Blackstone Secured Lending: 11.2% Dividend Yield, I’m Buying Any Dips (NYSE:BXSL)

The decision to make Blackstone Secured Lending (NYSE:BXSL) my second-largest business development company holding after Hercules Capital (HTGC) was driven by three core factors. The BDC’s net asset value per share has been rising, it continues to out-earn its quarterly base dividend, and underwriting quality remains extremely high with loans on non-accrual status of 0.1% at the end of its fiscal 2023 third quarter. The BDC last declared a quarterly base cash dividend of $0.77 per share, kept unchanged sequentially, for an 11.2% annualized forward dividend yield. Critically, this was 123% covered by third quarter net investment income of $0.95 per share. This was growth of 19% year-over-year but a dip of 11 cents sequentially from $1.06 per share in the second quarter.

This meant dividend coverage fell from 138% in the second quarter, as NAV at $26.54 per share grew by 3% year-over-year. NAV per share grew by 24 cents sequentially to maintain what has been a consistent rise in NAV since the start of 2023. This growth should continue, with the dividend set to be maintained at its present level in the near term. There was no indication by management during their third-quarter earnings call that they intend to hike the base distribution, with a general emphasis on playing defense with NAV and protecting investor capital.

Credit Underwriting Quality, Loans On Non-Accrual, And Investment Activity

BXSL’s investments at fair value stood at $9.5 billion at the end of the third quarter, up roughly $200 million sequentially, with broad metrics of health remaining strong. Loans on non-accrual status remained below 0.1% at fair market value and amortized cost with the portfolio diversified across 188 companies, up 8 companies from 180 in the second quarter. BXSL’s non-accruals are among the lowest in the entire BDC space and highlight the strength of its underwriting.

When aggregated with its investment grade “BBB-” credit rating from Fitch, BXSL forms a strongly defensive ticker going into a year when interest rates will play a more constrained role in driving investment income. BXSL’s average loan-to-value ratio did go up marginally by 40 basis points sequentially to 46.9%, but its portfolio company fundamentals are ahead of its private credit peers. EBITDA margins across its portfolio over the last 12 months are 20% ahead of its peers, with growth running at double the rate of its peers.

BXSL’s focus on larger middle market companies is attractive as it embeds lower credit risk, which means fewer defaults. BXSL has managed to still steer its portfolio to higher growth large companies and achieved a competitive 14.4% annualized return on equity on its third quarter NII. This was as 99% of funds invested during the first quarter were allocated to first lien senior secured at an average loan-to-value of 35.9%.

2024 Will Test The Goldilocks Economy

Net funded investment activity during the third quarter was $185 million, with a huge upswing seen versus the prior four quarters. Indeed, investment commitments at $656 million during the third quarter was more than the prior three quarters combined. This infers preparation for continued growth against a falling rate environment. To be clear, as BXSL’s portfolio was 98.8% invested in floating rate investments at the end of the third quarter, the BDC should still be able to drive or maintain investment income from a larger portfolio even as interest rates dip next year.

Potentially falling NII and NAV from a decline in interest rates next year is what keeps me up at night. The best performing BDCs will be those able to continually expand their portfolio whilst keeping non-accruals low to maintain NAV growth. The fear is that some BDCs when faced with lower interest rates, and a potentially more turbulent economy will see higher payment-in-kind income and a rise in loans on non-accruals status. This will force some to essentially pay out their dividend from NAV. BXSL saw its PIK income as a percent of total investment income fall to 3.87% from 4.85% in the year-ago quarter, a dip of 97 basis points.

BXSL’s debt-to-equity ratio has also been falling and came in at 1.08x at the end of the third quarter with a funding profile that’s heavy on fixed rate unsecured notes which do not start to mature until January 2026 when $800 million comes due. The Fed’s December dot plot showed 75 basis points worth of interest rate cuts next year, a move that would of course reduce the cost of their floating rate loans but have a more outsized negative impact on their nearly 100% floating rate portfolio. The pace and intensity of interest rate cuts will be the core determinant of BDC value creation next year, and BXSL forms a buy on any dip as a highly defensive play on 2024’s potential inversion on what has so far been a Goldilocks economy for BDCs.