Blackstone Secured Lending Fund (BXSL) Earnings Call Transcript & Summary

Good day, and welcome to the Blackstone Secured Lending First Quarter 2023 Investor Call. Today's conference is being recorded. [Operator Instructions] At this time, I'd like to turn the conference over to Weston Tucker, Head of Blackstone Shareholder Relations. Please go ahead.

Great. Thank you, Katie, and good morning, and welcome to Blackstone's Secured Lending First Quarter Call. Earlier today, we issued a press release with a presentation of our results and filed our 10-Q, both of which are available on the Shareholders section of our website, www.bxsl.com. We will be referring to that presentation throughout today's call. I'd like to remind you that this call may include forward-looking statements, which are uncertain and 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 Form 10-K. This audiocast is copyrighted material of Blackstone and may not be duplicated without our consent. With that, I'll turn the call over to BXSL's Co-Chief Executive Officer, Brad Marshall.

Thank you, Weston, and good morning, everyone. With me today is Jon Bock, Co-Chief Executive Officer, and we are excited to be joined by Teddy Desloge, our newly appointed Chief Financial Officer, effective as of close of business today. Many of you know Teddy as he has been with Blackstone Credit since 2015. First, on the direct lending investing team and then in a portfolio manager capacity for our direct lending business. We're excited to have him officially join the BXSL's management team. Turning to this morning's agenda. I'd like to start with some high-level perspective before Jon and Teddy go into the detail of our portfolio and first quarter results. Turning to Slide 4. BXSL reported another strong quarter with significant growth in net investment income, higher net asset value and strong credit performance, all in a period that was marked by meaningful uncertainty ranging from commercial bank failures to stubbornly high core inflation. Net investment income, or NII, increased 3% quarter-over-quarter to $0.93 per share, which represented a 14% annualized return on equity and our highest NII per quarter since inception, primarily driven by rising interest rates that have increased the average yield on our debt investments from 10.7% last quarter to 11.4% at quarter end. This earning power further reflects the quality and strength of our well-sourced portfolio, which as of March 31 was 98% senior secured first lien, 45.2% loan-to-value. Using cost basis to measure, less than 0.14% of the investments are in non-accrual or 0.07% on a fair market value basis, and less than 2% of our assets are marked below 90% at cost. Our net asset value per share, which increased 0.7% to $26.10 from $25.93 the previous quarter, further reflects portfolio stability. Earnings power again exceeded our quarterly dividend of $0.70 per share, which was increased 17% last quarter and has increased over 30% since the fund's IPO in late 2021. Our current dividend represents a 10.7% annualized yield for shareholders based on the higher first quarter NAV of $26.10 per share. We believe this represents the highest dividend yield for any listed BDC with as much of its portfolio invested in first lien senior secured assets. Slide 5 provides additional highlights on our portfolio activity and stability in our liquidity position. First quarter sales and repayments were $109 million, matched by $108 million in new investment commitments. The result of lower net origination was tied to both the seasonally slow period for new deal activity as well as a lower overall level of deal volume as private equity sponsors selectively adjust to the new market and rate dynamics. That said, we are beginning to see more market activity, which may lead to an increase in portfolio turnover. Subsequent to quarter end, we realized our debt and equity investments in Westland, the impact of which we expect to be accretive to NII by more than $0.05 per share. In terms of our balance sheet, we also believe we remain well positioned for both defense and continued growth with $1.2 billion of liquidity from cash and our undrawn lending lines. Our lending lines were set up 2 years ago at what are now below market prices with high-quality counterparties. We had 0 direct exposure to Silicon Valley Bank, Signature Bank, and First Republic Bank. And we have less than 1% of all secured debt commitments from regional banks in general. Turning to Slide 6. We ended the quarter with $9.6 billion of investments and leverage of 1.31x, which is down from 1.34x the previous quarter. Importantly, the ending yield of our portfolio, which is 98% floating rate debt expanded over 400 basis points over the last 12 months. Taking a moment on this slide, I want to outline that each quarter, the market continues to witness increased earnings power associated with floating rate nature of our loans and the attractive fixed rate liabilities. However, I believe that there is a growing demand for BXSL due to its defensive positioning during these more volatile times. In fact, if you look at senior secured debt, which is 98% of BXSL's portfolio composition, the private credit asset class, as measured by Cliffwater Direct Lending effects has generated consistent returns, ranking as the top first or second performer in fixed income and 13 over the past 18 years since Blackstone, then GSO launches private credit strategy, and only one down year, which was during the great financial crisis. And prior to the GFC, the average loan-to-value was 66% versus 57% in 2022 and 45% in BXSL. Part of the focus on limiting risk in our portfolio is to focus on larger deals. Our leadership in large private credit transactions where we have led or been the sole lender in approximately 50% of the $1 billion-plus direct lending deals is important as we have control over the outcome in these deals. That focus on building rights, lending to the right businesses, which some may consider to be a first line of defense, continues to generate solid returns for BXSL shareholders. Comparing our NAV returns to public market benchmarks, BXSL generated a total return of 3.4% in the quarter compared to 3.2% for leveraged loans, 3.6% for high-yield bonds, and 3% for investment-grade bonds. Jon will speak more to the portfolio later in the call. Additionally, there is a second line of defense to protect capital, often just as important as the first but goes less recognized by investors. That is the potential value add a manager can bring to the portfolio after investments are made. Many of you have heard us outline the benefits of Blackstone Credit Value team, formerly Blackstone Credit Advantage, but I'd like to put a few numbers behind this value add. Recall, we have an internal Blackstone team of 109 professionals who work with our portfolio companies, including over 20 professionals in Blackstone Credit. This team offers the scale and operating capabilities of the Blackstone network to our portfolio companies to drive both revenue and cost synergies to the benefit of the portfolio company and the private equity sponsor. We believe these benefits are unique to Blackstone Credit, and they provide substantial value to our shareholders. Let me share some detail with 2 examples where we held the equity. Last summer, we realized our position in the company called Datasite, a leading provider of Virtual Data Room or VDR, services in which BXSL had invested in equity and warrants alongside the debt commitment, which was never called. Recall VDRs are independent platforms used to host and share highly confidential files and manage workflows. By leveraging the Blackstone value creation team and the broader Blackstone network, we were able to identify and help Datasite execute on meaningful cross-sell opportunities and cost savings. One important element to assist Datasite was Blackstone's over 93 introductions across the Blackstone ecosystem, including Blackstone internal teams, the Blackstone portfolio companies, advisers, and private equity partners. Subsequent to quarter end, as I mentioned earlier, we realized our investment in Westland, a Canadian insurance brokerage business in its sale of Broadstreet partners. We first invested in Weston in 2021 and have provided a combination of debt and equity based growth capital that help turn them from a regional broker into a national scale player with nearly twice the operating profit. With the help of our adviser expertise, we provide support on their IT transformation to support growth, culminating in a payoff that we expect to be accretive to NII by more than $0.05 a share. Across these 2 investments, BXSL invested $207 million and received $265 million in proceeds on the sales, a 28% increase on our initial investment in addition to the $28 million of interest we received during our hold period. Remember, we offer cross-sell cost saving and advisory opportunities to all of our boards at no additional fee. Because we understand the end benefit of the investment portfolio. And while we are a lender first with a portfolio overwhelmingly invest in first lien senior secured loans, our operating platform allows us to realize additional equity upside or help derisk our debt investments. Datasite and Westland are 2 very recent and successful case studies of how truly unique our platform and our capital can be for the companies that we partner with. Generally, across our direct lending business, a substantial majority of the portfolio companies that are introduced to the valuation creation team actively participate in the program. And while we have a large portfolio monitoring team is one of the largest in the world in private credit, we go beyond that with our own resources and infrastructure to drive outcomes. That benefit not only our portfolio companies, but also our shareholders in real, tangible ways. With that, I'll turn it over to Jon to speak about the portfolio.

Thank you, Brad. And echoing your comments on strength and periods of uncertainty, let's again see what a defensive portfolio looks like. So jump to Slide 7. Let's start with seniority. Up to 98% of BXSL investments are in first lien senior secured loans, and over 95% of those are the companies owned by private equity firms or other financial sponsors who have access to additional equity capital to support their companies. The portfolio is highly equitized with an average loan-to-value of 45%. But it's not just that we're senior in the capital structure. More importantly, we're focused on seniority with companies with the right size and in the right industries. Focusing on size, our portfolio companies have a weighted average EBITDA of $179 million, growing to $128 million as of the first quarter of 2022, as we continue to orient the portfolio to larger, more durable businesses. I'll jump to Slide 8. Our focus on the upper end of the middle market is rooted in our belief that this area provides compelling value opportunity and the data bears this out. Note that recent data from Lincoln suggests that upper middle market companies with greater than $100 million of EBITDA, maintain a similar credit spread per unit of leverage compared to middle market businesses, but larger companies grew more than twice the rate of smaller companies in 2022 and have had substantially lower default rates since 2018. And for reference, BXSL had less than 2% of its portfolio in companies earning less than $30 million of EBITDA, which have historically had those higher covenant default rates. Now many of you know Lincoln is a leading valuation provider to private credit in the BDC space as they value and review over 4,000 private credit investments each quarter. Now Slide 9 focuses on our industry exposure, where we believe investing in better companies and better neighborhoods drive sustained returns over time. This means focusing on key sectors with low default rates, low CapEx requirements such as software, health care providers and services, and professional services, which account for over 35% of the investment portfolio. Now diving into the portfolio quality further sum to Slide 10. Here, we compare the BXSL portfolio to the Lincoln International Private Markets database. And you can see that our weighted average EBITDA of $179 million is more than double the market average of $80 million. Last 12 months EBITDA growth for our portfolio of companies was nearly triple that of the benchmark. And importantly, on profitability, our portfolio companies have EBITDA margins that are 25% higher. Now let's talk interest coverage. As mentioned last quarter, this is a stat that gets widely shared on other listed BDC earnings calls. But as we've mentioned previously, the way it's calculated by BDC managers varies widely. In some cases, certain sectors or types of loans are excluded. In other cases, managers exclude negative EBITDA companies, both decisions that obscured the averages and leave investors looking for better transparency. So when we calculate interest coverage, we include all private companies EBITDA, including companies that have borrowed on a recurring revenue loan and companies that may have amended some of their interest obligations to pick after initial underwriting. Next, we compare our portfolio to the Lincoln database, which we believe is a representative proxy for that entire credit market. Now, we currently sit at a last 12-month average interest coverage of 2.1x today, which is slightly higher than the market average of 1.8x via Lincoln. This difference remains resilient when we run interest rates at 5% through the portfolio, which brings our average interest coverage to 1.7x compared to the market of 1.4x, and we attribute this stability to our focus on larger, more profitable higher-growth businesses. Yet we also hear from investors and other market participants that it's less about averages, particularly the averages that are obscured by exclusions and much more about the tails, namely the percent of one's portfolio below an interest coverage ratio of 1x on a forward basis using higher base rates. If we flow through 5% interest rates, reflecting the lower end of the Fed funds target range today, we can see that BXSL would have had roughly 7% of its portfolio with an ICR below 1 compared to the private credit database or market, which is approximately twice that amount. And in the 5% interest rate example, of that estimated 7% of our portfolio below 1% or 1x interest coverage, 3% is related to a single transaction that we initially structured with a low ICR, given the anticipated ramp of EBITDA generation. That company continues to perform and expand its profit margins. So discerning investors will be right. Averages will not tell the story of direct lending performance, the tails will. And we seek to limit our tail risk with a focus on larger, better businesses and more stable sectors, and we continue to see favorable results. Blackstone fulfilled its conservative credit culture on a foundation of structural protections for investor capital. And we do this always while focusing on larger transactions. Note that when Blackstone leads or co-leads the vast majority of our deals, they have structural protections against asset stripping, collateral lease to prevent any shifting of assets out of our collateral package and almost not allow for uncapped EBITDA add-backs, all materially better than when compared to the leveraged loan market. Now let's just turn to amendments for a moment. We work with our companies constructively in the regular course to provide an idea scope. And so of the 45 amendment requests that we've received this quarter, 98% were related to M&A add-on activity and other benign technical amendments such as SOFR rate hedging or reporting. We did not have any situations where we provided immediate pig flexibility due to the inability to pay interest or principal. Now turning to Slide 7. Slide 11, sorry about that. As Brad mentioned, we increased our dividend distribution to $0.70 a share with the current dividend yield at NAV of approximately 10.7%, and that was up 17% from the last quarter and it has increased over 30%, to be clear, last quarter, 2 quarters ago, relative to the fund's IPO in late 2021. So importantly, we believe this 10.7% dividend yield at NAV is supported by a high margin of safety when you compare it to BXSL's net income yield of 14%. And it further reflects our view that the best dividend policy can support both a steady and stable distribution and long-term NAV growth. And with that, I'll turn it over to Teddy.

Thanks, Jon, and thanks for the introduction, Brad. I'm excited to be part of the management team and look forward to spending more time with folks here on the phone in the coming months. I will spend a few minutes on our operating results, summarize our investment activity and give some color into the pipeline activity we see on the ground today. I'll start with our operating results on Slide 12. In the first quarter of 2023, we generated our highest quarterly net investment income to date of $149 million or $0.93 per share, which was up 45% year-over-year as we continue to see the benefit of higher base rates flow through earnings on a predominantly floating rate first lien portfolio. Our net investment income yield in the quarter was 14%. Total investment income was up $79 million or approximately 43% year-over-year to $265 million in the first quarter. Importantly, we maintain a policy by which no origination fees are paid to the manager, mitigating conflicts associated with originating any particular transaction. In addition, 100% of upfront origination fees are amortized over the life of our loans. This results in a more stable income picture versus recognizing fees upfront, particularly in an environment where origination and repayment activity is lower. To that end, fee income was less than $1 million in the first quarter due to below average repayment volume of $109 million, yet we still generated earnings that represented 133% coverage to our dividend. Payment in kind or PIK income, was about flat quarter-over-quarter and represented less than 4% of total investment income. As Jon mentioned, we are encouraged by our borrowers' ability thus far to manage through higher financing costs at higher base rates, and we had no new amendments in the quarter providing for PIK flexibility. Moving down the P&L. Net expenses were up $33 million compared to last year's first quarter, driven primarily by higher interest expense. GAAP net income in the quarter was $139 million or $0.86 per share, up from $0.63 per share a year ago. Unrealized markdowns of approximately $15 million in the quarter were the primary driver of a $2 million capital gains incentive fee reversal or approximately $0.01 per share benefit to net investment income. Turning to the balance sheet on Slide 13. We ended the first quarter with $9.6 billion of total portfolio investments, of which approximately 98% are floating rate loans with a weighted average yield of 11.4%. This compares to $5.5 billion of outstanding debt with a weighted average cost of just 4.68%. The spread between our floating rate assets and low-cost mostly fixed rate liabilities has helped offset the impact of rising rates on our average cost of debt. As Brad previously mentioned, sales and repayment volume of $109 million was matched by new investment activity of $108 million, 90% of which was related to portfolio activity where we have incumbency. To give some context for the pipeline, we have seen an increasing activity in recent weeks, both as it relates to new opportunities and portfolio activity where we retain incumbency, which represents a significant competitive advantage from our scale and presence in the market. We believe this represents a strong foundation for new originations for BXSL to the extent capacity increases from repayment volume or new share issuance. Lastly, as a result of strong earnings in excess of the dividend in the first quarter, NAV per share increased to $26.10, up from $25.93 last quarter. Next, Slide 14 outlines our attractive and diverse liability profile, which includes 58% of drawn debt in unsecured bonds at an average fixed rate of less than 3%, which we view as having been a key advantage while the Fed increased its policy rate by 500 basis points since the beginning of 2022. Additionally, BXSL ended the quarter with $1.2 billion of liquidity and cash and immediately available but undrawn secured leverage capacity. Our debt-to-equity ratio was 1.31x down from 1.34x last quarter. Additional repayments realized subsequent to quarter end will help support deleveraging towards our target of approximately 1.25x. Importantly, we ended the quarter with a 0.14% non-accrual rate at cost versus the BDC market average of 2.2% as of March 31, and we maintain our 3 investment grade corporate credit ratings. Additionally, we have a low level of near-term debt maturities with just 6% of commitments maturing within the next 2 years and an overall weighted average maturity of 3.6 years. To that end, in March, we amended our $500 million Big Sky facility with Bank of America, which further expanded our revolving period by 2 years with no pricing step up until September 2024. Importantly, BXSL's model is very different from some of the regional banks that have had issues. We do not hold deposits. We run a little over 1 turn of leverage, while banks typically run above 10 turns of leverage. We do not hold fixed rate liquid assets to cover funding obligations, and we manage the duration of our liabilities to match or exceed the expected duration of our assets. As mentioned, we have available liquidity of $1.2 billion at quarter end, which we believe is sufficient to repay the $400 million bond maturing in July of this year. Should we choose to do so, this will maintain ample pro forma leverage capacity for unfunded commitments, which at quarter end totaled approximately $600 million, with over 40% expiring by the end of this year if unused. We continue to balance the attractiveness of the market opportunity today in direct lending and quality of our pipeline with our focus on managing the balance sheet toward our target of approximately 1.25x leverage. We may see additional repayments materialize beyond the approximately $200 million realized subsequent to the end of the first quarter, which would further support deleveraging and capacity for new deployment. With that, I'll pass back over to Brad.

Thanks, Teddy. Blackstone has been investing in cycles for over 37 years and Blackstone Credit and private credit for 17 years. Since the very beginning, our investment committee has been working together navigating through cycles, and we've delivered a 12 basis point annualized realized loss rate in direct lending for our track record as of March 31. We have 100 specialized industry advisers that support our underwriting. We cover over 3,000 companies across private and liquid credit strategies. And we have 300 investment professionals globally across 17 offices, and what we believe to be one of the largest teams in the industry at 57 in our CIO office specialized in active portfolio management. While we remain highly disciplined in an uncertain macro environment, we believe the dynamics at play create a once-in-a-generation opportunity for direct lending and remain positive about the outlook for BXSL's shareholders as a result. And with that, I'll ask the operator to open it up for questions. Thank you.

[Operator Instructions] We'll take our first question from Finian O'Shea with Wells Fargo.

A question for Brad. I guess for one, is the post-quarter repay you noted in the presentation, is that going syndicated? And then can you touch on the general potential for your portfolio being large first lien, well performing, et cetera to flow out into the BXSL channel?

Yes. Sure. So to answer your question on the first, on the asset, Westland, a corporate is buying that asset. And yes, they are using public debt to fund that acquisition. On your second point around the syndicated markets, I would say that continues to be a market that hasn't fully recovered. But as some of the larger assets outperform and look to lower their cost of capital, there is an opportunity for there to be more turnover in the portfolio, and we would get our call protection on those assets. But as I look across the opportunity set in, we have about $30 billion of assets in our pipeline right now. So I think the IC turnover as a potential very positive from an earnings standpoint because the pipeline is so large for us that will be able to easily replace it.

Okay. Great. That's helpful. And then a follow-up. I think Teddy touched on this, I apologize if I didn't hear the full answer. The fee income has been pretty anemic. Can you remind us if any of the fees are retained at the adviser level? And relatedly, would you expect this to eventually pick up for the BDC?

Yes, I'm happy to take that, Finian. Thanks. No fees are retained at the adviser level to answer your first question. And to answer your second question, I think it somewhat depends on market volumes. As Brad mentioned, we are seeing an increase in activity across our pipeline. That's been the case for the last couple of months, and that could lead to more repayment volume, which would drive fee income and accelerated OID as well.

When we do a deal then, that upfront OID gets amortized over the life of the loan, which Teddy highlighted. And I'll be a little more emphatic than Teddy. The manager does not scrape fees for the benefit of the manager, every fee that we generate goes to investors. Thanks so much.

We'll take our next question from Casey Alexander with Compass Point.

First off, in past quarters you've had a chart that discussed it when all resets flowed through the portfolio what the earnings power might be, have we pretty much captured all of the resets at this point in time? Or is there additional flow-through that could punch earnings a little bit higher?

Thanks, Casey. No, so we just -- to put some numbers to it, our average base rate earned in the quarter was right around 4.7% across our portfolio. That's versus the 3-month LIBOR spot rate at 3/31 of close to 5.2%. So what we would say is there is still some use left to see just based on where rates are today. Historically, we have shown that chart if we run that through our analysis today, that's an extra $0.04 or so of earnings potential just from base rates.

All right. Great. Secondly, while I appreciate the statistic that only 2% of your portfolio is trading at below 90% at cost. Do you know what across the portfolio, what the average discount to per value that the portfolio is priced at right now? I'm just trying to get at how much potential NAV accretion there might be when you start to get repayments on the portfolio?

So our average mark as a percentage of per at the end of the first quarter was 97.8%.

We'll take our next question from Ken Lee with RBC.

You talked in the prepared remarks about seeing more market activity more recently. I wonder if you could just further expand upon that? Where are you seeing activity coming from and looking a little bit further out for the rest of the year, granted incumbency is going to help how dependent or origination bonds going to be on M&A activity picking up, do you think?

Yes. Thanks, Ken. I'll take it. So where we're seeing activity public to private, so public companies looking to be taken private by private equity sponsors. We're seeing add-on financings, we're seeing corporate carve-outs. And we're actually seeing a pickup in sponsor to sponsor activity. Any time you're in a period of volatility, the bid-ask spread is fairly wide. And with the passage of time, that tends to come down. So we're seeing valuations come down and more transactions as a result of that. And for us, the reason why our pipeline is so big is because we have such large incumbency and 3,000 credits. Anything that is large will have to come through Blackstone Credit, anything complicated such as carve-outs as well. And so I don't think, as we think about investing and continuing to invest out of BXSL, that we're 100% dependent on what the broader market is seeing because kind of our deal funnel is as busy as it is.

Got you. Very helpful there. And one follow-up, if I may. You've been out earning your common dividend meaningfully. Wondering if there's any updated thoughts around dividend coverage and how it could trend over the near term?