Blackstone Secured Lending Fund (NYSE:BXSL) Q3 2022 Earnings Conference Call November 10, 2022 9:30 AM ET
Corporate Participants
Michael Needham – Head of Investor Relations
Brad Marshall – Chief Executive Officer
Kevin Kresge – Interim Chief Financial Officer
Conference Call Participants
Casey Alexander – Compass Point
Finian O’Shea – Wells Fargo
Ryan Lynch – KBW
Kenneth Lee – RBC Capital Markets
Melissa Wedel – JPMorgan
Operator
Welcome, everyone to the Blackstone Secured Lending 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. [Operator Instructions]. I’d 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.
Michael Needham
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 for the 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 copyrighted material of Blackstone and may not be duplicated without consent.
On results, we reported GAAP net income of $0.58 per share for the third quarter and net investment income of $0.80 per share. With that I’ll turn the call over to Brad.
Brad Marshall
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 and 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 NAV.
We expect another step up in 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 $0.60 a share, which represented a 9% annualized yield based on September 30, 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 NII 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 BCRED 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-accrual, only 1% of our private assets are marked below 90. Our estimated average interest coverage is 2.7x 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 of themes. Firstly, NII growth, higher rates in 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 at an average coupon of less than 3%. We expect additional NII 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 30.
With 76% of our assets based on LIBOR, the blended base rate would have been 4.3%, if all loans were to reset yesterday. September 30, base rate of 3.5% had been in effect for the entire quarter, we estimate that third quarter NII 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 BXSLs capital with an eye towards downside protection by focusing on the top of the capital structure, the 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 BXSLs 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 BXSLs portfolio is invest 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 leveraged 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 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 leveraged loan index.
Our weighted average EBITDA margin is 30% versus 18% for S&P companies leverage 2x or higher. Further, we estimate that our portfolio average interest coverage was about 2.7x on LTM basis, and 2.2x based on annualized third quarter market rates. In either case, approximately 2% of the portfolio had interest coverage less than one time. 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 and 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 BCRED 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 out pro forma earnings for 9/30 rates over yesterday’s closing share price. That is over 15% NII yield not 12 or 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 BXSLs 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.
[Indiscernible] 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, BXSLs access to operating resources, and executives that can be positioned alongside companies across multiple functions we’ll 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.
Kevin Kresge
Thank you, Brad, and good morning, everyone.
Against the 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’ll 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 $49 or 21%, quarter-over-quarter, despite no material prepayments and zero dividend income, meaning our revenues were virtually all recurring interesting.
Payment-in-kind or PIK income was flat quarter-over-quarter, with no new PIK players 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.
GAAP net income in the quarter was $96 million, or $0.58 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 continue 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 3x our initial investment.
As previously announced, our dividends for the quarter included a $0.60 regular dividend up 13% from $0.53 last quarter, plus an additional $0.20 special dividend. This resulted in NAV per share at quarter end of $25.76 down marginally versus last quarter. However, it would have been about $0.07 before the $0.20 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 in 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 was 1.33x 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 1x to 1.25x. Excluding share buybacks and assuming net capital was instead used to pay down debt, our leverage would have been 1.22x.
We ended the quarter with $1.1 billion of liquidity in cash and undrawn debt, up from $890 million last quarter, as we pay 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 $253 million share repurchase program was put into place at the time of our IPO, this is formulated and triggered if BXSL shares [indiscernible].
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 $0.11 of NAV accretion in the quarter, including $0.09 from buying back shares at a discount, plus $0.02 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 reach that 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 30 level for the entire quarter, all else being equal. And there’s additional upside potential from here, given the recently announced 75 basis point Fed rate hike and expectations for more increases in the future.
While we were very pleased of 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 will ask the operator to open up for questions.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions]. And your first question coming from Casey Alexander from Compass Point. Please go ahead.
Casey Alexander
Yes, good morning. And first of all, let me say that that we have loved BDCs the talk [lip service] [ph] 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?
Brad Marshall
Well, thanks for those comments. Casey, as we’ve said, from the start, you wanting to lead the market with best practices has always been core to Blackstone program. As it relates to reaching out to companies and working through what will be a challenging or more challenging 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 in 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, particularly to accompany whether it’s regulatory or other. But interest rates alone on 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 a top of the list right now.
Casey Alexander
All right. Thank you for that. My one follow on question is, 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.
Brad Marshall
Yes, sure. So 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 business is $184 million. So think about that these are three plus billion-dollar 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 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, firstly in 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.
Casey Alexander
All right. Great. Thank you for taking my questions.
Operator
The next question is coming from the line of Finian O’Shea from Wells Fargo. Please go ahead.
Finian O’Shea
Hi, everyone. Good morning. Thank you, sort of a follow up here and appreciate the color you gave in the portfolio Brad tying together some of that still good EBITDA growth at 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 their based on the forward curve right now?
Brad Marshall
Thanks, Fin. So based on the forward curve, where it peaks right now, we think interest cover will be at 1.8x. And we expect that 10% of our companies will have interest coverage below one time. Again, that doesn’t — 10% doesn’t necessarily alarm me, given the ability to work through a solution with small subset of our companies. And that’s assume between now and then they don’t actually grow, which we think they will.
Finian O’Shea
Okay. Thank you. That’s helpful. And a follow up on 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?
Brad Marshall
We’re not in BXSL leaning into the liquid markets, Fin, I don’t know what’s necessarily driving the uptick in what you’re seeing. But I remember, we only invested 200 and some odd million dollars in the quarter. So it was a fairly light investment period for us, and those were all in private assets.
Finian O’Shea
Okay. Thanks so much.
Operator
The next question is coming from Ryan Lynch from KBW. Please go ahead.
Ryan Lynch
Hey, good morning. Yes. 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, 85% of your portfolio and in defense 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, we looked at the runway, like you said, $0.90, kind of at the end of the quarter versus the dividend of $0.60, the core dividend. So I’m just curious, as we look forward, dividend earnings are going to be significantly above the current dividend. What are you guys thinking regarding sort of like a dividend policy? Are you guys thinking that it makes more sense to get that core dividend close to the earnings run rate? Are you guys looking to supplement that with variable or supplemental dividends or specialty? And just how are you thinking about, kind of this good problem to have regarding dividends in regards to kind of acceleration?
Brad Marshall
I think you characterize it the right way, Ryan. I think you broke up a little bit, but I think we got the question. But you characterize it the right way. The right way, which is we are in a very fortunate position, that our earnings are accelerating into this rate environment 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 math. But we’ll come up with a longer-term plan with respect of that excess income on how to return that to investors.
Ryan Lynch
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 resources in the year, 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 that potentially gives you an advantage as if we go into a more choppier credit environment.
Brad Marshall
Yes. It is an enormous advantage Ryan and it starts very early starts well before a company is stressed. We have five people on our team. If we’ve mentioned this in the past, all they do every day is call our companies that are performing and say, how can we help? How can we lower your costs? 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, 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 are something like the third largest company in America. And we hope that company grow its revenue from where it was and lower its cost 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.
Ryan Lynch
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.
Operator
[Operator Instructions]. Our next question coming from Kenneth Lee RBC Capital Markets. Please go ahead.
Kenneth Lee
Hi, good morning, and thanks for taking my question. Pretty good amount of debt pay downs in the quarter? I think it depends, you had alluded to potential pick up there. But just wondering, looking forward given the potentially slowing M&A activity. What sort of like your best sense of the outlook for debt pay downs over the next few quarters? Thanks.
Brad Marshall
Yes, 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.
Kenneth Lee
Got you. 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 terms of deal flow. Thanks.
Brad Marshall
Yes. So, deal flow, the M&A environment has definitely slowed 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 markets. So the fact that the public markets are broken is steered more deals into the private markets and that helps to 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 are a little bit wider, you have documents that are better, you have set up leverage, it’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 a pickup in activity.
Kenneth Lee
Great. Very helpful there. Thanks again.
Operator
Our final question comes from the line of Melissa Wedel from JPMorgan. Please go ahead.
Melissa Wedel
Good morning. Most of my questions have been asked already. But given that you have completed the share repurchase authorization, I wanted to see, 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?
Brad Marshall
Yes. 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.
Melissa Wedel
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, 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 commitment to completion or just as something to have as one tool in the toolkit?
Brad Marshall
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 1.33x, had we not done the buyback, it would have been 1.22x 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 that I’ve been buying and many other employees at Blackstone have been buying. And it is something that will 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.
Melissa Wedel
Understood. Thanks very much.
Operator
We’ll now turn the call over to Michael Needham for closing remarks.
Michael Needham
Thank you everyone for joining our call. The Investor Relations team is available for any additional follow up questions.
Operator
Thank you everyone. That concludes your conference call for today. Thank you for joining. You may now disconnect. Enjoy the rest of your day.
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