Description

BXSL is a BDC managed by Blackstone. BXSL differentiates itself from other BDCs by its conservative lending practices, positive exposure to rising short-term rates and shareholder-friendly structure. At current prices, BXSL has a 10% dividend yield with earnings power likely to increase 30-50% over the next 2-4 quarters due to rising short-term rates. BXSL has zero credit losses today and even though credit losses will certainly normalize, I believe BXSL is a good place to park some cash and earn a 10% yield.

I believe BXSL has a more conservative credit book than most other BDCs. BXSL’s loan portfolio has a weighted average LTV of 46% and 98% of its portfolio is first-lien debt (BDC universe average is 65-70% first lien). BXSL also lends to larger companies who tend to have better management teams and stronger financial sponsors – the weighted average EBITDA for its portfolio companies is $149m. As part of the larger Blackstone credit platform, BXSL is one of 3 public BDCs who can compete in large private debt deals (the others are ARCC and ORCC), so large private loans are less competitive than middle-market private loans where there are dozens of competitors. Blackstone credit’s direct loan platform has had an annualized loan loss rate of 0.11% from Dec 2006 through Jun 2022 and as of 6/30/22 BXSL had no non-accrual debt investments. BXSL has a diversified portfolio but is underweight cyclical companies with its largest sector exposures being software (14%), healthcare providers & services (14%) and professional services (7%).

As short-term interest rates rise, BXSL’s earnings will benefit as almost 100% of its debt investments are floating rates (typically LIBOR/ SOFR base rate +500-600bps) and 55% of its debt outstanding have fixed rates (fixed rate debt has an average cost of 3.0%). On the Q2 ’22 call, BXSL’s CEO said: “…expect earnings to go up 25% to 50% depending on your view on rates…” I think this outlook is very achievable over the next few quarters as rate increases flow through the income statement with a 1-2 quarter lag. BXSL earned 62c per share in Q2 ’22. In Q2 ’22 the average base rate for their portfolio was 1.1% despite 3mo LIBOR ending Q2 ’22 at 2.3%. BXSL estimates if the base rate at the end of Q2 were in place for the entire Q2, earnings would have been 11c per share or 18% higher. In addition, if base rates were to increase a further 100bps earnings would have been 20c per share or 32% higher. Currently, 3mo LIBOR is 3.6%, or 120bps higher than the Q2 ’22 ending level, so at the current level of short-term rates, BXSL’s quarterly earnings power should be 84c (22c or 35% higher than Q2 levels) by Q2 ‘23. The rates market is forecasting another 100bps of Fed hikes by end of 2022, so earnings power could be 90c/Q (or ~45% higher than Q2 ’22) by Q3 ‘23.

BXSL has a more shareholder friendly structure than other BDCs. For one, its fee structure is 1% annual mgmt. fee +17.5% incentive fee. This is on the lower-end of the BDC universe – annual mgmt. fees range from 1.0%-1.75% and incentive fees range from 17.5%-20%. Note that for the first 2 years post IPO (until Oct 2023), BXSL fees are capped at 0.75% + 15%. In addition, BXSL has a 6% annual total return hurdle with a 3-year look back.  Thus, if total returns are below 6% annually on a trailing 3-year basis, BXSL will not earn incentive fees. The majority of the BDC universe does not have a total return hurdle. The benefit of a lower fee structure is two-fold: 1) shareholders get to keep more of the returns and 2) with a lower cost structure, the manager can build a portfolio of lower-yielding (and lower-risk) securities to deliver a competitive return to investors. As another example of shareholder friendliness, BXSL has in place a share repurchase authorization and is buying back shares when they trade below NAV.

Of course, BXSL’s credit losses will not stay at zero forever, but with the benefit from rising rates, I believe BXSL can maintain its dividend in a “normal” recession and can stay profitable in a severe recession. Using an annual 6% loss rate as a “stress test,” I believe BXSL will be net income positive in a severe scenario. A 6% loss on the portfolio is $3.50/sh, which deducted from 90c/Q earnings power and adding back 33c/yr in incentive fees results in 43c in “stress test” earnings. Note that peak annual leveraged loan loss rates during the 2008-2009 financial crisis were 5-6% and Fed Stress Test assumptions for C&I loans are 7.9% losses over 2 years. Another way to conceptualize the 6% loss rate assumption is 10% defaults across the portfolio and 60% recoveries. A less draconian “normal” recession scenario would be defaults of 3% and ~70% recoveries leading to a 2% annual loss rate. Deducing 2% loss rates ($1.20/sh) from 90c of quarterly earnings power results in $2.40 of annual earnings, which is equivalent to the BXSL’s current dividend level.

Despite the favorable outlook for earnings, BXSL trades at 95% of NAV. I think the primary reason for this discount is an overhang resulting from its IPO in Oct 2021. Prior to the IPO, this was a private BDC so there are shareholders who have been selling since the IPO. As of July 1, 2022 all the pre-IPO shares were unlocked and available for sale. While it’s impossible to know when the selling overhang will be completed, I think that with earnings inflecting positively and the company opportunistically repurchasing shares below NAV, this is a good entry point for BXSL.

Catalyst

Rising short term rates flow into earnings over the next few quarters