Blackstone Secured Lending Fund

NYSE:BXSL

Earnings Call Analysis

BXSL Stands Strong Amid Rising Rates

In a rising interest rate and slower economy, BXSL focuses on first lien senior secured debt, believing it to be the safest investment, constituting over 98% of its portfolio. Investments are predominantly in sectors with historically lower default rates, larger scale companies, and backed by private equity firms. BXSL has outperformed peers with less than 0.1% of loans non-accrual and a dividend increase of 45% since IPO, covered by earnings at a strong 123% ratio. Net investment income grew 25% year-over-year to $161 million, driven by higher interest income, with a GAAP net income of $171 million for the quarter, translating to a robust 14.4% annualized return on equity. The balance sheet shows a spread between floating rate assets and lower-cost mostly fixed rate liabilities, with a NAV per share increase to $26.54. Discussions reveal considerations about market dispersion, with credit performance expected to be influenced by sector seniority, scale, and a potential increase in defaults in sectors that don't generate much cash.

Disciplined Portfolio Construction Emphasizing First Lien Senior Secured Debt

BXSL has deliberately structured its portfolio to predominantly hold first lien senior secured loans, constituting over 98% of its investments. These selections are influential in a high-interest rate, slow-growth economy, aligning with a conservative stance prioritizing preservation of capital. Such loans are largely extended to companies backed by equity sponsors like private equity firms, who not only maintain considerable equity investments in these ventures but historically demonstrate a commitment to bolster their portfolio companies. BXSL's selective approach reflects in the weighted average loan-to-value at 46.9%, and the company maintains a low non-accrual rate of less than 0.1% at cost, which is significantly below the average in its peer group.

Dividend Growth and Strong Coverage Ratio

Investors would be encouraged by BXSL's increased dividend, now at $0.77 per share, representing a 10% jump quarter-over-quarter and a significant 45% spike since its IPO two years ago. Dividends are well-covered, with earnings at 123% of the distribution, showcasing BXSL's capability to sustain shareholder returns amid economic challenges.

Robust Financial Performance

The third quarter saw BXSL's net investment income reach $161 million, which translates to $0.95 per share. This 25% year-over-year surge in total investment income is primarily attributed to heightened interest income, bolstered by elevated rates. Importantly, the quality of earnings is underscored by its high-interest income proportion, which, excluding payment-in-kind (PIK), fees, and dividends, forms 96% of the total investment income for the quarter. The financial strength is further reflected in the net asset value per share, which increased to $26.54 from $26.30 in the preceding quarter. This performance can be traced back to a carefully curated portfolio, prudent balance sheet management, and attention to sectoral and company scales, where BXSL's average portfolio scale notably surpasses that of the broader private credit market.

Investment Strategy Focused on Scale and Quality

BXSL emphasizes investing in larger companies with substantial market shares and the capability to navigate economic downturns. The average EBITDA growth of companies in BXSL's portfolio far exceeds that of smaller enterprises, and these businesses exhibit superior profitability and growth metrics. BXSL's strategy also entails direct relationships and incumbency advantages, allowing it to leverage its broad relationships, such as with New Mountain Capital, to create a favorable deal flow and client rapport. The company's value creation team exemplifies this strategy by working proactively with portfolio companies to identify cost savings and growth opportunities, providing more than just financial support but also strategic assistance to enhance performance.

Leverage and Debt Structure Optimized for a Rising Rate Environment

BXSL keeps its leverage under control, targeting a debt-to-equity ratio between 1x and 1.25x, and maintaining floating-rate liabilities, which could become more profitable as rates climb. The portfolio holds predominantly floating rate loans, which, combined with lower-cost mostly fixed-rate liabilities, positions the company to potentially capitalize on future rate increases. Additionally, a diverse and strong liability profile furthers BXSL's resilience, marked by an investment-grade rating and a substantial liquidity pool, which endows the company with substantial transactional flexibility and a cushion to cover dividend payments and growth ventures.

A Forward-Looking Approach to Market Dispersion and Credit Cycles

In anticipation of varied market performance, driven by sectors' susceptibility to interest rate surges, BXSL has focused on sectors and companies that are more resilient, particularly those with larger scales and those less dependent on strong economic conditions. Moreover, the company fortifies itself against potential defaults by paying close attention to company performance indicators and preemptive intervention. As defaults may rise in several sectors including healthcare and industrial manufacturing, BXSL's emphasis on seniority, sectors, and scale, its sophisticated underwriting processes that include AI, and a comprehensive investment office, all contribute towards shielding its portfolio from future market volatility.

Earnings Call Transcript 2023-Q3

[Operator]

Good day, and welcome to the Blackstone Secured Lending Third Quarter 2023 Investor Call. Today's conference is being recorded. [Operator Instructions].

At this time, I'd like to turn the conference over to Stacy Wang, Head of Stakeholder Relations. Please go ahead.

[Stacy Wang, executive]

Thank you, Katie. Good morning, and welcome to Blackstone Secure Lending's Third Quarter Call.

Earlier today, we issued a press release with a presentation of our results and filed our 10-Q, both of which are available on the Shareholders section of our website, www.bxsl.com. We will be referring to that presentation throughout today's call.

I'd like to remind you that this call may include forward-looking statements, which are uncertain and outside of the firm's control and may differ materially from actual results. We do not undertake any duty in updating these statements, for some of the risks that could affect results, please see the Risk Factors section of our most recent annual report on Form 10-K. This audio cast is copyright material of Blackstone and may not be duplicated without consent.

With that, I'd like to turn the call over to BXSL's Co-Chief Executive Officer, Brad Marshall.

[Brad Marshall, executive]

Thank you, Stacy, and good morning, everyone. Thank you for joining our call this morning.

With me today is, Co-CEO, Jon Bock; our President, Carlos Whitaker; and our CFO, Teddy Desloge.

Turning to this morning's agenda. I will start with some high-level thoughts before Jon, Carlos and Teddy go into more detail on our portfolio and third quarter results.

Looking at the presentation and turning to Slide 4. I want to highlight that Q4 marks the 2-year anniversary since our IPO in 2021. I'm very pleased with the results that we have delivered to our shareholders, and I'm very confident in the strength of the portfolio we have built, and highly optimistic about BXSL's investment opportunity set.

Focusing on the third quarter, BXSL reported another strong quarter of results including growth in net asset value and net income per share, along with higher regular dividend distributions, all built on BXSL's strong credit fundamentals with a predominantly first lien portfolio invested in large resilient businesses in historically low default sectors.

Looking at the details, our 98.8% floating rate portfolio continues to benefit from sustained higher interest rates. Net income per share increased 12% to $1.01 per share in the quarter compared to second quarter, and is up over 74% compared to last year at this time. Net investment income or NII, of $0.95 per share represents a 14.4% annualized return on equity.

The quality of our earnings remains high, with limited payment-in-kind, limited nonrecurring and fee-driven income. Further, interest income, excluding PIK, fees and dividends, represented 96% of our total investment income in the third quarter. I'll repeat that. Interest income, excluding PIK, fees and dividends represent 96% of our total investment income in the quarter.

We distributed our previously declared increased dividend of $0.70 per share as well. This represents an 11.6% annualized distribution yield, one of the highest among our BDC peers with as much of its portfolio invested in first lien senior secured assets. while covering our third quarter dividend by 123%.

In a higher interest rate environment, investors may benefit from an elevated interest income yield. However, higher interest rates place pressure on floating rate borrowers. As a result, we continue to focus on building our portfolio with the intention of protecting investors' capital.

During the third quarter, more than 99% of funds invested were first lien senior secured with an average loan-to-value of 35.9%. As of September 30, BXSL portfolio is over 98% first lien senior secured with 46.9% average loan-to-value. We have a minimal nonaccrual rate below 0.1% at both amortized cost and fair market value, and approximately 1% of debt investments marked at fair value below 90. We believe our net asset value, which increased to $26.54 per share in the third quarter, from $26.30 the previous quarter further highlights portfolio stability.

Turning to page -- Slide 5 of the presentation. We saw a meaningful increase in new investments ending the quarter with $656 million at par in new investment commitments, and $390 million in investment funding during the quarter, compared to $144 million new commitments and $117 million funded during the last quarter. Unfunded commitments represent -- commitments increased to $761 million in Q3 compared to $551 million in Q2. Proceeds from third quarter sales and repayments were $205 million.

During the quarter, we also issued $210.7 million of additional common shares before underwriting and offering costs, through both an underwritten public follow-on offering and our existing ATM program at accretive levels to BXSL.

We have seen an uptick in our investment pipeline since the first quarter, the number of deals in the pipeline doubled as of the end of Q3 versus the end of Q1. These pipeline deals are predominantly first lien senior secured exposure in companies with historically recession-resilient sectors, we know very well. Important to highlight, we are also seeing a resurgence in transactions valued in excess of $1 billion, with a number of these larger deals also increasing by 2x in our pipeline during the same period.

Looking forward, we are optimistic about the outlook of new investment opportunities, driven by what we believe is a more active M&A environment and additional financing needs from our existing portfolio of over 3,150 corporate issuers across Blackstone Credit.

I also wanted to highlight the firm's recently announced integration of our corporate credit asset-based finance and insurance groups into a single new unit, Blackstone Credit and Insurance, or BXCI. We are very excited about the integration as we believe it will further expand the capabilities and scale of our platform, and create more seamless experience for both our clients and borrowers by offering a one-stop solution.

As the demand for private credit continues to expand, the BXCI integration should allow us to better capture this opportunity. For BXSL specifically, the integration should allow us to lean into our core key areas of differentiation: scale, expertise and value creation.

Taking those in turn, as it relates to scale, it's not just about scale of capital, but it's about the scale of the platform, a scaled platform like Blackstone often allows us to have deeper connectivity with M&A advisers, with banks, with corporates, with sponsors, all of which we extend globally.

As it relates to expertise, I don't think there is any credit platform that has as extensive a reach in certain sectors as Blackstone. We have 950 technologists that support our different platforms. We have over 100 advisers. We have 28 PhDs, MDs, doctors. All of this really helps us be smarter in certain areas of expertise like tech software, life science, health care and energy transition.

As it relates to value creation, this remains a core focus of ours. We aim to add value after we make our investment in the company. And as we have highlighted in the past, over 90% of the companies we finance through Blackstone Credit that are offered these programs, use it.

So when I put all of that together, we are the sole or lead lender in approximately 84% of the transactions in BXSL, which shows that companies seek Blackstone Credit to lead their financing transactions, which allows us to better negotiate the terms that govern these loans instead of being a passive investor in the capital structure. We believe passionately in these advantages. And in developing a highly defensive portfolio that is predominantly senior and investing primarily in scaled businesses in historically lower default sectors.

Relative to our peer set, we believe BXSL leads the market on quality of income, as I mentioned earlier, quality of the portfolio, which we just discussed, quality of our liabilities, which you'll hear about a little bit later, and the quality of our structure and alignment.

So with that, I will turn it over to Jon Bock.

[Jonathan Bock, executive]

Thank you, Brad. And Brad mentioned the focus on building a healthy and defensive portfolio that we believe allows us to continue to take advantage of our expanded pipeline from a position of strength.

So jump to Slide 6. We ended the quarter with $9.5 billion of investments. We also continued to delever modestly. The fund leverage at quarter end was 1.08x and quarterly average was 1.11x, and those are well within our target range of 1 to 1.25x. We also remain well positioned with $1.5 billion of liquidity comprised of cash and borrowing amounts available across all our revolving credit facilities to lean in to that expanded pipeline, Brad mentioned.

Our weighted average yield on debt investments at fair value continues to increase steadily, to 11.9% at this quarter end, from 11.8% last quarter, primarily driven by higher base rates. New investments continue to be accretive to our investment income. The yield on new debt investment fundings during the quarter averaged 12.2%, while yield on assets repaid or sold down averaged 11.6%, improving our weighted debt yield in the portfolio.

And importantly, the base rates of the third quarter expanded approximately 300 basis points or a 98.8% floating-rate debt portfolio compared to the same quarter in the prior year. In this environment of higher rates, we continue to focus on constructing a portfolio for resiliency and downside protection.

So jump to Slide 7. Since BXSL's inception, we've been disciplined in building our portfolio to focus on first lien senior secured debt, as we believe that is the most defensive place for investors, especially in a higher interest rate and slower growth economy. Now over 98% of BXSL investments are in first lien senior secured loans and over 95% of loans are the companies owned by private equity firms or other financial sponsors who generally have access to additional equity capital, and historically have shown a willingness to support their portfolio companies. These sponsors have significant equity value in these capital structures with an average loan-to-value of 46.9% in BXSL.

We don't only stress the importance of seniority in the portfolio. We've also emphasized what we view as better investment neighborhoods or historically lower default rate sectors, companies and sectors that we believe are facing more favorable tailwinds, consistent growth trends, and specifically, businesses that we believe have stable growing margins, revenue visibility, strong management, lower CapEx. And in addition, we focus on the larger scale businesses with significant market share, greater ability to pass through price increases and that should be able to withstand a slowdown.

Now looking at scale specifically, BXSL portfolio companies have a weighted average EBITDA of $185 million as of Q3 compared to $162 million as of Q3 last year. This focus on higher quality, lower default rate sectors and larger-scale businesses is a key driver in our credit performance, as supported by the fact that BXSL has less than 0.1% of loans on nonaccrual to cost compared to 2.8% at cost for traded BDC peers. Our nonaccrual rate declined from the previous quarter, driven by a restructuring in the third quarter.

Now Slide 8 focuses on our industry exposure, where we believe investing in better companies in better neighborhoods to drive strong returns over time. This means focusing on key sectors with among other themes, lower default rates, lower CapEx requirements and approximately 90% of BXSL's total portfolio is invested in historically lower default rate sectors, including software, health care, commercial services, which are some of the highest exposures in the portfolio.

Now Slide 9 further outlines our portfolio quality. In addition to our focus on investing in higher quality and lower default rate sectors, BXSL's portfolio is focused on investing in larger companies based on our belief that larger scale businesses are more resilient in the face of economic headwinds relative to smaller counterparts and that historically has had lower default rates. Our origination effort has been based on supporting companies of scale because we believe that's where the most compelling risk-adjusted return is found.

The slide indicates that the relative risk-adjusted return of spread per turn of leverage for smaller deals versus larger deals has a slight disparity, but we noticed more substantial differences in underlying credit health. Based on data from Lincoln International Private Markets database, larger companies of $100 million or higher in EBITDA have experienced 7x greater LTM EBITDA growth and a default rate at an 80% lower rate than the company's measured at $50 million in EBITDA or less, what we would refer to as the true middle market direct lending. This is why we remain steadfast in our belief that larger scale businesses handle the adversity of economic cycles better.

Now turn to Slide 10. We can see that BXSL's portfolio company fundamentals compared to the private credit market as measured by Lincoln. Compared to the private credit market, BXSL's average LTM EBITDA on the portfolio is nearly 2x larger and has over 2x higher growth and generates over 20% greater profitability, and that leads me to the importance of interest coverage.

We go deep into this discussion on the last call, and it's our goal to continue to provide this level of portfolio transparency. So let's dive into it. According to Lincoln today, nearly 20% of the private credit market has an interest coverage ratio below 1 at 5.5% forward base rates. Of that 20%, over 70% are companies with $50 million in EBITDA or less, as the pressure of higher rates build, we believe we will see dispersion in the market as not all private credit is created equal.

For BXSL, the LTM average interest coverage ratio was 1.8x versus the private credit market average 1.5x. And when we run interest rates forward at 5.5%, that brings BXSL's average ICR to 1.6x versus the private credit market at 1.4. And we attribute this stability to our focus on larger, more profitable higher-growth businesses.

And when we assess the tails for BXSL's portfolio on an LTM basis, 3% of the portfolio has an ICR below 1x. And on a forward basis at 5.5% rates, we can see that we would have 10% of our portfolio with an ICR below 1 compared to the broader market of 20% mentioned earlier, about double BXSL exposure. And of that 10% with a 1x ICR at 5.5% base rates, about half of that is associated with transactions originally structured as higher growth investments with lower ICRs, namely ARR facilities that exhibit still year-over-year growth.

Averages will not tell the story of performance. In our view, the tails will, and we seek to limit our tail risk through our focus on choosing what we believe to be better, larger businesses in historically lower default sectors, disciplined underwriting and proactive portfolio management, we continue to see favorable results in the portfolio.

We're also focused on protections in the agreements governing our loans, with over 85% of BXSL's loans measured by fair value, documented to provide at least 1 financial covenant. In addition, to leverage and liquidity covenants, we also focus on key protections not commonly seen in syndicated loans. Blackstone Credit maintains an in-house team focused on legal documentation who review and aim to ensure the quality of our private loan documentation. And as a result, 100% of the deals held in BXSL or Blackstone Credit was a lead lender, have protections against asset stripping and collateral release.

And turning to amendments. We had 44 amendments in the third quarter. Approximately 95% of the amendments, they were technical, audit extensions, add-ons and another 5% were related to refinancings or repricings. And there were no amendments during the quarter related to covenant relief or immediately take relief due to inability to pay interest or principal.

As we jump to Slide 11, BXSL is now delivering an increased dividend distribution of $0.77 per share, a 10% increase quarter-over-quarter and a 45% increase since our IPO, 2 years ago. Our increased dividend is covered at a ratio of 123% by earnings. And as you can see, we've continued to focus on delivering high-quality yield to our shareholders, building a level of confidence through continuing to raise our base dividend, while also steadily building NAV per share. We believe that speaks to the fund's ability to deliver for our shareholders despite macroeconomic headwinds.

And with that, I'll turn it over to Carlos.

[Carlos Whitaker, executive]

Thanks, John. Our people are our most important resource. With over 500 professionals, we have the scale and bandwidth to form investment opinions on over 3,150 corporate issuers. We take those valuable insights and plow them back into BXSL's investment process through portfolio monitoring and origination to drive BXSL's investment performance. The performing credit investment committee has worked together for an average of 16 years, and that continuity helps us refine our investment process.

Since BXSL's inception, our global private credit investment team has grown meaningfully, while we've only seen a few departures amongst senior investment team significantly involved in a North American direct lending strategy. Blackstone Credit has a team of senior investment professionals who engage with hundreds of the top financial sponsors we transact with. In addition, we have a dedicated team that cover strategic relationships with M&A and sell-side advisers globally, sharing pipeline and joint investment opportunities that often drive deal flow.

We also leverage our sector expertise and insights across the credit platform, with over 100 senior advisers, 950 technologists and over 50 data scientists across Blackstone, providing us with valuable perspectives on how we invest, while also helping us monitor our portfolio. Blackstone's deep platform can benefit BXSL in other ways. Blackstone Growth, our private equity platform, real estate, life sciences, strategic partners, GP stakes business and tactical opportunities all offer deep insights and support deal flow for BXSL, widening our funnel. That's made possible from a platform with the size and scale of Blackstone.

In an increasingly competitive private credit market, we differentiated ourselves by providing more than just capital to our portfolio companies. BXSL borrowers are offered full access to Blackstone Credit's value creation program. through cross-sell opportunities, cost savings, procurement and capabilities, including cybersecurity and data science, all at no additional cost because we understand the end benefit to the investment portfolio.

I echo Brad's point earlier on the strength of our deal pipeline, owed to our origination franchise that benefits from the scale and platform of Blackstone. Let me walk through a recent transaction we led in which the combination of our platform advantages came into play.

Blackstone Credit was the sole lender of the recently announced $3 billion merger of HealthComp and Virgin Pulse by New Mountain Capital, a top-tier sponsor with deep expertise in the health care IT sector. We believe a number of factors differentiated us from other private credit lenders. Our scale and our ability to deliver a one-stop solution for the entire capital structure. Blackstone Credit committed to 100% of the financing, a large commitment across various levels of the capital structure.

This is where scale really matters, especially when confidentiality is critical, or in a situation where a sponsor can only call 1 or 2 partners. We have an excellent relationship with the sponsor, New Mountain Capital, and lend to a number of existing portfolio companies. In addition, Blackstone has a broader relationship with New Mountain across the firm. While that doesn't mean we lead every deal for them. our relationship is strong and presents us with opportunities to work closely with them.

We talk about incumbency, leveraging our existing portfolio, and this is a great example across our private and liquid credit platform. Prior to this deal, we were the existing lead private lender to HealthComp and we were also an existing lender to Virgin Pulse on our liquid credit side and their broadly syndicated loan. We knew both companies well and like their credit merits individually which added to our conviction in the merger.

Finally, the Blackstone Credit value creation program has multiple levers to pull to assist the combined company, particularly on potential cross-sell opportunities across the broader Blackstone portfolio. This has been demonstrated during the last 3 years when Blackstone Credit was a private lender to HealthComp. We believe our value-added capabilities truly differentiate us as we are no longer just a lender to HealthComp, but also a value-added partner who aims to help grow equity value.

As another example in BXSL's portfolio, our Blackstone Credit value creation team, worked with a health care services company to prepare for a $15 million firm-wide procurement project. And we already know, the first stage of this project yielded approximately 20% in savings for the company. We believe our engagement on this project has not only improved the financial results, but also helped professionalize the procurement function of the borrower and view this as another instance of being a value-added partner.

Parallel to our borrower experience, we are highly focused on shareholder experience. BXSL has among the lowest fee structures, expense ratios and cost of debt of our peer set as of the end of the second quarter, which allows us to pass on more returns to our investors. Additionally, 100% of deal fees owed to BXSL are paid to BXSL. We believe these are important points of distinction, ones that complement our strong results and strengthen our ability to continue to drive attractive risk-adjusted returns for our investors.

And with that, I'll turn it over to Teddy.

[Teddy Desloge, executive]

Thank you, Carlos. I'll start with our operating results on Slide 12.

In the third quarter, BXSL's net investment income was $161 million or $0.95 per share. Our total investment income was up $57 million or 25% year-over-year, driven by increased interest income primarily due to higher rates. Payment-in-kind or PIK income remained flat year-over-year, and represents less than 4% of total investment income.

GAAP net income in the quarter was $171 million or $1.01 per share, up from $0.58 per share a year ago, driven in part by $21 million of net unrealized depreciation this quarter. Our net investment income yield of $0.95 per share represents a 14.4% annualized return on equity.

Importantly, as Brad mentioned, the quality of our earnings remains high, with limited payment-in-kind, nonrecurring and fee-driven income. Interest income, excluding PIK, fees and dividends represents 96% of our total investment income in the third quarter.

Turning to our balance sheet on Slide 13. We ended the quarter with $9.5 billion of total portfolio investments, of which 98.8% are floating rate loans with a weighted average yield at fair value of 11.9%. This compares to less than $5 billion of outstanding debt with a weighted average cost of just over 4.9%. That spread between our floating rate assets and lower cost, mostly fixed rate liabilities provides the company with potential for additional earnings growth if rates continue to rise. As a result of strong earnings in excess of our dividend in the third quarter, NAV per share increased to $26.54, up from $26.30 last quarter.

Next, Slide 14 outlines our attractive and diverse liability profile, which includes 56% of drawn debt in unsecured bonds. These unsecured bonds have a weighted average fixed coupon of less than 3%, which we view as a key advantage in this rising rate environment. We maintained our 3 investment-grade corporate credit ratings, and BXSL was the first listed BDC to receive an improved outlook from stable to positive by Moody's.

We ended the quarter with approximately $1.5 billion of liquidity in cash and undrawn debt available to borrow. We believe this provides us with significant flexibility and cushion. Average fund leverage was 1.11x over the quarter and ending leverage was 1.8x. Based on our pipeline activity, we would expect to remain within our target of 1 to 1.25x through the balance of the year.

Additionally, we have low level of debt maturities over the next few years. The next maturity date for any of our outstanding debt facilities in 2025, with only 6% of debt maturing within the next 2 years and an overall weighted average maturity of 3.5 years.

We continue to believe BXSL is well positioned to maintain earnings in excess of our dividends as rates on 98.8% floating rate debt investments have continued to reset higher. As Brad and John mentioned, while floating rate debt brings higher yield for investors, it also may result in more pressure for our borrowers. And to that end, we established a Chief Investment Office several years ago, aimed at leveraging data insights and resources unique to Blackstone to enhance investment and portfolio management processes to ultimately drive positive outcomes across our portfolios. We believe early intervention and proactive management will be a key driver of differentiation across managers through this cycle.

Today, this team is nearly 60 individuals, which includes resources dedicated to financial reunderwriting, legal and restructuring expertise, data science and operational asset management. We deployed quantitative screens on a regular basis and have an independent review process for assets that we deem to be on our watch list, ultimately rolling up to senior Blackstone management. We've applied lessons learned from over 17 years history of managing direct lending portfolio through cycles and have established a culture and process that supports and encourages early intervention benefits from unique insights across Blackstone and deploys specialized resources to our portfolio of companies.

In conclusion, we remain positive about the company's outlook, given our healthy and defensive portfolio positioning, with portfolio company earnings growth "outpacing" the broader direct lending market, ample dry powder to deploy into a large opportunity set and continued elevated earnings power along with low-cost financing sources, all of which is backed by Blackstone's platform advantage, providing for premier sourcing, resources and an infrastructure built to protect investors' capital.

With that, I'll ask the operator to open it up for questions.

[Operator]

[Operator Instructions] We'll go first to Finian O'Shea with Wells Fargo.

[Finian O'Shea, analyst]

Just a housekeeping question. Did the fee waiver lapse pursuant to the 2-year anniversary last week or so?

[Teddy Desloge, executive]

Yes, Fin, this is Ted. Yes, the fee waiver ended October 28 of 2023.

[Finian O'Shea, analyst]

Okay. Great. And a question on leverage. Brad, you mentioned it's still within your target range, but it's obviously come down some this year, and that has an impact on returns. So we're seeing how you feel about the pipeline as you see it today. And if we could expect to see this come off the low end or if we need a real market come back to see that.

[Brad Marshall, executive]

Thanks, Fin. Just to follow on my comments. The pipeline picked up quite a bit, and you saw that in the third quarter with our commitments being $650 million or so.

In the fourth quarter, just from the overall Blackstone credit pipeline standpoint, is probably the busiest we've seen it all year. And I think that's just indicative of a little bit more of an active M&A market, but also existing portfolio companies looking to do more things, whether it's add-on financings, whether it's recapitalization. So I would expect, Fin, you can never perfectly time deals, which is always the tricky thing, which is why we give a range. As we get towards the end of the year, you could see us get a little bit higher than where we are today.

[Finian O'Shea, analyst]

Awesome. And if I could sneak in a third, I appreciated John's color on the amendments that -- which none came from covenant or pick relief. I was curious if anyone asked for covenant or pick relief?

[Jonathan Bock, executive]

No, Fin, they didn't.

[Operator]

We'll go next to Robert Dodd with Raymond James.

[Robert Dodd, analyst]

Congrats on the quarter. On kind of the pipeline and to your point, Brad, I mean the commitments in Q3 versus if we look back over the last multiple quarters, the gap between commitments and fundings was much more substantial than normal. Can you give us any color on that to -- was that DDTLs that people are looking to start making acquisitions instead of setting up the financing first? Or can you give us any color on what was the reason for the large spread there? And should we expect that to be recurring going forward?

[Brad Marshall, executive]

Just timing. So actually, a handful of those have already funded in the fourth quarter. So we just made the commitments towards the end of the third quarter. It usually takes 30 to 60 days for some of these deals to close. So that's all, that's the gap in the number, Robert.

[Robert Dodd, analyst]

Got it. And then as we look to next year, I mean, your focus, obviously, I mean, as you've maintained all time first lien, do you expect to see some structural changes in kind of the deals getting done with rates being elevated in terms of maybe seeing lower leverage on a first lien, maybe you're not doing the whole stack with somebody coming in behind who's willing to take a bit of more risk than you're willing to do? Because obviously, I mean, on some of the large first lien tranches, if it's at 6x of rates where they are or 8x or whatever it is, versus, do you expect kind of the market to shift in terms of how some of the leverage is structured as we go through next year, if it's more active with rates being so elevated?

[Brad Marshall, executive]

Yes. You're seeing that now because you're right to point out, with higher interest expense, companies are being set up with less leverage in order to service their debt appropriately.

So you saw that a little bit in the quarter. Our average loan-to-value was 35.9% versus our historical LTV, which is in the kind of mid-40s. So you're seeing companies put on less leverage. And yes, in some cases, you're seeing a preferred equity piece get put in behind the senior debt in order to kind of help the equity sponsor fund some of these transactions. But this is -- I'm glad you pointed out because it's what we get excited about in this environment is, you're seeing more yield, so more return, primarily because of base rates. But you're also seeing better companies come to market with less leverage and lower loan-to-value.

So more return and less risk is kind of how we think about it. And it will drive our portfolio construction going forward because you don't actually need to take a lot of risk in this market to get a very attractive return relative to most other asset classes.

[Operator]

We'll go next to Ken Lee with RBC.

[Kenneth Lee, analyst]

Just one on the potential implications of the integration of the Blackstone Credit and insurance platform. How do you think about potential changes in the portfolio mix or originations over time based on the integration.

[Brad Marshall, executive]

So appreciate the question, Ken. So I don't think it has any implications for portfolio construction. What it does for us, it gives us a bigger team with more exposure to sponsors, with more exposure to corporates, because at the end of the day, what we're offering these clients is more solutions.

BXSL will continue to be focused on senior secured corporate credit, top of the capital structure, a very kind of simple strategy, but when we're out facing clients, we're that much more relevant to them because we can do an asset-based facility, we can do something more junior in the capital structure. We have more points of connectivity, more people, more scale, more resources, and that's the power of the BXCI integration. As you look at the private credit asset class expanding, those managers that can provide multiple solutions will become more relevant to our end clients.

[Kenneth Lee, analyst]

Got you. Very helpful there. And just one follow-up, if I may. In terms of some of the recent deal activity in terms of some of the newer investments, could you just talk a little bit more about trends that you're seeing in terms of deal terms, docs, protection? Just wondering if there's been any changes there.

[Brad Marshall, executive]

Well, I would say a couple of things. Spreads have come in a little bit over the course of the year. But I attribute that more to what I was saying earlier, which the risk has gone down as rates are -- look like they're going to stay higher for longer, capital structures are being set up with less leverage, and therefore, spreads have come in a little bit, which is a trade that we will take all day.

So that's maybe one trend. The public markets were briefly open now, they feel a little bit shaky again. So that gives us a lot more leverage as it relates to negotiating docs, especially for the larger deals, one of which Carlos highlighted in his prepared remarks. So I would say, by and large, it's very, very attractive, both from a return for a level of risk and from a documentation standpoint.

[Operator]

We'll go next to Paul Johnson with KBW.

[Paul Johnson, analyst]

Just kind of adding on a little bit to Ken's last question, I mean, how long do you think the terms that you guys are seeing today can -- I guess, be sustained in the market? I mean, I guess in addition to that, I mean, what is it that you think that would probably start to threaten that a little bit? I mean, is it all predicated on the CLO market kind of returning? Or what -- how long, I guess, do you guys think that the private market can keep up what's going on today?

[Brad Marshall, executive]

Listen, if you look at the U.S. leverage finance market, it's a little over $4 trillion. Private market has grown from, what, $70 million when we started to a little over $1 trillion.

We expect that there's a lot more runway under the premise that the private solution for some issuers, regardless of whether the public market is open or closed, is a much more attractive solution for them. And the best evidence of that was, the largest growth period for private credit was 2021 when the public markets were wide open. And sponsors were looking for privacy, they were looking for certainty, they were looking for flexibility. So we're very bullish on the long-term trends of private credit.

Now getting to my earlier comments on spreads, spreads will move around a little bit. But it's not spread that's driving returns right now in private credit, it's -- most of it's coming through increase in base rates. And so the returns in private credit will be predicated on your view and our view on how long we think base rates or interest rates will stay higher. Our view is that they'll stay higher for longer, they may move around a little bit, but long-term trend is actually quite good. So the market opportunity is there for those investors who can create deal flow, not just rely on the M&A market, and returns should stay very robust in this rate environment.

[Paul Johnson, analyst]

Appreciate that. And one last one. It's just kind of a more general question, but I'm just curious because your portfolio has a decent amount of software-related companies. And this is the case, it's pretty much across the sector as well.

But I'm curious of your thoughts in terms of just the evolution of AI, I mean it would seem -- it could be a big game changer for some of your companies both in a positive and a negative way, if that proliferates and seems there could be an opportunity to maybe cannibalize I guess, parts of the software sector. So I'm just curious, I mean, you guys have any kind of broader thoughts on how that technology changes, I guess, the underwriting story of the software sector?

[Brad Marshall, executive]

So that is a 5-hour conversation. What I will say is, Blackstone has been leading the charge in terms of understanding AI, using AI, integrating that part of our investment process. So this -- well, it may be new to kind of everyone on this call over the past kind of 3 to 6 months because of ChatGPT, it is not new to Blackstone. So every underwriting that we've done in this space, AI has been at the forefront of our decision-making, and AI has its applications and where it's going to be impactful and where it's not going to be impactful.

So the shorter answer to the 5-hour answer is, we think about it a lot. We don't see it having issues on the portfolio that we selected in this space. But you're right, it will have implications in parts of the market.

[Operator]

We'll go next to Melissa Wedel with JPMorgan.

[Melissa Wedel, analyst]

I wanted to follow up on one of the comments from the prepared remarks. I think it was Brad, you were talking about expecting some dispersion in the market. I think that was related to sort of the higher for longer environment and the pressure that could put on credit. Just hoping you could elaborate on that, and if it doesn't incorporate a view on how you expect the credit cycle to evolve, could you add that in.

[Brad Marshall, executive]

So higher rates are meant to slow down the economy. And so it has 2 areas of impact on portfolios. One, higher rates obviously consume more cash, so it puts a little bit of pressure on people's cash flows. And secondly, if you're more correlated to the overall health of the economy, then you're going to have some potential earnings top line pressure. So that kind of -- that is the driver behind our remarks that higher rates are meant to cause a little bit of slowness.

So as I think about kind of where we'll feel that next year because really this -- most of this year were just because of the lag on rates, because of interest rate hedges, you haven't seen the full impact of higher rates this year. So as you think about next year, it's going to be felt in sectors that typically don't generate a lot of cash. So that probably means because they're more capital intensive, an industrial, manufacturing business. It could be a smaller business that just has less diversity of revenue, may have higher customer concentration, it has less -- maybe talent in its senior management.

So we think the stress in the system will be driven by which sectors you're in and the size of your business. And then, of course, layer in the further up the capital structure you are, the kind of the better protected you will be, older vintage, John talked about the tail, tails will become more of a focus in portfolios. So if the company was already struggling a little bit, next year won't make it any easier.

So that kind of was the driver of my comments. And when we talk about it internally, Melissa, we talk about the 3 Ss, which will really drive performance and dispersion, and that's seniority, that's sectors and that's scale. Those for us as being the driving factors when we're building the BXSL portfolio.

[Melissa Wedel, analyst]

Thanks, Brad. Could you -- do you have any broader thoughts about what you expect to see across the space in terms of defaults and nonaccruals, seems like what's come up so far has been pretty manageable, and we've seen some restructurings. Just wonder if you expect that to continue to be sort of a one-off in nature, or if you're expecting some sort of broad weakening perhaps along the line of the things that you just talked about, more capital-intensive businesses, smaller certain sectors?

[Brad Marshall, executive]

Well, I don't have a crystal ball. What I would say is, and we look at how everyone else is doing, too. I think everyone is probably a little bit surprised this year how well their portfolios have done. You haven't seen a big uptick in nonaccruals. I think Teddy gave some stats on the year-over-year growth in earnings of our portfolio companies, which is actually quite strong. And obviously, nonaccrual is 0.0 something in our portfolio, so almost nonexistent.

I would say next year, you could see in the market, default rates tick up in some subsectors of health care and industrial manufacturing, retail, anything touching kind of housing market and consumer. So I would say you have to look at people's portfolio composition, and that will, I think, maybe better answer your question. I'm sure there's stats that JPMorgan and others have out there for kind of market default rates, which is 4% or so. So that may be another kind of number you could use. But it really, really comes down to, and I've heard others say this, next year will be more dispersion driven by these areas that I've mentioned.

[Operator]

[Operator Instructions]. We'll go next to Mark Hughes with Truist.

[Mark Hughes, analyst]

Just following up on that, you mentioned that the higher interest rates are meant to slow down the economy. Do you think that will work?

[Brad Marshall, executive]

Yes, I do think it will work. It's -- you've started to see kind of a change in the labor market. So you're starting to see the effects of higher rates. You see it in portfolio companies and the impact on how much excess capital they have to spend on growth. So all of that is slowly starting to have an impact, whether it has the full desired impact that the Fed is hoping that will a little bit depend on how long they keep rates elevated, but yes, it will certainly have the desired effect, I think what's debatable is how long and how deep.

[Mark Hughes, analyst]

You mentioned spreads have come in a little bit, but you, I think, attributed to that to largely the deal structure. You think there's been more competitive pressure. There's a lot of dry powder amongst private equities, but a lot of dry powder presumably among direct lenders? Is there -- have you felt that? Or do you think you're still insulated from that?

[Brad Marshall, executive]

No. And some deals are actually -- have been quite competitive and other deals less so, and -- but in terms of how deals are ultimately getting priced, I think there's a fair amount of discipline in the market.

Again, if a company is taking a turn, a turn and a half less leverage, it's not surprising that spreads for those deals are a little bit lower than what they might have been for a more leveraged structure, I would say, kind of the large end of the market, which we tend to like, the public markets just haven't been open for those deals.

So the deal that Carlos mentioned is $1.6 billion. We were the sole lender. That's a really good dynamic for us because we can customize a solution for the sponsor and set it up with the right pieces of the capital structure to allow them to grow, you contrast that with a $200 million lower middle market deal. That may be more competitive because there's been a lot of new capital raised by new entrants. They can all write smaller ticket. So it will really depend on where the deal was created, how it comes to market and the size of that deal.

[Operator]

We'll take our final question from Arren Cyganovich with Citi.

[Arren Cyganovich, analyst]

Maybe you could talk a little bit about conversations with equity, sponsors and whether or not you see them kind of starting to accept the different environment we're in, where equity valuations where they maybe previously expected are now down to lower levels. And what will necessarily be needed to get folks to that point? Is it just a matter of time and a little less volatility in the market?

[Brad Marshall, executive]

Yes, valuations will have to come down. You're seeing that in new deals get done. I think they're probably in by 2 turns in the second half of the year. So I think it's coming through buyers and sellers. We'll always have a different view. But as you point out, the structures of their private equity funds force them a little bit to transact, and that will kind of accelerate the bid-ask and get it closer together.

I just -- I think we're maybe another 3, 6 months away from that acceleration picking up. A lot of our deal flow right now, Arren, is just coming from our existing portfolio. So coming from our incumbency and not necessarily just from M&A, so whether it's on a public deal that we're taking private or whether it's our private companies, they're looking for to do acquisitions versus new platform investments, that's what's driving activity right now. But I do think next year, you'll see this -- you'll see the bid-ask and closer together, deal flow start to accelerate.

[Operator]

That will conclude our question-and-answer session. I'd like to turn the call back over to Ms. Wang, for any additional or closing remarks.

[Stacy Wang, executive]

That would wrap up our call for today. Thank you, everyone, for joining us, and thank you for all the great questions. We look forward to speaking to you next quarter. Thanks, everyone.

[Operator]

Goodbye.