Blue Owl Capital Q4 2023 Earnings Call Transcript

Quartr
Provided by Quartr
February 22, 2024

There are 11 speakers on the call.

Operator

Hello, and welcome to the Blue Owl Capital Corp. Q4 and Fiscal Year 2023 Earnings Call and Webcast. As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to Dana Schleffani, Head of BDC Investor Relations for Blue Owl. Please go ahead, Dana.

Speaker 1

Thank you, operator. Good morning, everyone, and welcome to Blue Owl Capital Corporation's 4th quarter earnings call. Joining me this morning are our Chief Executive Officer, Craig Packer and our Chief Financial Officer and Chief Operating Officer, Jonathan Lam as well as Alexis Magid, our Chief Credit Officer and Logan Nicholson, Portfolio Manager for OVDC. I'd like to remind our listeners that remarks made during today's call may contain forward looking statements, which are not a guarantee of future performance or results and involve a number of risks and uncertainties that are outside the company's control. Actual results may differ materially from those in forward looking statements as a result of a number of factors, including those described in OBDC's filings with the SEC.

Speaker 1

The company assumes no obligation to update any forward looking statements. Certain information discussed on this call and in our earnings materials, including information related to portfolio companies, was derived from third party sources and has not been independently verified. The company makes no such representations or warranties with respect to this information. OBDC's earnings release, 10 ks and supplemental earnings presentation are available on the Investor Relations section of our website at blueowlcapitalcorporation.com. With that, I'll turn the call over to Craig.

Speaker 2

Thanks, Dana. Good morning, everyone, and thank you all for joining us today. We are very pleased to report another record quarter of earnings with continued excellent credit performance across the portfolio. Net investment income was $0.51 per share, up $0.02 from last quarter. Our NII increased in each quarter of 2023 and we generated new record NII for the 4th consecutive quarter.

Speaker 2

In total, we earned $1.93 of NII in 2023, up $0.52 or 37% year over year. Our strong results throughout the year are the outcome of our emphasis on great credit selection and a proactive approach to liability management. Results also benefited from the higher rate environment and continued strong economic conditions. Based on these results, our Board has approved another $0.02 increase in our base dividend to $0.37 per share. This is our 3rd $0.02 increase since the Q4 of 2022.

Speaker 2

This reflects our strong results to date and incorporates our expectations for the future trajectory of earnings even in a more normalized rate environment. In addition, for the Q4, our Board declared a supplemental dividend of $0.08 We instituted the supplemental dividend framework in the Q3 of 2022 to allow shareholders to participate in our earnings upside in a predictable manner, and we are pleased to have paid $0.36 per share of supplemental dividends over these last six quarters, while also meaningfully growing net asset value. Going forward, we believe shareholders will continue to benefit from the supplemental dividend framework. Net asset value per share increased to $15.45 up $0.05 from the 3rd quarter. This represents the highest NAV per share since our inception and the 2nd quarter in a row of record net asset value.

Speaker 2

As a result of strong earnings and continued NAV growth, we earned a record 13.2% return on equity in the 4th quarter, resulting in an annual ROE of 12.7% for the full year. This is right in line with the expectations we set at our Investor Day in May. Looking at our borrowers results, we saw continued resilience across our portfolio companies throughout 2023. We came into the year appropriately cautious and prepared for a more challenging economic environment. Over the last 12 months, our borrowers on average delivered low to mid single digit growth in both revenue and EBITDA each quarter.

Speaker 2

They were proactive in cutting costs and raising prices where appropriate to combat inflationary pressure and supply chain challenges. These initiatives contributed to the solid performance we saw this year. Further, we believe our borrowers are well positioned coming into 2024. Our largest sectors continue to be software, insurance brokerage, food and beverage and healthcare, all of which serve diversified and durable end markets. The weighted average EBITDA of our portfolio companies is over $200,000,000 and we believe this scale provides strategic benefits and operational stability as many of our borrowers remain market leaders within their sectors.

Speaker 2

Looking forward, while markets are expecting rates to decline, short term rates remain elevated. And as a result, we remain focused on potential portfolio company challenges. We believe coverage levels will trough in the first half of twenty twenty four at around 1.5 to 1.6 times interest coverage. We continue to have a small list of borrowers who we believe may see challenges in the months ahead. Our underwriting and portfolio management teams are closely monitoring and we believe any challenges ultimately will be manageable across our portfolio as a whole.

Speaker 2

I would note we had a few borrowers migrate lower in our rating scale, but overall, the names on our watch list remains consistent. Based on the visibility we have today and the strong positioning of our borrowers, we expect that the vast majority of our portfolio companies will maintain solid coverage metrics and adequate liquidity throughout this period. While we added one very small position to non accrual in the quarter for a total of 4 names, our non accrual rate remains low at 1.1% of the fair value of the debt portfolio. Overall, our record year in 2023 demonstrates the resilience of our portfolio companies and the strength of our investment and portfolio management process. With that, I'll turn it over to Jonathan to provide more detail on our financial results.

Speaker 3

Thanks, Craig. We ended the quarter with total portfolio investments of $12,700,000,000 outstanding debt of $7,100,000,000 and total net assets of $6,000,000,000 Our 4th quarter NAV per share was $15.45 a 0 point 0 $5 increase from our 3rd quarter NAV per share of $15.40 attributable to the continued over earning of total dividends. In terms of deployment, we continue to largely match originations with repayments to maintain a fully invested portfolio. Repayments increased this quarter to $1,100,000,000 which was matched by $1,000,000,000 of new investment fundings. This was a sizable increase compared to the roughly $390,000,000 of repayments we saw in the 3rd quarter and is consistent with our belief that we will see an increase in repayments as the market environment continues to be more favorable for refinancings.

Speaker 3

We ended the quarter with net leverage at 1.09x, down slightly from the prior quarter. This is largely reflective of the timing of repayments versus new originations in the quarter. Turning to the income statement. We earned a record $0.51 per share in the 4th quarter, up from $0.49 per share in the prior quarter. The increase in NII was driven by roughly $0.015 quarter over quarter increase of accelerated income, driven by a pickup in repayments as well as modest increases in our dividend and interest income.

Speaker 4

For the

Speaker 3

Q4, the $0.08 per share supplemental dividend will be paid on March 15 to shareholders of record on March 1. Reflecting this supplemental and the previously declared $0.35 regular dividend, shareholders will receive total dividends of $0.43 which equates to an annualized dividend yield of over 11% based on our NAV per share for the Q4. For the full year 2023, we paid a total of $1.59 per share in dividends, an increase of $0.30 or roughly 25% from the prior year. The Board also declared a 1st quarter regular dividend of 0 point to shareholders of record as of March 29. Pro form a for our new increased regular dividend, coverage remains robust at 138%.

Speaker 3

We finished the year with $0.30 of spillover income as a result of meaningful over earning of our dividends, inclusive of our supplemental dividends throughout 2023. Turning to the balance sheet. We continue to proactively manage our liability structure to maximize returns to our shareholders. In the Q4, we increased our revolver capacity to $1,900,000,000 and continue to maintain a robust liquidity position, which increased to $2,100,000,000 This is well in excess of our unfunded commitments to our portfolio companies. In January, we opportunistically raised $600,000,000 in new 5 year unsecured notes.

Speaker 3

A portion of the proceeds will be used to repay our $400,000,000 unsecured notes that mature in April 2024. Taken together, these actions will modestly improve our overall cost of unsecured financing and increase our total unsecured debt as a percentage of total debt to 61%. We continue to be very focused on maintaining a well laddered liability structure and lowering our financing costs. The spread on this new issuance represents 1 of our tightest spreads to treasuries. Further, we were able to swap this new issuance at a rate of S plus 212 basis points, which when taken together with the maturity of the April 2024 notes is accretive to ROE for our shareholders and attractively priced relative to our current secured financing costs.

Speaker 3

The BDC bond market continues to deepen and expand with new investors. We are pleased to see investors' recognition of OBDC's high quality portfolio and continued performance, which allowed us to drive improved pricing for this issuance even in a higher rate environment. As we have since inception, we continue to be proactive at addressing our financing needs and continuing to deepen our investor base and improve our liability costs. With that, I'll turn it back to Craig for closing comments.

Speaker 2

Thanks, Jonathan. To close, I wanted to spend a minute on what we're seeing in the market today and what we expect for 2024. We continue to see deal activity pick up in the 4th quarter. As Jonathan noted, we had over $1,000,000,000 in both originations and repayments in OBBC. This nearly equates to the total activity we saw in the 1st 3 quarters combined.

Speaker 2

Across our broader Blue Owl direct lending platform, we deployed over $8,000,000,000 in the quarter, the highest quarterly level since 2021. We continue to believe the scale of our platform is an advantage for OBDC as our large origination effort allows us to efficiently match our repayment and deployment activity each quarter in order to maintain a fully invested portfolio and to scale up deployments in quarters where repayment activity is higher. We closed on several attractive new deals in the 4th quarter, including the $1,000,000,000 plus financings for PetVet, New Relic and IFS Envoy, all three of which Blue Owl serves as lead arranger and administrative agent on. We believe our role as administrative agent on these large deals demonstrates the private equity firm's confidence in our platform and as importantly, positions us to maintain frequent dialogue and to have the greatest influence on credit documentation and terms. Further, we continue to benefit from incumbency across our portfolio with significant add on activity for our current borrowers in the quarter.

Speaker 2

As noted earlier, repayments stepped up materially in the 4th quarter as we saw a more active market for refinancings and company exits. We expect repayment activity to continue to revert to these higher, more normalized levels, which could generate meaningful repayment income for OBDC. Looking forward, we expect to see increased market activity throughout 2024. We believe there is substantial pent up desire for private equity firms to return capital to LPs by exiting companies and increased clarity on the rate environment could drive more activity. That said, to date, activity in the Q1 has been lighter, which is consistent with the typical seasonality we see after many issuers seek to transact before year end.

Speaker 2

Reflecting this dynamic and with strengthening public and private markets, we're seeing some pressure on spreads across new investment opportunities. However, we continue to see larger and larger companies doing direct deals. The credit quality is some of the highest we've seen in our history and the structures and terms on new deals remain attractive. Finally, on behalf of the entire OPDC management team, I want to reiterate how pleased we are to have delivered another quarter of impressive results. We are grateful to the investment and portfolio management teams who continue to assess new opportunities, carefully monitor our portfolio companies, the financing team who continues to optimize our liability structure and the entire Corporate Solutions Group who support the company's complex operations.

Speaker 2

As a result of these efforts, we delivered a total return of more than 40% to shareholders in 2023. We once again delivered record NII and a record high NAV per share, ultimately providing a 12.7% ROE for the year to our shareholders. We're also pleased to be able to raise our regular dividend, which we believe reflects our continued confidence in the portfolio. We are entering 2024 on strong footing and believe we are well positioned for the year to come. With that, thank you for your time today.

Speaker 2

And we will now open the line for questions.

Operator

Thank you. We'll now be conducting a question and answer session. Our first question is coming from Brian McKenna from Citizens JMP. Your line is now live.

Speaker 4

Okay, great. Good morning, everyone. So maybe just a question on credit quality to start. The portfolio is clearly in a very strong position today. But could you just provide any details on the one company you added to non accrual during the quarter?

Speaker 4

And then is there any update on the other 3 companies just in terms of resolving these? And then more broadly, can you talk about the size of your portfolio management team today? How much has related headcount grown over the last couple of years? And then then where is the team spending a lot of their time today just given the low level of non accruals today?

Speaker 5

Good morning, Brian. You shoved like 4 questions in there. You're going to have to remind me before I take it to the first couple. Look, overall, we continue to be really pleased with the credit quality of the portfolio. I think it's pretty striking.

Speaker 5

Think back a year ago, rates as high as they were across the space, I think there was a lot of concern about how direct funding credit quality would hold up. And here we are more than a year into this higher rate cycle and we're really happy with credit quality across the board. And I would say the space is our overall has also been really strong. And I think it really is a testimony to the quality of the companies that are coming into the direct lending space, which is as high as it's higher than it's ever been. We had a really de minimis position in a company, a deal image that was less than $15,000,000 of exposure in OBBC.

Speaker 5

We had some really small exposures in several other funds. And it was a business backed by a couple of private equity firms that we do a lot of business with and had some operational challenges and just it just is in a position where we felt it was appropriate to put it on non accrual and we're working through with the borrower and the sponsors a plan going forward. So it's a credit specific issue to that business and not reflective of any greater credit issues. Beyond that, the other three names, nothing to report in the case of 2 of them. Well, I guess one of them we've taken over the business, the other 2 we continue to work with the existing sponsors.

Speaker 5

And I'll just call out one of the names CIBT because I think it's interesting, there's a business that has been on non accrual for us for several years now, was significantly impacted by COVID as a travel oriented business. And it's sponsors have worked really diligently over the last 4 years to try to rehabilitate the company in light of changing travel patterns and the like and continue to own the business and support the business and we and the other lenders in the capital structure working with them. We continue to have that particular position marked at a very low price. But we'll see, we're hoping to do better. We'll just have to see.

Speaker 5

But it really is a testimony to how far the private equity firms work to avoid giving up the companies and that's very much central to our model. I think you asked about resources. We have added significantly to our portfolio management and workout resources. Our investment team overall is about 115 people. There's probably about 15 of those 115 that are doing full time portfolio management and workout.

Speaker 5

Our approach to workout here is some have the same approach, some are different. We have our existing underwriting team that stays involved in the credits. Even if they go into workout, they know the company is the best. And we think that connectivity and consistency is very valuable to maximizing recovery. So beyond our workout team, which is more than enough size, we really use our whole team.

Speaker 5

Many other firms have a different approach, a little more receptive, pushing into the workout group, if you will. So I feel very comfortable that we have the capacity. There was a business POI that we took over during COVID. It's been restructured. We own that business today.

Speaker 5

It's not on accrual anymore. But if look through the marks of our debt and equity position, what you will see is that position, although we took a realized loss way back in 2020, if you take the combined value of our debt and equity in that company today, it's pretty much on top of what our original basis was in the business when we first made the loan. We haven't realized on that yet, so I'm not declaring victory. But I think it's headed in a direction where we'll be able to report at some point that we are declaring victory. I think it's again a testimony to our ability to have a very long time horizon to take over a business, to work with existing management team or supplement that with new management team and to play for long term value creation.

Speaker 5

And I think that's core to being the scaled direct lending business that we are. It's part of our value proposition is maximizing recovery. I think PLI will be hopefully a great case study when we realize it on our ability to do that. So, Brian, I think I got most of it. I don't

Speaker 2

know if I

Speaker 5

missed any, I'll give you one more shot.

Speaker 4

Yes. No, that's great. Appreciate all that color. And I'll hop back into the queue and congrats on another great quarter.

Speaker 5

Thank you.

Operator

You. Next question is coming from Casey Alexander from Compass Point. Your line is now live.

Speaker 6

Yes. Hi, good morning and thank you for taking my questions. Just again, everything I understand that Brian's question sounded like 4 because everything is sort of interconnected. Your discussion about somewhat tighter spreads, private equity, refinancing is up, private equity want to return money back. And the fact that you guys work in the upper middle market, does that all combine to what seems like a little bit of rejuvenation of the broadly syndicated loan market?

Speaker 6

And is that contributing to some of the tighter spreads that you see in the upper middle market?

Speaker 5

Good morning, Casey. I think that's great way to great word for rejuvenation. The bank's willingness to commit to leverage finance deals is completely a function of there being a bid from buyers' loans, primarily CLOs and CLO creation rebounded towards the end of last year and has been quite healthy this year and the strengthening of the syndicated markets is giving the banks confidence to commit to deals and the market is quite good. And so the banks will only commit, distribute and the pricing in that market can be attractive for certain companies. And so you're seeing, I would say, a more normalization of the mix of flows.

Speaker 5

The normal market environment is a fully functioning public market and a fully functioning private market. The trend has been decidedly towards private market execution and direct lending execution. That trend has been going on for certainly since the history of our business and our growth has tracked that trend. But most normal market environments and most of our existence, the public markets have been open and have banks have been wanting to finance deals and the sponsors have been increasingly picking direct. But in this environment, they've got choices and they're making those choices.

Speaker 5

And I think that's a healthy market environment. It does contribute to some of the spread compression in the first half of last year. The pulp markets were shut and so no naturally direct lenders such as ourselves could charge more. And today pulp markets are open. And so there's a price check there and that can contribute to spread compression.

Speaker 5

To be forthright, I think spread compression is also a function of a really good economy, expectation that rates are going to come down and just generally health of the markets. But private credit has raised capital. We have capital. Other direct lenders have capital and so there's competition. So we're on the tight end of the range of spreads that we see in direct lending.

Speaker 5

I think it's kind of trough probably where it is now, but it's on the tighter end of where things are. So I think that pendulum will swing back and forth. I like to talk about the secular and the cyclical. The secular trend is going to continue to be the direct lending. There will be cyclical periods of time where it skews a little more to the public markets, a little more to private markets.

Speaker 5

Right now, I think it's a pretty healthy balance. And so you're seeing some spread tightening.

Speaker 6

Okay. Thank you. That's very helpful. My follow on question is, last two quarters you've raised base dividend a couple of times. In the face of what is generally a consensus that as you mentioned that rates are going to normalize some, so you got rates going one way and your base dividend going the other way.

Speaker 6

What gives you the confidence that you're going to be able to maintain and cover that adequately as rates come down? Is it potential growth of the JV or the specialty finance verticals Or is it expanding the leverage ratio somewhat? You've got kind of a modest ratio right now. But I'm curious and holistically how you mix all of those things together to make sure that the Board has confidence to raise the base dividend again?

Speaker 5

Sure. So I think that we've tried to be really thoughtful about our dividends. I would pull the lens back to more than about a year and a half ago when the square rates had gone up and we felt really confident that the portfolio was not only performed but generate a really much higher step function, higher level of income. And we thought about how do we what's the right way to share that with shareholders. And we introduced this notion of a supplemental dividend, so shareholders would have a very predictable understanding of how our earnings in higher rates or lower rates would flow through to them.

Speaker 5

And we thought that and we got a lot of great feedback on that. I think that mechanism has worked really well. And so we had our base dividend at that time, we raised from 31% to 33% and we had the supplemental. And what happened since then is rates have stayed higher for longer, portfolios are extremely well. And look at it, we've generated terrific earnings, record earnings 4 quarters in a row.

Speaker 5

And so what our shareholders have enjoyed is growing supplemental in a base that was more than adequately covered. And so we wanted to think hard. We don't we're not just complacent with that success. We wanted to think hard about do we have the balance right. And we looked at our peers and their payout ratios and we did a lot of work around our portfolio and sensitized as you would expect us to as rates drop and making some thoughtful assumptions about credit performance, do we have cushion to raise the dividend further?

Speaker 5

And we felt really comfortable that even in a lower rate environment and making some appropriate assumptions around credit quality, that we have more than enough cushion to raise the dividend an additional $0.02 a share. And so we did that. Naturally, it's not this isn't complicated. We invest in floating rate assets. If rates come down, earnings are going to go down.

Speaker 5

Rates went up, earnings went up. And every shareholder should understand that. It's some fundamentals investing in a BDC or something like BDC like ours. But what we would expect over time is if rates come down, we tend to look at the forward curve. We feel very comfortable continuing to earn our base dividend.

Speaker 5

But we're putting more of our dividend in the base and the supplemental will be lower if rates come down. And I think that's the cushion of that supplemental. We just put up $0.51 a share. We raised the base of $0.37 a share. There is plenty of cushion there.

Speaker 5

And so we felt really comfortable. So fundamentally, as to your question, we looked at it holistically. We're going to just keep doing exactly what we're doing. We feel really confident in our portfolio. We don't need to change any levers.

Speaker 5

We will continue to do what we have said, stay on our target leverage range, certainly would like to tweak that higher, continue to invest in some of our specialty finance verticals. Those are accretive, especially in the lower rate environment. But fundamentally, just continue to deliver great credit performance and we feel good about the new dividend model.

Speaker 6

Thank you.

Operator

Thank you. Our next question today is coming from Eric Zwick from Hovde Group. Your line is now live.

Speaker 7

Thanks. Good morning, everyone. I wanted to start first with a question on the pipeline. And I know in the prepared comments, you mentioned that activity has been kind of seasonally slow to start, but not out of the range of normal. I'm just curious, as you look at the pipeline today, what it looks like in terms of the mix of new versus add on opportunities and whether also you're seeing any commonalities in the kind of themes in terms of industries or type of companies that are in the pipeline look attractive today?

Speaker 5

Sure. It's a mix. New opportunities, add ons, refinancings, it's a mix. I would tell you that it's my hopeexpectation that at some point this year we'll see a significant pickup in new buyouts. I mean new buyout activity remains moderate.

Speaker 5

And I think that that should pick up given generally a more stable rate environment, good economy, sponsors have lots of capital to deploy and they really have a imperative to return capital to their LPs and that should reflect itself in selling companies that would result in new financings. So I would I was hopeful we might see that starting in the Q1, seeing some, but I wouldn't say it's a real resurgence. But at some point this year, I think we will. So it's a healthy mix. At some point, I think it will be more skewed to new buyout activity.

Speaker 5

There are some of those, but it's not, I wouldn't call it robust, I would say it's sort of a reasonable environment that I would expect to increase over time.

Speaker 7

Thanks. And next just looking at your common equity portfolio continues to grow in both dollar terms and as a percentage of total assets. How are you thinking about these investments in terms of the overall concentration? And what is your inclination to realize some of the embedded gains and over what potential timeframe?

Speaker 5

Sure. So, look, I think that for shareholders that are less familiar with our company, while technically those investments referring to are common equity investments, the vast majority of them, our equity investments in specialty finance verticals, where essentially their portfolio companies, OBDC, where the underlying assets are

Operator

pools

Speaker 5

of typically 1st lien senior secured loans. And so the credit characteristic of the vast majority of our common equity more than half of it is an income stream, it's a dividend stream of a diversified portfolio of loans underwritten by management teams and companies with deep expertise in the domain that they're investing in. So again, for those of you who are newer examples, Wingspire to their asset based lending business, 5th season, which is our life insurance settlements business, Ameringen, which is our rail and aircraft business. These are all essentially portfolio companies that have very diverse pools of assets that generate income. And we are an equity owner, but we are getting an economic very consistent predictable and growing income stream that we think will generate generally double digit ROEs.

Speaker 5

And we have been building each of these in a very sort of patient and methodical way. And in addition to that income stream, if our teams do a good job, we also have an asset, an equity investment in asset that's valuable and valuable to us, valuable to others and as we create an enterprise value through our ownership stake in those businesses. We've grown that part of our portfolio and continue to do so. But it would be sort of off key of it to think of that as a common equity investment. From an accounting standpoint, it certainly is.

Speaker 5

But from our standpoint, it's really just a pool of assets that generate income to us and that as we invest more, we will earn more. No plans to realize on any of that. We do have a much smaller number of either equity co investments. We have a couple of positions. I mentioned POI a minute ago.

Speaker 5

We took over a business. But the combination of like what I'll call pure equity is like 2% or 3%. It's really de minimis. And so I think this has been a powerful return generator to build long term income and long term gain for OBDC and we'll continue to do so. But I would urge shareholders to spend a minute understanding it and become a way I think really happy with it.

Speaker 5

When we did our Investor Day last year, we did a whole section on this. I think all that's still available on our website. So again, if you're newer, please take a listen or have e mail us if you're not sure how to get hold of it. Obviously, I think it will come away. I'm not really, but I would hope excited about what we're building in some of these verticals.

Speaker 7

That's a helpful explanation. And last one for me, looking at Slide 13, there was about a $100,000,000 increase in the portfolio companies rated either 4 or 5. So wondering if you could just talk a little bit about the recent developments of those companies that drove the downgrades during the quarter?

Speaker 5

Yes. We I alluded to this on the call. Our overall rank percentage rate at 3.45 which for us is underperformance, stayed the same. But I made a point of calling out on the call that we did have an increase amidst those 3, 4, 5s in the 4, 5 category. We don't put out individual ratings disclosure on each name, but you'll note we certainly have a couple of names on non accrual.

Speaker 5

And so those one of the movers was a non accrual name. The other was one of our more significant marks down this quarter. So I wouldn't what I would offer you is, at this point in the cycle, given how rates are, we have had expected and we mentioned it again on this call and mentioned it pretty consistently in our earnings calls that we would expect to have a few credit issues, just given the magnitude of the rate move. And so couple of those downgrades are reflective of credits that have been performing well, well expectations combined with higher debt burden starting to catch up to them. But what I would say is the fact that the 345s as a grouping has stayed stable, essentially that's our watch list.

Speaker 5

Because our watch list has stayed stable. We're not adding new names of concern. There's really just less than a handful of names that have been a concern for a year and that concern is growing as their credit problems continue to fester in a higher rate environment. So that's what that is. I don't want to minimize it.

Speaker 5

These are the areas that I spend the most time on with our workout team and hope that we can reverse the course on a couple of these, but they are a concern. But again, you're talking about the overall portfolio, 1.7% of the portfolio in aggregate. So it's a very small pool of a few names that we're going to continue to spend a lot of time on.

Speaker 7

I appreciate the answers, Craig. Thanks for taking my questions today.

Speaker 5

Great. Thank you.

Operator

Our next question is coming from Paul Johnson at KBW. Your line is now live.

Speaker 8

Yes, good morning. Thanks for taking my questions. Kind of looking just at on fee income going forward, obviously, it was a very active quarter for you guys, but a slower year overall, I mean, dollars 16,000,000 or so fee income on a $13,000,000,000 portfolio. I mean, do you think in the relatively near term, maybe over this year, there's potential to generate some fairly meaningful fee income there to offset some of the potential decline from rates?

Speaker 3

Yes. I mean, this quarter, we had $1,000,000,000 of sales and repayments and we had some fair amount of prepayment related income. As we said, that was some of the driver of the earnings. And I think that you can certainly expect relative to last year where there was very muted activity, an increase and for some of that fee income to represent an offset to the rates. Depending on those rate moves, will it be dollar for dollar?

Speaker 3

Certainly, we couldn't say depending on the magnitude of those rate moves, but certainly a pickup in that activity will in overall activity will mute or dampen the decline in income from rates.

Speaker 5

I hope at some point, I talked about a world where there's real pickup in M and A activity. In that world, it would stand to reason that we see meaningful pickup in fees as well as accretion. So I expect it to happen. This number has been to little bit better this quarter, but it's been sort of frustratingly low. I expect it to happen at some point.

Speaker 5

I don't want to I'm not necessarily saying it will happen in the Q1 either, but at some point in a much more robust M and A environment, it should pick up nicely.

Speaker 8

Thanks. And I guess as the leverage loan market starts to come back, there's more syndicated activity. I mean, did you expect to potentially see some of those deals that are in the pipeline today potentially flip over to the liquid market?

Speaker 5

We I expect to see again, the public markets are wide open today. It's not something we have to wait to see. It's already happened. It's happening now. Our pipeline of deals we're looking at, the sponsors are actively making choices about how they want to finance them.

Speaker 5

And today, despite wide open public market, they continue to choose direct money for certain deals in the public market for certain deals, as it has been and as it will be. And that's ordinary course decision making. We I would expect in this environment that will get repaid from some companies that choose to refinance in the public markets. We've seen a little bit of that. I expect we'll continue to see some of that particularly really high quality companies in our portfolio have been there for a while.

Speaker 5

They have performed, delevered and can get a good execution. So that will generate some income from us. As sort of the normal circle of life, if you will. I expect us to continue to do that. So I think it's just a normalized market.

Speaker 5

I think we had an environment a year ago when it wasn't a normal environment. Everything was going direct. If we pull back, we would have cautioned you not to assume that would stay that way forever. That was not a normal state of affairs. This is a normal state of affairs and a healthy one and one that we can continue to have really good success originating deals and getting new payments and keeping our portfolio invested.

Speaker 8

Thanks. Appreciate that. And then public valuations have been surprisingly strong last year and into this year in the growth market, tech sector, I mean really the broader market, the public markets as a whole. I feel like that's maybe been a little bit contrary to kind of what's going on in the private markets last year with the adjustment to higher peak rates. I'm just curious, how does that affect the companies in the upper middle market that you're looking at today?

Speaker 8

I mean, have you seen this kind of multiple expansion that we've had in the public markets or I'm just curious to how that affects the market that you guys play

Speaker 5

We continue to see private equity firms have a tremendous amount of capital, tremendous amount of expertise, a really tremendous track record of finding opportunities to deploy that capital, generate great returns for their LPs. Private equity is a very it's a market that the institutional piece like quite a bit have significant exposures to and have generated really terrific returns in excess of public markets often over many, many years. That's the market we choose to back. We work really closely with the private equity firms And they were active last year, it wasn't quite as robust year as they would all like, at some point that will pick up and resume. But I just want to make a point, which is an obvious one, but I'll make it anyway.

Speaker 5

We are on average lending at 40% loan to value. We're lenders. We want to have a lot of equity cushion. We want to have commitment from the private equity firms in form of capital and form of resources. Their role is to figure out valuation and whether they can get a great return.

Speaker 5

Our role is to acquire a loan that we feel really confident in a downside scenario we can get repaid. I think that part of the reason why you haven't seen as much private M and A resuming is the sponsors I think are being patient. They see some of what you're seeing. They see the pulp market valuation is high and they're not going to rush to sell companies once they feel really confident they can get the valuation that they deserve. That means they wait 6 months or a year, they're doing that.

Speaker 5

I think that's probably why M and A has slowed down. But I don't want to sound flip or trite about it, but it's like not our problem. Our problem is just making sure we're backing good companies with significant equity beneath us and that even if valuation comes down meaningfully, we're going to be covered. And I think that's central to our underwriting thesis. And we don't get distracted by public market valuations that might be a federal or even private market valuations that might be a bit too high.

Speaker 5

We just go through our downside analysis, assume operational results are off, value multiples are lower, will we get our money back and that's how we look at it.

Speaker 2

It. Got it.

Speaker 8

Thanks for that, Craig. Those are all my questions today.

Speaker 2

Congrats on a good quarter.

Operator

Thank you. Next question is coming from Mickey Schleien from Ladenburg Thalmann. Your line is now live.

Speaker 6

Yes, good morning. I apologize if my question has already been asked, but I'm juggling multiple calls. Craig, you mentioned that the BSL market is normalizing. And I'm interested in understanding how you see that impacting the spreads that you may be able to capture as the year progresses and going into next year?

Speaker 5

Sure, Mickey. We did talk about this a bit. We in my prepared remarks, I mentioned that we don't see spreads tight. It's tightened because the public markets have been open. They are open.

Speaker 5

They're normalized. They're not normalizing, they're normalized. And so that's a price check that private equity firms will look at. And generally it's a moderate deal flow environment and public markets have a lot of capital, private markets have a lot of capital. So you've seen some spread compression.

Speaker 5

I think almost all of that has already taken effect in how we look at new deals. And don't think it's going to go much higher than we are now, but it's on the tight end of historical ranges. Absolute returns on our lending remain very high because current short term rates remain very high. And so even if we do it, the unitranche at 5.50 over current base rates, we're still earning 11 plus percent. But we all recognize that there's a good likelihood that in 2 years that base rate will be equally lower and so we'll earn less over time.

Speaker 5

By the way, I think markets are coming aggressive exactly how best rates will come down and what that will look like and maybe there's a bit of a reconsideration there, but we're assuming we look at the forward curve. So spreads are tighter, they're livable, they're more on the annoying category than in the do the returns work for us, we still get great returns. And it's a more just a back to a more typical market with sponsors and companies picking between private and public markets. We continue to get a premium for private solutions. And that premium is not only higher spread, but essentially the OID that we get to underwrite at, we continue to offer premium.

Speaker 5

But I always like to remind clients and shareholders is, you got to think about on a relative basis, We may not be earning as much, but all the markets tighten and we're still earning a nice premium and we earn premium in all market environments and we'll the relative premium should stay the same, but the absolute return will move around based on market conditions. So hopefully that gives you a little bit of context.

Operator

Thank you. Next question today is coming from Kenneth Lee from RBC Capital Markets. Your line is now live.

Speaker 9

Hey, good morning. Thanks for taking my question. Just to piggyback on the broadly syndicated loan questions. Do you anticipate any kind of shift in either of these sectors you're normalization of the leverage loan markets? Thanks.

Speaker 9

Yes. Just given the normalization of the leverage loan markets? Thanks.

Speaker 5

We're really boring on this. It's not sort of like lack of thought on our part. We really like recession resistant sectors with very predictable earnings in non cyclical parts of the market. We're not trying to time the economic cycle. And we track private equity activity.

Speaker 5

And so consistently where we find the best opportunities, software, insurance brokerage, some parts of healthcare, food and beverage, a lot of services businesses, distribution businesses. That's our sweet spot. Those have been our most significant sectors for years. And we continue to see a lot of activity there. Software continues to be the best sector that we have.

Speaker 5

We offset several funds that is software space, but it's the biggest single industry sector for many of our funds. Tina like that a lot and we're not going to deviate from that. And so I think that should be reassuring to investors, we made 7 year loans even if we thought the economy might be really good for cyclicals for a year or 2. We're not willing to underwrite stable economic conditions for 7 years. And so we think that that's the right approach.

Speaker 5

So no change. We lent to a lot of businesses that the underlying economic feature is a very predictable and recurring revenue stream. That's the single defining factor of our underwriting process. And you can find those types of businesses that serve a variety end markets depending what they do and that's really what we seek out.

Speaker 9

Got you. Very helpful there. And one follow-up if I may. In terms of the new investments, I wonder if you could just give a little bit more color in terms of what you've been seeing in terms of terms and documentation on your investments and whether there's been any change just given the current landscape? Thanks.

Speaker 5

Overall, terms and protections remain very strong for direct lending. And I would sort of underscore this, the protections that we get are significantly better than what's in the public markets. That's fundamental to what we do. We care not only about business and the returns, but the credit protections given our significant exposure to the companies, given that the liquidity that we have, we need to be in a position to protect ourselves and the CLOs that buy public loans, simply don't have nearly the same credit protections. It's really pretty dramatically different, in particular in areas around protecting our collateral at cash flow leakage and the like.

Speaker 5

So we just get much better protection is fundamental, we won't sacrifice that, have not, will not. It's they're on the edge, there are a few things that can creep in when markets are strong as they are now, which we will do selectively if the rest of our credit protections and economics are appropriate. But I'd say fundamentally leverage on the deals, along the value on the deals, credit agreements are fundamentally consistent with what we've been doing the last 7 or 8 years, no change. You'll read about portability, PIC, there's a couple of features that are crept in. We do those in very, very small number of circumstances for really, really high quality credits in a very reason way it's not reflective of overall market conditions, but you will see a couple of deals done in that matter.

Speaker 5

And I think for the right credits, we're willing to consider those markets willing to do it, but nothing that would sacrifice our credit quality. It's fundamental to us and I feel really good about that for every loan that we do and if not, we won't do it.

Speaker 9

Got you. Very helpful there. Thanks again.

Operator

Thank you. Next question is coming from Maxwell Pritchard from Truist Securities. Your line is now live.

Speaker 10

Good morning. I'm calling in for Mark Hughes. In the prepared remarks, you mentioned that net leverage ratio ticked down, which we've seen for the last several quarters. Is there a specific range you had in mind for 2024, 2025 as investment activity presumably starts ramping up?

Speaker 5

The range is the same range we've been happy with what we said for a long time, 0.9 to 1.25. This quarter we had $1,000,000,000 origination, dollars 1,000,000,000 repayments. We can't manage that leverage ratio with a scalpel. It's a little bit of just a function of fuel flow. I look on the margin, I prefer it to be a tick or 2 higher, but there's nothing deliberate about us trying to tweak it a bit lower.

Speaker 5

I think it's just a function of fuel flow and we'll try to optimize a little bit. Our returns are terrific. We're putting up record returns, record ROE, record NII, record NAV. And so I think it should be reassuring that we can do all that and have leverage not be at our peak. We're not stretching new deals, we're not stretching the mass leverage to try to grind out returns.

Speaker 5

We can do it very comfortably and it gives us a little bit of our own quiver over time to offset if there is a little bit of rate reduction.

Speaker 10

Helpful. And so you mentioned the industry that you find attractive, but are there any particular industries in your portfolio that are having more credit issues than others?

Speaker 5

We have very few credit issues. So there's no sectors that are having more credit issues than others. We have almost none. I would say overall really consistent across the board low single digit revenue and EBITDA growth. There's a couple of consumer facing businesses that are having a bit of struggle.

Speaker 5

There's a couple of industrial businesses that were benefiting when supply chains were loosening up and maybe they're facing some commodity price pressures or some supply chain challenges. So I'd say every company is doing perfectly well to have a watch list. But there's no thematic comments I would make about areas of great weakness and I think that speaks to the broad strength of our portfolio.

Speaker 10

Okay, got it. Thank you.

Operator

Thank you. We've reached the end of our question and answer session. I'd like to turn the floor back over to management for any further or closing comments.

Speaker 5

Thank you so much for everyone for joining. We're really pleased with the quarter. If you have any other questions, please reach out. We'd love to engage with you and we look forward to seeing you and speaking with you again soon.

Operator

Thank you. That does conclude today's teleconference and webcast. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.

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Earnings Conference Call
Blue Owl Capital Q4 2023
00:00 / 00:00