very supportive over the years. I think based on the current level of trading, we're simply going to look to modify - mitigate that a little - maybe a little bit smaller, just based on the current trading levels.

In terms of the dividend, we've noted we're focused on retaining some of that NII, and that's what we've done historically. When you look at the - our level of returns, we feel really good at that $0.44 level in terms of delivering really solid returns on both NAV and on the current share price. As we, say, stockpile some of that NII, we're going to look at do we potentially - it wouldn't be - it wouldn't potentially be this year, but perhaps next year that we may be required to pay a special dividend just based on the 90% payout requirement.

So that's something we're going to take a look at. But otherwise, I think we'll continue to retain that NII payout at $0.44 based on what we see as a - feeling pretty good about assuming benchmark rates stay where they are [ph] at (00:13:52) earning $0.50 to $0.52 per share.

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Sure. That was a transaction - it's a typical restructuring where the lenders took a write-off of debt in exchange for majority equity in that company. So that you'll see that there's multiple levels of debt now on the SOI, as well as equity that we're marking at zero. There are the different tranches. There's that holdco loan and - as well as two different loans at the operating company level, so you see the multiple line items in that capital structure.

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Operator: Thank you. One moment for our next question, please. It comes from the line of Bryce Rowe with B. Riley.

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Thanks a bunch. Good morning. I wanted to maybe ask about portfolio activity, originations and repayments here for the quarter. Just kind of curious how the pipeline looks and the repayment and sales activity, exceeding originations. Just curious how kind of intentional that was or that - was that kind of a more normal course, in terms of the repayment activity?

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So, hey, it's Aren LeeKong. Nice to meet you. So I would say, look, we view the world - there are some strategic decisions that we make at any given moment. We have a portfolio. Today, I've mentioned in the - in my opening remarks, if you think of sort of the three big places that we're focused: we're focused on farming the portfolio so that we can get more out of it; we're focused on, the One Carlyle sourcing opportunities; and we're being exceptionally picky when it comes to just regular way sponsor finance.

Now if our goal today and you'll see, I think, year-to-date, our average spread that we have originated transactions on is somewhere between 6.70%, 6.80%, significant premium to last year. Our goal is focused on improving the portfolio at every moment. So whenever we're thinking about what's being repaid and - over the next year, we have a fairly detailed model. Everything that is up for maturity, we're at all times thinking about replacing what's being repaid which, on average, has a five handle on it with, sort of 6.50% to - and above spreads with fairly [indiscernible] (00:16:52).

So the bottom line is, we're not - I know that, this is a constant conversation on private credit land. We are focused on quality and portfolio construction. So, to be fair, and the previous question also touched on this, we're fine holding a little bit more cash to make sure that we have a very steady, battle-tested, kind of cap structure and balance sheet here, and we're improving our portfolio. So, yeah, we're - as things come off, we don't have - we're focused on quality, not quantity.

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Okay. And then - and kind of reading into that, is there an expectation that, maybe we see balance sheet leverage compress a little bit more, versus re-levering up over the - I don't know, over the next six months or so?

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So, it's great question. So when we think about - and we can obviously talk about this offline as well in further detail, but this is sort of a - kind of a 3-D chess match that we're playing. So we're thinking about, Tom just mentioned that we bought, over the course of last year and a half, two years, almost, a little over 23% of our float back. It was $0.65 in total accretion. We've held back on NII and been able to take the leverage down a little bit, so that we can actually have more dry powder but also take less risk in this market.

We've tried to focus on, higher-quality names and while - while repaying some of the older vintages. So to the point, we are, quite frankly, thinking about all of it and trying to create the best portfolio we can, but - so the answer is, we are - all of these things are under consideration.

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Got it. Appreciate that, Aren. And then, maybe last one for me. Just thinking about capital structure, seeing, debt capital markets kind of start to open back up here. Really, over the last month, you've got maturities at the end of next year, so a decent ways away. But just kind of curious how you're thinking about capital structure, maybe any commentary around the preferreds, too, within that would be helpful.

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You must be sitting here in our office in our planning sessions. I think you're [indiscernible] (00:19:16). Tom, do you want to start and I'll [indiscernible] (00:19:22)?

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Yeah, sure. We're in constant dialogue with our banking relationships and [indiscernible] (00:19:27) was - we had a meeting less than two months ago. It was like, hey, the public market is shut. Well, guess what? It's opened

very quickly. So we're certainly considering those options. We're mindful of those maturities at the end of 2024, always looking at what's the best - optimizing the capital structure - diversified capital structure, looking at the prefs, looking at potential public bond offering, and getting the right mix in the capital structure. It's something that we have constant dialogue in, and we'll continue to assess and do what's best for our shareholders.

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And in terms of [indiscernible] (00:19:59), as Tom said, we're kind of focused holistically and everything I've mentioned and Tom mentioned kind of all worked together. And the prefs, we're in constant contact and dialogue with Carlyle proper, as well as the board, and thinking about, how to think about that as a long-term part of our cap structure.

Right now, if you look at the comparable preferred trades in the market, quite frankly, our pref is at 7%, which is about 200 basis points cheap to what the comparable trades are today, so it's actually a pretty good piece of paper as it stands. But we are, along with the unsecureds, thinking about long-term shareholder value. So stay tuned.

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Operator: Thank you. One moment for our next question. [Operator Instructions] Our next question is from Arren Cyganovich with Citi.

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Thank you. Maybe you can talk a little bit about your investment pipeline and how that's flowing in in the competitive environment you're seeing from other BDCs or non-bank competitors.

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So I'm going to take your question because I like your name, you're Arren [indiscernible] (00:21:17). So I'd say, if you think about - I mentioned it two questions ago, if you think about the three sleeves of where we source capital. One, you have the sponsor market. Sponsor market is quite busy. Obviously, the BSL market is still choppy. High-yield market is coming back a little bit, but it is quite busy.

I'd say our average deal in our portfolio is kind of low $70 million of EBITDA. I'd say the - the large market transactions that we've seen are priced a lot more competitively today. And, we - so we are kind of shying away from those to be able to get better terms and better rate down in our core mid-market. But we are being quite selective in terms of sponsor.

The One Carlyle sort of sourcing channel, there's been some transactions that we've announced over the last week or two. Those were - those transactions are less sponsor-driven and more One Carlyle-sourced, so sourced from other teams within Carlyle. That sourcing channel is fairly robust today. Folks trying to partner with Carlyle as a whole and as Carlyle, that's just direct lending. But our other partners are showing up to be a solution provider. So I would expect that to be a much bigger contributor.

And then the last piece, which I view as the highest ROIC segment today, which, again, after this call, we're happy to get on the phone and walk through things, is literally farming the portfolio. There's a pretty significant portion of this portfolio and - that we're going after that have the yield that can be improved, stocks that can be improved. Amendment fees, they can be taken. The cash, they can be contributed by sponsors in order to better extend the transactions and do what's right for the company. The solution provider to the sponsors; but also actually improve our current portfolio with credits we're already very familiar with. And any changes to the current portfolio that - those improvements drop straight to the bottom line.

So if you were inside of our offices, I guess two or three weeks ago when we did our Q2 review, you would have kind of heard that message probably ad nauseum, which is let's focus on our portfolio and trying to - trying to be solutions providers but also, grab value and extract value for our current shareholders because, quite frankly, that's the best risk we have - loans that we are already quite familiar with and in improving those terms. So I'd say those are the three - those are the three general buckets. Was that helpful?

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Yeah, yeah. Thank you. And then on the American Physician breakdown; that seemed to kind of move relatively quickly from, I guess, the beginning part of the year to the markdown last quarter. What happened there? What's more specific to that investment versus some of the other health care investments?

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Yeah. Arren, this one remains an active and sensitive situation, so we can't get into too many of the deal-specifics of that transaction. But I think that some of the broader items we've highlighted across the industry are inherent here. As we discussed, health care services, the headwinds in the industry, labor shortages, wage inflation, regulatory changes, specifically the No Surprises Act.

In summary, costs have gone up dramatically, and the top line has been squeezed. When you were getting last - two years ago, you were getting $150 million per encounter and now it's $130 million, while you're faced with wage inflation, that results in a pretty sharp compression of your earnings. And, it is just really industry-wide. We've seen it with other large cap health care firms, for example, Envision Health is in a similar space.

What I'll note is, we've [indiscernible] (00:25:33) - we've actually - compared to our peers, we value this one relatively conservatively. Last quarter, we were 20 points lower than other BDCs, marking this one. The good and bad now is we have - the zero valuation right now, full non-accrual, so the current NAV and the $0.52, that's fully reflective of any negative of this particular position.

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And look, the - I think everyone has asked great questions today because they're all kind of actually related, Arren. And so, for us, we have a super - that's a technical term, a superdiversified portfolio for average positions

less than 1%. The goal of keeping leverage low, maintaining - kind of preserving NII just in the event that there's any bumps in the road, managing portfolio risk and trying to improve each quarter, that allows us to, quite frankly, mark a little bit more conservatively.

So for us, we marked conservatively last quarter. We are - we've decided that it was most prudent to mark this position even more conservatively here. The goal of a direct lending portfolio is to have a diversified portfolio that also has predictable and sustainable cash flow. So for us, it isn't really about the position, it's about kind of the overall portfolio management, so we are trying to be very conservative here. But we're taking a - we, quite frankly, took a much larger portfolio view as to how conservatively the market.

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Operator: Thank you. And as I see no further questions in queue, I will pass it back to Aren LeeKong for closing comments.

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Aren LeeKong

President, Chief Executive Officer & Director, Carlyle Secured Lending, Inc

Everyone, have a great morning. Thank you. We look forward to speaking to you - some of you next quarter. We look forward to speaking to some of you over the next few days to go deeper on the story, and thank you all for your support. Have a great rest of your summer.

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Operator: Thank you all for your participation in today's conference. This does conclude the program and you may now disconnect.