Blue Owl Capital Corp
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Blue Owl Capital Corp
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Good morning, and welcome to the Owl Rock Capital Corporation's Third Quarter 2021 Earnings Call.
[Operator Instructions]
I'd like to advise all parties that this conference is being recorded. I'd now like to turn the call over to Dana Sclafani, Head of Investor Relations for ORCC.
Thank you, operator. Good morning, everyone, and welcome to Owl Rock Capital Corporation's third quarter earnings call. Joining me this morning are Co-Founder and Chief Executive Officer, Craig Packer; our Chief Financial Officer and Chief Operating Officer, Jonathan Lamm; and other members of our senior management team. 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 of 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 ORCC's filings with the SEC. The company assumes no obligation to update any forward-looking statements. We will also be referring to non-GAAP measures on today's call, which are reconciled to GAAP figures in our earnings press release and supplemental earnings presentation available on the Investor Relations section of our website at owlrockcapitalcorporation.com.
Craig will start by briefly discussing our financial results before providing an update on our portfolio and deal activity. Jonathan will then cover our results in more detail. After which, Craig will close with some thoughts on our outlook before opening the call up for questions.
With that, I'll turn the call over to Craig.
Thanks, Dana. Good morning, everyone, and thank you for joining us today to discuss our third quarter earnings. We are very pleased to report strong results for the quarter. Our net investment income per share was $0.33, up from $0.30 per share in the second quarter and in excess of our $0.31 per share dividend. This was driven by the continued growth of our portfolio, maintaining low operating expenses, the cost effective and prudent use of our balance sheet and our ongoing superior credit performance. We ended the third quarter with net asset value per share of $14.95, up $0.05 from the previous quarter, which represents our sixth consecutive quarter of NAV increases.
As you will recall, our NII had been previously impacted by the expiration of our fee waivers in the fourth quarter of 2020, and we had been expecting to achieve full coverage of our $0.31 per share dividend sometime in the second half of 2021. With these strong results, we have now achieved this milestone and are well positioned to continue to fully earn our dividend going forward. We experienced a record level of originations this quarter, which resulted in a fully ramped $12 billion-plus portfolio.
We also had a record level of repayments. Prior to this quarter, we had not yet seen the pace of repayments expected for a portfolio of our size but this trend finally materialized in the third quarter. We had more than $2 billion of repayments, which generated healthy fee and amortization income. At the same time, we're able to seamlessly replace those repaid investments with equally attractive new investments of a similar credit quality and comparable economics, which has allowed us to finish the quarter in an equally strong position and with leverage comfortably in our target range. We are also benefiting from a terrific environment for direct lending. Continuing the trend we saw in the first half of this year, M&A activity remains at record levels.
Private equity firms remain flush with capital and are investing at a very fast clip. We are also witnessing the continued penetration of direct lending into the overall leverage finance space, taking share from the broadly syndicated markets. With larger pools of capital available for direct lending solutions, private equity firms are using these solutions more frequently and for larger transactions.
In particular, we continue to see growing demand for large privately placed unitranche loans. This year, we have evaluated more than 30 opportunities over $1 billion in size and this quarter alone closed on 5 loans, $1 billion or more in size, most of which were structured as unitranches. We believe these trends favor large-scale direct lenders who can provide sizable financing solutions and who have the resources, relationships and expertise to partner with the private equity community.
The Owl Rock platform is especially well positioned for this trend due to our scale, full suite of products and a large, deeply experienced team with strong relationships with financial sponsors. The broader Owl Rock platform deployed a record amount of capital in the third quarter, and we will look to further enhance our strong competitive position by investing in additional resources to remain a market leader.
Turning to our investment activity for the quarter. We were extremely pleased to originate $2.8 billion of investments with $2.3 billion of funded activity and $2.1 billion of repayments resulting in net funded originations of $198 million. Our investment pace was driven in part by our strong and growing base of incumbency positions, which provide a natural pipeline of differentiated deal flow.
Nearly half of our investment activity was in a handful of refinancings for existing portfolio companies, where we were able to leverage our in-depth institutional knowledge and strong relationships. Two of these companies, Associa and Troon Golf have been in our portfolio for over 3 years and have delivered strong operating results over this time. They have historically represented some of our largest positions, and we are pleased to be able to reinvest in names we know extremely well and have great confidence in.
Another trend, which drove the growth in our origination volume this quarter was the opportunity to make larger investments in larger companies. We deployed roughly $2.2 billion across 21 investments, excluding add-ons. This compares to $1.2 billion across 16 investments last quarter. So we were able to deploy 80% more capital with only 5 additional investments, which allows us to be efficient with our resources and continue to devote the full attention to credit underwriting that we think is so critical.
We also continue to grow the size of the companies in our portfolio. The weighted average EBITDA of our borrowers is now $114 million, which is up from $95 million a year ago. In addition to allowing us to invest more efficiently, we believe larger companies are safer to lend to, and that has been borne out by our results over the last 5 years.
As you may recall, we had been expecting to see a pickup in repayments for a while. We finally saw this occur this quarter with 21 fully exited investments. While this quarter may prove to be on the higher end, we do expect repayments to continue to exceed the levels we have seen in the last couple of years.
Importantly, we were able to deploy capital from our sizable repayments into attractive opportunities without deviating from our investment strategy. Roughly 90% of activity this quarter was in first lien and unitranche loans, and our average spread on new commitments was approximately 625 basis points, which was in line with the average spread on repaid investments. As a result, the overall portfolio spread remained in line with previous quarters at roughly 650 basis points.
Credit quality, leverage levels and credit protections for new investments remain consistent with those of the rest of our portfolio. So despite the high repayments and competitive market conditions, we continue to feel very good about our ability to deploy capital and maintain a high-quality asset base. Today, the portfolio stands at $12.1 billion across 130 companies and continues to deliver extremely strong credit performance. The overwhelming majority of the portfolio continues to perform very well and the weighted average fair value remains at approximately 98%, and there were no significant change to our portfolio ratings.
As we look at the performance of our borrowers, I would note that we have now had at least 4 quarters of normalizing performance since the worst of the COVID impact was felt in the second quarter of 2020. We are pleased to see the continued improvement in performance in each quarter since. And today, many of our borrowers are reporting record sales driven by strong consumer health and economic activity.
That said, we are carefully monitoring the current headwinds caused by the labor shortages and supply chain disruptions. To date, we have not seen a material impact as many of our companies are services businesses which have modest exposure to the manufacturing economy. For example, some of our largest sectors are software, insurance and health care, which are not as exposed to the current economic headwinds. In line with last quarter, our nonaccruals remained low with only 2 investments on nonaccrual status, representing 0.4% of the portfolio based on fair value, one of the lowest levels in the BDC sector. And our annualized loss ratio is 14 basis points.
I will now turn it over to Jonathan to discuss our financial results in more detail.
Thank you, Craig. We ended the third quarter with total portfolio investments of $12.1 billion, outstanding debt of $6.9 billion and total net assets of $5.9 billion. Net asset value per share increased to $14.95, up $0.05 from last quarter. This increase was primarily driven by the growth in our net investment income, which exceeded our dividend by $10 million as well as from $12 million of unrealized gains. We ended the third quarter with net leverage of 1.06x debt to equity, roughly the midpoint of our target leverage range and with liquidity of $2.4 billion.
Our net investment income was $0.33 per share, $0.02 above our previously declared third quarter dividend of $0.31 per share. For the fourth quarter, our Board has again declared a $0.31 per share dividend payable on January 31, 2022, to stockholders of record on December 31, 2021. Our total investment income for the quarter increased to $269 million, up $20 million from the prior quarter. This increase was primarily driven by dividend income, which increased by $8 million. We received our first dividend from Wingspire this quarter as well as continued dividend income from Windows Entities and our senior loan fund. We expect dividend income from Wingspire and our senior loan fund to continue to increase as our committed capital is deployed.
Craig noted we had a significant amount of repayments this quarter, which drove a material increase in earnings from accelerated accretion and prepayment fees. While this is not a contractual earnings stream, we do expect repayment-related income to broadly stay around these levels in future quarters as we expect that our repayments will remain at a more normalized pace, recognizing that the timing of repayments is idiosyncratic in any specific quarter.
Interest expense was $56 million, up from the prior quarter as our leverage slightly increased in the quarter. Management and incentive fees modestly increased to $73 million, reflecting the growth in the portfolio. From a capitalization perspective, we continue to be pleased with the strength and flexibility of our balance sheet. As of quarter end, 62% of our debt outstanding was in the form of unsecured bonds, and we continue to execute secured and unsecured financings at attractive levels.
With that, I'll turn it back to Craig for closing comments.
Thanks, Jonathan. To close, I would like to touch on our outlook for the rest of the year. Based on our pipeline, we expect another active quarter for both originations and repayments. In terms of repayments, we expect to see a healthy level, likely lower than this quarter's record but higher than previous quarters. Now that the portfolio is fully ramped, we will generally be targeting originations in line with repayments in order to maintain a fully levered, fully invested portfolio, and we have a strong backlog of attractive deals expected to close this quarter. We do see some ongoing competitive pressure on spreads, but we are focused on ways to offset this pressure while maintaining portfolio quality.
To this end, we have made 2 strategic investments in the last few years that have generated attractive returns, and we think can help us achieve this goal. One is our investment in Wingspire, an asset-based lender to U.S.-based middle market companies, with roughly $350 million of assets and very strong credit performance. We currently have approximately $195 million invested in Wingspire and see opportunities to invest more capital going forward. We expect Wingspire will be run rating at a high single-digit ROE by the end of this year and can generate a 10-plus percent ROE over time.
The other investment is in our senior loan fund. As you recall, last quarter, we increased our equity commitment in the fund to $325 million and our economic ownership to 87.5%. The fund has already generated an attractive average quarterly ROE over the past 3 years of approximately 10%, and we will look to increase our capital invested over time. We continuously look at opportunities for additional investments such as these in situations where we can leverage our expertise, resources and relationships in ways that are accretive to ORCC shareholders.
Lastly, we continue to see an opportunity to improve our portfolio mix. We still have just over $1 billion of debt investments in the portfolio with a spread lower than 550 basis points. Our portfolio spread will benefit as these investments are repaid, and we seek to redeploy this capital into higher spread investments, typically unitranches, which is an area where we have been able to achieve attractive pricing.
We are very proud of where the portfolio stands today. It is fully scaled with leverage in our target range. We have executed on the earnings levers we have previously laid out and are now earning the dividend from NII. We have demonstrated our ability to originate and underwrite deals across credit cycles and have proven to be a lender of choice for sponsors, all while delivering one of the strongest credit performances in the sector. We had a record quarter for originations and have now deployed nearly $18 billion of capital since inception while delivering a very low loss rate. We look forward to continuing to build on our current progress.
I would like to close with a note of appreciation for our investment and corporate solutions teams at Owl Rock. Like many of you, we have recently reopened our office and after more than 18 months of working remotely, it is wonderful to be able to interact in person with our colleagues after so long working apart and seeing each other only on video calls. Our team has worked tirelessly and selflessly during these 18 months to build a large portfolio with terrific investment results, maintain very high credit standards and do it in a remote work environment that often created a unique level of stress and strain. And they did it with tremendous pride, teamwork and esprit de corps. On behalf of the entire Owl Rock leadership, I just want to thank our team for their incredible dedication to our company. And with that, thank you all for joining us today.
Operator, please open the line for questions.
[Operator Instructions]
And we'll take our first question from Devin Ryan with JMP Securities.
Maybe start with one here on the liability side of the balance sheet. You guys have been obviously very active in growing and optimizing. In Slide 13, you show how you've managed to reduce the weighted average interest rate on debt by 40 basis points over the past year, which is great. So where do you guys sit today? Are there any other opportunities that may be further optimized or diversify the funding profile? And if there are, kind of what type of funding is maybe most appealing right now?
Yes, sure, Devin. On the margin, there are opportunities. We've fully raised capital really across all of the various legs of the stool from a financing perspective, both in unsecured and drop-down SPVs with banks as well as CLOs and our revolver. And we're well financed and well diversified in our financing really out a number of years. There are things that we can continue to do on the margin, incremental CLOs and opportunistic unsecured financings. But I wouldn't say that there's a massive amount of moves that we can do from a cost perspective in the very near term.
I mean the unsecured bonds that we have are trading today 125 basis points tighter than where we issued, but they have call protection that makes it expensive for us to take them out. Over time, when they are callable or repayable, we will take them out and we should experience meaningful savings. But that's not an immediate opportunity. It's something that will happen over time.
Yes. Okay. No, that's helpful. Just want a little perspective there. Maybe a follow-up just on some of the conversation on more, I guess, large companies and something you guys have been talking about for a while. But -- and it makes sense, just given you can differentiate there, there's attractive opportunities. But is that a function of how the market more broadly is evolving? There's just more opportunities at the large end of the spectrum, just given whether it's the M&A markets or just broader market dynamics? Or it's just more of a concerted effort at Owl Rock? I understand it is a concerted effort, but like has that part of the market also grown and so you're just -- there's more opportunities out there for you to do there?
It's both, it's both. And it's not too incidental that it's both. I mean part of the reason we started Owl Rock is we thought that more companies would want direct lending solutions if there were bigger pools of capital available, and we went out and raised a pretty sizable pool of capital. As bigger pools of capital are formed, we can offer the advantages of a direct lending solution to bigger companies, and we're finding great receptivity to them. The sponsors are finding more and more opportunities to come to us and other larger direct lenders and ask for direct lending solutions when they could find those options available in the syndicated market, and they're choosing direct lending solutions. So direct lending is getting greater market share in the overall leverage finance space. And that -- by the way, that trend is accelerating and it's doing so at a time where the broadly syndicated markets are extremely strong. So they're not coming because they can't get a deal done in the broadly syndicated markets. They're coming despite that.
What that means is if we get a period where there's instability in the broadly syndicated markets, I would expect an even greater penetration of direct lending into the overall leverage finance space. So the trend is accelerating now as is and with, I think, upside from a share standpoint in the future.
Next, we'll go to Robert Dodd with Raymond James.
Congratulations on the quarter. I just want to go to one of the things in your prepared remarks, Craig. I mean, you talked obviously about Wingspire and the SLF and other areas where you can kind of combat competitive pricing conditions, right? I mean, obviously, the SLF is a financial engineered similar product to the BDC versus Wingspire, which is a different vertical, right? It's not sponsor-backed lending. Are there other verticals that you're looking to expand into that are really differentiated from large-scale private credit where that -- you've got advantages, but the competitive pressures are most elevated right now?
So there's no area that I want to highlight as an area you should expect us to go into. Obviously, if we were about to do that, I would -- I'd share that with you. We get approached regularly by teams that are in, I'll call it, specialty finance verticals across the spectrum that are attracted to the Owl Rock platform and our very significant capital base that we look at and evaluate from time to time. And if we find something that we think provides a really attractive risk/reward and opportunity that makes sense relative to the rest of our platform, we would do it. I don't have anything I really want to signal right yet other than to tell you, I'd like to find 1 or 2 more. And so we're actively looking and hope to find something. But we're quite picky about what we'll go into, and so we'd want to make sure it was something that really made sense for us.
Okay. Understood. And one more, if I can sort of follow up. I mean you also talked about, obviously, you're at scale now. Deployments would be targeted roughly at repayment levels to maintain portfolio size. Should we expect though that over time, the number of assets in the portfolio would rise? Because if the BDC -- if the public BDC isn't growing but the platform is, and the BDC represents a little bit over, I think, 50% of the private credit kind of capital you're investing right now, but it's arguably shrinking as you say, would -- are we going to see more diversification within the BDC? More asset positions and a smaller average hold size? Or is the target to keep the hold size and the number of positions similar as well while maintaining the portfolio size?
It's a good question. What I would say is this quarter, we -- it stayed about flat. So we're -- there's a number of different factors that are at play there. So without making it too complicated, with respect to ORCC, we've always been most comfortable targeting 1% or 2% position sizes, and we've held -- and we've been very consistent with that, and that's about where things have wound up. So I think from when we size ORCC positions, I think we're going to continue to do what we're doing. As our platform has grown, you're right, we'll -- ORCC will shrink as a percentage of the incremental investment dollar, but it really depends on other portfolios' needs at the time, how much we're putting into ORCC. So as we construct the portfolio, my guess is we grind higher on position sizes but not dramatically so. But over time, it wouldn't surprise me if we grind a bit higher but not dramatically so.
Next, we'll go to Ryan Lynch with KBW.
First one I had, if I look at Slide #6 and your guys, the weighted average spread of new commitments, at 6.2%, which is down pretty meaningfully over the last several quarters. I'm just wondering, in this ever evolving upper middle market, mega-tranche market, which again, is changing as it's still in formation with new players entering it, do you think that, that 6.2% that's sort of hitting that spread is kind of hitting a floor level that folks in that market are willing to go to? Or you could just still see further pressure in those numbers? And is there any sort of floor level that you guys feel comfortable stopping at and not going any less lower than?
Sure. So one thing I would point out is this quarter, we were almost entirely first lien or unitranche whereas in the second quarter, we had meaningful second lien, and we also had a couple of really high-spread tech deals in there. So what you're seeing in the drop from the second quarter to the third quarter is in part driven by mix as well as a couple of really, really widespread deals done in the quarter.
For example, if you went back to the first quarter, we're at 6.4% versus 6.2%, certainly lower but not as significant. Having said that, there is spread pressure in the market. I mentioned that in my comments. I think one of the real advantages now for us that we've gotten to fully invested is we can be very disciplined about the incremental investment, and we are being disciplined about the incremental investment. And we are being shown opportunities for high-quality credits that would fit our credit characteristics, but are being offered at spreads that we think are not super attractive. And so in those situations, we may do less than before or none at all. So we are, I think, afforded the opportunity now to be disciplined, and we are, but there is some spread pressure.
My sense is that the spread pressure has leveled off based on what I've seen market activity-wise in the last couple of months. A couple of other large lenders seem to have found their floor and maybe not kept pushing it lower than that. But these things can vary, and so we'll just have to see. I know that for ORCC, we continue to find attractive spread opportunities, I would say, in excess of the market spread. And compared to the peers, what I'm seeing, I think we're continuing to find deals that are attractive, in part based on our growing base of incumbencies. And so we have the ability to offset some of that spread pressure, and we're not totally immune to it, but offset some of it. So hopefully, that gives you a little bit of color what we're seeing, what I see out there. I think it's leveled off. I don't think it will go tighter, but it's possible it could. I don't know how other people run their business.
Sure. Understood. That's helpful color though. I wanted to get some more detail on the comment you mentioned earlier because of where you are right now from a capital deployment standpoint, leverage standpoint, it matters. You said you're at scale, so originations will roughly equate to repayments. I think you said going forward. I'm just curious, you guys have a -- the upper end of your leverage target is 1.25x. Looking like from a growth standpoint, you guys are 1.18 or so. But from a net standpoint, you guys are only about 1.05. So there's quite a bit of room to go if your leverage target of the upper end of 1.25x is on a net standpoint. So could you just give some clarity of your leverage range? Is that a net basis or gross basis? And do you feel comfortable going to the upper end because if it is the latter, that would suggest that you guys could still handle a decent amount of net growth from here?
So we -- when we talk about it, we talk about it on a net basis. Obviously, the cash can move around meaningfully at the end of the quarter as deals close. So that's the -- just so we're all speaking the same language. We're comfortable operating anywhere in that range. That's why we have the range. I -- we try to balance, obviously, our great returns for shareholders, but also being terrific stewards of our balance sheet with respect to our lenders and our bondholders who've been terrific supporters of our growth, rating agencies. All of these factors come into account. We would be comfortable operating anywhere in that range. And where we land in any 1 quarter is dependent on deal activity for that quarter, which can be lumpy, and we don't have perfect precision on where we might land at the end of a quarter.
So I think folks should expect in any given quarter, we could be anywhere in that range. I don't want to signal that we're going to go out and just operate at the high end of the range is I think what you're asking me. I don't think that, that should be your expectation. But in any quarter, we could drift towards the higher end of that range. There's a trade-off there. But for shareholders overall, we want to balance getting great returns, which come from higher leverage but also maintaining very low financing costs, which is a countervailing force. And we're trying to take all that into account.
[Operator Instructions] And next, we'll go to Mickey Schleien with Ladenburg.
Most of my questions have been answered. I just have a couple of housekeeping questions on Innovative Water. I see it's on nonaccrual, but it's actually marked above par. So could you just give us some guidance on its outlook? And maybe for Jonathan, did you reverse any previous income accruals for Innovative Water?
Innovative water is not on nonaccrual. So we can take it offline, Mickey, but it's a performing investment. So there was no reversal of income there.
Okay. Sorry, that must be my mistake. That's it for me this morning.
[Operator Instructions] Next, we'll go to Kenneth Lee with RBC Capital Markets.
It sounds like you're still expecting to see a potential benefit over time in terms of pickup in portfolio yield as you rotate towards higher-spread new investments. Just wondering, in terms of that remaining $1 billion that's at lower spread, and it sounds like the time is dependent on prepayments. Is there any way to bracket the potential time frames for when you could expect it to start rotating a meaningful amount of that remaining investment?
Sure. Not with any great precision. There's a portion of that $1 billion that I think there's a reasonable chance we'll get repaid in the next 1 to 2 quarters. And then there's a portion that I think will take longer than that. There's a portion in there that we might choose to sell over time, and then there's others that probably aren't easily sold because there's not other lenders in the credit with us, not from a credit reason.
So I don't want to put out -- it's not a predictable thing for us. It depends what's going on at the companies. There's certainly some in there that probably will get repaid in the fourth quarter. I talked about our expected repayments being meaningful in the fourth quarter. But I don't have a number to give you to model in. So if I was modeling something, I would just assume it's over the next 2 years, 2.5 years, something like that.
Got you. Very helpful. And just one follow-up, if I may. Wondering if you could just talk a little bit more about your current appetite for second lien loans. Just seeing that the percentage allocation within the portfolio has trended down slightly over the last couple of quarters, but I just want to gauge your latest thinking there.
Sure. We have been consistent on this. We're very selective on the second liens that we do. We only do them in really very strong credits with meaningful equity cushions and businesses that we think are really stable and sort of commensurate with taking the risk of being a junior lender. But in situations like those, we like second liens and are more than willing to do them. We haven't -- we oftentimes get shown opportunities that we say no to.
But if there are credits that meet those characteristics, we'll be very pleased to do them. So in any given quarter, could be 0, it could be a couple of deals. I'd like to, on the margin, take that percentage up. But I've been saying that very consistently probably for 8 quarters in a row. And I think the fact that it's gone down a little bit is just a demonstration of our discipline. But I would -- if we find quarters where we see good opportunities to do more second liens, I hope that, that would not surprise anyone because we've been continuously pointing to this.
They obviously help our overall spread and returns. Just so you have a sense of it, our average EBITDA on our second liens is twice the EBITDA in our portfolio. Our average EBITDA on our second lien borrowers tends to be $200 million plus with all the same credit characteristics of our overall portfolio in terms of leverage and loan to value. So bigger companies, stable, we'll continue to do them, but we're very selective.
That concludes today's question-and-answer session. I'll now turn the call back over to Craig Packer for any additional or closing remarks.
Well, terrific. Thanks for the questions. Thanks all for your tuning in. We're really pleased with the quarter. I appreciate everyone's support. We're pretty accessible. If anyone has follow-up questions, please reach out to Dana. And other than that, enjoy the rest of your afternoon. Thank you.
This concludes today's conference call. You may now disconnect.