DBRS, Inc. (Morningstar DBRS) confirmed the Long-Term Issuer Rating and Long-Term Senior Debt Rating of Carlyle Secured Lending, Inc. (CGBD or the Company) at BBB (high).
The trends on the credit ratings remain Stable. The Company's Intrinsic Assessment (IA) is BBB (high) while its Support Assessment is SA3, resulting in CGBD's final credit ratings positioned in line with its IA.
KEY CREDIT RATING CONSIDERATIONS
The confirmations of the credit ratings reflect the Company's solid franchise underpinned by its broad relationship with The Carlyle Group L.P. (Carlyle), which provides meaningful competitive advantages along with its largely consistent earnings generation and diversified funding profile. The credit ratings also consider CGBD's elevated credit risk profile given its focus on the inherently riskier middle market lending and its capitalization limitations as a business development company (BDC), both of which the Company has historically managed well by adopting sound risk management practices and prudent capital management. Also supporting CGBD's credit ratings is Carlyle's demonstrated commitment and support through its preferred equity investment in the Company during the pandemic-related market dislocation in May 2020.
The Stable trends reflect Morningstar DBRS' expectation that the Company will continue to generate solid operating results, despite the lackluster net investment activity caused by the broader economic uncertainty, while maintaining sound risk management and balance sheet fundamentals. The Stable trends also incorporate a modest deterioration in the Company's credit performance metrics, consistent with Morningstar DBRS' expectations across all BDCs in its credit ratings coverage. The key downside risk to Morningstar DBRS' expectations is a contraction in U.S. economic activity because of the higher-for-longer interest rate environment.
CREDIT RATING DRIVERS
Over the longer term, improved earnings generation accompanied by sound credit quality and low leverage would result in a credit ratings upgrade. Conversely, a sustained increase in overall financial and regulatory leverage outside of the Company's current leverage target and/or a significant deterioration in operating results causing a notable erosion in net asset value would result in a credit ratings downgrade. Additionally, increased balance sheet encumbrance could have adverse credit ratings implications for the Company.
CREDIT RATING RATIONALE
Franchise Building Block (BB) Assessment: Strong/Good
The Company's franchise is underpinned by its broader relationship with Carlyle, a leading global alternative asset manager with $425 billion of firmwide assets under management (AUM), including $186 billion of credit-focused AUM. CGBD's external advisor, Carlyle Global Credit Investment Management LLC, is a subsidiary of Carlyle that has co-investment exemptive relief from the SEC to invest in assets across its managed investment vehicles. As a result, CGBD can participate in loans originated across Carlyle's platform. The Company can underwrite larger loan commitments and take lead arranger roles while at the same time enabling itself to diversify those exposures by syndicating them across multiple managed vehicles, including private BDCs, institutional funds, and separately managed accounts. Morningstar DBRS views Carlyle's investment in the Company's preferred equity as being indicative of its commitment and implicit support for CGBD and its franchise. The Company invests in sponsor-backed U.S. middle market companies, with a $1.8 billion investment portfolio at fair value at March 31, 2024.
Earnings Building Block (BB) Assessment: Good/Moderate
The Company has demonstrated acceptable and mostly consistent earnings generation capabilities that are supported by the strength of CGBD's franchise and market positioning, providing it with good access to quality investment opportunities with attractive risk-adjusted returns. CGBD has remained mostly profitable on an annual basis since its inception as well as for the past 16 consecutive quarters. The Company's entirely floating-rate portfolio has benefited from the higher market rates resulting in net investment income (NII) growth of 7% year-over-year (YOY) in Q1 2024 following 6% growth YOY in 2023. Nonetheless, Morningstar DBRS expects this benefit will have likely peaked in the absence of net portfolio growth. The net increase in net assets from operations (net income) for Q1 2024 of $29.3 million was up 5% YOY, as a small decline in net realized and unrealized gain/appreciation partially offset the NII growth. In 2023, net income was $92.3 million, 8% higher than in 2022, as NII increased by 6% while realized and unrealized losses were slightly lower YOY.
Risk Building Block (BB) Assessment: Good/Moderate
CGBD's risk profile is supported by a highly selective investment process, rigorous underwriting, and diligent portfolio monitoring. Furthermore, CGBD's portfolio is diversified, predominantly first-lien focused, relatively granular, and with limited exposure to cyclical industries. As of March 31, 2024, the Company's portfolio at fair value comprised 70.9% first lien investments, 9.3% second-lien investments, 5.9% equity investment, and 13.9% in two joint-venture (JV) investment funds where first-lien investments accounted for 98.4% of the combined JVs' investment portfolios. Additionally, 92% of CGBD's investment portfolio being associated with sponsored backed companies provides an added risk mitigant relative to investments where sponsors' equity is not at risk. As of March 31, 2024, the non-accruals as a percentage of total portfolio at cost were 0.2%, down from 3.2% at YE2023, driven by non-accrual write-offs that were partially offset by a successful recapitalization of a portfolio company.
Funding and Liquidity Building Block (BB) Assessment: Good/Moderate
The Company has a diversified funding profile that encompasses access to multiple funding channels and investor bases. As of March 31, 2024, of the $935.3 million principal debt outstanding, 29% was institutional senior unsecured debt, 46% securitized debt (collateralized loan obligations) with the remaining 25% being the outstanding balance of a credit facility with a total committed borrowing capacify of $790 million following its latest renewal in August 2023. CGBD has a well-laddered maturity profile with the nearest maturity of $190 million of senior notes due December 2024, which can be adequately met by the available liquidity. Of note, a portion of the upcoming senior notes maturity was also partially addressed by the senior notes issuance of $85 million in November 2023. The Company has no other debt maturities in the two subsequent years. At March 31, 2024, the Company had $265.0 million of undrawn capacity based on collateral within the credit facility and unrestricted cash of $29.3 million for liquidity purposes versus its unfunded commitments of $138.7 million, comprising $67.9 million of delayed draw term loans and $70.7 million of revolving credit facilities.
Capitalization Building Block (BB) Assessment: Moderate
The Company has historically kept its leverage at manageable levels with a track record of prudent capital management. As of March 31, 2024, CGBD's regulatory leverage, which treats preferred equity as debt, was 1.13 times (x), comfortably below the limit of 2.0x, while the net financial leverage (debt, net of excess cash-to-equity, including Preferred equity) was 0.95x, well within its set target range of 1.0x to 1.25x. Both leverage ratios were lower than the prior quarter and the same prior year period. Morningstar DBRS estimates the Company's cushion to regulatory leverage limits to be approximately $375 million, implying that it would need to incur a loss of 21% of the investment portfolio at fair value to breach the regulatory limit. Morningstar DBRS views this cushion as adequate, given the CGBD's average hold size for portfolio companies of approximately $14 million, which is below the median of its Morningstar DBRS peer group. The dividend coverage from NII, including common and preferred dividends declared, was 113% in Q1 2024 and it has averaged 110% over the past five fiscal years.
ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.
A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) at https://dbrs.morningstar.com/research/427030.
Notes:
All figures are in U.S. dollars unless otherwise noted.
The principal methodology is the Global Methodology for Rating Non-Bank Financial Institutions (April 15, 2024) https://dbrs.morningstar.com/research/431187. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024), https://dbrs.morningstar.com/research/427030, in its consideration of ESG factors.
The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.
The primary sources of information used for these credit ratings include Morningstar, Inc. and company documents. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings was of satisfactory quality.
The credit rating was initiated at the request of the rated entity.
The rated entity or its related entities did participate in the credit rating process for this credit rating action.
Morningstar DBRS had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit 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. Morningstar DBRS' outlooks and credit ratings are under regular surveillance.
For more information on this credit or on this industry, visit dbrs.morningstar.com.
DBRS, Inc.
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CARLYLE SECURED LENDING, INC. 
