Carlyle Secured Lending, Inc.

Good day, everyone, and thank you for standing by. Welcome to the Carlisle Secure Lending Inc. Second Quarter 2023 Earnings 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 the question, you will need to press star 1-1 on your telephone. You will then hear a message advising your hand is raised. To withdraw the question, simply press star 1-1 again. please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Daniel Hon. Please go ahead.

Good morning, and welcome to Carlyle Secured Lending Second Quarter 2023 Earnings Call. With me on the call this morning is Aaron Lee Kong, our Chief Executive Officer, and Tom Hennigan, our Chief Financial Officer. Last night, we filed our Form 10-Q and issued a press release with a 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 on them. These statements are based on current management expectations and involve inherent risks and uncertainties. including those identified in the risk factor 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 Aaron.

Thanks, Dan. Good morning, everyone, and thank you all for joining. I will focus my remarks on three topics for today's call. I'll start with an overview of our second quarter results. Next, I'll touch on the current market environment. And finally, I'll conclude with a few thoughts on our investment activity and current positioning. Starting off with earnings, we continue to see the benefit of higher base rates and attractive pricing on new investments, generating total net investment income of 52 cents per share for the quarter, which is up 30% year on year. Our net asset value at June 30th was $16.73 per share as compared to $17.09 for Q1. As Tom will detail later, the change in NAV for the quarter was primarily driven by a markdown on one of our healthcare services investments that was partially offset by earning NII in excess of the dividend. We declared total Q3 dividends of $0.44, consisting of our $0.37 base dividend plus a $0.07 supplemental, both of which were in line with the prior quarter. Although we are pleased with the quarter's earnings, we remain focused on the credit performance of the overall portfolio. The credit fundamentals of our portfolio, in the aggregate, have continued to perform well, with revenues up more than 30% and EBITDA margins largely flat year over year, despite inflationary pressures to the economy. And importantly, Our borrowers have reported consistent quality results as we've not seen a meaningful increase in non-cash outbacks and interest coverage remains stable. This gives us comfort in the strength of our portfolio. Turning now to the current market environment. We saw the key trends discussed on our last call continue through the balance of the second quarter. Terms and pricing lead favorably to lenders. and deal activity in high yield and syndicated markets is still sluggish with overall net loan supply at 15-year longs. Given these market dynamics, sponsors continue to favor the private credit market to finance the limited number of LBO transactions that have been completed. While we continue to view the LBO market as a core component of our strategy, we also complemented our traditional sponsor pipeline with other sources of transaction flow. In particular, we've seen attractive sourcing opportunities from three main areas. One, as mentioned, new deal flow from sponsors-backed companies. This is our largest generator of our deal flow, and we've continued to be increasingly selective. Two, Carlyle-generated and non-sponsored deal flow. The one Carlyle platform provides us access to a wide swath of deal flow. And three, finally, what I would call farming the portfolio. We're able to leverage our position as an incumbent lender along with our long-standing relationships with companies and sponsors to execute collaborative solutions for amendments, extensions, and M&A activity that provide added flexibility to borrowers and attractive incremental economics to our portfolio. Regardless of sourcing channel, We focused our efforts in Q2 on opportunities that were accretive to the portfolio's return. One example of this was that our average spread at origination on new deals improved by approximately 100 basis points compared to this period last year. In addition, as previously mentioned, we generated significant incremental value from our existing borrowers from amendment activity, which has driven tighter documentation, incremental fees, additional equity contribution from sponsors, and spread increases. In the second quarter alone, approximately 16% of our loans saw an improvement in one or more of these areas due to amendment and other related activity. I'll now hand the call over to our CFO, Tom Hannigan.

Thank you, Aaron. Today I'll begin with a review of our second quarter earnings. Then I'll discuss portfolio performance, and I'll conclude with detail on our balance sheet positioning. As Aaron previewed, we had another strong quarter on the earnings front. Total investment income for the second quarter was $60 million, up 3% from the prior quarter. This increase was primarily driven by higher benchmark rates. Total expenses increased in the quarter from $33 to $34 million. Similar to last quarter, the increase was primarily driven by higher interest expense from rising base rates. The result was total net investment income for the second quarter of $26 million, or 52 cents per share, up 4% versus prior quarter. Importantly, this recent level of earnings is materially above our quarterly core earnings from 2022. Our board of directors declared the dividends for the third quarter of 2023 at a total level of 44 cents per share. That's comprised of the 37 cent base dividend plus a $0.07 supplemental, which is payable to shareholders of record as of the close of business on September 29th. This total dividend level of $0.44 allows us to build NAV in the face of an increasingly complex macroeconomic environment. At the same time, it also represents an attractive yield of over 10% on NAV and over 11% on the latest share price. And the $0.52 of NII that we earned this quarter equates to a 12% plus return on 630 NAV. In terms of the forward outlook for earnings, we see stability at this 52 cent level based on the combination of current benchmark rates and attractive economics on new deals. So we remain highly confident in our ability to comfortably meet and exceed our 37 cent base dividend and continue paying out supplemental dividends each quarter. On evaluations, Our total aggregate realized and unrealized net loss was about $22 million for the quarter. The decrease was driven by a markdown on one of our healthcare services names, American Physician Partners. As we've noted in the past, the healthcare services sector has faced headwinds from labor shortages, wage inflation, and regulatory changes in the U.S. However, recent financial performance of our other healthcare services names has trended favorably. and we see valuation and earnings upside in these other investments. Additionally, one of the key tenets to our strategy is an acute focus on portfolio management and construction. Maintaining a highly diversified portfolio that is conservatively marked with a prudent use of leverage has allowed us to deliver consistent dividends. Part of our strategy also has been retaining NII. We've retained 15% of NII, or 32 cents per share, during the LPM period to act as a buffer to NAB volatility. This also has resulted in a dividend coverage ratio of over 140%. Outside of APP, we continue to see overall stability in credit quality across the book. The total fair value of transactions risk rated 3 to 5, indicating some level of downgrade since we made the investment, was down slightly from last quarter. Total non-accruals decreased from 3.5% to 1.8% based on fair value, aided by the completion of the ProPT restructuring this quarter. Erin noted that most of our portfolio companies have weathered the inflationary environment well. And of note, we continue to see financial performance improvement and positive valuation migration in investments like direct travel and dermatology associates. 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. Statutory leverage was about 1.3 times, and net financial leverage ended the quarter slightly lower at 1.1 times, comfortably within our target range. This positioning allows us to effectively deploy capital, given the attractive yields and terms available for new investments in the current market. With that, I'll turn it back to Aaron.

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

Thank you. And ladies and gentlemen, as a reminder, to ask a question, simply press star 1-1 on your telephone and wait for your name to be announced. To withdraw the question, simply press star 1-1 again.

One moment while we compile the Q&A roster.

And our first question comes from the line of Melissa Weddell with JP Morgan. Please proceed.

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

Good morning. Hi, it's Tom. On the share repurchases, you know, we take a close look at where our current trading price is, and that's certainly a big factor in evaluating the level of repurchases. You know, you can see this last quarter we're trading up in the 90, 95% of NAV territory. We've stated in the past that we got that level. We'd certainly look to curtail the buybacks, and that's certainly what you saw this past quarter. We'll continue to evaluate, you know, where the stock is trading, you know, as well as looking, importantly, at our overall float. That's something we keep a close eye on and we want to be mindful of. We talk to investors. Some of us say, hey, those buybacks, yes, depending on the level of accretion, but we also want to make sure we've got good float in that stock. So historically, you know, we've purchased over $150 million. We've been very supportive over the years. I think based on the current level of trading, we're certainly going to look to modify that, mitigate that, make it a little bit smaller just based on the current trading levels. In terms of the dividend, you know, we've noted we've focused on retaining some of that NII, and that's what we've done historically. When you look at our level of We feel really good at that 44 cent level in terms of delivering really solid returns on both NAV, the current share price. As we, I'll say, stockpile some of that NII, we're going to look at, do we potentially, it wouldn't potentially be this year, perhaps next year. We may be required to pay a special dividend just based on the 90% payout requirement. So that's something we're going to take a look at. But otherwise, I think we'll continue to retain that NII payout, that $0.44 based on what we see as a feeling pretty good about assuming benchmark rates stay where they are, that earning $0.50 to $0.52 per share.

Okay, gotcha. And then just one more. Can you walk us through the Bayside restructuring?

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

Great. Thank you.

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

Thanks a bunch. Good morning. Wanted to maybe ask about portfolio activity originations and repayments here for the quarter. Just kind of curious, you know, how the pipeline looks. and you know the repayment and sales activity you know exceeding originations um just just curious how kind of intentional that was or that was that kind of more normal course um you know in terms of in terms of the repayment activity hey bryce good morning i i'd characterize it just as normal what was normal course yeah so hey it's aaron lee kong nice to meet you so i would say

Look, we view the world, there's some strategic decisions that we make at any given moment. We have a portfolio today I've mentioned in my opening remarks. If you think of sort of the three big places that we're focused, we're focused on farming the portfolio so that we can get more out of it. We're focused on the one Carlisle sourcing opportunities, and we're being exceptionally picky when it comes to just regular way sponsor finance. Now, if our goal today, and you'll see, I think, year to date, our average spread that we have originated transactions on is somewhere between 670 and 680, significant premium to last year. Our goal is focused on improving the portfolio at every moment. So when we're thinking about what's being repaid and, you know, over the next year, we have a fairly detailed model of everything that is up for maturity. We're at all times thinking about replacing what's being repaid, which on average, you know, has a five handle on it with, you know, sort of 650 to, you know, and above spreads. with fairly tight docks. So the bottom line is, you know, we're not, I know that this is a, a constant conversation on private credit land. We're focused on quality and portfolio construction. So, you know, to be fair, and the previous question also touched on this, we're fine holding a little bit more cash to make sure that we have a, you know, a very steady battle-tested, you know, kind of cap structure and balance sheet here, and we're improving our portfolio. So, yeah, as things come off, we don't have, you know, we're focused on quality, not quantity.

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

So it's a great question. So when we think about, and we could obviously talk about this offline as well in further detail, but This is sort of a kind of a 3D chess match that we're playing. So we're thinking about, you know, Tom just mentioned it. We bought over the course of the last year and a half, two years, almost, you know, a little over 23% of our float back, which is 65 cents in total accretion. We've held back on NII and been able to take leverage down a little bit so that we can actually have more dry powder, but also take less risk in this market. We've tried to focus on higher quality names while repaying some of the older vintages. So to the point, we are, quite frankly, thinking about all of it and trying to create the best portfolio we can. So the answer is all of these things are under consideration.

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

You must be sitting here in our office in our planning sessions thinking about all the things we're doing.

Tom, do you want to start and I'll burn up the room? Yeah, sure. We're in constant dialogue with our banking relationships. And heck, we had a meeting less than two months ago. It was like, hey, the public market is shut. Well, guess what? It's open very quickly. So we're certainly considering various options. We're mindful of those maturities at the end of 2024. Always looking at what's the best, optimizing the capital structure, diversified capital structure, looking at the press, looking at potential public fund offering and getting the right mix in the capital structure. It's something that we have constant dialogue and we'll continue to assess and do what's best for our shareholders.

And in terms of, as Tom said, we're kind of focused holistically and everything I've mentioned and Tom mentioned kind of all work together. And the PREF, we are in constant contact and dialogue with Carlisle proper as well as the board and thinking about how to think about that as a long-term part of our cap structure. Right now, If you look at the comparable preferred trades in the market, you know, quite frankly, our prep is at 7%, which is about, you know, 200 basis points cheap to what the comparable trades are today. So it's actually a pretty good piece of paper as it stands, but we are, along with the outsecures, you know, thinking about long-term shareholder value. So stay tuned.

Got it. Okay. Appreciate the comments, guys.

Appreciate you.

Thank you. One moment for our next question. And as a reminder, if you do have a question, simply press star 11. Our next question is from Aaron Siganovich with Citi.

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

I'm going to take your question because I like your name, yours. So, I'd say, you know, if you think about, I mentioned it two questions ago. If you think about the three, the three sleeves of where we source capital. One, you have the sponsor market. Sponsor market is quite busy. Obviously, the BSL market is still choppy. High yield market is coming back a little bit. but it is quite busy. I'd say our average deal in our portfolio is kind of low $70 million of EBITDA. I'd say the large market transactions that we've seen are priced a lot more competitively today. And so we're kind of shying away from those to be able to get better terms and better rate down in our core mid-market. But we are being quite selective in terms of sponsors. the one Carlisle sort of sourcing channel. You know, there's been some transactions that we've announced over the last week or two. Those were, you know, you know, those transactions are less sponsor driven and more one Carlisle sourced. So sourced from other teams within Carlisle that put that sourcing channel is fairly robust today. Folks trying to partner with Carlisle as a whole and us, you know, Carlisle, that's just direct lending, but our other partners showing up to be a solution provider. So I would expect that to be a much bigger contributor. And then the last piece, which I view as the highest RIC segment today, which again, after this call, we're happy to get on the phone and walk through things, is literally farming the portfolio. There's a pretty significant portion of this portfolio that we're going after. that have yields that can be improved, docs that can be improved, amendment fees that can be taken to cash that can be contributed by sponsors in order to amend or extend the transactions and do what's right for the company, be a solution provided to those sponsors, but also actually improve our current portfolio with credits we're already very familiar with. And any changes to the current portfolio, that those improvements drop straight to the bottom line so if you were inside of our offices you know i guess two or three weeks ago when we did our q2 review you would have you know kind of heard that message probably ad nauseam which is let's focus on our portfolio and trying to you know try to be solutions providers but also you know grab value um and and extract value for our current shareholders because quite frankly that's the best risk we have uh loans that we are already quite familiar with and improving those terms. So I'd say those are the three, those three general buckets. Is that helpful?

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

Aaron, this one remains an active and sensitive situation, so we can't get into too many of the deal specifics of that transaction, but I think that some of the broader items we've highlighted across the industry are inherent here. As we discussed, healthcare services, the headwinds in the industry, labor shortages, wage inflation, regulatory changes, specifically the No Surprises Act. In summary, you know, costs have gone up dramatically, and the top line has been squeezed. When you were getting last two years ago, you were getting $150 million per encounter, and now it's $130 million while you're faced with wage inflation. That results in a pretty sharp depression of your earnings. And, you know, this is really industry-wide. We've seen it with other large-cap healthcare firms, for example, Envision Health. is in similar space. What I'll note is, you know, we've actually compared to our peers. We value this one relatively conservatively. Last quarter, we were 20 points lower than other BDCs marking this one. The good and bad now is we have the zero valuation right now, full non-accrual. So the current NAV and the 52 cents, that's fully reflective of any negative of this particular position.

And, you know, look, the I think everyone's asked great questions today because they're all kind of actually related, Aaron. So for us, we have a super, that's a technical term, super diversified portfolio. So our average position is less than 1%. The goal of keeping leverage low, maintaining, kind of preserving NII just in the event that there's any bumps in the road, managing portfolio risk and trying to improve each quarter, that allows us to, quite frankly, mark a little bit more conservatively. So for us, we marked conservatively last quarter. We decided that it was most prudent to mark this position even more conservatively here. The goal of a direct lending portfolio is to have a diversified portfolio that also has predictable results. and sustainable cash flow. So for us, it isn't really about the position. It's about, you know, kind of the overall portfolio management. So we're, you know, trying to be very conservative here, but we're taking a, we quite frankly took a much larger portfolio view as to, you know, how conservatively the market. Thanks.

Appreciate it.

Appreciate you.

Thank you. And as I see no further questions in queue, I will pass it back to Aaron Lee Cohn for closing comments.

um everyone have a great morning thank you we look forward to speaking to you some of you next quarter we look forward to speaking to some of you over the next few days to uh to go deep on the story and thank you all for your support have a great rest of your summer thank you all for your participation in today's conference this does concludes the program and you may now disconnect