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

DBRS, Inc. (DBRS Morningstar) confirmed the ratings of Carlyle Secured Lending, Inc. (CGBD or the Company), including the Company’s Long-Term Issuer Rating of BBB (high). The trend on all 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 based on CGBD’s solid operating performance, including acceptable earnings and credit quality metrics, while maintaining regulatory leverage within its target range. The Company’s ratings benefit from the strong franchise, underpinned by its relationship with The Carlyle Group L.P. (Carlyle) that provides meaningful competitive advantages. In April 2022, the Company rebranded to Carlyle Secured Lending, Inc. from TCG BDC, Inc. in order to better reflect one recognizable brand name to the market. Carlyle is one of the largest global alternative asset managers with $325 billion of AUM, including $91 billion dedicated to credit strategies. The ratings also consider the Company’s diversified funding profile that includes a $50 million preferred equity investment from Carlyle, further demonstrating support for CGBD.

The Stable trend reflects our view that the geopolitical instability in Europe, as well as the rising interest rate environment and heightened inflationary pressures, while increasing risk to the continued U.S. economic recovery, will not overly burden U.S. private middle market companies. Nevertheless, increased public market volatility may decrease portfolio valuations in the near-term. CGBD’s portfolio companies generally have been able to maintain profit margins despite inflation, supply chain disruptions and increased input costs, by the price inelasticity of their goods and services. However, we expect if these issues persist long-term, that some portfolio companies may undergo financial stress.

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. Weak performance in the investment portfolio that erodes net asset value (NAV), or if dividend distributions are not covered by net investment income for an extended period of time, would also result in a ratings downgrade.

RATING RATIONALE
CGBD’s strong franchise is supported by its external advisor, Carlyle Global Credit Investment Management LLC (Advisor), a subsidiary of Carlyle. While CGBD does not have an explicit guarantee from Carlyle, we view implicit support, as well as demonstrated support from the preferred equity investment as significant to the ratings. CGBD invests in sponsor-backed U.S. middle market companies, with a $1.9 billion investment portfolio at fair value, consisting of 65.4% first lien, 16.2% second lien, 4.2% equity investment, and 14.2% in two joint-venture investment funds at 1Q22. With $91 billion of credit-related AUM, Carlyle has co-investment exemptive relief from the SEC to invest in assets across its managed investment vehicles. This allows the platform to underwrite larger loan commitments, take lead arranger roles, and syndicate those exposures across multiple managed vehicles, including a private BDC and separately managed accounts, which mitigates idiosyncratic portfolio company concentration risk.

Earnings have been acceptable, supported by its scaled investment portfolio, which generates consistent interest income and recurring dividend income from its investment funds. CGBD reported a net increase in net assets from operations to common (net income) of $156.9 million in 2021, up significantly from $4.6 million in 2020, largely due to significant reversals of unrealized losses in realized and unrealized gains from its investment portfolio. In 1Q22, net income was $29.8 million compared with $35.0 million in 1Q21, as net realized and unrealized gains leveled off from the prior period.

The Company’s risk profile is acceptable as the Company has exited many of its historical non-accrual positions, with two investments comprising the bulk of the remaining non-accrual investments, which totaled 4.6% of the investment portfolio at cost ($87.6 million) at 1Q22. Historical losses on the investment portfolio were concentrated in the wound down Carlyle Unitranche Program, in which CGBD took higher yielding last-out exposure in unitranche financings for small borrowers (average EBITDA of under $20 million). The Company’s junior capital investments are now to larger borrowers (average EBITDA of approximately $200 million), which constitute 16% of the overall investment portfolio. The investment portfolio is diversified, with 156 investments in 117 portfolio companies across 27 industries in 1Q22. As the investment portfolio is 98.4% floating rate, interest rate risk from continued Fed rate hikes is limited, and earnings should benefit once prevailing rates increase above the investment portfolio’s interest rate floors.

CGBD has a diversified funding profile with $1.0 billion of debt outstanding at 1Q22, comprised of secured borrowings (including the revolving credit facility), CLOs, private placement issuances and convertible preferred equity. The debt maturity profile is well-laddered, with the nearest maturity in December 2024 of $190 million of its private placement issuances. The Company has sufficient liquidity with undrawn capacity at its credit facility of $328.3 million (subject to borrowing base limitations), and cash of $69.5 million, compared with unfunded commitments of $237.9 million ($173.1 million of delayed draw term loans) at 1Q22.

Capitalization has been kept at a manageable level, within CGBD’s leverage target of 1.0x to 1.4x debt-to-equity. At 1Q22, regulatory leverage was 1.16x, which includes preferred equity as a senior debt instrument, while financial leverage was 0.98x, accounting for the preferred equity as equity on a converted basis. The Company’s cushion to the asset coverage ratio (ACR) regulatory limits was $376 million at 1Q22, implying that it would need to incur a loss of 20% of its investment portfolio at fair value to breach the covenant. We view this cushion as sufficient for the rating level, particularly given the average hold size of $16 million within the investment portfolio.

ESG CONSIDERATIONS
There were no Environmental, Social or Governance factors 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.

Notes:
All figures are in US Dollars unless otherwise noted.

The principal methodology is the Global Methodology for Rating Non-Bank Financial Institutions (September 2, 2021): https://www.dbrsmorningstar.com/research/383936/global-methodology-for-rating-non-bank-financial-institutions. Other applicable methodologies include DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (May 17, 2022): https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

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