Blackstone Secured Lending Fund. (NYSE:BXSL) Q2 2022 Earnings Conference Call August 11, 2022 9:30 AM ET
Michael Needham - Head of Shareholder Relations
Brad Marshall - Chief Executive Officer
Stephan Kuppenheimer - Chief Financial Officer
Conference Call Participants
Finian O'Shea - Wells Fargo
Robert Dodd - Raymond James
Ryan Lynch - KBW
Casey Alexander - Compass Point, LLC
Kenneth Lee - RBC Capital Markets
Good day, and welcome, everyone to the Blackstone Secured Lending Second Quarter 2020 Investor Call. At this time, all participants are in a listen-only mode. [Operator Instructions] I'd like to that this conference is being recorded.
And with that, let me hand the call over to Michael Needham, Head of Shareholder Relations. Michael, please go ahead.
Good morning and welcome to Blackstone Secured Lending's second quarter call. Joining me today are Brad Marshall, Chief Executive Officer and Stephan Kuppenheimer, Chief Financial Officer.
Earlier today, we issued a press release with a presentation of our results and filed our 10-Q, both of which are available on our website. I'd like to remind you that today's call may include forward-looking statements which are uncertain outside of the firm's control, and may differ materially from actual results.
We do not undertake any duty to update these statements. For some of the risks that could affect results. Please see the risk factors section of our most recent annual report on Form 10-K. This audio cast is copyrighted material at Blackstone and may not be duplicated without consent.
On to our results, we reported GAAP net income of $0.47 per share for the second quarter and net investment income of $0.62 cents per share.
With that, I'll turn the call over to Brad.
Good morning, and thank you, everyone, for joining today's call. Thank you, Michael, for those opening remarks. As Michael said, BXSL reported a very strong quarter highlighted by a 1.9% total return based on NAV, along with outstanding credit performance and a well-covered dividend.
For the first half of the year, we reported two regular dividends and three special dividends for a total of $1.51 per share, and we will pay another $0.20 special dividend later this year. Over the last 12 months, while LIBOR has averaged only 57 basis points, we have generated a dividend yield of approximately 10% for our investors.
In the second quarter, we continue to out-earn the regular dividend, with net investment income exceeding the regular dividend by 17%. We believe our dividend coverage is poised to grow in the near-term as portfolio yields benefit from higher interest rates. Something we discussed last quarter and are now seeing play out across the portfolio.
Today, I'd like to cover a few key themes before I turn it over to Steve to review our financial results. First, on rates, we expect material growth in net investment income from the recent increase in short-term interest rates. Second, on credit, the portfolio remains in great shape. Overall sector selection being senior in the capital structure and focusing on larger companies, combined with active portfolio management has proven to be an effective strategy. And third, on the outlook, we believe BXSL is well positioned to benefit from positive NII tailwinds along with defensive portfolio positioning, lower effective leverage than our peers and the fact that our four major share unlocks are behind us.
So first, framing the upside from higher rates. Since the start of the year, three month LIBOR has increased more than 200 basis points to 2.29% as of June 30 and 2.92% as of this morning. The forward LIBOR curve as it reaching 3.89% by the end of the year. As we have noted previously, BXSL benefits from rising rates because of its favorable asset liability profile. The portfolio is approximately 100% floating rate and the liabilities are 55% fixed rates.
To put some context around the potential near-term earnings uplift from rising rates, 97% and of BXSLs loans reset based rate on three-month schedules or more frequently than that. As a result, the average base rate earned in the second quarter was 1.1% despite three-month LIBOR of 2.3% and three-month SOFR of 2.1% on June 30.
If the average base rate would have been at June 30 level for the entire quarter, we estimate that second quarter net investment income would have been 18% higher or an additional $0.11 per share. If base rates were to increase another 100 basis points from June 30 level, we estimate that another $0.09 benefit to net investment income or 32% above second quarter actual NII all else being equal.
As we noted last quarter, we expect the benefit from higher rates to largely begin this quarter, given the timing of base rate resets. Our macro view from Blackstone's Chief Investment Strategist, Joe Zidle, is that base rates should go higher and stay elevated for longer than the curve suggests, driven in large part by continued near-term economic momentum and inflation that could prove more persistence and consensus expects, with pressures across wages and shelter costs. In short, we believe interest rates represent a meaningful near-term tailwind to the earnings power of BXSL and our ability to pay dividends.
Second, BXSL was designed to protect investor capital in challenging market environments, and we expect that to be a defining differentiator for us in the future. Today, we continue to have zero assets on non-accrual. And I want to spend a bit of time on this defensive approach, our philosophy and the resources of BXSL.
As we have highlighted previously, our fees and expenses are industry-leading. As compared to most BDCs, our management fees are lower, our incentive fees are lower, our G&A expenses are lower and our liability expenses are lower despite being over 50% fixed rate.
When we took BXSL public, our goal was to offer the lowest fee structure across the public BDC, which allows us to take less risk in our portfolio through cycles without compromising returns.
To that end, we have a portfolio of 98% first lien assets, generally in larger companies in less cyclical, high cash flow sectors. These companies should be well positioned to withstand headwinds created by higher inflation, higher interest rates and an economic slowdown should one materialize.
Fundamental performance across the portfolio has been supportive, including healthy revenue growth with net leverage and loan-to-value levels consistent with prior quarters. We are seeing particularly strong trends across our tech, services and healthcare sectors, which are our largest sector exposures.
I also want to spend a bit more time on our operating platform, which we call Blackstone Credit Advantage. We believe we are the only BDC manager with a dedicated operating team that utilizes the scale and breadth of its broader platform.
The 16% growth responsible for this inside Blackstone Credit seeks to drive value for our portfolio of companies through areas such as procurement, cross-selling products and services, cyber security, and data analytics, among other areas. We have five people alone focused on calling our portfolio companies every day on procurement.
To give you a sense of how impactful this can be, Blackstone Credit provided a financing package to a company, including a unitranche loan and equity. During our investment to date, the company has grown nicely and we helped drive revenue growth through over 75 new customer introductions. We also plugged in our group purchasing team who helped significantly lower expenses across software licenses, rental car expenses and we help with cyber security.
Earlier in this quarter, in the third quarter, we exited our equity position at a significant gain in this company. While we recognize that the zero default environment may not last forever and are cognizant of potential risk in the broader economy, we are highly focused on minimizing mistakes and maximizing recoveries through how we design the portfolio, how we underwrite the risk and add value after we make our investment. Since 2006, this active management approach has resulted in Blackstone Credit's annualized loss rate in US direct lending of only 11 basis points.
Third, despite being -- despite potential macroeconomic headwinds on the horizon, we believe the outlook for BXSL shareholders is bright. On July 1st, we completed our fourth major share unlock related to our IPO, which was an important milestone. Those unlocks while creating temporary pressure on our stock has led to higher trading volumes and higher float. Our trading volume has multiplied more than tenfold since January.
Taking a step back, we formed BXSL over four years ago to build a company that harnesses the best attributes of private credit in a public BDC structure. I talked about our industry-leading fees and expenses, the quality of our assets and liabilities, and the resources we are offering our portfolio companies. We also added a look back into performance fee structure. We waived some of our already industry-leading fees. We bought back shares at a discount, as you will hear later from Steve.
Investor experience is exceptionally important to us. We believe we are entering a period where quality will outperform from a credit standpoint. Incorporated in all of this is a defensive portfolio construction with first lien assets with an average LTV loan-to-value of 46%. Taken together, we believe that BXSL's position as a premium B2C with a differentiated risk return profile should ultimately benefit shareholders. It has both defensive qualities to protect investors' capital and meaningful earnings upside.
With that, I will now turn it over to Steve.
Thank you, Brad, and thank you all for your time today. BXSL had a remarkably stable quarter given the broader market backdrop and is notably well positioned going forward. Our focus on senior loans to growing sponsored companies across less cyclical industries drove material outperformance versus the broader loan market and our floating to fixed asset liability profile is compelling, as we look ahead given the current interest rate environment.
I will focus on three primary topics today; our financial performance for the quarter, asset and liability trends for the company, and an update on our share repurchase program.
Starting with our financial performance, we recorded $0.73 of dividends in the quarter, including $0.53 of regular dividends and a $0.20 special. Since the end of the previous quarter, our trailing 12-month dividend yield increased to 9.8% from 8.8%, and we also continue to out-earn our regular dividend.
In the second quarter, our net investment income of $0.62 per share exceeded our regular dividend by $0.09, representing dividend coverage of 117%. We have now out-earned our regular dividend for 13 straight quarters.
Turning to our balance sheet, BXSL ended the second quarter with total portfolio investments of $101 billion, outstanding debt of $5.8 billion, and total net assets of $4.4 billion. Net asset value per share decreased from $26.13 to $25.89, primarily due to the special dividend, which was paid from accumulated undistributed net investment income from prior quarters.
Excluding the impact of the special, NAV per share was down only $0.04 or 0.2% from a quarter ago and up 0.7% from a year ago. We had $26 million of net realized and unrealized losses, driven by unrealized investment markdowns and partially offset by a realized gain on investments of $2.5 million.
The $105 million of net investment income represents $0.62 per share, up from $0.61 per share in the prior quarter, mainly driven by higher interest rates and still well in excess of our regular dividend of $0.53.
Focusing on our assets, the company's total portfolio at fair value at the end of the quarter was $10.1 billion and we had total assets of $10.4 billion. Our second quarter weighted average yield on debt investments and other income-producing securities at fair value was 7.8%, up from 7.2% in the prior quarter, driven by increase in base rates.
During the second quarter, the company made $296 million of funded investments, offset by $28 million of sales and $186 million of repayments for net activity of $82 million.
Prepayment income was at a historically low level for BXSL in the second quarter due to low portfolio turnover across the market. Prepayment fees account for less than $0.01 of our $0.62 of NII. Even if those fees were zero, however, we still would have out-earned our regular dividend by over $0.08. We expect a slight increase in prepayment activity in the third quarter.
Because of this muted activity, our quarter-over-quarter portfolio statistics are relatively similar. On a year-over-year basis, we have continued to increase the defensive nature of our assets by increasing diversity and average issuer size. Over this period, the number of portfolio companies has increased 47% and from 111 to 163, and the average EBITDA of our borrowers has increased 101% and from $74 million to $149 million.
Over the same period, the average LTV of our borrowers and the mix of first lien loans has remained relatively constant with LTV at 46% as of the end of this quarter versus 44% a year ago and the concentration of first lien assets in the portfolio at 97.6% versus 98.1% a year ago.
Altogether, this means we have added material diversity to the portfolio as well as quality to larger companies, while not compromising on risk. We continue to be diversified across industries as we ended the quarter, invested across 35 different industries, which is consistent quarter-over-quarter.
Now moving to our leverage, capitalization and liquidity. We ended the quarter with $6.6 billion of committed debt with over $700 million of undrawn capacity. Our average and ending leverage ratio for the quarter was 1.3 and 1.34 times, respectively, which is slightly above our one to 1.25 times target.
However, we are comfortable at this level in the short-term as we have no off-balance sheet leverage and our 98% concentration in first lien loans is extremely senior. Our overall cost of debt for the quarter was 3.1%, up 30 basis points from the previous quarter.
Just to highlight this for a moment. As I mentioned earlier, our yield on investments increased by 60 basis points quarter-over-quarter, and our cost of debt only increased by 30 basis points. This is due to the concentration of fixed rate liabilities we have in place for the company, which we believe will continue to be a positive contributor to performance.
As mentioned, 55% of our debt outstanding was in the form of fixed rate unsecured bonds, which provides the company with significant flexibility and push-in as well as the potential for additional earnings upside as rates continue to rise.
Importantly, the average cost of this fixed rate debt is 3.0%, and we have not swapped any of it the floating. We have a low level of debt maturities over the next few years with our nearest maturity in July of 2023 and the weighted average maturity of our debt portfolio at four years as of quarter end.
Now, I'll summarize our share repurchase program. During the quarter, we bought back $52 million worth of shares at an average price of $24.76. Since quarter end, we have purchased an additional $69 million of shares at an average price of $23.34 and for a total of $121 million at an average price of $23.94. We have $141 million remaining on the buyback authorization. These repurchases below net asset value are accretive for the company.
In conclusion, the second quarter of 2022 saw continued stable performance for the company in a materially volatile market. We believe BXSL is well positioned going forward with a defensive portfolio and upside to earnings.
And with that, I'll ask the operator to open the call for questions.
Thank you so much. [Operator instructions] Thank you. And the first question is coming from Finian O'Shea from Wells Fargo. Please go ahead.
Hi. Thank you. Good morning. First question, it looks like the spread-based marks were fairly contained here, understanding the portfolio is in great shape. But does this reconcile to your pipeline of new money, those spreads, or maybe is there sort of an additional impact we would expect next quarter?
Great. Thanks, Fin. Good to hear your voice. So with respect -- I think you're asking with respect to marks. And as you know, marks are a product of what we see in the environment from a spread standpoint and the overall performance of our assets. Those are kind of the two primary make-ups of how we drive marks.
And maybe to give you some example, we fund -- our largest funding during the quarter in early April, with a position called ASPI [ph]. So we funded that in April -- and because of spreads widening, we took that mark down 2%. So it's going to be an inter kind of play between spreads and performance. And we took, I think, over 25 names down during the quarter in light of spread widening.
Offsetting that is really strong performance in the portfolio. As we've talked about before, our focus on certain sectors, our focus on bigger companies is really starting to shine. If you look at our top 20 positions, I think EBITDA growth is approaching 10%. So there's just a nice offset in terms of performance.
We will look at where spreads are at the end of the third quarter and decide kind of what we should do from a mark-to-market standpoint. But I think you know that it's an interplay of performance and market observations. I will highlight -- while we have seen spreads widening in the private markets, we've actually started to see them tighten in the public market. So it will be interesting to see kind of how that interplay plays out through the balance of the year.
Sure. That's very helpful. Thank you. And a small follow-up, maybe sort of a crystal ball question. with portfolio activity, obviously, your leverage target, the market is slower on deal flow, at least it has been, but any sort of guidance on how things are picking up in terms of origination and repay and what we should sort of look for in the back half of the year for turnover.
Yes. So I would say just from an origination standpoint, the market is definitely slowing from the start of the year. And just to put some numbers in perspective, the second quarter for us from a direct lending standpoint was the second most active quarter for us in our history. So it's actually a fairly active quarter. And we're starting to see some of those sales processes slow down through the balance of the year. Offsetting that is because the public markets are still -- there's limited capacity to tap the public markets private lenders are seeing close to 100% market share in new deals.
So there is an offset while the market is slowing, the private activity is picking up nicely. But invariably, I think deal activity will slow as valuations get reset and because capital is more expensive. From a repayment standpoint, you're right, Crystal balls are hard. But from a third quarter standpoint, we expect repayments to pick up relative to the second quarter.
And our next question is coming from Robert Dodd from Raymond James. Please go ahead.
Hi, guys. And congrats on the quarter. I’ve just two quick ones, if I can. But I mean last quarter, you gave us the percentage and it was small. Percentage of the portfolio that had interest coverage under one times, it was all recurring revenue, 5%. Can you give us an update? Has any of that changed or where you would expect that to be given the base rate increases that are going to flow in, in Q3?
Yes. Thanks, Robert. So right now, our interest coverage is 2.7 times. And as we spend a lot of time on the sensitivity table, just given our view on rates as that they will stay higher for longer. When we project forward and take out we've got a couple ARR type loans that make up 3% of the portfolio, which are performing very well.
So if you just exclude those, if LIBOR gets to 4.3%. So today, we're at, what, $2.92. And let's just say we go past the curve which is 3.9. And we're at 4.3%. And we stay there for a 12-month period.
The percentage of our companies that have less than one-time interest coverage is 4.3%. And if you go up from base rates from 4.3% and you go north of 5% that ticks up a little bit, but not much more from there.
Really appreciate that level of detail. Thank you. Another one on the rate sensitivity, I mean as you said, 97% floating rate that reset at three months or more frequent. Are you seeing a shift in mix? Are you seeing more one-month elections or people requesting even maybe going to a six-month collection or anything in terms of the mix of the base rate is the curve, so to speak, right now?
Yeah, great question, and we've tracked that quite closely. We have not seen a change in how our companies are approaching their resets.
Got it. Thank you.
The next question is coming from Ryan Lynch from KBW. Please go ahead.
Hey good morning. First question I had is, you guys as a firm Blackstone direct lending, private credit has certainly made a pretty big splash in the direct lending markets over the last year or so and particularly with the focus in kind of these larger mega tranche deals in the marketplace.
I'm just curious, as we look at BXSL today, that's kind of like fully leveraged are fully kind of deployed. And then when we look at your other Private BDC, BCRED, it looks like the overall fundraising has slowed down there pretty meaningfully relative to what we've seen over the last several quarters.
So I'm just curious, I'd love to hear about how you feel your overall positioning and ability to commit to kind of these larger deals are in this marketplace when it looks kind of from the outside looking in that maybe capital is a little more constrained across that strategy or the direct lending platform?
Sure. And I'll try and answer it as high-level as I can. I would say and take my earlier remarks the second quarter was our second most active quarter in our history. And that's despite what you quote as lower capital raising in BCRED and BXSL being at our target leverage.
So our position in the market where we laid, I think, seven -- invested in seven deals over $1 billion during the quarter is unchanged.
In fact, just looking at BCRED alone, we're still have investable capital given our capital raise of $2 billion a month, in addition to kind of other pockets of capital that we have in insurance in some of the largest institutions in the world.
So our leadership position in the large end of the market, we expect to continue. And we expect it to continue, because it's really important to us. If you remember what I said at the start, we set up BXSL to have low fees and expenses. We set up BCRED to have low fees and expenses.
That allows us to focus on bigger companies, take less risk for our investors and drive better returns over the long term. So nothing has changed from a capital raising standpoint that's materially shifting where we want to focus our capital.
Okay. That's very helpful color and context for what you guys are doing across the firm. The other question I had -- and I do appreciate the details you provided on kind of the benefits from rising rates. That's very helpful to kind of help us kind of think through your guys' positioning and the potential impacts.
So as I think through that, I look at kind of the outlook of a very strong, potentially operating earnings growth, and you're already having very strong dividend coverage. I know you guys still have, I think, a little more special dividend to pay next quarter and you guys have already declared.
I'm just curious, can you remind us what is your, sort of, overall dividend policy and your thoughts around how you want to pay out dividends. And, obviously, you guys have another kind of wrinkle, because there eventually, your fees are a little bit lower and will eventually go up a little bit.
But I'm just wondering, where are you guys thinking from operating earnings versus dividend coverage? And how do you see that interplay? And what is your thoughts of core dividend versus regular supplemental that could be variable or special dividend? How are you guys just thinking about that, as you guys are going to have a big tailwind from rising rates?
Yes. So what I would say, Ryan, and we spend like others, a lot of time talking about this, and rates have moved so quickly that it is a kind of a fresh topic. But you're right, when you're paying an 8.5% dividend and you expect earnings to go up by 25% to 50%, depending on your view on rates, it has to be a focal point of discussion with management and with the Board.
And what I would say to that is, clearly, we have a special dividend that we're paying out. We have our regular dividend. We are going to have to consider what we pay out over time. But I think what we want to be super transparent about is regardless of whether it's a regular or a special dividend or simply stays in as NAV appreciation.
The earnings uptick will all accrue to the benefit of investors. And I think we've done a pretty good job of kind of highlighting what that looks like between the base rates increasing between the buyback kicking in and accruing to the benefit of investors, some prepayment income flowing through.
So I know, I'm not answering your question specifically, because it is a topic of -- that is very current with the Board right now. But regardless, you are seeing this uptick in earnings that will accrue to the benefit, whether it's regular or special or just a NAV.
Okay. Yes. I understand. That's helpful framing the detail. That's all for me. I appreciate the time today.
Our next question is coming from Casey Alexander from Compass Point, LLC. Please go ahead.
Yes. My questions have now been asked and answered, but I would appreciate if you could review the share repurchase notes that you put out in the text part of your remarks just because I didn't quite get them all down?
Sure. Thank you. How are you doing? So I'll just reread the highlights there. During the second quarter, we bought back $52 million worth of shares at an average price of $24.76. And since quarter end, we have purchased an additional $69 million of shares at an average price of $23.34, those things total $121 million at an average price of $23.94 and we have $141 million of capacity remaining in the buyback authorization.
All right. Great. Thank you. That's the only question I had left.
And our final question is coming from Kenneth Lee from RBC Capital Markets. Please go ahead.
Hi. Good morning. Thanks for taking my question. Just one on portfolio construction, you talked about an increase in issuer size. Just wondering if you could share your thoughts over the near term, would you anticipate any other changes or shifts in portfolio construction, just given what you're seeing in the pipeline and the macro backdrop? Thanks.
Thanks, Ken. We don't see a shift right now. I think our position from the start has been to be very defensive, so that's why you see this kind of move to larger companies, which we have to view that have better management teams, better sponsors, more leadership in their space. And we've deemphasized more industrial businesses that have more of an impact from rising inflation, maybe have less pricing power if they're kind of midsize. So our portfolio construction has really been designed to be defensive, and that is -- will continue to be the posture that we take for our investors.
Got you. Very helpful. That's all I have. Thank you very much.
And there are no further questions in the queue. So let me hand it back over to Michael Needham for closing remarks.
Great, thank you. Thanks everyone for joining our call. Our Investor Relations team is available to answer any additional questions should you have them. We look forward to speaking again next quarter.
Thank you so much everyone. That marks the end of our conference call for today. You may now disconnect. Thank you for joining, and enjoy the rest of your day.