This article was first published to Systematic Income subscribers and free trials on May 16.
In this article, we provide a Q1 update for business development company Blackstone Secured Lending (NYSE: BXSL). BXSL is a very large BDC with over $10 billion in assets with a focus almost entirely on senior assets as well as a relatively shareholder-friendly fee structure.
BXSL has seen its valuation drop sharply since its IPO due to a number of lockout expiries. A last major one is expected in July, which will be partly mitigated by its share buyback program.
BXSL pays a regular dividend of $0.53, which equates to an 8.5% yield. This is the bottom end of the BDC sector where the median regular dividend yield is 1% to 9.5% higher.
This is partly due to 1) its conservative regular dividend (i.e. high regular dividend coverage) – in contrast, the company has a net income price yield of 9.8% – more in line than the sector average, 2) its senior defensive allocation and 3) its large special dividends – the last one is scheduled for July – equivalent to an annualized return of 11.4%, well ahead of the sector.
In our view, BXSL is likely to continue its special dividends or increase its regular dividend closer to the industry average.
Total revenue decreased approximately 3%, primarily due to lower prepayment revenue. Unfortunately, BXSL doesn’t seem to break down prepayment revenue, which makes it hard to track. This decline in prepayment revenue is a theme we’ve highlighted before that was expected to occur in the first quarter. The key point here is that the sharp increase in revenue across the industry that we saw in the fourth quarter was not sustainable and we have to judge the first quarter numbers against the third quarter levels.
Net investment income fell approximately 8.4% from fourth quarter levels.
Regular dividend coverage remains high at 115%. The regular dividend has been increased from $0.50 last year and will likely continue to be increased given the company’s consistently high hedging – NII has exceeded the current regular dividend for the past 7 quarters. Its high income sensitivity to rising short-term rates should further strengthen the hedge, all other things being equal.
Net asset value fell 0.5% from the previous quarter, which is in line with the industry average.
However, as shown in the NAV bridge below, this was entirely due to the large special dividend which was almost half of the regular dividend. The special dividend schedule will change from $0.25 in the first quarter to $0.20 each in the second and third quarters. Ex-special dividend, the net asset value increased by 0.4%, mainly due to the relatively low regular dividend. More importantly, the net realized/unrealized gains were positive, which is what we want to see and this is a very good result in a period of declining credit and equity prices.
BXSL is well positioned to grow its earnings in response to rising short-term rates. His net income sensitivity to Libor rising to 2% (i.e. a 1% increase in the chart below) is +17.5%. With the Libor at 1.4%, it is already close to halfway there. This is well above the industry average of +7% increase in net income.
Obviously, some spread compression is likely to mitigate this increase, but two factors should mitigate its impact. First, spread compression usually comes with prepayment charges for borrowers who choose to refinance before maturity. And second, the overall level of prepayments should remain subdued given the recent increase in credit spreads. With high yield credit spreads having fallen from 3% to 4.5%, spread compression should not be very widespread. Management confirmed this on the call saying it had not seen material spread compression since the start of the year despite a 1.2% rise in Libor.
BXSL was one of the few BDCs without, what we call, net income valley, i.e. a drop in income for a rise in the Libor to 1%. This is due to its relatively high leverage, high allocation to floating rate assets and a relatively low weighted average Libor floor. This means that its revenues already started to rise at the end of the first quarter, with the Libor approaching 1%.
Leverage increased to 1.28x – slightly above the upper target of 1.25x. This suggests that we should not expect significant increases in leverage going forward, which will remove this previous earnings tailwind. At the same time, management has indicated that it does not plan to significantly reduce leverage, so it should not become a significant headwind for earnings either.
Weighted average return balance sheet assets remained stable at 7.2% after a long decline. In our view, it should start to rise, supported by positive net investments in recent quarters and rising short-term rates. Balance sheet liabilities also increased by 0.26% to around 3% given the large floating rate debt at 44% – in line with the industry average.
The company has done a great job timing its recent bond issue. The chart below plots the timing of its $2 billion bond issuance, which accounts for about a third of its total debt and 63% of its total fixed-rate debt, again BBB-rated yields. The company is rated BBB- by Fitch and Baa3 (equivalent to BBB-) by Moody’s.
The average coupon for these bonds was 2.575% over the 2026, 2027 and 2028 maturities. For comparison, the 5-year Treasury yield is currently 2.9%. The first maturity is their $400 million July 2023 bond with a 3.65% coupon which represents 6.4% of their debt. If rates and credit spreads stay where they are, BXSL may have to pay around 4.75% on a 5-year issue to refinance it, so the impact on the bottom line will be quite marginal or d about 1%.
Non-recognition remained at zero, which is very unusual in the sector.
Income PIK has increased significantly over the past two quarters and is worth watching although it is still below average.
BXSL outperformed the broader industry in the first quarter with a total net asset value return of 2.4% versus an average of 1.8%. Its total return since inception, according to its commentary, is 10.1%, which is similar to the industry average.
The stock’s valuation fell considerably and converged with the sector average. He’s been under pressure from the lockdown exhales highlighted above. With a valuation below the industry average, it is starting to look attractive, especially given its lower fee structure and more defensive profile.
The company has set up a share buyback program which gives it the possibility of acquiring shares below the NAV. The size of the program is equal to $262 million, or the size of the IPO has been placed. The program is triggered when shares trade below net asset value and is due to end in November.
Take away food
BXSL offers a somewhat defensive position in the sector given its consistent track record of non-zero counting and its heavy focus on senior loans. Its performance in the first quarter confirmed this position with an increase in net realized / unrealized gains compared to a decline for most BDCs.
BXSL is also an attractive holding given the breadth of its platform, the depth of its analyst bench and business support team, its fairly user-friendly fee structure, historical returns as well as its high sensitivity of income to rising short-term rates.
We recently initiated a position in BXSL in the high income portfolio. And while we wouldn’t be surprised to see some short-term volatility around the final expiration of the lockdown, a valuation level in the mid-90s (i.e. at a price of around $25 or less) based on its first quarter net asset value makes it a “Buy” in our view.