Carlyle Secured Lending, Inc. Q2 FY2025 Earnings Call

Thank you for your patience, and welcome to Carlyle Secured Lending's earnings conference call for the second quarter of 2025. I will now turn the call over to Nishil Mehta, Head of Investor Relations. Please proceed.

Good morning, and welcome to Carlyle Secured Lending's conference call to discuss the earnings results for the second quarter of 2025. I'm joined by Justin Plouffe, 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. Today's conference call may include forward-looking statements reflecting our views with respect to, among other things, the expected synergies associated with the merger, the ability to realize the anticipated benefits of the merger, and our future operating results and financial performance. These statements are based on current management expectations and involve inherent risks and uncertainties, including those identified in the Risk Factors sections of our 10-K and 10-Qs. These risks and uncertainties could cause actual results to differ materially from those indicated. CGBD assumes no obligation to update any forward-looking statements at any time. During this conference call, the company may discuss certain non-GAAP measures as defined by SEC Regulation G, such as adjusted net investment income or adjusted NII. The company's management believes adjusted net investment income, adjusted net investment income per share, adjusted net income, and adjusted net income per share are useful to investors as an additional tool to evaluate ongoing results and trends and to review our performance without giving effect to the amortization or accretion resulting from the new cost basis on the investments acquired and accounted for under the acquisition method of accounting in accordance with ASC 805 and the onetime purchase or nonrecurring investment income and expense events, including the effects on incentive fees, and are used by management to value the economic earnings of the company. A reconciliation of GAAP net investment income to the most directly comparable GAAP financial measure to adjusted NII per share can be found in the accompanying slide presentation for this call. In addition, a reconciliation of these measures may also be found in our earnings release filed last night with the SEC on Form 8-K. With that, I'll turn the call over to Justin, CGBD's Chief Executive Officer.

Thanks, Nishil. Good morning, everyone, and thank you all for joining. I'm Justin Plouffe, the CEO of Carlyle BDCs and Deputy CIO for Carlyle Global Credit. On today's call, I'll give an overview of our second quarter 2025 results, including the quarter's investment activity and portfolio positioning. I'll then hand the call over to our CFO, Tom Hennigan. During the second quarter, CGBD benefited from growth in the overall portfolio, but was also impacted by historically tight market spreads. We generated $0.39 per share of net investment income for the quarter on both a GAAP basis and after adjusting for asset acquisition accounting. Our Board of Directors declared a third quarter dividend of $0.40 per share. Our net asset value as of June 30 was $16.43 per share compared to $16.63 per share as of March 31. Despite muted sponsor M&A activity, Carlyle Direct Lending achieved a platform-wide deployment record with $2 billion in originations closed during the quarter. At the CGBD level, we funded $376 million of investments into new and existing borrowers, the highest level since our IPO in 2017, resulting in net investment activity of $238 million after accounting for repayments. Total investments at CGBD increased from $2.2 billion to $2.3 billion during the quarter after adjusting for $150 million of investments sold to MMCF, our joint venture. Looking ahead, CGBD origination activity is expected to be somewhat slower in the third quarter due to the seasonal summer slowdown and delayed transaction timelines resulting from the market uncertainty that began in April. However, we see our pipeline rebuilding to a busier end of the year and remain optimistic for the fourth quarter. As trade policy evolves, we continue to monitor our portfolio for tariff exposure. In line with last quarter, we believe that less than 5% of the portfolio has material direct risk from tariffs. Spreads in the private credit space remain at historically tight levels and, when combined with potential Fed rate cuts, may present a headwind to near-term earnings. Overall, we remain selective in our underwriting approach, seeking quality credits at the top of the capital structure. We remain focused on overall credit performance and portfolio diversification while maintaining target leverage and growing the credit fund. As of June 30, our portfolio was comprised of 202 investments and 148 companies across more than 25 industries. The average exposure to any single portfolio company was less than 1% of total investments, and 94% of our investments were in senior secured loans. The median EBITDA across our portfolio was $92 million. As always, discipline and consistency drove performance in the second quarter. We expect these tenets to drive performance in future quarters. With that, I'll now hand the call over to our CFO, Tom Hennigan.

Thank you, Justin. Today, I'll begin with an overview of our second quarter financial results, then I'll discuss portfolio performance before concluding with detail on our balance sheet position. Total investment income for the second quarter was $67 million, up significantly from the prior quarter as a result of a higher investment portfolio balance attributable to the merger with CSL III which closed at the end of Q1, and the purchase of Credit Fund II in mid-February. Total expenses of $39 million also increased versus prior quarter, primarily as a result of higher interest expense from a higher average outstanding debt balance, along with higher management and incentive fees driven by growth in the size of the portfolio. The result was net investment income for the second quarter of $28 million or $0.39 per share on both a GAAP basis and after adjusting for asset acquisition accounting, which excludes the amortization of the purchase price premium from the CSL III merger and the purchase price discount associated with the consolidation of Credit Fund II. This quarter's earnings, which demonstrate the first full quarter of the combined CGBD and CSL III portfolios, decreased by about $0.01 per share as we continue to work towards achieving our target leverage levels at both CGBD and the MMCF JV. As previewed last quarter, the earnings power of the combined portfolio remains in the same range as pre-combination Q1 CGBD earnings. Our Board of Directors declared the dividend for the third quarter of 2025 at a level of $0.40 per share, which is payable to stockholders of record as of the close of business on September 30. This dividend level represents an attractive yield of over 11% based on the recent share price. In addition, we currently estimate we have $0.89 per share of spillover income generated over the last 5 years, so we feel comfortable in our ability to maintain the quarterly dividend. On valuations, our total aggregate realized and unrealized net loss for the quarter was about $14 million or $0.19 per share, partially attributable to unrealized markdowns on select underperforming investments. Turning to credit performance, we continue to see overall stability in credit quality across the portfolio with some underperformance in a handful of names. On the metrics, the risk rating distribution remained relatively stable with one name added to non-accrual during the quarter, increasing non-accruals to 2.1% of total investments at fair value. At the beginning of July, we closed the successful restructuring of Maverick which, all else equal, decreases non-accruals to 1% of total investments at fair value on a pro forma basis. And while our non-accrual rates may fluctuate from period to period, we're confident in our ability to leverage the broader Carlyle network to achieve maximum recoveries for underperforming borrowers. Moving to our credit fund, as previewed last quarter, we've been focused on maximizing both asset growth and returns at the MMCF JV over the last few quarters. As you can see from our investment activity, we continue to bolster the asset base and expect the MMCF JV dividend to achieve a run rate of mid-teens return on equity. Separately, we continue to work on optimizing our nonqualifying asset capacity and anticipate using this flexibility going forward for other strategic partnerships. I'll finish by touching on our financing facilities and leverage. In July, we closed a small upsize to our primary revolving credit facility, increasing total commitments to $960 million in total. At quarter end, statutory leverage is about 1.1x, towards the midpoint of our target range, and given our current strong liquidity profile and targeted incremental sales to the MMCF JV, we're well positioned to benefit from the expected pickup in deal volume in future quarters. With that, I'll turn the call back over to Justin.

Thanks, Tom. As we approach the middle of the third quarter, our portfolio remains resilient. We continue to focus on sourcing transactions with significant equity cushions, conservative leverage profiles, and attractive spreads relative to market levels. Our pipeline of new originations is active. With a stable, high-quality portfolio CGBD stockholders are benefiting from the continued execution of our strategy. As always, we remain committed to delivering a resilient, stable cash flow stream to our investors through consistent income and solid credit performance. Finally, I'd like to conclude with some comments on our recently announced leadership addition. We are thrilled that Alex Chi will join Carlyle as Partner, Deputy Chief Investment Officer for Global Credit and Head of Direct Lending in early 2026. Alex will lead Carlyle's Direct Lending team and will work alongside Global Credit leadership to drive strategic decisions for Carlyle's Global Credit business and the Carlyle Direct Lending platform. Alex joins Carlyle from Goldman Sachs, where he spent more than 30 years serving in a variety of roles, most recently as Co-Head of Private Credit within Goldman Sachs Asset Management and Co-Chief Executive Officer and Co-President of the Goldman Sachs BDC complex. With Alex's deep experience, proven leadership, and strong industry relationships, we are confident he will help us further accelerate the growth of our Global Credit business, including CGBD. I'd like to now hand the call over to the operator to take your questions. Thank you.

Our first question comes from Erik Zwick of Lucid Capital Markets.

I wanted to start with maybe just kind of a bigger picture question first regarding the tighter spread environment that you're currently operating in, not just you, but the entire sector. And curious from your seat, what's driven the tighter spreads over the past year or so? And what would it take to return to maybe a more normal relative to historical level environment? Or do you think this is something that is likely to persist for the near to midterm?

Yes. Erik, thanks for the question. Look, I think a couple of things. One, deal activity probably wasn't as robust in the first half as we hoped it would be across the market. Now we had a record deployment quarter for the second quarter. So we're taking more market share. But I think what we'd really like to see across the market is increased deal activity. And anecdotally, we're optimistic about that for the rest of the year and into 2026 just from what we hear in people's pipelines. But I also think that part of this is the fact that in 2022 and 2023, spreads were probably wider than you would expect in a mature market. So I don't think that this is necessarily about spreads going back to that level, but more just having them normalize with a normal amount of deal activity with private equity sponsors entering the market in a more robust fashion in the second half of the year. And as I said, we're optimistic about that deal activity coming to the market in Q4 and in 2026. So I think there will be plenty of opportunities for us to invest.

I appreciate the commentary there. And just kind of following on the theme there with you had a very strong quarter of originations in Q2 but still remain very optimistic. It sounds like the pipeline remains robust. So there's a lot of broader market uncertainty or concern about the trajectory of the economy, but it sounds like based on what you're seeing, you're seeing more opportunities, finding deals that you're comfortable underwriting. So I guess from your seat, is there anything that gives you any pause or concern about the U.S. economic environment going forward?

Yes. Look, I think that certainty is what our markets like to see. And any sort of certainty that we get on things like tariff policy is a positive for our markets. But we're very happy with the companies we're investing in, right? As a BDC, of course, we'd like to see spreads be a little bit more in our favor. But the real key to our long-term performance is investing in great companies, and we've continued to be able to do that. We see great companies coming to market and we're very optimistic about our ability to continue to invest with great companies going forward.

That's good to hear. And I think you addressed it in the prepared remarks but I just wanted to make sure I heard it correctly. With respect to the unrealized losses that were recorded in the quarter, that sounded like those are more company-specific and not something broader. And if so, if you could just maybe add a little color to what developed at those particular companies that resulted in the unrealized marks.

Yes, when considering the unrealized losses, it was primarily driven by about 60% to 65% due to credit factors, with the remaining 30% to 35% attributed to market and technical influences such as loan repayments. There weren't any significant singular events, but there were several company-specific situations where underperformance led to markdowns. We are actively working, where necessary, with our workout team, other lenders, and sponsors to ensure stability in those companies and to position them for reasonable recoveries based on our current valuations.

Yes. We certainly haven't seen broader reasons to worry about credit in the market. They are very specific situations in the book.

Got it. And then last one for me. In terms of the buyback authorization that you do have, and I know you're very focused on growth and that would be the preferred use of capital today. But just how do you think about the opportunity given where the stock trades relative to NAV to potentially buy back shares?

It's something we didn't have to think about last year. Over the last few months, it's definitely something as a management team we've had more regular conversations. We are in dialogue with our Board of Directors. You mentioned the last couple of years we've been very focused on growth of our equity base, and that culminated with the merger that we closed last quarter. So we get all the benefits of scale, whether it be better liquidity in the stock, leveraging our expense base, better liability. So we're still very much focused on growth and focused on getting that and getting that share price back up to NAV. So we're positioned to grow, but certainly something we're considering in terms of potential buybacks. Right now there's nothing in the imminent plan, but we're certainly considering just based on where the stock has been trading.

Our next question comes from the line of Finian O'Shea of Wells Fargo Securities.

Tom, first question on the credit fund, mid-teens ROE. Does that indicate the $5 million dividend or a different level?

That indicates we'll be deploying more capital, and we anticipate being in the range of approximately $4.5 million to $5.5 million, and possibly a bit higher if we utilize the full equity commitments. Currently, the fund has about $700 million in total investments. With the equity committed by both partners, we can't quite double that, but that is certainly our long-term plan. We expect the dividend rate to increase slightly, although there may not be significant movement in the absolute dividend level from JV1. Our primary focus is on exploring potential other joint ventures and leveraging our non-asset capacity. While there is nothing imminent in that regard, we are in discussions with other partners about new JVs. I would suggest that this will likely involve leveraging the broader Carlyle network, maintaining our current focus, while also examining our asset capacity. The existing joint ventures collectively provide a solid base with JV1, and we aim to expand that with the second one.

Yes, that's helpful. And I guess just a follow-up, bigger picture. You talked about Alex coming on, growing the credit business including the BDC. Seeing if this suggests any sort of style drift. Like do you want to get back to where you were? I know you were just at a premium, grow a little bit, sort of remain more specialty. I know a lot of the origination this quarter looks pretty interesting. And as you just said, there are plans on the 30% bucket. Or do you want to go more into overdrive like some of the large market peers and issue maybe a lot on the ATM or secondary every quarter? Which the flip side of that is it might ask that you go with a more modernized or lower fee. So seeing if you're weighing those two items against each other and how we should think about that.

Sure, Fin. No change to our strategy. We are focused on originating in the core middle market in the U.S. That's going to continue to be the case. Alex brings tremendous experience in that area. So this is just adding strength to strength. And as Tom mentioned, we certainly are considering adding to the JV program, but no change in overall strategy between now and when Alex comes or after Alex comes. We're going to continue to provide the same type of investment exposure that we have in the past. And of course, we'd love to trade at a premium but we're in this for the long-term investment returns, and we think core middle market investing is where we can do the best for our investors.

Our next question comes from the line of Melissa Wedel of JPMorgan.

I wanted to circle back to your comments about optimism for deployment in the second half. I want to make sure I heard you right. I got the impression from what you said that you're particularly optimistic about 4Q versus 3Q. Is that fair?

Yes, that's fair, Melissa. 3Q is always a little bit muted in terms of closings on origination just because it's the summer. But what we're looking at is the pipeline of deals we have today. And we think for the rest of the year, we feel pretty good about it.

Okay. On the other hand, as you notice an increase in activity, are you also anticipating a similar increase in repayments? So perhaps considering the net deployment in the second half, it might be somewhat subdued.

I'm not expecting or I don't see reason in the market, I should say, to expect a significant change in prepayments in the second half. I think this is just more about new deal activity in the private equity space and the pipelines we're seeing. And we'll have to see if it actually materializes, but right now our pipelines are looking pretty good.

I appreciate that. My final question is about your growth plans and potential joint ventures that could enhance the earnings profile. I'm also interested in how you view the impact of potentially lower rates on your earnings power and what that might mean for the base dividend of $0.40 a share.

Yes, we achieved $0.39, just a penny short. Looking ahead to the third quarter, which we are already a month into, we expect to remain in a similar range. At the quarter's end, our statutory leverage was in the middle of our target range, though on an average daily basis it was lower, indicating some upside potential in leverage. We talked about nonaccruals; Maverick holds a significant position that has been restructured, resulting in a lower debt balance that will return to accrual. This gives us some positive momentum regarding overall nonaccruals. Our cost of debt will be adjusting due to our baby bond issuance, and we are likely to launch another index-eligible deal in the coming quarters. We plan to repay a higher-priced legacy facility from CSL III, so overall, we expect to be neutral regarding liabilities. Additionally, our joint ventures present potential upside, which we are prioritizing. The main challenge we are facing remains interest rates, and while spreads have stabilized, our overall portfolio spread has been gradually declining. Overall, we are comfortable with the spread situation, and despite the various factors at play, we see several positives, with joint ventures expected to be a significant growth driver, supporting our goal of achieving $0.40.

I appreciate your honesty. I have one final follow-up regarding Maverick. Can we assume that the mark you had on June 30 was closely aligned with the restructuring economics from July 3?

Yes. So our anticipation is you're going to have a different capital structure. So you're going to have a lower debt quantum. You're going to have an equity holding. And the total fair value dollars will be equivalent, roughly the same. That's our current valuation.

Our next question comes from the line of Robert Dodd of Raymond James.

What do you believe is a realistic timeline for fully utilizing the equity in the current credit fund, especially considering your optimism for the second half of the year and Q4, which would create a favorable environment for maximizing this fund? If you could provide any insights on the timeline for this process, it would be appreciated.

Based on the current equity base, our target, our goal was the next 2 or 3 quarters in terms of any additional JV. Having worked on the first JV and realized we had an agreement inked and then it took us 9 months to negotiate, we think it will be less than 9 months. But in terms of actual economic benefit from any second JV, it would likely be a 2026 event just because they're very complex structures, negotiating with the other partner, getting everything in the ground.

Got it, yes. Regarding another joint venture, are you planning to use a similar conceptual structure, essentially the same type of loans but with a different partner? Or are you considering something a bit different? I mean, it's generally easier to hold international assets in a joint venture rather than on the balance sheet. Will it just be a straightforward replication of the first joint venture, only with a different partner? Or are you thinking of implementing any variations in the second one?

Yes. Look, not necessarily decided yet. What I will tell you is that we're going to lean into our strengths within Carlyle Global Credit overall. So we have a lot of tools at our disposal in what we do with that JV or with that basket. And in some way, shape, or form, I think it benefits our investors greatly to use all of the experience and the origination engine we have in our $200 billion global credit platform. But right now, for the second JV, we're considering options, and we'll just go with where we think we can produce the best value for the entity.

Got it. And one more question if I may. Regarding deal flow, you seem optimistic, which has been a theme for March this year. We’ve heard there’s a significant mix in the quality of deals entering the market right now. How would you describe it? They were sufficiently high quality for you in Q2, but looking ahead, A+ deals have been completed even in '23 and '24. Is there any change in the quality of opportunities that are starting to come into the pipeline, potentially getting rejected but still entering the flow in the second half of '25 and into '26? Do you anticipate a shift in the quality mix?

No. We have not seen a material change in quality. The quality of the companies we've been able to invest in has continued to be strong, and the quality of the overall pipeline has continued to be strong. Certainly, we would prefer spreads to be a little wider than they are, and we'd prefer more deals in the market rather than less. But so far, I think quality has remained good both in our pipeline and certainly in the investments we're doing.

Thank you. I would now like to turn the conference back to Justin Plouffe for closing remarks. Sir?

Well, thank you, everyone, for joining our call. We hope it was helpful, and we will talk to you next quarter.

This concludes today's conference call. Thank you for participating. You may now disconnect.