Carlyle Secured Lending, Inc. (CGBD) Earnings Call Transcript

Hello, and welcome to Carlyle Secured Lending Third Quarter 2026 Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to Nishil Mehta. You may begin.

Good morning, and welcome to Carlyle Secured Lending's Third Quarter 2026 Earnings Call. I'm joined by Alex Chi, CGBD's Chief Executive Officer, and Tom Hennigan, our President and Chief Financial Officer. Last night, we filed our Form 10-Q and issued a press release with the 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. Today's earnings call may include forward-looking statements reflecting our views with respect to, among other things, our future operating results and financial performance. Any forward-looking statements made today do not guarantee future performance, and undue reliance should not be placed on them. These statements are based on current management expectations, estimates and projections that involve inherent risks and uncertainties, including those identified in the risk factors and cautionary statement regarding forward-looking statements sections of our 10-K and 10-Qs. These risks and uncertainties could cause actual results to differ materially from those indicated in our forward-looking statements. CGBD assumes no obligation to update any forward-looking statements at any time. During this call, the company may discuss certain non-GAAP financial 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 common share, adjusted net income and adjusted net income per common share are useful to investors as additional tools 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 of 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 evaluate the economic earnings of the company. A reconciliation of GAAP net investment income per share, the most directly comparable GAAP financial measure, to adjusted NII per common share can be found in the accompanying slide presentation for this call that is available on our website. In addition, a reconciliation of these measures may also be found in our earnings press release filed last night with the SEC on Form 8-K. With that, I'll turn the call over to Alex.

Thanks, Nishil, and good morning. On today's call, I'll give an overview of our third quarter results, including the quarter's investment activity and portfolio positioning, and provide an update on our investment outlook. I'll then hand the call over to our President and CFO, Tom Hennigan. During the third quarter, macroeconomic and geopolitical uncertainty weighed on direct lending volume, which declined year-over-year as private equity activity remains slower than anticipated. However, we continue to be very pleased with the strength of Carlyle Direct Lending's origination platform and the consistent credit performance of CGBD. In total, excluding joint venture activity, we funded $81 million of investments at CGBD as our origination engine remained active during the quarter despite lower market-wide volume. On our new originations, weighted average spreads on those deals were approximately 505 basis points, approximately 35 basis points wider than the fourth quarter of 2025. Our weighted average leverage on entry continued to decrease by over 2/3 of a turn quarter-over-quarter to 4.9x, with a substantial majority of the deals in the quarter having financial maintenance covenants. Our rejuvenated origination team leveraged the OneCarlyle platform to drive differentiated deal flow, increased selectivity and credit discipline. Proprietary OneCarlyle deal flow sourced from outside of direct lending generated half of new platform originations with spreads that averaged approximately 35 basis points wider compared to core U.S. originations. Over 80% of this quarter's originations were to new borrowers, and Carlyle played a lead role in all of those investments. As an example, Carlyle Direct Lending leveraged Carlyle's private equity business line's deep expertise in aerospace and defense to secure a lead role in a solution for Avantus, a leading manufacturer of mission-critical aerospace materials and components. Repayments increased in the quarter with $129 million of activity, and combined with investment activity related to our joint ventures, net investment activity resulted in total investments at CGBD remaining relatively flat, ending the quarter at $2.3 billion. Moving to our investment funds. Both of our JVs, MMCF and SCP, continue to scale and generate attractive returns to CGBD. The annualized dividend yield at MMCF increased by 80 basis points to 18.4% in the quarter and over 300 basis points since the first quarter of 2026. At SCP, the portfolio grew to $2.1 billion and produced an annualized dividend yield of 20.3% to CGBD. During the quarter, we generated $0.36 per share of net investment income on both a GAAP and adjusted basis. In line with the revised dividend policy, our Board of Directors declared a fourth quarter 2026 dividend of $0.35 per share, which is fully covered by net investment income. Our net asset value as of September 30 increased to $15.65 per share, up from $15.61 per share as of June 30. With 0.25 point Federal Reserve hike in September, consensus estimates suggesting an additional 2 to 3 hikes through 2027, we expect rising rates to be an earnings tailwind as nearly 100% of our portfolio is floating rate. Our portfolio companies continue to perform well. And based on the latest forward curve, we do not expect an increase in rates to have a material impact on our borrowers' ability to service debt. The markets continue to experience volatility related to the anticipated quantum of future debt issuance needed to finance the AI compute build-out. From an underwriting perspective, Carlyle continues to take a measured approach to data center and GPU financing transactions despite their prominence in the credit market. While we continue to review potential opportunities, we have minimal exposure to compute infrastructure and remain selective in our approach to investments in this sector as structures and documentation continue to loosen and market pricing continues to tighten. Turning to portfolio construction. We remain focused on portfolio diversification while managing the target leverage. As of September 30, our portfolio grew to 180 companies across more than 25 industries. The average exposure to any single portfolio company was less than 60 basis points of total investments, and 96% of our investments were in senior secured loans. The median EBITDA across our portfolio was $97 million. As always, discipline and consistency drove performance in the third quarter, and we expect these tenets to drive performance in future quarters. Looking ahead, despite the complicated market backdrop, we continue to expect strong activity in our market over the medium and long term once there is greater macroeconomic and geopolitical certainty, and we are well positioned with our revitalized origination platform to take advantage of increasing market activity and to continue taking share. Looking at our pipeline, a significant majority of deals continue to be in old economy sectors, including industrials, aerospace and defense, health care and consumer products. As managers' performance dispersion increases, we expect the breadth of the Carlyle platform and the consistency of our performance to differentiate us through our ability to leverage Carlyle's scale, scope of investment capabilities and dedicated in-house investing, portfolio management and restructuring resources. With that, I'll now hand the call over to our President and CFO, Tom Hennigan.

Thank you, Alex. Today, I'll begin with an overview of our third quarter financial results. Then I'll discuss portfolio performance before concluding with detail on our balance sheet positioning. Total investment income for the third quarter was $63 million, up from $62 million last quarter, primarily driven by an increase in dividend income from both the MMCF and SCP JVs. This was partially offset by a lower average investment balance for the loan book. Total expenses of $38 million were in line with prior quarter. The result was net investment income for the third quarter of $25 million or $0.36 per share on both a GAAP basis and after adjusting for the impact of asset acquisition accounting, which means we again fully earned our new base dividend. Our Board of Directors declared the dividend for the fourth quarter of 2026 at that $0.35 per share base dividend level, which is payable to stockholders of record as of the close of business on December 31. As a reminder, we maintain our existing supplemental dividend policy, which targets paying out 50% of excess earnings above the base dividend, allowing us to deliver additional value to shareholders as earnings grow. We still anticipate achieving full dividend coverage in future quarters, along with an increase in earnings and supplemental dividends as we continue to ramp the JVs and benefit from increasing rates based on the latest forward curve. During the quarter, we repurchased $6.1 million of shares at an average discount of 32%, resulting in $0.04 of accretion to NAV per share. Total repurchases since the inception of the program exceed $200 million, and the Board approved the reauthorization of the existing $300 million plan through November of 2027. On valuations, our total realized and unrealized net loss for the quarter was about $1 million or $0.02 per share as valuations remain relatively flat in the aggregate. Turning to credit performance. We continue to see overall stability in credit quality across the portfolio. Key credit stats continue to be stable, including portfolio company leverage levels, interest coverage and LTVs. Both PIK income and the fair value of loans utilizing PIK provisions decreased during the third quarter. And the majority of our PIK was underwritten at origination or for performing borrowers and is what we would consider to be good PIK. We did add 2 positions to nonaccrual in the quarter, resulting in nonaccruals totaling 1.1% of investments at fair value and 2.2% at amortized cost. We continue to work closely with these sponsors and borrowers to position the portfolio companies for improved financial performance. And while our nonaccrual rates may fluctuate from period to period, we're confident in our ability to leverage the broader Carlyle network, including our dedicated workout team, to achieve maximum recoveries for underperforming borrowers. Moving to the Middle Market Credit Fund, our long-standing JV. We continue to focus on maximizing both asset growth and returns. During the third quarter, MMCF achieved an 18.4% dividend yield, an increase of 80 basis points quarter-over-quarter and over 300 basis points since the first quarter of this year. MMCF currently holds $1.2 billion in direct lending assets with no fees at the joint venture, resulting in an effective net base management fee of less than 1% for CGBD on all direct lending assets. The increases in both debt and equity commitments to MMCF that closed earlier this year position us to continue asset growth and income generation at the JV. In addition, our newer JV, Structured Credit Partners, or SCP, ramped to $2.1 billion of investments and produced a dividend yield of 20.3%, which was again elevated this quarter as a result of delayed settlements on loan purchases as is common for broadly syndicated loans. We expect the more normalized yield to be mid-teens longer term. During the quarter, SCP priced another CLO with long-term non-mark-to-market and predominantly investment-grade rated CLO debt. SCP priced an additional CLO in the fourth quarter of '26, and that's in line with our plan to ramp at a cadence of 4 CLO issuances per year to ensure vintage diversification. Both recently issued CLOs benefited from market volatility as we locked in tight liability pricing while purchasing broadly syndicated loans at discounted prices. Over time, the JV is expected to manage approximately $6 billion to $7 billion of assets fee-free at the JV. I'll finish by touching on our financing facilities and leverage. Our debt stack is 100% floating rate, matching our primarily floating rate assets, meaning CGBD is well positioned in advance of any additional interest rate movements. At quarter end, statutory leverage was 1.26x and net financial leverage was 1.2x after adjusting for working capital. Given our current strong liquidity profile, we believe we're well positioned to benefit from both more attractive terms for new investments and the expected pickup in deal volume in future quarters. With that, I'll turn the call back over to Alex.

Thanks, Tom. As we approach the middle of the fourth quarter, our portfolio remains resilient, and our strategy remains unchanged. We continue to focus on sourcing transactions with significant equity cushions, conservative leverage profiles and attractive spreads relative to market levels and expect to take advantage of improved conditions in the market with a revitalized origination platform. Our pipeline of new originations is steady, and 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. I'd like to now hand the call over to the operator to take your questions.

[Operator Instructions] Our first question comes from the line of Erik Zwick with Lucid Capital Markets.

First question, more of, a kind of, just a housekeeping question, maybe for Tom. Just looking at the balance sheet and the growth -- recent growth in derivatives liabilities. Just curious what's kind of driven that increase?

That is our interest rate swaps for our bonds. So you'll see it's really an offset. We hedged the 2 bonds. So you see that liability goes up, but actually on the balance sheet, the face of the debt is lower. So it's just an offset based on interest rates going up.

Got it. That makes a lot of sense. And then just thinking about your commentary on the strong pipeline. Cash position is certainly higher than it's been in a number of quarters, but also the stock is attractive from a valuation standpoint for continued use of the buyback. So just curious if you could expand a little bit on your thoughts or how you continue to execute on those 2 strategy priorities.

Yes. Look, we'll continue to -- Erik, it's Alex. Thanks for the question. Look, we're going to continue to focus on new investments. The pipeline is starting to build. I think that in the third quarter, as you can see from our originations as well as for the whole market, it was a bit muted just heading into the midterms as well as the volatility in the macro as well as the geopolitical environment. But now that we have the midterms behind us, it looks like we're going to be in an environment where at least for the next couple of years, there probably won't be a whole lot of movement, which actually ironically creates some stability. Therefore, we're pretty optimistic actually that it sets us up well next year for a more active deal environment. So we want to make sure that we have enough capacity to take advantage of that. At the same time, we can't ignore where the stock is trading, and we do have some additional capacity for buybacks. So we're going to continue to look at both. As you can see in the third quarter, we did buy back some stock, but more of a modest amount as we just balance the origination activity.

Our next question comes from the line of Chris Muller with Citizens.

This is [ Nate ] on for Chris. Just maybe one on Structured Credit Partners. I know you guys talked about it a little bit, but the vehicle continued to scale in the quarter with about -- I think about $30 million of activity on your side. Can you guys just talk a little bit about how that partnership is progressing relative to what you expected originally? And how we should think about the pace of deployment and maybe earnings contribution going forward?