DBRS Morningstar Initiates Coverage of TCG BDC, Inc. at A (low), Negative Trend

Previously a private rating (assigned on September 27, 2019), DBRS, Inc. (DBRS Morningstar) assigned a public Long-Term Issuer Rating of A (low) to TCG BDC, Inc. (CGBD or the Company). At the same time, DBRS Morningstar assigned a Long-Term Senior Debt Rating of A (low). The trend on the ratings is Negative. The Company’s Intrinsic Assessment (IA) is A (low), while its Support Assessment is SA3.

KEY RATING CONSIDERATIONS
The ratings consider the strength of CGBD’s franchise, which benefits from its relationship with The Carlyle Group L.P. (Carlyle), providing the Company with significant competitive advantages. Additionally, the ratings consider CGBD’s investment portfolio that is highly diversified, heavily first lien, relatively granular and with limited exposure to cyclical industries. Relative to most other business development companies (BDCs), the Company has a sound funding and liquidity profile, including more than 20 lending relationships with leading global financial institutions across the Carlyle Direct Lending platform, which should contribute to CGBD’s ability to manage through this highly stressed period. The ratings also consider CGBD’s increased leverage, which is approaching the top range of the peer group and may reduce financial flexibility. Further, as a BDC, the Company’s inability to retain its organic capital to support balance sheet growth is also a ratings constraint.

The Negative trend reflects DBRS Morningstar’s view that BDCs are facing increasingly considerable headwinds over the near term, given their focus on lending to U.S. middle market companies, many of which are significantly pressured in the current environment. Given the abrupt and severe economic contraction caused by the Coronavirus Disease (COVID-19), combined with the uncertainty of the magnitude and duration of the downturn, DBRS Morningstar sees the potential for fair value markdowns on CGBD investment portfolio, resulting in reduced profitability and potentially higher balance sheet leverage. Investments on non-accrual status are likely to rise over the near term, further pressuring profitability and balance sheet fundamentals. This will likely be buffered somewhat by support from private equity sponsors, which provide a first line of defense, though this is not guaranteed and support may prove to be selective if resources are limited.

RATING DRIVERS
DBRS Morningstar sees a reversion to a Stable trend as unlikely for the duration of the coronavirus-related downturn. Over the longer term, the trend could revert back to Stable if CGBD continues to maintain appropriate balance sheet fundamentals, while generating acceptable earnings despite the headwinds from the downturn. Should the coronavirus pandemic be sustained longer than anticipated, leading to a severe and prolonged economic downturn that results in significantly weakened credit fundamentals, the ratings would be downgraded. A significant deterioration in the buffer to debt facility covenants or regulatory requirements could also result in a ratings downgrade.

RATING RATIONALE
The Company has a strong franchise that benefits from its relationship with Carlyle. Carlyle is a leading global alternative asset manager, with $224 billion of firmwide assets under management (AUM), including $49 billion of credit-focused AUM. CGBD is managed by Carlyle Global Credit Investment Management LLC, a subsidiary of Carlyle. CGBD is a relatively large BDC and operates a business that is core to the development of Carlyle Global Credit. Carlyle’s credit platform is a key growth area for Carlyle, particularly given its importance to the diversification of the overall Carlyle franchise. As such, DBRS Morningstar sees Carlyle’s commitment and potential support, if needed, as key underpinnings to the ratings. However, DBRS Morningstar notes there are no explicit guarantees or support agreements in place between CGBD and Carlyle.

The scale of the entire Carlyle platform provides a substantial amount of investment opportunities, allowing CGBD to be highly discretionary when adding to the portfolio, as evidenced by an investment rate of less than 10% annually. The Company targets sponsor-backed U.S. middle market companies since the sponsor may provide strategic and/or financial support, if appropriate. Overall, the loan portfolio is highly diversified (largest single sector exposure is less than 12% of the portfolio’s fair value), predominately first lien (70% of total investments), relatively granular (largest individual loan represents 2.7% of the portfolio’s fair value and the top 10 loans account for 21% of the total portfolio) and with limited exposure to cyclical industries. CGBD’s exposures to the most adversely impacted sectors of the economy from the coronavirus disease are relatively low, as the oil and gas industry represents just 0.6% of the portfolio’s fair value, while the hotel, gaming and leisure sector comprises less than 4.5%.

While the Company’s track record is limited, having been founded in 2012, credit performance has largely been sound, albeit during a benign environment. DBRS Morningstar notes that the “Carlyle Unitranche Program”, an origination partnership that ran from 2015 to 2017, has been responsible for more than half of CGBD’s total losses post IPO and more than two-thirds of losses during the past year. While concerning, these positions have largely been exited, as they now comprise less than one percent of the total investment portfolio. In addition, management has indicated it will further leverage the strength of Carlyle’s global platform and its expertise to prevent such an occurrence in the future. At YE19, CGBD had 4 borrowers with a fair value of $52.4 million on non-accrual status, representing 2.47% of total investments at fair value, all of which are first lien.

CGBD has been profitable every year, except its first year of operations, but the loss was due to upfront costs related to the launch and not related to credit deterioration. DBRS Morningstar sees CGBD’s investment income as predictable given the prevalence of recurring income, considering the aforementioned investment portfolio composition. In 2019, total investment income was $221 million, up 7% compared to the prior year, reflecting continued portfolio growth. CGBD’s net investment income as a percentage of the investment portfolio at cost was 5.1% in 2019, in line with the peer group average and consistent with historical trends. While the Company has maintained a healthy and consistent core yield from its investment portfolio, we expect this to be challenged over the near to intermediate term due to the current economic downturn.

CGBD has a sound funding and liquidity profile for a BDC, which was enhanced by its inaugural senior unsecured debt issuance in December 2019. In aggregate, its liability structure includes a revolving credit facility, an asset-based lending facility, unsecured notes and a CLO. Its debt maturities are well-laddered and termed out. Specifically, the average duration of the Company’s liabilities is greater than five years and the lending facilities have maturities greater than three years. Liquidity is solid, with $346 million of total unused commitments at YE19, which was in excess of the $150 million of unfunded commitments. Leverage is appropriately managed. CGBD’s debt-to-equity ratio was 1.2x at the end of 2019, within its long-term target range of 1.0x to 1.4x, which DBRS Morningstar considers acceptable.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

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

The principal methodology is the Global Methodology for Rating Non-Bank Financial Institutions, (September 2019), which can be found on our website under Methodologies & Criteria: https://www.dbrsmorningstar.com/research/ 350802/global-methodology-for-rating-non-bank-financial-institutions.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The primary sources of information used for this rating include Company Documents and S&P Global Market Intelligence. DBRS Morningstar considers the information available to it for the purposes of providing this rating was of satisfactory quality.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had have access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

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

For more information on this credit or on this industry, visit www.dbrsmorningstar.com.

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