Blackstone Secured Lending Fund

Welcome, everyone, to the Blackstone Secure Landing Third Quarter 2022 Investor Call. It is hosted by Michael Needham, Head of Investor Relations. My name is Chris, and I'm your event manager. During the presentation, your lines will be on mute. If you need assistance at any time throughout the call, please key star zero on your device. I would like to remind everyone that the call is being recorded for replay and transcription purposes. And with that, I will hand the conference over to the host, Michael. Sir, please go ahead.

Thank you, Chris. Good morning and welcome to Blackstone Secured Lending's third quarter call. Joining me today are Brad Marshall, Chief Executive Officer, and Kevin Kresge, Interim 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 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 annual report on Form 10-K. This audio cast is copyright material of Blackstone and may not be duplicated without consent. On results, we reported GAAP net income of 58 cents per share for the third quarter and net investment income of 80 cents per share. With that, I'll turn the call over to Brad.

Thank you, Michael, and good morning, everyone, and thank you for joining our call today. As Michael mentioned, we reported another excellent quarter, including strong growth in investment income and solid credit performance. Net investment income increased 29% quarter over quarter to a record $0.80 a share, which represented a 12.4% annualized net investment income yield on third quarter NAF. We expect another step up in the NII over the near term from higher rates. Stronger earnings have also driven higher dividends. In September, we raised our regular quarterly dividend by 13% to 60 cents a share, which represented a 9% annualized yield based on September 30th NAV. Including special dividends, our yield was 11% over the past year, And this is from a portfolio of virtually all first lien senior secured loans during a period where short-term rates averaged below 1%. I would also note that we repurchased $164 million of shares during the quarter below book value, which contributed to $0.02 of NAI accretion in the quarter, in addition to $0.09 of NAV accretion. Kevin will cover our share repurchases in more detail. As many of you know, we recently celebrated our one-year anniversary of BXSL as a publicly traded company, and we will soon mark our four-year anniversary since launch. When we created BXSL and B-CRED, our non-traded BDC, we told investors that we would lead the market with best practices, including lowering our fees, so we could build a more defensive portfolio that would protect capital in more challenging market conditions, yet still deliver attractive returns. Today, you'll hear how that plan is playing out with respect to our sector selection, our seniority in the capital structure, and the size of the businesses that we lend to. To put just a few numbers to it, as of 9-30 of this year, 0% of our assets are on non-recall. only 1% of our private assets are marked below 90. Our estimated average interest coverage is 2.7 times for the last 12 months. And our portfolio companies have registered healthy EBITDA growth quarter over quarter. We're seeing similarly strong metrics across our more than $80 billion of U.S. direct lending platform. We believe this quality bias will lead to resiliency in a more challenging macroeconomic backdrop. Before turning it over to Kevin to review our financial results, I want to spend a few minutes on a couple themes. Firstly, NAI growth. Higher rates and an advantageous asset liability profile are driving powerful growth in our net investment income. Secondly, credit. BXSL was designed to outperform in more difficult credit environments and we have confidence in the resiliency of our business. And third, outlook. We believe BXSL is well positioned to deliver high and growing income and dividends for our investors given our deep platform, positive NII tailwinds, and defensive portfolio positioning. So first, the third quarter represents the beginning of a material expansion of our earnings. BXSL out-earned its dividend by 33%, driven by a favorable asset liability profile with virtually 100% floating rate investments and 58% fixed rate debt, an average coupon of less than 3%. We expect additional NAI growth over the near term as the portfolio more fully incorporates recent rate increases. Our average base rate was 1.1% in the second quarter, 2.5% in the third quarter and would have been 3.5% at quarter end if all the loans reset on September 30th. With 76% of our assets based on LIBOR, the blended base rate would have been 4.3% if all loans were to reset yesterday. If the September 30th base rate of 3.5% had been in effect for the entire quarter, we estimate that third quarter NAI would have been 13% higher or an additional $0.10 per share. Our credit performance was solid in the quarter, and we believe we will continue outperforming from a credit standpoint. Over the past four years, we invested BXSL's capital with an eye towards downside protection by focusing on the top of the capital structure in more resilient sectors, partnering with large companies and leading sponsors. I want to share a few metrics that give you a better picture of why we feel so optimistic about the resiliency of our portfolio. Seniority, 98% of BXSL's investments are in first lien, senior secured loans, and over 95% of those loans are to companies owned by private equity firms or other financial sponsors who have access to additional equity capital to support their companies. Our portfolio is highly equitized. with an average loan-to-value of 47%, below the market average of 55% for leveraged buyouts over the past 12 months. Sectors. Blackstone Credit has increased its headcount by more than 30% over the last year, with a focus on expanding resources in key sectors with low default rates such as technology, healthcare, and our sustainable resource group. We estimate that over 85% of BXSL's portfolio is invested in sectors that have seen annual default rates of less than 2% since 2007. Based on data from Fitch, this is well below the S&P leverage loan index at 55% for similar low default sectors. Scale. We also believe that larger companies have more resources to weather difficult macroeconomic environments. Our average portfolio company EBITDA grew to $162 million, and we've orientated the portfolio to larger, more durable businesses. Our company's EBITDA grew an estimated 5% quarter-over-quarter on same-store sales basis versus 2% for the S&P Leverage Loan Index. our weighted average EBITDA margin is 30% versus 18% for S&P companies leveraged two times or higher. Further, we estimate that our portfolio average interest coverage was about 2.7 times on an LTN basis and 2.2 times based on annualized third quarter market rates. In either case, approximately 2% of the portfolio had interest coverage less than one times. Of those loans, the vast majority are represented by two companies for which we believe earnings profile are improving. And the remaining loans were intentionally set up with lower than average LTV and larger than average liquidity reserve. Lastly, we've not seen a significant pickup in amendment requests. But should our companies face more challenging times like we saw immediately post-COVID, we have a large operational team that can help them reduce expenses, improve operational efficiencies, or source new revenue channels. There are over 20 professionals in or affiliated with Blackstone Credit focused on managing and improving our investments, plus over 100 operational professionals across Blackstone's broader platform to whom we have access. We believe that having access to an operational team to take an active role with our portfolio companies is beneficial to the BXSL and B-Cred franchise and will continue to distinguish our platform and performance over time. So despite macroeconomic headwinds on the horizon, we believe the outlook for BXSL shareholders is bright. Blackstone is highly focused on shareholder experience. We set our fees materially lower than the average public BDC. We've elected not to scrape fees for the manager. We have a performance look back mechanism, and we just finished a $263 million buyback, including repurchases after quarter end. Earnings. If you take a pro forma earnings for 930 rates over yesterday's closing share price, that is a over 15% NII yield. Not 12, not 13, but 15% in a portfolio of performing first lien assets, at 47% loan-to-value. And while our assets and liabilities have positioned us for this out-earning, a meaningful portion of that yield is the result of having lower fees than our competitors. Credit, 0% on non-accrual, and only 1% of BXSL's portfolio marked below 90. Our focus on sector and size and recency of vintage bodes very well for the future. Even in an environment with headwinds, we're built to be defensive. Lastly, on platform, as I mentioned, across BXC, our headcount is up more than 30% over the past year as we continue to lean into the build-out of our sector verticals, our geographic expansion, portfolio management teams, and in particular, our operating resources. As we think about what will truly differentiate outcomes over the next few years, BXSL's access to operating resources and executives that can be positioned alongside companies across multiple functions will be defining. So as we think about where and how we are positioned with both our BDCs, with lower fees and expenses, elevated earnings outlook, some of the best credit metrics, and a platform resource to support our companies, we feel like Blackstone will be a net winner as we move ahead in the quarters to come. So with that, I'll turn it over to Kevin.

Thank you, Brad, and good morning, everyone. Again, for challenging macro backdrop, we delivered excellent third quarter results. highlighted by strong earnings growth, which was driven by rising interest rates and supported by the defensive positioning of our portfolio and solid capital structure. I will walk you through the key drivers of our earnings growth, our capital structure, an update on our share repurchase program, and finally, the outlook on our future earnings potential. First, our operating results. In the third quarter, net investment income was $132 million, or $0.80 per share, which was up 29% from $0.62 last quarter. Our revenues were up $40 million, or 21% quarter over quarter, despite no material prepayments and zero dividend income, meaning our revenues were virtually all recurring interest income. Payment in kind, or PIC income, was flat quarter over quarter, with no new PIC payers and represented under 5% of total investment income. This reflects the continued ability of our portfolio companies to pay cash interest despite rising rates. Meanwhile, net expenses were up just $13 million compared to last quarter. Nearly 60% of our interest expenses fixed at a weighted average rate of 2.97%, which drove significant operating leverage in this rising rate environment. Gap net income in the quarter was $96 million, or 58 cents per share. up 23% quarter-over-quarter despite $36 million of net realized-unrealized losses, largely resulting from unrealized mark-to-market declines as credit spreads continued to widen. This was partially offset by solid portfolio company performance. And in a challenging market environment for M&A, we were able to generate $34 million of realized gains in the quarter, primarily from the realization of a single equity position in a software company at over three times our initial investment. As previously announced, our dividends for the quarter included a 60-cent regular dividend up 13% from 53 cents last quarter, plus an additional 20-cent special dividend. This resulted in NAV per share at quarter end of $25.76, down marginally versus last quarter. However, it would have been up 7 cents before the 20-cent special. Next, moving to our capital structure and liquidity, which we view as a key differentiator for BXSL. We ended the third quarter with $9.7 billion of total portfolio investments, which are approximately 100% floating rate at a weighted average yield of 9.1%, compared to $5.5 billion of outstanding debt with a weighted average cost of just 3.7%. This includes 58% of drawn debt and unsecured fixed rate bonds at less than 3%, which we view as a key advantage in this rising rate environment. The spread between our floating rate assets and low-cost, mostly fixed rate liabilities provides the company with potential for additional material earnings growth as rates continue to rise. Our ending debt-to-equity ratio is 1.33 times, which is down slightly from last quarter, and close to our near-term goal to operate around the high end of our target range of 1 to 1.25 times. Excluding share buybacks and assuming that capital was instead used to pay down debt, our leverage would have been 1.22 times. We ended the quarter with $1.1 billion of liquidity in cash and undrawn debt, up from $890 million last quarter, as we paid down debt with proceeds from loan repayments. This provides us with significant flexibility and cushion. Additionally, we have low level of debt maturities over the next few years, with just 6% of commitments maturing prior to September 2024, and an overall weighted average maturity of nearly four years. Importantly, we ended the quarter with no assets on non-accrual and maintained our three investment-grade corporate credit ratings. Now moving to an update on our share repurchase program, which has been accretive to shareholders. As you may recall, a $263 million share repurchase program was put into place at the time of our IPO. This is formulaic and triggered if BXSL shares trade below NAV. During the quarter, we bought back nearly 7 million shares for approximately $164 million at a weighted average price of $23.82, representing an 8% discount to NAV. As a result, we saw approximately 11 cents of NAV accretion in the quarter, including 9 cents from buying back shares at a discount, plus 2 cents from higher NII per share as a result of fewer shares outstanding. Subsequent to quarter end, we repurchased an additional $47 million at a weighted average price of $23.65. And as a result, have now reached the full capacity of the program. Overall, we bought back 11 million shares, which, in addition to growing earnings and raising our dividends, reflects our commitment to driving incremental value for shareholders. Lastly, turning to the outlook. We believe we are very well positioned to grow earnings meaningfully in the coming quarters, as rates on our nearly 100% floating rate investments continue to reset higher. As Brad mentioned, we estimate our third quarter NII per share would have been $0.10 higher, or $0.90 total, if the average base rate would have been at the September 30th level for the entire quarter, all else being equal. And there is additional upside potential from here, given the recently announced 75 basis points Fed rate hike and expectations for more increases in the future. While we are very pleased by our third quarter results, as we enter the fourth quarter, we remain very positive about the outlook given our defensive portfolio designed to protect capital in times of stress and earnings upside potential from rising rates. And with that, I'll ask the operator to open up for questions.

Thank you. So, everyone, if you wish to ask a question, please key star 1 on your device. Also, please remember to only ask one question and one follow-up. If you have more questions than that, please get in the queue by pressing star one once again.

And your first question coming from Casey Alexander from Compass Point.

Please go ahead.

Yeah, good morning. And first of all, let me say that we have a lot of BDCs that talk lip surface to lip service to share repurchase programs. I think it's entirely impressive that you completed the entire share repurchase program, which was true to your promise as a pre-IPO company. And regarding the impressive statistics that you gave about your portfolio metrics and the small number of amendment requests, I still think it's reasonable to ask that certain companies that might be at the margins, how forward looking and how aggressive can you be about reaching out to those companies and preparing a plan relative to the interest rates that you see, because it's just math, to help make sure that your last dollar of interest doesn't tip that company and help them get through the cycle?

Well, thanks for those comments, Casey. As we've said from the start, wanting to lead the market with best practices has always been core to Blackstone's program. As it relates to reaching out to companies and working through what will be a challenging or more challenging market, period from a cash flow standpoint because interest rates are up 50, 60, 70%. We've had conversations with some sponsors, but largely it's not on top of their mind right now. And a little bit is because of what we said earlier, our interest coverage across the portfolio is actually pretty high. So they're not looking at the rate environment as being a material headwind for them going into next year. What I would say just generally, though, Casey, and we've talked to some investors about this, and this is just a viewpoint from experience, interest rates do not impair businesses. It's certainly a headwind. It's certainly kind of part of the calculus that they need to take into consideration for them to manage their expenses. But interest rates alone... are not terribly problematic. What gets a company, especially with sponsor-backed businesses, so sponsors will support their businesses through transitory periods, interest rates are arguably transitory, it's really all the other factors that go into creating problems, which is secular headwinds with respect to an investment, issues particular to a company, whether it's regulatory or other. But interest rates alone aren't a singular problem that drives defaults. So we are talking to companies. Some of them are reaching out to us. We're reaching out to some. But that is not atop of the list right now.

Thank you for that. My one follow-on question is, you know, obviously there's a lot of exposure to the software space. I think it would give investors some comfort if you could give some color as to the performance of your companies in the software space.

Yeah, sure. So the software companies are probably our best performing sector right now. And I think that's largely because we're in profitable businesses, that very good revenue visibility, very sticky top line growth. And we're seeing so far quarter over quarter EBITDA growth of around 4% or 5% in our software sector. Average EBITDA of those businesses is $184 million. So think about that. These are $3-plus billion enterprise value businesses. So we've skewed to the large end of the software market. And their margins on average are about 26%. So what that means, Casey, is they're generating a lot of free cash flow. to service interest and to manage through, you know, what could be a market with more headwinds. And the last thing I would say, as you know, we are at the very tip top of the capital structure in first lane securities in our software sector. We are 43% loan-to-value, and that's based on our view on value today, not at the time of making the investment, but today. So good place in the capital structure, a lot of equity subordination, large companies that we're seeing growth from.

All right, great. Thank you for taking my questions. Thanks, Casey.

We have the next question coming from the line of Finian O'Shea from Wells Fargo. Please go ahead.

Hey, everyone. Good morning. Thank you. Sort of a follow-up here, and I appreciate the color you gave in the portfolio, Brad, tying together some of that still good EBITDA growth, but the higher base rates still making their way through. What's your sort of feel on where interest coverage glides into next year or where things will ultimately settle there based on the forward curve right now.

Thanks, Ben. So based on the forward curve where it peaks right now, we think interest coverage will be at 1.8 times, and we expect that 10% of our companies will have interest coverage below 1 times. Again, that doesn't, 10% doesn't necessarily alarm me given the ability to, you know, work through a solution with a small subset of our companies. And that's assumed between now and then they don't actually grow, which we think they will.

Okay. Thank you. That's helpful. And a follow up on the, the, valuation inputs table, it looks like a bit of an uptick in level two assets that you're classifying within the first lien book. Is this indicative of leaning into the liquid markets or I guess what else might be happening there?

We are not in BXSL leaning into the liquid markets, Finn. I don't know what's necessarily driving the uptick in what you're seeing. But remember, we only invested $200 and some odd million in the quarter, so it was a fairly light investment period for us, and those were all in private assets.

Okay, thanks so much. We have the next question coming from Ryan Lynch from KBW.

Please go ahead.

Hey, good morning. Yeah, I just want to echo. I really appreciate a lot of the granular details you guys provided on kind of the portfolio statistics, EBITDA margins, you know, 85% of your portfolio in defensive sectors, that sort of stuff was very helpful as we kind of think through your portfolio and think through credit quality going forward. The one question I had was, Obviously, earnings significantly above the dividend this quarter. If you look at the run rate, like you said, $0.90 at the end of the quarter versus the dividend of $0.60, the core dividend. I'm just curious, as we look forward, earnings are going to be significantly above the current dividend. What are you guys thinking regarding a dividend policy? Are you guys thinking that it makes more sense to get that core dividend close to the earnings run rate or are you guys looking to supplement that with variable or supplemental dividends or special dividends? How are you thinking about this good problem to have regarding dividends? in regards to kind of accelerating?

Well, I think you characterized it the right way, Ryan, and I think you broke up a little bit, but I think we got the question. But you characterized it the right way, which is we are in a very fortunate position that our earnings are accelerating into this rate environment for all the reasons that we mentioned. And yes, we're considering all those options Right now, as you know, we have to pay out 90% of our income, and so we're trying to sort through with the board the best way to do that. In the meantime, based on our share price, we're paying out about a 10% regular dividend that we're out earning, and the rest is helping build NAV. But we'll come up with a longer term plan with respect to that excess income on how to return that to investors.

Okay. And then you mentioned kind of building up your operating resources or executives. Can you just talk about – because I think you are one of maybe a few platforms that have kind of access to significant resource in the area. You guys may have the most, in fact. But can you just talk about what sort of advantage that gives you if a company starts to show some stress? I don't know if you can give any past examples of what you have done to sort of – help out and work out those situations that potentially gives you an advantage if we go into a more choppier credit environment?

Yeah, it is an enormous advantage, Ryan, and it starts very early. It starts well before a company is stressed. We have five people on our team. I think we've mentioned this in the past. All they do is every day is call our companies that are performing and say, how can we help? How can we lower your cost? Can we cross-sell your products across Blackstone? Let us be a good partner. That is unique in the credit space, and we have put a lot of resources and energy into that effort. Why that's important is because we establish a relationship at an operating level very early with our portfolio companies. So we get to know management. We get to have those conversations. We're not a passive lender trying to give capital to a company and expecting to get that back in five or six years. So it's very important on the front end to invest into those relationships. so that down the road when there is a bump in the economy or something specific to a company, we can actually go in with a relationship and play a more active role. We're able to play the most active role as an owner, but even before that, we can send in a SWAT team of operating executives, or a procurement team or a cross-selling team or a cybersecurity team to help them navigate through a tricky period. To give you some examples, or maybe just one for the interest of time, you know, during COVID, we had a company that lost 80% of their revenue during a short period of time. And we literally sent in a SWAT team of our procurement team as well as some operating executives to figure out how to help them through that period. And what we did is that we helped them kind of lower their expenses through our procurement group. We helped cross-sell their products across the entire Blackstone network. And I think if you put all our buying power together, all our companies together, we're something like the third largest company in America. And we help that company grow its revenue from where it was and lower its costs and navigate through a very, very challenging period. So I could spend an hour talking about this, Ryan, but for the benefit of time, I won't. But it is a real competitive advantage for us. What we do after we make an investment, and this is very unique and why I highlighted it during our prepared remarks, is because in an environment like we're headed into, this will become a defining differentiator for our platform.

That's a really helpful color and detail on that, and I do agree with you completely. That is a big competitive advantage. That's all from me. I appreciate the time today.

Thanks, Ryan.

Everyone, just a quick reminder, please key star 1 on your telephone in order to ask a question. Okay, our next question coming from Kenneth Lee from RBC Capital Markets. Please go ahead.

Hi, good morning, and thanks for taking my question. Pretty good amount of debt paydowns in the quarter. I think in the past you had alluded to potential pickup there, but just wondering, looking forward, given the potentially slowing down M&A activity, what's your best sense of the outlook for debt paydowns over the next few quarters? Thanks.

Yeah, so thanks, Ken. I appreciate the question. So we are tracking about six different situations where companies are looking to potentially repay our debt. That will get to about $800 million. of repayments if all of them happen. So over what time period that happens, it depends on their own processes. But that's what we're looking at, and we'll use those pay downs to both reduce leverage as well as make new investments into this environment.

Gotcha. Very helpful there. And then looking on the other side, What's your sense of the deal flow you're seeing? Obviously, some slowdown in M&A activity, but then again, certainly seeing some pullback from banks and other competitors, but just want to get a better sense of the top of the funnel, what you're seeing in terms of deal flow. Thanks.

Yeah, so deal flow, the M&A environment has definitely slowed significantly. in part because we're in a period of more volatility, in part because the financing markets are a little bit broken right now in the public markets. So you've seen less activity. I will say, though, 100% of the deal flow for new deals is going into the private market. So the fact that the public markets are broken has steered more deals into the private market. the private markets, and that helps offset a slower M&A environment. But I would say just from an investment New Deal standpoint, this is probably the best environment that we've seen in the 17 years that we've been doing this at Blackstone Credit. You've got very good kind of base rates driving returns. You have spreads that are a little bit wider. You have documents that are better. You have set up leverage that's more attractive. So you have a very favorable investment environment given the market dynamics and given the rate environment. So we expect that as we head into next year, a lot of sell-side processes that have been put on hold will actually start coming back into the market, and we'll see it pick up in activity.

Great. Very helpful there. Thanks again.

Thanks, Ken. Our final question comes from the line of Melissa Waddle from J.P. Morgan. Please go ahead.

Good morning. Most of my questions have been asked already. But given that you have completed the share repurchase authorization, I wanted to just get your comments on how you're thinking about having something in place as a tool to use opportunistically at the very least or on a regular basis going forward. Any contemplation about re-upping that?

Yeah, we're definitely going to have a program in place. Let's appreciate the question. As you know, we're trying to balance leverage and buyback opportunity. And all that kind of goes into the calculus. But yes, we will definitely have another program in place after we meet with the board and come up with the exact specifics.

Okay. Certainly understand there's a lot of details to hash out there. But maybe we can just talk conceptually about share repurchases going forward. I think as Casey mentioned, you guys made a commitment to that full authorization sort of upfront at the beginning of the process. You've completed it. Would you view repurchases going forward with the same degree of sort of commitment to completion or just as something to have as one tool in the toolkit?

I think it's another tool in our toolkit. Leverage right now for us is a little bit higher than where we'd like it, Melissa, at 1.33 times. Had we not done the buyback, it would have been 1.22 times, I believe. So we want to manage risk along with buybacks and how we use our capital. But we definitely believe in the stock. I think you know that I've been buying and many other employees at Blackstone have been buying, and it is something that we'll want to support going into the future, but we do have to balance our balance sheet and make sure that we have the right amount of capital to do both new deals and to manage our leverage.

Understood. Thanks very much.

Thanks, Melissa.

We now turn the call over to Michael Needham for closing remarks.

Thank you, everyone, for joining our call. The investor relations team is available for any additional follow-up questions.

Thank you, everyone. That concludes the conference call for today. Thank you for joining. You may now disconnect. Enjoy the rest of your day.