DBRS Morningstar Confirms Carlyle Secured Lending, Inc.’s Long-Term Ratings at BBB (high) with a Stable Trend

DBRS, Inc. (DBRS Morningstar) confirmed the Long-Term Issuer Rating and Long-Term Senior Debt rating of Carlyle Secured Lending, Inc. (CGBD or the Company) as BBB (high). The trend on the ratings is Stable. The Company’s Intrinsic Assessment (IA) is BBB (high), while its Support Assessment is SA3, resulting in CGBD’s final ratings positioned in line with its IA.

KEY RATING CONSIDERATIONS
The confirmation of the ratings is driven by CGBD’s operating performance as it has generated acceptable earnings with manageable non-accruals in line with a seasoned investment portfolio while maintaining regulatory leverage within its target range. The ratings benefit from a strong franchise underpinned by CGBD’s relationship with The Carlyle Group L.P. (Carlyle), a global alternative asset manager that provides substantial competitive advantages particularly in times of crisis. The ratings consider CGBD’s diversified funding profile which includes a $50 million preferred equity investment made by Carlyle in May 2020 at the height of market turmoil driven by the onset of the coronavirus pandemic, demonstrating support for the Company.

The Stable trend considers the turmoil in the U.S. banking system and a worsening macroeconomic environment. While the failures of Silicon Valley Bank (SVB), Signature Bank (Signature) and First Republic Bank (First Republic) had no direct impact on CGBD, overall regional bank stress and financial market volatility may pressure middle market companies. The lender-friendly private credit origination market with higher spreads and stronger documentation is balanced by business development company (BDC) regulatory capital constraints from leverage discipline and lack of traditional sponsor-driven M&A pushing deal flow. We expect CGBD’s investment portfolio growth will be somewhat constrained despite the bank pullback in lending, and volatility may drive near-term mark-to-market losses, challenging profitability at CGBD.

RATING DRIVERS
Over the longer term, sustained improved earnings supported by an improvement of credit quality and a conservative leverage profile would result in a ratings upgrade. Conversely, a sustained increase in overall financial and regulatory leverage outside of CGBD’s current leverage target would result in a ratings downgrade. Should operating performance worsen, including a notable loss that erodes net asset value, or if there is significant credit deterioration above our expectations, the ratings would also be downgraded.

RATING RATIONALE
The Company’s franchise greatly benefits from its external advisor relationship with Carlyle Global Credit Investment Management LLC (the Advisor), a subsidiary of Carlyle. While there is no explicit guarantee from Carlyle on behalf of CGBD, we view implicit support, as well as demonstrated support from the preferred equity investment as significant to the ratings. As the preferred is now callable, even if the instrument is paid off, we view the timely investment as an important factor to the relationship between Carlyle and the Company. Carlyle is a global alternative asset manager with $381 billion of firmwide assets under management (AUM) including $150 billion of credit-focused AUM with a deep bench of investment professionals. CGBD has undergone some recent management turnover but we see Carlyle’s broad investment team as limiting key person risk.

CGBD provides financing alternatives to sponsor-backed middle market companies, and at 1Q23 has a $2.0 billion investment portfolio at fair value consisting of 68.5% first lien debt, 13.1% second lien debt, 5.2% equity and 13.2% in joint venture investment funds. The JVs are primarily invested in first lien debt and CGBD has exemptive relief to invest in assets across the various investment vehicles Carlyle manages, which includes private BDCs, institutional funds, and separately managed accounts. This enables the platform to underwrite larger loan commitments and take lead arranger roles while maintaining proper diversification within each investment vehicle.

Earnings remained acceptable through full year 2022 and 1Q23, but the positive impact from higher base rates was less pronounced at CGBD than other BDCs. The weighted average yield on debt and income producing investments was 12.4% at fair value at 1Q23, up from 8.9% at 1Q22 as base rates increased, but as liabilities were predominantly floating-rate, annualized interest expense at 1Q23 increased to 6.1% compared to 3.0% at 1Q22. Net investment income (NII) was $26.6 million in 1Q23, relatively flat to $25.5 million in 1Q22. This follows strong NII expansion in 2022 to $104.0 million from $86.9 million for full year 2021. However, net increase in net assets resulting from operations to common shareholders (net income to common) was $27.1 million for 1Q23 down from $29.8 million for 1Q22. Full year 2022 net income to common was $82.1 million, down significantly from $156.9 million for full year 2021, which benefitted from reversals of unrealized losses in mark-to-market valuation changes of the Company’s investment portfolio.

Credit performance has been acceptable with three portfolio companies on non-accrual at 1Q23 constituting 4.2% of the investment portfolio at cost for a well-seasoned investment portfolio. CGBD’s underlying borrowers had a median EBITDA of $73 million at 1Q23. The investment portfolio is well-diversified with 171 investments in 133 portfolio companies across 27 different industries at 1Q23. The investment portfolio is also 99% floating-rate and 94% sponsor-backed, which should continue to benefit NII as base rates are held higher for long periods of time.

The Company has a diversified funding profile with $1.1 billion of debt outstanding at 1Q23 which consists of a revolving credit facility, two unsecured issuances (approximately 17%), a CLO and a convertible preferred equity issuance. The revolving credit facility was amended in April 2023 to upsize the facility total commitment to $745 million from $688 million with a scheduled maturity of May 2027. The debt maturity is well-laddered, with $190 million of unsecured debt issuance due in December 2024. Additionally, the $50 million preferred equity is now callable by CGBD, which pays cash interest of 7% but is perpetual in nature (increases by 1.0% per year after May 2027). At 1Q23, the Company had sufficient liquidity coverage with $235.6 million of undrawn credit facility capacity and $37.3 million of excess cash compared to $164.4 million of unfunded commitments.

Capitalization remained within the Company’s stated target leverage of 1.0x to 1.4x debt-to-equity. At 1Q23, gross regulatory leverage was 1.32x, which includes the convertible preferred equity as a senior debt instrument, with net financial leverage of 1.16x, which reflects the convertible preferred equity as equity and nets out excess cash. At 1Q23, the cushion to CGBD’s asset coverage ratio (ACR) regulatory limits was approximately $296 million, implying that the Company would need to take a full loss on 15% of its investment portfolio at fair value to breach the ACR limit.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/ Social/ Governance factor(s) that had a significant or relevant effect on the credit analysis.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings. (May 17, 2022)

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal methodology is the Global Methodology for Rating Non-Bank Financial Institutions: https://www.dbrsmorningstar.com/research/402314/global-methodology-for-rating-non-bank-financial-institutions. (September 2, 2022). In addition, DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings: https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings in its consideration of ESG factors. (May 17, 2022)

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

The primary sources of information used for this rating include Morningstar, Inc. and Company Documents. DBRS Morningstar considers the information available to it for the purposes of providing this rating was of satisfactory quality.

The rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the rating process for this rating action.

DBRS Morningstar had access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this rating action.
This is a solicited credit rating.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

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