Q2 2022 Carlyle Secured Lending Inc Earnings Call

Okay.

Good day, and thank you for standing by welcome to the Carlyle secured lending second quarter 2022 earnings call.

At this time all participants are in a listen only mode.

After the Speakers' presentation, there will be a question and answer session. Please be advised that today's conference is being recorded.

Now I'd like to hand, the conference over to your Speaker today, Daniel Hutton you may begin.

Good morning, and welcome to Carlisle secured lending second quarter 2022 earnings call.

Last night, we issued a press release and earnings presentation outlining our quarterly results both of which are available on the Investor Relations section on our website.

Following our remarks today, we will hold a question and answer session for analysts and institutional investors.

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.

That could cause actual results to differ materially from those indicated.

Carlisle secured lending assumes no obligation to update any forward looking statements at any time with that I will turn the call over to our Chief Executive Officer Linda pace.

Thank you Dan Good morning, everyone and thank you all for joining us to discuss another strong quarter of performance.

With me on the call today is our president and Chief Investment Officer, Taylor, Boswell, and our Chief Financial Officer, Tom Hennigan.

Before we begin I'd like to highlight a few key themes that you'll hear from us throughout today's call.

First we remain committed to our goal of delivering sustainable income by constructing a diversified portfolio of senior secured floating rate loans to high quality sponsors and borrowers.

Second we are pleased to announce the increase of our base dividend rate starting in the third quarter.

Third we are well positioned to continue increasing our base dividend over the coming quarters.

Turning now to my usual quarterly remarks, I'll focus on three topics.

I'll start with an overview of our second quarter financing results.

Next I'll touch on our credit performance and investment activity and finally, I'll conclude with a few thoughts on how we are approaching the current investment environment.

We generated solid net investment income of <unk> 40 per share. Despite our LIBOR floor is limiting the earnings benefit from higher base rates during the quarter.

We declared total third quarter dividends of <unk> 40 per share consisting of our newly increased 34 cents per share base dividend plus a six cents per share supplemental dividend.

Our net asset value for the second quarter was $16 81 per share approximately one 8% lower than the prior quarters NAV.

This decline was almost entirely driven by the impact of widening market yields importantly, our NAV remains one 5% above our pre COVID-19 NAV in Q4, 2019, reflecting strong through cycle performance.

We repurchased an additional $7 million of our common stock during the quarter, resulting in free sense of accretion to our net asset value per share.

Once again, we were active re purchasers of our stock during the quarter based on its evaluation and the attractiveness of the returns for our shareholders in.

In total we have repurchased over 10 million shares or 17% of our float since the commencement of our share repurchase program.

The board of directors approved a $50 million increase to the program and extended it through November 2023.

This stock repurchase program represents just one aspect of our firm and continued commitment to creating value for our shareholders.

Turning now to the portfolio, we continued to see positive credit performance in our portfolio, especially in our watch list names as.

As Tom will discuss further we expect to see a lower level of non accruals in the third quarter.

We funded $199 million of new investments in the second quarter, essentially all of which were in a first lien position.

Total repayments and sales in the second quarter were $161 million.

We ended the quarter with just under $1 $9 billion of investments roughly in line with the prior quarter.

Looking ahead, we feel very good about our positioning of the portfolio are funded asset level and leverage being at the lower end of our target range. This will allow us to selectively deploy capital into attractive opportunities in this favorable investment environment.

With that I'd like to hand, the call over to our President Taylor Boswell.

Thanks Linda.

It's been an eventful several months since our last quarterly call.

Provide an update on two topics the current deployment environment.

How we assess the progression of fundamental credit performance against an evolving economic backdrop.

As for the current deployment environment.

Simply it is a highly attractive time to be a provider of capital.

While private credit pricing and terms lag liquid market signals early in the sell off.

June <unk> produced the short reset in favor of lenders.

The market reset performed as it always has in private credit reliably a little slow but reliably there.

Day pricing leverage and terms are all very lender friendly.

At the same time, and perhaps more surprisingly our pipelines remain robust with continued transaction activity in non cyclical sectors paired with a pronounced rotation of opportunities from dislocated liquid markets into healthier private credit markets.

As such it is not only an attractive environment for deal terms, but also one for credit selectivity.

Our strong balance sheet with leverage towards the lower end of our target range allows us to continue to invest through this market without taking elevated cyclical risk.

Confident this vintage of investments will position the portfolio well for sustained performance in future periods.

Of course.

All of our attention today should focus on the existing portfolio and how we see credit performance progressing in the coming quarters.

Allow me to reiterate our message from last quarter.

We have transitioned from one economic and liquidity conditions to a far more complex credit environment.

That complexity, principally stems from several well known dynamics.

First as described on our last call is the broad base rising operating costs and resulting price increases at our borrowers produced by this inflationary environment.

We have previously said the net impact of these factors will require several quarters to fully flow through their results and that remains the case of course. This does not mean, we are merely passive observers rather we are fully engaged on the topic with various interim sign posts on which to report.

That report for certain says not every borrower is recovering every dollar of increased costs, but as we assess with dynamic today.

Good data across our portfolio remains supportive of the continued performance for our senior secured credit investments.

Okay.

While aggregate demand has remained strong in recent quarters, we are seeing signs of sharp rotation and the nature of demand in certain sectors as we exit COVID-19 impacted periods generally from goods into services, but thankfully our portfolio's current exposures position us to be net beneficiaries of this rotation.

We remain disciplined through the Covid up cycle cautiously underwriting COVID-19 bumps with a through cycle perspective.

Good for demand and or margin retrenchment.

Meanwhile, we're seeing increases in demand for some of our borrowers most notably direct travel, which should accrue to the benefit of our shareholders overtime we.

We currently feel well positioned against this dynamic.

Third borrower liquidity.

Of course, our floating rate loans, I mean rising rates are beneficial to returns, but they also mean, our borrowers must come up with more cash to service their debt.

Given the mechanics of interest payment.

The full impact will begin to flow through to borrowers in the coming quarters to frame the risk for the average borrower can fall to free cash flow neutral, we would require approximately sustain 6% sulfur environment nearly double current expectations.

In addition, our portfolio is currently in a strong liquidity position with revolver draws standing under 20% well below the peak usage of over 60% during the Covid crisis.

With this setup, we feel our portfolio has significant cushion to absorb increasing interest rates or other unexpected liquidity draws which may arise.

Add it all up and companies are certainly facing more challenges than they have since the depths of the COVID-19 crisis.

In response as these high quality businesses path through this moment of significant macroeconomic transition we are seeing appropriate efforts and strong support from both management teams and owners across our portfolio.

Our current assessment of these dynamics is that they are creating a choppy or environment for fundamental corporate performance, but on the whole they are not creating broad based issues for senior credit performance.

Finally, a quick note on general recessionary risks.

Our strategy and our portfolio have always been and continues to be built where they recycle perspective.

We understand that each loan to be outstanding for five six or seven years periods of time long enough to be surprised many times over by changes in any of the macroeconomic market industry our company prospects.

Why we stay senior in the capital structure of high quality businesses. That's why we build portfolios with far less cyclicality than traditional fixed income markets. That's why we lend to borrowers of scale that just again withstand surprises.

That's why we invest with top quality owners to support their businesses and the events of those surprises and that's why we run highly diversified portfolios by industry borrower.

This discipline deployed over the course of years allows us to feel confidently positioned to perform through cycle on an absolute and relative basis, including in a recessionary environment should one emerge.

With that I'd like to turn the call over to Tom.

Taylor.

I'll begin with a review of our second quarter earnings that will provide further detail on our balance sheet position and conclude with a discussion of our portfolio performance as.

As Linda previewed we had another strong quarter on the earnings front.

Total investment income for the second quarter was $45 million down from 48 in the prior quarter.

Importantly, core investment income was actually up $1 million driven by both higher outstanding investment balance and the benefit of rising benchmark rates.

Total expenses increased modestly in the quarter from 23% to $24 million as higher interest expense was partially offset by lower incentive fees.

The result was net investment income for the second quarter of $21 million or <unk> 40 per common share.

That's in line with our core earnings over the last few quarters and exceeded the guidance we provided on last quarter's call.

And as a reminder, the second quarter was expected to be a low point for our earnings as we lost the impact of LIBOR floors.

On August eight our board of directors declared the dividends for the third quarter of 2022 at a total level of <unk> 40 per share that is comprised of our new 34 base dividend up from the prior level of 32 plus.

Plus the <unk> supplemental.

Which is payable to shareholders of record as of the close of business on September 30.

In terms of the forward outlook for earnings based on the combination of lower non accruals attractive economics on new investments and higher benchmark rates, we see a near term path to materially grow earnings in coming quarters.

We expect third quarter results to benefit from an improvement in non accruals, specifically derm growth.

<unk> contributed at least <unk> of incremental earnings per share each quarter.

And as a note on prior calls for every 33 basis points of additional increase in LIBOR sofa, who experienced a <unk> <unk> increase in NII each quarter.

All told we see NII for the second half of the year in the 43% to 44 per share range with a number of potential factors that would generate further upside.

So we remain highly confident in our ability to comfortably meet and exceed the new 34 base dividend and continue to payout sizable supplemental dividends each quarter.

And based on this anticipated increase in earnings in the coming quarters, we intend to evaluate and consider incremental increase increases to the base dividend level each quarter.

When valuations our total aggregate realized and unrealized net loss was $17 million for the quarter.

Yes. This breakthrough streak of eight consecutive quarters of positive NAV and valuation migration with.

This decline was almost entirely driven by the increase in market yields not credit in fact, our watch list investments experienced a net positive of $7 million for the quarter.

And our June 30, NAV remains one 5% above the December 2019 levels.

Next I'll touch on our financing facilities and leverage we continue to be very well positioned on the side of our balance sheet.

Cacciatore Leverages about one three times, while net financial leverage ended the quarter up slightly at 105.

So we remain at the bottom end of our target leverage range, which bodes well given the attractive yields in terms available for new investments in the current market.

During the quarter. We also had positive developments related to our financing lines at the BDC and JV level.

In conjunction with closing the regular annual extension on our revolving facility were successful in reducing the interest spread from $2 25 to 187 five.

And we also closed extensions for the core credit facilities at East JV positioning those vehicles for continued stable earnings generation.

I'll finish with a review of the portfolio and related activity.

We continue to see overall stability in credit quality across the book and improvement positions historically with credit issues.

The total fair value of transactions risk rated 3% to five indicating some level of downgrade since we made the investment was roughly flat on the quarter.

Total non accruals increased modestly to 4% based on fair value, but this was due to higher valuations on both derm growth and direct travel.

An important highlight there were no new non accruals during the quarter.

Also very pleased to report that derm growth, we've placed back on partial accrual status effective July one.

That should reduce net non accruals from 4% to under 3% and also contribute about <unk> quarterly NII.

This leaves direct travel is our largest nonaccrual position.

That borrower continues to move in the right direction recovering from the pandemic driven declines in air travel.

Leaving more potential positive news in the near term on the non accrual fronts.

With that back to Linda for some closing remarks.

Thanks, Tom.

Before opening it up for your questions I'll say again, we feel very good about our prospects for Carlyle secured lending with.

The combination of lower net non accruals and favorable investment environment and earnings upside from rising base rates, we expect to meaningfully grow our earnings and dividends over the coming quarters.

Thank you all for joining us today, and we hope you and your families all enjoy the remaining weeks of summer.

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

Thank you at this time I would like to remind everyone in order to ask a question press star one on your telephone keypad, well pause for just a moment to compile the Q&A roster.

Your first question comes from Finian O'shea from Wells Fargo Securities. Please go ahead.

Hi, everyone. Good morning.

The coupon.

<unk> growth, which looks like it had some.

Positive developments there can you expand on how.

The partial accrual works does the does the limitation there has to do more with it so overall.

Valuation.

Or or the income it's producing.

And then sort of how do you weigh this.

Against say paying down the principal with those proceeds.

As its income presumably improves.

Hey, good morning, guys.

Let me I'm, a little bit garden, what I can say about that situation because it's it's still developing in I would say that this is phase one of multiple phases in resolving that credit.

We had a favorable amendment.

Based on that amendment, we're comfortable with.

Part of that tranche part of that loan being cash pay.

And therefore that will be on accrual status and then we anticipate as.

As the company continues to perform.

Not there yet but in the future potentially.

Full recovery on that loan that's not today.

We are seeing in the numbers, but in the future and that's why we're comfortable with the current status. There was a partial accrual in the future in anticipation as the earnings continue to grow the potential for full recovery of that loan and full accrual status.

Yes.

Helpful. I appreciate that.

Limitations of.

Discussion on an individual name.

Can you talk a bit more about the the base.

<unk>.

As you outlined in your presentation that debt.

A C Moore.

Upside just sort of any.

Any context, there you still earn well above that amount but.

Does this mean, maybe a higher payouts or youre still under earning because of your.

Your leverage profile or however, we should think about that.

Yes, what I'd say.

We've been saying for the last almost eight quarters.

When the time when we set the 32 basis that we always felt very comfortable that we're going to meet and exceed that level. Now we have and we were very comfortable earning that 38% to 40 over the last number of quarters now as we look at our forward earnings really three drivers that we feel quite comfortable that we're going to be able to exceed that 38 to 40 number one non accrual.

Number two more favorable spreads in investment environment and the number three out of our control, we don't want to put too much stock in but rising benchmark rate certainly can reverse but right now.

It'll ball says that those are obviously that had had added up and they're going to be headed.

Higher so you put those three together and as we noted we feel comfortable with a 43% to 44.

<unk> set a third quarter in future earnings based on where we see those three dynamics right now so with that we're comfortable very comfortable with 34 set base and we'll continue to evaluate each quarter incremental increases to that number.

Okay, Great all for me thanks, so much.

Again, if you'd like to ask a question press star one on your telephone keypad and your next question comes from Melissa Wedel from Jpmorgan. Please go ahead.

Good morning, Thanks for taking my questions today.

I just wanted to clarify it looks like with the <unk>.

Rising of the repurchase authorization.

We have about $60 million of capacity available in total through November 'twenty three that rate.

Most of Thats right, yes, yes, okay I appreciate that.

Just thinking about your comments about the attractiveness of the investment environment.

Operating at the lower end of your leverage target range.

It sounds like it's fair to say, we should expect a more rapid pace of capital deployment.

As we enter the back half either side from normal December quarter seasonality.

I guess, one is that fair to assume in Q.

That's on the deployment side in terms of repayments is there anything that youre anticipating are aware of that we should be thinking about.

Yeah, Hi, Linda.

Thanks for the question.

And I do think youre spot on we're seeing.

Yes, good investment opportunities and ones that where we can be.

We're really selective and employ the.

All the resources that Carlyle brings to bear to take advantage of some kind of unusual market opportunities that we're seeing given the given the.

Limited capital being deployed in the liquid.

Loan and bond markets. So.

Saying things that we're pretty excited about and will be nicely accretive to our portfolio.

You should expect for us to have a pretty nice robust investment number coming into the third quarter.

Hard to look out.

Too much past that quite frankly things seem to be moving pretty pretty quickly.

And repayments have slowed.

So we're cognizant of that as well but.

We have capacity to add to our portfolio when we see really nice opportunities and this is this is a this is a great environment for us to put money to work, albeit selectively given all of the macroeconomic challenges that are out there. These days.

Tom do you want to give her a little bit more specifics around that.

I would echo what you said Linda definitely repayments tough.

Tough to forecast, but lower.

And.

Let me say, we were surprised to see it is still very robust deal environment, but we're being highly selective and it's those deals that were that same deal that was priced.

L plus 550.

Six months ago, or even three months ago, perhaps is now L. Plus 650 with instead of a 90 897, LNG and terms are tighter in terms of legal documentation. So from that perspective, we're being selective but certainly we're seeing them.

Reasonably positive move in terms for new deals.

Yes.

The middle market private credit.

Market took.

Take a while to catch up to.

Yields were going in the liquid markets, but over the recent 30 60 days, we've really started to see that move.

A lender friendly way so as Tom said yields are increasing.

And not just because of the increase in the base rates, but the actual spreads are increasing and we finally are getting some better terms I think kind of going back to types of terms in the credit agreements that.

With that that we really want to see.

So from that.

One of the main reasons, we think it's an attractive environment to put money to work.

And I appreciate that context, it's really helpful. I guess, one last question for me if I could.

Okay.

Think what Youre, saying is very much ethylene the sentiment that we've heard from a lot of other management teams about the relative attractiveness of the environment.

How do you weigh.

The opportunity set.

Ken.

Sort of the <unk>.

Certainty in the environment and does that impact your thinking about where you wanted to operate portfolio leverage within your target range.

Yes.

Yeah, I'll start and then Tom can.

<unk> can jump in.

Yes.

I think yes that is the balance we really tried to need to.

Think about it and strike.

It's <unk>.

We like a lot of the deals that we're seeing but we also don't like a lot of the deals that were saying when you think about our our funnel of deal flow. Our our hit rate is still kind of.

We closed 3% to 4% of all the deals that we see.

And I think that's the real that's the right approach because.

As we look at.

The new deals that are coming in the pipeline and we look at our own portfolio. We're still in discovery mode right and how companies are going to perform how theyre going to be able to pass along the increased costs.

The top line seems to be pretty good and.

That's echoed everywhere right.

Dark market.

Fortunately <unk> hundred where the syndicated market second quarter looked pretty good but third quarter is obviously going to have more uncertainty. So we wanted to.

B kind of kind of.

We're optimistic.

About the environment, but we're also we're also cautious so cautiously optimistic.

Great.

As appropriate.

So.

As it plays into where we think about leveraging.

In the portfolio, where comfort we'd be comfortable taking it up moderately.

But you shouldn't expect us to go back to the top end of our leverage.

I think too much.

Macroeconomic volatility.

Certainty out there.

And we don't want to be caught in an over levered situation.

Things things start going the wrong way fundamentally so.

I think we have room to move it up a bit.

Which obviously.

We will do as we as we see opportunities.

To make good investments in the portfolio.

But you won't you won't see a drastic uptick.

In leveraged finance.

Tom Fair got it.

Yes, I agree two points I'll add is that we're still trying to be balanced with our approach, it's an attractive market, but instead of a 2% position we may make a 1% position and we're also focused on borrowers we know and like if I look at our current pipeline. There are four different transactions that we're working on that we're going to be closing that off.

Our existing portfolio companies.

In our BDC or existing portfolio companies that Carlyle has invested in and knows well from long.

Long history with those businesses. So it's investing in areas, we know and in business as we know unlike.

Got it thanks.

And there are no further question at this time I will turn the call back over to the presenters for closing remarks.

Great well. Thank you all for joining today and appreciate your questions and if theres anything further.

How to reach us and apologies that you Didnt hear from Taylor on the Q&A. He had some technical difficulties so.

But obviously.

If theres any specific questions for him.

We'll get him get him back on to you So <unk>.

Have a great rest of your summer and look forward to talking to you next quarter.

This concludes today's conference call you may now disconnect.

[music].

Yes.

Yeah.

Okay.

[music].

Sure.

Okay.

[music].

Yes.