Q4 2023 Carlyle Secured Lending Inc Earnings Call
Thank you for standing by and welcome to the Carlyle secured lending Inc. Fourth quarter 2023 earnings conference call. At this time all participants are in a listen only mode. After the speaker's presentation. There will be a question and answer session to ask a question. During this session you will need to press star one on.
And your telephone if your question has been answered and you'd like to remove yourself from the queue simply press Star One again as a reminder, today's program is being recorded and now I'd like to introduce your host for today's program Dan Johan shareholder Relations. Please go ahead Sir.
Good morning, and welcome to Carlisle secured lending fourth quarter 2023 earnings call.
With me on the call this morning, and Eric <unk>, Our Chief Executive Officer, and Tom Harrington, Our Chief Financial Officer.
Last night, we filed our Form 10-K and issued a press release with the presentation of our results, which are available on the Investor Relations section of our website.
Following our remarks today, we will hold a question and answer session for analysts and institutional investors.
This call is being webcast and a replay will be available on our website.
Any forward looking statements made today do not guarantee future performance and any undue reliance should not be placed.
These statements are based on current management expectations and involve inherent risks and uncertainties, including those identified in the risk factors section of our annual report on Form 10-K.
These risks and uncertainties could cause actual results to differ materially from those indicated.
Carlisle secured lending assumes no obligation to update any forward looking statements at any time.
With that I'll turn the call over to Eric.
Thanks, Dan.
Good morning, everyone and thank you all for joining.
As has become custom I will focus my remarks on three topics for today's call.
First I'll provide an overview of the fourth quarter and full year 2023 financial results.
Next I will touch on the current market environment.
And finally, I'll conclude with a few comments on the quarter's investment activity and portfolio positioning.
Starting off with the earnings we continue to see our financial performance benefits from the higher base rate environment.
The fourth quarter, we generated net investment income of 56 per share.
Which is an increase of 8% from the prior quarter and represents an annual yield of 13% based on 12 31. Now. This continues the trend upward from last quarter and the LTM period.
As a result of our continued execution of our strategy the quality of our portfolio and our confidence in the future. Beginning this quarter, we are increasing the base dividend by <unk> <unk> from 37 to <unk> 40 per share.
Our board of directors declared a total first quarter dividend of <unk> 48 per share.
<unk> of our new base dividend of <unk> 40, plus.
Plus an eight supplemental.
A total increase of 9% compared to the prior quarter, an increase of 8% on the base dividend.
Our net asset value as of December 31 was $16 99 per share.
The 13th or approximately 1% from the September 30 period.
Primarily as a result of our Q4 earnings outpacing our dividend.
Turning now to the market environment too.
2023 with defined by market volatility.
Low private equity capital formation, and muted M&A activity for most of the year.
For context, private equity deal activity and M&A activity were down significantly in 'twenty, three compared to 22% and 21, though there was a pickup in M&A activity in the fourth quarter.
With this backdrop throughout the year.
Our investment team leveraged the breadth and depth of the one carlyle platform to drive value in the evolving market environment by generating significant volume across our existing portfolio of borrowers and carlyle's broad sourcing network.
Leveraging our incumbencies allowed us to source transactions, where we had diligence and information advantages.
And existing portfolio companies accounted for approximately half of our deal closings during the year.
Our flexible origination capabilities enabled us to source transactions from the lower end of the middle market at $25 million of EBITDA and Opportunistically, all the way up to $450 million of EBITDA in the last year that includes sponsored and non sponsored companies across North America and Europe.
Outside of our core middle market strategy.
We leveraged the one Carlyle network to source complementary differentiated specialty lending transactions within the asset based and recurring revenue markets. These trends were evident throughout the year and continue with fourth quarter origination activity.
We continue to be pleased with the overall credit performance of our existing portfolio with revenue and EBITDA quarter over quarter and since inception.
Compared to the prior year portfolio company revenue and EBITDA, both expanded by an average of approximately 13% and compared to the prior quarter, 1% and 3% respectively.
Non accruals were stable in the fourth quarter and as Tom will discuss in detail later, we expect these levels to improve in the coming quarter.
Tactical origination activity.
Strong credit fundamentals and the current rate environment drove record income for <unk>.
Despite the rising base rate environment over the last two years, we have been intentionally conservative with our dividend through the cycle.
In our view, our new dividend policy, which Tom will expand upon later provides a sustainable base dividend along with a transparent framework for supplemental dividend that will enable investors to better anchored your expectations.
Lastly, I'd like to spend a few minutes on current positioning.
Our portfolio remains highly diversified and is comprised of 173 investments in 128 companies across over 25 industries.
The median EBITDA across our portfolio at the end of the quarter with $76 million.
The average exposure in any single portfolio company is less than 1% and 95% of our investments are in senior secured loans.
I'll now hand, the call over to our CFO Tom Hennigan.
Thanks, Erinn today I'll begin with a review of our fourth quarter earnings.
I'll discuss portfolio performance.
With detail on our balance sheet positioning.
As Eric previewed, we had another strong quarter on the earnings front.
Total investment income for the fourth quarter was $63 million.
Up about $2 million from the prior quarter.
It's increasingly driven by the continued positive impact of base rates.
And an increase in both other income and OID acceleration.
We're aided by prepayment activity.
Total expenses of $34 million were flat versus prior quarter.
Of note.
Total interest expense was up modestly as base rates stabilized during the quarter.
The result, with net investment income for the fourth quarter of $28 million or.
<unk> 56 per share up nearly 8% from the prior quarter.
This level represents an all time high for core NII in any quarter.
Our board of directors declared the dividends for the first quarter of 2024 at a total level of 48 per share.
That's comprised of the new 40 base dividend plus an eight supplemental.
Which is payable to shareholders of record as of the close of business on March 29.
This total dividend level reflects an increase of 9% over the previous <unk> 44 per share.
It reflects the earnings power and stability of our portfolio. Despite a complex macroeconomic environment.
Our base dividend coverage of 140% for the quarter remains above the BDC peer set average and we've grown the base dividend by 25% since 2022.
At the same time the <unk>.
Total dividend level also represents an attractive yield of over 12% based on the recent share price.
In terms of the forward outlook for earnings for the rest of 2024.
We see stability at the 50 plus level.
Based on the latest interest rate curves and our current conservative positioning on leverage.
Despite rising rates, we've maintained a conservative disciplined approach that we believe will enable us to continue consistent dividend payout.
A variety of rate environments, including when rates normalize.
So we remain highly confident in our ability to comfortably meet and exceed our new 40 base dividend.
And continue paying out supplemental dividends each quarter.
And going forward, we're going to shift to a floating supplemental dividend construct and target paying out at least 50% of excess earnings through the supplemental dividend.
Which will allow us to be flexible as the portfolio evolves and base rates fluctuate.
On valuations, our total aggregate realized and unrealized net gain was about a half a million for the quarter.
Ported by a slight net positive movement in valuations.
This increase in valuation combined with Q4 earnings exceeding the dividend resulted in our NAV increased from $16 86 to.
$16 99 per share.
Turning to the portfolio.
We continue to see overall stability in credit quality across the book.
Similar to last quarter, there were no new non accruals and no additions to our watch list, which are deals with risk ratings four or five.
Total non accruals were effectively flat quarter over quarter.
And we're very pleased to report that dermatology associates was successfully recapitalized in early February with the lenders taking equity control.
So we expect an improvement in non accruals when we report March results.
We continue to proactively manage the portfolio and are working with sponsors to ensure borrowers have adequate liquidity.
Youll see the Pik interest ticked up over the course of 2023.
In almost all cases, when we provided pick released for existing borrowers.
That was accompanied by significant equity support from the sponsor.
I'll finish by touching on our financing facilities and leverage.
We continue to be well positioned on the right side of our balance sheet.
<unk> leverages down quarter over quarter.
And we are intentionally running leverage conservatively at the lower end of our target range to maintain the flexibility to invest in attractive opportunities.
Statutory leverage was about one two times.
And net financial leverage ended the quarter modestly lower right about one turn.
The lowest level since early 2022.
This positioning allows us to remain opportunistic as the macroeconomic environment evolves and deal activity looks to pick up in 2024.
With that I'll turn it back to Eric.
Thanks, Tom.
I would like to finish by highlighting the consistency of our investment approach and reiterate our overall investment strategy.
We are primarily focused on making senior secured floating rate investments to U S companies.
By high quality sponsors primarily in the mid market.
Market demand for private credit remains high and.
And we continue to focus on sourcing transactions with significant equity cushions.
Tractive leverage levels strong documentation and attractive spreads relative to not only the current market, but also historical originations through our disciplined underwriting prudent portfolio construction and conservative approach to risk management.
With attractive new originations, our stable portfolio and reduced non accruals. We benefited from continued execution of our strategy in 2023 and.
And remain committed to delivering a non volatile cash flow stream to our investors through consistent income and solid credit performance.
I'd like to now hand, the call over to the operator to take your questions and thank you so much.
Yes.
Certainly one moment for our first question.
And our first question comes from the line of price ROE from B Riley Your question. Please.
Thanks, a lot good morning.
Hey, Doug.
I'm good thanks Sarah.
Wanted to maybe piggyback on some of the prepared comments there around.
Potential pick up in activity, we've heard that from some other bdcs.
And if you could kind of just help us think about what that might look like especially relative to the leverage profile of your balance sheet. At this point I mean, you've noted that you are and one of the lowest leverage points.
In quite a while so just kind of want to understand how that could evolve over the course of 'twenty four.
Yes.
So.
And as usual.
Ask the question probably is multifacet. So when we think of leverage I'll just start there.
And Tom and then should happen a bit like but that is a sort of multi variable topic.
So one we're able to in todays market originate loans that at ASP plus six plus.
I think last year the average loan.
<unk> was probably around $6 50.
The team here will tell me if I'm off by a few basis points youre able to actually payout.
Sustainable in non volatile cash flow stream, which is actually the ultimate product of any BDC without being over Levered and Brian you and I and the team have talked about this behind closed doors many times.
The goal here isn't to run hot just for the sake of being invested the goal here.
Pay off debt.
That non volatile cash flow stream. So for us the leverage is really just a function of the rest of the strategy. So the in terms of a pickup in.
And I'm, just going to the fourth quarter. So there was a pickup in transactions in the fourth quarter and in the first quarter has actually.
Ben it's been stable for the fourth quarter.
The reality, though is our first question isn't hey, how do we do.
10 more deals.
Our first question is is the incremental transaction that we're doing it right for you and I've talked about this behind closed doors is it going to improve.
Current portfolio.
So when we think about whether we have to take up leverage we think about how an uptick in volume impact.
Impacts to fund. The first question is how many more deals can we do the first question is how do we actually create the cleanest most.
Non volatile cash flow stream that we can so.
It.
Is leverage.
Going to stay down in one turn forever.
Don't mean, it to but in this market based on our current base returns, we actually have the benefit of being able to do that.
The same token and I'm sorry for if this doesn't perfectly to get to your question hopefully its getting around it even if deal flow picks up.
Effectively that I'd, rather the biggest funnel to be able to choose the best deal side, rather always see more deals, but just because originations and see more transactions has picked up again, my my product and our team's productivity to you in the street and this is kind of the strategy, we try to execute as how do you create a clean portfolio that kicks off the cash flows that you all can pre.
Is that helpful.
Yes for sure I appreciate it.
Definitely definitely gets gets to the meat of the question.
Maybe a follow up for Tom since you talked about it in the prepared remarks, the dermatology associates investment.
Crystallized here in February as you noted can you talk about what the mechanics of that might look like in the first quarter given that you are actually carrying it at.
Yes.
On a fair value mark above cost.
Right so.
The new capital structure like the similar structure is going to have to trust. The data first out in our last out and then you'll see there'll be a new equity tranche on our Soi one important notice in the aggregate.
Our total fair value will be.
Crystal ball RF is roughly unchanged. So total fair value is not going to change very much. It's just there'll be different instruments and there'll be more value moving from what is now our last out on nonaccrual to an equity tranche.
And then there'll be more debt on accrual status in those new tranches. So net net positive impact on our quarterly but full quarter basis of about one penny per share.
Okay, no impact on fair value, but.
Non accruals going down.
Materially with that.
Transaction in the aggregate being removed from non accrual status.
Okay got it.
And then maybe last one for me.
You all had swapped out the fixed rate for a floating rate on the.
The baby bonds.
Maybe an obvious obvious answer from you all but just any any thought around why.
Why do that.
As dependent as opposed to just keeping keeping our fixed rate there.
Okay.
First with the 8% when we're looking at our maturities at the end of 'twenty four we wanted to be measured and not put all eggs in one basket and wait for the market to rebound. So we consider this kind of step one and addressing those upcoming maturities.
Two for the market with a good rate, but candidly not a rate we wanted to stick with for any long term amount of time. So it's not the right thing to do would be to swap out the floating certainly seen the likelihood that base rates are going to come down so over time.
Hang much less than the $8, two and thats at least with the right where the rate curves are going to grow that's what we anticipate happening with that instrument.
And in terms of the.
The next step is we're going to look to do potentially an index eligible deal whether it be later in 'twenty for early 'twenty five increased our overall unsecured debt.
That exposure, that's something that will be one.
Working on in looking we will say in court over the course of the next year.
Got it okay. Thanks for that.
Thank you.
Thank you one moment for our next questions.
Okay.
And our next question comes from the line of Finian O'shea from Wells Fargo Securities. Your question. Please.
Yes.
Hey, everyone. Good morning.
So erin.
Aaron I appreciate the portfolio cover it.
Relates to the core middle market strategy and Opportunistically.
Partaking in the larger market and or <unk> deals.
So in these instances does that mean.
The direct lending platform.
That serves the BDC under you.
Is.
Opportunistically doing other styles or is it that the BDC complex.
Claiming this deal flow from other Carlyle credit verticals and then second part there are you still dedicated to the core middle market or are you drift.
Drifting up to market by design. Thanks.
Excellent.
Okay.
Yes.
The first time that <unk> guys have been on an earnings call.
[laughter].
Okay.
It should be a target school now.
So let me start from the first question, which was a great one so our.
Meeting.
Core middle market. So if you think about the for our entire platform. So it's a great question. If you think about the median EBITDA of our company.
We lend to its about $76 million.
With that said, we have a pretty big and this is all within direct lending and the private credit business, we have a large origination footprint.
So for us.
When I think into the team thinks about direct lending my ultimate goal and I'm going to go back to the previous question as well.
We're putting together a big portfolio with the average position being less than 1%. So my ultimate product is the cash flow stream to kicks out.
So in the first half of last year.
When there were a lot fewer transactions to be had and was the first time in many years, where quite frankly, the terms of the upper part of the market, so well north of a $100 million of EBITDA, we were able to get.
Spreads that were on top of the mid market. So call. It $75 700, we're able to get covenant that we're able to get terms that we are the same so from a from a risk standpoint in the first half of the year.
Opportunistically, we're able to do direct lending and we have to make a choice for our investors. What is the what is safer if I can get similar term similar protections and similar spread to the mid market and actually have the protection of a much larger business.
We historically haven't had those covenants.
Those protections, we opportunistically went up market by the second half of the year and you and I have talked about this behind closed doors as well as the upper part of the market got a little bit more crowded CLO.
Cielo bid came back.
Significant retail flows went into other direct lending.
Strategies and some of our peers.
We skewed back.
Back down to the core mid market so.
And that core mid market again, I would define as somewhere between 25 and the.
Second half of the year, probably 25% to $75 million.
The point on ABL strategies, we do have a team focused on asset backed lending and when we think about asset back lending. It has two core middle market companies, but as opposed to being structured as a cash flow loan where literally thinking about our downside protection being true assets.
<unk> cash et cetera real estate.
And then we have <unk>.
We are very big software practice, who also reports to me and that team Opportunistically has done some <unk> deals we are.
Quite frankly been probably less exposed to <unk> and some of our peers, but again my goal and this doesn't sound.
It is going to sound sexy my goal and how do you get overpaid.
For taking less risk. So so again, we're focused on direct lending once in a while if I can go up market if that market is dislocated we do it and we did it last first half of last year. Today, we are probably more focused on the mid market, though opportunistically, we do go up market if something attractive.
Hopefully that answers the question.
Yes, very much thank you.
Two.
Back to the dermatology associates.
Sorry, if I missed any of this part.
Of the dialogue.
But it sounds like you just took control or received control, but this of course had been along.
Challenged credit, where you had restructured the debt somewhat previously.
So can you give some more color on.
The.
The state of the investment now do you.
And to put more money into it or may be.
Immediately bring in a new sponsor partner.
And then has the EBIT trajectory.
Stabilized or is it still in decline thanks.
So let me tackle.
Last part first because thats one of my favorite.
Questions or answers that company has exhibited 12 consecutive quarters of EBITDA growth steady performance continued upward trend modest increases every quarter for 12 quarters in a row.
Coming out of the pandemic of EBITDA increases in terms of the future its stable growth, we're not looking to issue for the fences and get put in material new dollars to grow it we're going to now is it new equity group assess the right time to.
The investments, we're going to invest prudently.
Don't have any grand plans.
Performance is stable and improving and we will look at the at the right time to exit the investment.
It's a good question I think.
Where we are in the cycle.
We here at Carlyle direct lending spent a lot of time, a year plus ago I think it was behind the scenes looking at our processes figuring out exactly.
How would you be prudent and more careful in terms of again being proactive in situations that were teetering. So I would say that we're kind of we're not in the first inning of that for our portfolio.
Closer to the end of the game.
We have full control of it I think a lot of our peers are.
Or just on the front end of that so for us part of the boring stuff.
Youre not going to.
Tom is that going to be in front of the street like we are today, saying, Hey, we've turned the quarter without those 12 consecutive quarters of positive numbers so for us the.
The key is the key to making sure that we have a clean portfolio when we come to you and we're being conservative.
We feel pretty good about where things are.
Hasan Thank you Paul.
I appreciate you hopefully we get you for the next quarter to spend.
Okay.
Absolutely.
Alright.
Sure.
Thank you one moment for our next question.
Okay.
And our next question comes from the line of Erin So kind of itch from Citi. Your question. Please.
Thanks.
Question on maybe just the competitive dynamics.
Hey, Erinn activity will increase.
Aaron do you mind, we cant youre.
You're a little muffled.
A muffled.
Better.
Sure.
Sorry about that.
I guess from a competitive.
Standpoint activity, increasing mortgage spreads are tightening a bit.
How is that changing I guess relative to maybe three or six months ago.
Yeah.
I've listened to a few of our peers calls and that seems to be a common question.
So.
Yes.
I've been saying there is a lot recently this time isn't different usually when youre getting outsized returns.
What we learned in economics 101 as capital comes into try to attract those outsized returns and Thats what gets the spreads to go back to normal.
I would say that relative to.
First quarter and first half of last year.
And again I'm, giving you directional numbers I actually don't have them off the top of my head. So the average deal. We're seeing was probably close to 60 75 700.
That's not normal so relative to an abnormally.
Wide.
Spread.
Quite frankly, a very high base rate base returns, we're going to be 13% plus.
Things have come in significantly since that I'd say at the upper end of the market. If you are talking about.
A transaction that nor is north of $100 million and could easily be considered for the BSL market in a previous slide those transactions have certainly gone from north of 600 to somewhere between.
On the larger end 500 and up.
To $5 50.
For our regular way direct lending deal that as mid market.
What we're seeing is somewhere between.
550, 625 on average so those have come in with.
With that said with base rates still where they are you are you are achieving sort of a historic level of return without much leverage and what you haven't seen or at least we've been.
We tried to be disciplined here, but what youre seeing on the upper part of the market certainly covenants.
Look a lot of our covenant.
The existence of covenants looks a lot more like the BSL market. There. So there is.
Lot more cub light in the upper end of the direct lending market in the regular way mid market I'd say more times than not you're seeing your covenants and.
And then the documentation is still holding in I would also say what else is holding in as leverage levels.
So just because of the overall, even if spreads have come in you're still talking about a 530 base rate give or take so.
The average leverage level that we're seeing hasn't really increased much youre still talking about.
Low fives and in some cases high fours, so youre still seeing a fairly low amount of leverage so what I'd say is dependent on where you are and it goes to the previous person's pre Mo's question. That's why we are opportunistic as to where we play there are certain times for certain parts of the market that are much more.
Competitive and aggressive in.
Times avoid those so that we can actually get overpaid in other parts of the market.
The larger market is probably the most competitive today.
What I'd say for things.
And that's why we're being a little bit more opportunistic.
The mid market I think youre seeing a little bit more value there.
More likelihood of covenants more likelihood of stronger documentation.
And I would say all of the market not just the mid market I'd say the leverage levels are continuing to be.
Lower than historical leverage levels.
Is that does that work.
Yes, and then just a quick one on the on your other income I think you said that that was the chemical.
Chemical to the prepayment activity happening with more prepayments.
Do you expect that.
Other income was.
Back.
<unk> will be a longer term historical and this kind of environment.
Would that be.
That will come back down.
Paul.
Please proceed.
It's well ahead of when something goes wrong.
I think one of the issues that we've forgotten in direct lending sometimes is.
If something's wrong. If you are managing your book and you actually you are looking at your numbers and <unk>.
<unk>.
Designed the documentation correctly you have 12 months 24 months long ahead of time to start preparing so.
Outset I'll start that.
The slight movement from two to three <unk> from three <unk>, that's generally going to be particularly for flight.
Fire alarms, thats generally going to be us, saying, hey, we want more resources to look at it a name or two then the last piece I would tell you is relative to a year ago.
A year ago, a lot of what were seeing was inflationary tripled.
So you would have heard us a year ago, when we had our issues in the healthcare space of them took care of them. We've taken care of at this point.
A lot of that was about inflationary.
Pressures this past year, if you look at our overall portfolio and then I'll hand, it's Tom.
The inflationary theme, though it may still be there in small parts, but I think our average.
Our average business was up about 13% of revenue with just a little bit north of that in EBITDA. So you are done.
By definition revenue and EBITDA to grow in line.
As of late EBITDA is outpacing that so I'd.
Let's say a year ago. The inflationary theme was the conversation today not as much and by the way Melissa I'll tell you.
Yeah.
A year ago. It was a theme today not as much today, it's changed so much that we you and colleagues in the analyst field one of the other questions. No one's asked is what's your view on forward interest rates. So think about the fact that we're asking we're talking about interest rates being cut.
And on the same call asking about inflationary pressures. So I think we turn that corner generally knock on wood on our portfolio, Tom what did I missed.
But I'd say specific to the changes in the risk ratings this quarter or the dollars on the page that for category two loans two positions.
<unk> contributed a fair value increase one is dermatology, which is continuing to inch up every call. The other is <unk>, which is now called base side. That's the other deal that's on non accrual with value that again improved so it's slightly up.
The four movement this quarter, that's a positive our two deals on nonaccrual with value actually going in the right direction and the three category that increased about $15 million was driven primarily by two deals when you say the three category. It means to Aaron's point, we're focused on at risk has increased probably up for those particular credits leverages up <unk>.
I was likely down from when we closed but importantly, we're not worried about losing money and so we're focused on it but we're really not worried about losing money.
The particular themes for those deals.
One is.
Consumer just consumer discretionary deals we don't have very much in the portfolio, but we've seen lower demand in consumer driven businesses and then across our industrial but just destocking.
One of the credits.
Without that in a couple of credits in the book and that was one of the downgrade just the general Destocking in the current environment. Those are a couple of things I've mentioned in terms of as we're looking at deals that migrates from that two to three category much more.
Relative to a year ago, where everything was inflation now it's more <unk>.
We're on top of it.
Does that help.
That's very helpful. Thank you.
Thanks for joining the call.
Thank you.
Does conclude the question and answer session of today's program I'd like to hand, the program back to Eric Lee for any further remarks.
Thank you operator, everyone. Thanks for joining.
Look forward to talking to you later in the day, we appreciate your partnership in <unk>.
And your next quarter.
Thank you, ladies and gentlemen for your participation in today's conference. This does conclude the program you may now disconnect good day.
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