Q1 2024 Barings BDC Inc Earnings Call

Participants

Joe Mazzoli; IR; Barings BDC, Inc.

Eric Lloyd; Executive Chairman, CEO; Barings BDC, Inc.

Matt Freund; President; Barings BDC, Inc.

Elizabeth Murray; CFO, COO; Barings BDC, Inc.

Finian O'Shea; Analyst; Wells Fargo Securities, LLC

Kyle Joseph; Analyst; Jefferies LLC

Robert Dodd; Analyst; Raymond James & Associates, Inc.

Presentation

Operator

And I would like to welcome everyone to the Barings BDC Inc. Conference Call for the Quarter Ended and year ended March 31, 2024. (Operator Instructions) Today's call is being recorded and a replay will be available approximately two hours after the conclusion of the call on the company's website at w. w. w. dot Barings BDC.com under the Investor Relations section.
Time, I will turn the call over to Joe Mazzoli, Head of Investor Relations for Barings BDC.

Joe Mazzoli

Good morning, and thank you for joining today's call. Please note that this call may contain forward-looking statements that include statements regarding the company's goals, beliefs, strategies, future operating results and cash flows. Although the Company believes these statements are reasonable, actual results could differ materially from those projected in forward-looking statements.
These statements are based on various underlying assumptions and are subject to numerous uncertainties and risks, including those disclosed under the sections titled Risk Factors and Forward-Looking Statements in the Company's quarterly report on Form 10-Q for the quarter ended March 31, 2024, as filed with the Securities and Exchange Commission. Barings BDC undertakes no obligation to update or revise any forward looking statements unless required by law.
And I'll now turn the call over to Eric Lloyd, Chief Executive Officer of Barings BDC.

Eric Lloyd

And thanks, Joe, and good morning, everyone. We appreciate you joining us for today's call. Please note that throughout today's call, we'll be referring to our first quarter 2024 earnings presentation that's posted on the Investor Relations section of our website on the call today, I'm joined by Barings BDC's President, Matt Freund; Chief Financial Officer, Elizabeth Murray; and bearings, Head of Global Private Finance & DBDC. Bryan High.
We are happy to be in a position to share a variety of positive performance metrics at BBDC. for the March quarter, but I'll also spend a moment speaking of some of the developments at our manager Barings LLC that have occurred during the quarter. First, let me begin with BDCs performance. DBDC. exhibited stability and strong operating results during the quarter ended March 31, our focus on the top of the capital structure investments and sponsor-backed issuers continues to serve investors well, our portfolio is predominantly sponsor-backed and is complemented by a selection of non-sponsored and platform investments.
Our portfolio strategy is outlined in greater detail on slide 5. This strategy serves as our guiding light as we continued to successfully invest throughout the market and deliver compelling returns to our shareholders. Net asset value per share was $11.44 compared to the prior quarter of $11.20, reflecting a year-over-year increase of 1.4%. And this is the highest point the portfolio has exhibited in the past two years.
Net investment income for the quarter was $0.28 and out earned our quarterly dividend by 7.6%. Perhaps most importantly, and a metric that we are particularly proud of our nonaccruals during the quarter declined to 0.3% of the fair market value of the portfolio, a level a level we consider to be best in class and especially in light of the inconsistent economic backdrop, our performance is the result of our focus on the top of the capital structure and within more defensive industries.
We believe GBDC remains well positioned for any further volatility and uncertainty in the market going forward. As our shareholders know, we are actively working to maximize the value in the legacy holdings acquired from MVC Capital and Sierra Income and rotate them into compelling Barings originated positions. Non Barings originated assets now only amount to 11% of the portfolio at fair value, down from 24% at the beginning of 2022.
And potential losses from these assets are protected by credit support agreements, limiting downside risks for BBDC. investors, Arndt, but our investment portfolio continued to perform well in the first quarter, there's no substitute for fundamental credit analysis, which has been core to Barings underwriting thousands to early 1990s as reflected in the health of the DBDC. portfolio today, including the acquired year and MVC assets, our total nonaccruals are industry leading 0.3% on a fair value basis and 1.5% of the portfolio on a cost basis, this is down from 1.5% on a fair fair value basis and 2.5% on a cost basis as of December 31st, 2023.
Turning to the earnings power of the portfolio, the increase in base rates has largely been reflected within the portfolio with weighted average yields on a fair value basis stabilizing at 11.3%, substantially comparable to the prior quarter's figures. We remain conservative on our base dividend policy and our Board declared a fourth quarter dividend of $0.26 per share, consistent with the prior quarter. On an annualized basis, the dividend level equates to a 9.1% yield on our net asset value of $11.44. We believe the best measure of the portfolio's performance, nonaccruals, net asset value and NI were extremely compelling from the March quarter and anticipate continued strength in the quarters ahead.
I would now like to take a moment to acknowledge the recent developments at Barings before I do so I want to begin by highlighting several key points. First, Barings is a global asset management firm with more than $400 billion of assets under management as of March 31st, 2024. Second, bearings directly employs more than 800 professionals dedicated to investing in our core strategies and driving long-term value for our clients and sponsors.
Third, we were a wholly-owned subsidiary of MassMutual and have been investing in private credit on its behalf for more than three decades. We also want to emphasize that when it comes to private credit, specifically CBDC. is just one part of the Barings global platform, which also includes its other BDCs and the entire private assets business and which bearings remains fully committed to and is actively investing in.
As you may be aware on March eighth, 2020 for Barings receive resignations of a number of members of the investment team within the Global Private Finance organization. Six of these individuals were focused on the North American strategy out of a total North American investment team of 56. We have successfully executed a retention strategy across the entirety of the remaining global investment team. BBDC. investors know that the principal investment strategies for the BDC portfolio include sponsored investments, nonsponsored investments and platform investments.
Furthermore, BDC status as a business development company regulated under the 1940 Act has always necessitated that the portfolio tilt primarily towards North American assets as a result of the overwhelming stability of the Global Private Finance North American investment team and under uninterrupted focus on North American investment opportunities.
And in combination with the fact that the BDC resource assets from a variety of other investment teams within Barings BDC management believes we are well positioned to deliver compelling risk-adjusted returns for shareholders in the quarters ahead. Stability offered by the current team is important, but we also plan to augment this team by making strategic hires in the quarters to come. Our hiring efforts will target experienced origination professionals who maintain existing sponsor relationships and possess a strong fundamental credit approach.
We look forward. We look forward to sharing more as we recruit and onboard these hires in the quarters to come like us. Massmutual takes a long-term view when it comes to the asset class of the business MassMutual intends to continue to actively invest with Barings in the middle market direct lending sector, reflecting their ongoing confidence in both the value and performance of the asset class and our capabilities. With that said, we know that many of you have reached out with questions regarding the personnel changes.
As we look ahead, we see incredible opportunity to leverage the strength of our scaled private credit franchise and leveraging the resources that support more than $300 billion of credit investments. Our investment process and philosophy remains unchanged and our deep bench of talent continues to leverage our originate our route, our origination network and deploy capital consistent with our stated strategy. Most importantly, our commitment to our investors is unwavering and as strong as it's ever been.
I'll now turn the call over to Matt.

Matt Freund

Thanks, Eric. To begin discussing market activity, I would first like to give an update on inbound deal volumes post the original resignations that were received on March eighth. I'm happy to share that over the past two months, we have seen received inbound deal volume in line with the levels experienced historically moving to specifics during the quarter, the BDC's portfolio increased $23 million on a net basis during the quarter with gross fundings of $142 million, offset by $119 million of repayments. \
Activity broadly remained tempered during the quarter, but directionally comparable to the immediately preceding quarters, much unchanged from last quarter and based on recent conversations, investment bankers have reiterated their expectation that LBO activity is expected to meaningfully increase in the quarters to come. Our sponsor issuer clients have expressed the same anticipated uptick in transact However, while we have seen an uptick in the number of early-stage opportunities, the conversion rates to close transactions are trending towards historic lows.
Sponsors do continue to execute add-ons for companies already within their portfolios, which make logical sense. And add-on multiples are below the original platform purchase prices in effect, enabling sponsors to reduce their cost bases and hedge against any compression in exit multiples, investors and Barings BDC benefit by having a seasoned portfolio that provides opportunity to deploy capital into issuers. We already know well, while new LBOs are below historical averages refinancing activity has increased, which started in a liquid market in early 2024.
The recent wave of refinancings is not solely isolated to the broadly syndicated markets. We have started to witness the competitive dynamics in the direct lending ecosystem as well, though it appears most acute for issuers and EBITDA of $75 million and above at the moment, Barry's commitment to the core of the middle market is anticipated to serve investors well as the terms of large issuers gravitate towards the terms offered by broadly syndicated markets. And we're able to preserve some pricing protection in the core of what we focus.
Turning to our current portfolio, 72%, which can Turning to the current portfolio, 72% of our investments consist of secured investments with approximately 66% being first-lien securities. Ebdt experienced a stabilization of interest coverage during the quarter and finished the quarter with a weighted average interest coverage of 2.2 times in line with the fourth quarter. It's fair to say that the full impact of an increase in the interest rates has not been reflected within the cash flow metrics of the portfolio.
The stabilization of the interest rate coverage at the high end of our previous guidance ranging between two and two and a quarter times sort of another data point of the strong credit quality within the our avoidance of various industries prone to economic volatility, oil and gas restaurants, retail metals, among them has proven to be a sound strategy against a backdrop of less economic predictability, combined with what we believe are reasonable going in leverage multiples, the median gross margin in the North American global private finance portfolio a portfolio similar to EBDT stood at 50%, up from 48% one year earlier and gives us confidence that our issuers are successfully pushing through price increases to combat inflationary pressures in their businesses.
Adjusted EBITDA margins for the same sample set were 21% and unchanged from the prior year's period. Portfolio composition remained highly diversified with the top 10 issuers accounting for 22.6% of the fair market value. Recall that the top two positions within the portfolio, Eclipse business capital and repaid holdings, our platform investments originating middle-market loans. These positions have a number of underlying issuers. Assets included in the other classification within our materials include structured positions and certain acquired positions that will not be originated on a new issue basis going forward.
As Eric highlighted, we anticipate rotating out of these positions as market conditions allow in the quarters to come. Risk ratings exhibited minimal movement during the quarter as our issuers exhibited by our issuers exhibiting the most stress classified risk ratings four and five were 8% on a combined basis quarter over quarter, while nonaccruals accounted for only $8 million of fair market value within the portfolio and 30 basis points of assets.
Encouragingly, we also experienced some positive movement at certain issuers performing consistent with expectations as underwriting have outperformed in the recent quarter. We remain confident in the credit quality of the underlying portfolio, the uncorrelated nature and associated value of investments in Eclipse and repaid continued to provide exposure to additional middle market lending markets within industries not suited well to conventional cash flow loans.
BBD is committing committed to delivering an attractive risk-adjusted return to shareholders over the long term, we are investors in middle market companies. Our goal, our global reach and significant scale across asset classes is BBDC., a unique ability to select risk and return compared to other managers, but at our core middle-market credit is what we do.
I'll now turn the call over to Elizabeth.

Elizabeth Murray

Thanks, Matt. On Slide 15, you can see the full bridge of NAB per share movement in the first quarter. Nap per share was $11.44 as of March 31st, which is an increase of 1.4% over the prior quarter and an increase of 2.4% year over year. Our net investment income exceeded the $0.26 per share dividend by 7.6%. Net unrealized depreciation from investments, CSA and FX lifted now per share by $0.34, which was offset by net realized losses on the portfolio and FX by $0.2 per share.
Net realized loss on the portfolio was predominantly due to the restructuring of our investments in core scientific and resolute investment managers, which was primarily reclassified from and unrealized depreciation evaluation of the credit support agreements decreased by approximately $6.3 million, which is driven by unrealized appreciation in the underlying portfolios and an increase in the applicable discount rate during the quarter. The fair value of the CRSCSA. decrease from $40.5 million in the fourth quarter to $35.4 million as of March 31st.
During the first quarter of this year, portfolio had sales and repayments of approximately $15 million, and we have 36 positions remaining in the portfolio fair value of the NBCCS., a decrease from $17.3 million to $16.1 million, with four positions remaining in the portfolio and anticipate the sale of MBC auto in the second half of this year.
Our net investment income was $0.28 per share for the quarter compared to $0.31 per share in the prior quarter and $0.25 per share for the first quarter of 2023. Investment income in the quarter was primarily driven by the continued benefit of higher base rates, partially offset by lower dividends from our investments in Eclipse capital and Sierra JV increase in NAB, driven by portfolio appreciation was accompanied by an increase in incentive fees earned by the manager through the incentive fee look-back calculation.
Our net leverage ratio, which is defined as regulatory leverage, net of unrestricted cash and net unsettled transactions, was 1.17 times at quarter end, up modestly from 1.15 times at the quarter ended December 31st, and currently sits within our long-term target of 0.9 times to 1.25 times. Our funding mix remains highly defensible, both in terms of seniority and asset class, including a significant level of support provided by the unsecured debt in our capital structure. At March 31st, our unsecured debt accounted for $1 billion of our fundings and equated to 70% of our outstanding.
As you may recall, during the first quarter of 2024 for Barings BDC issued nearly $300 million senior unsecured notes to enhance the flexibility of our capital structure. Note issuance was significantly oversubscribed. It has positioned BBDC. with significant operating flexibility in the quarters to come. We continue to maintain significant flexibility in our capital structure with the next bond maturity in the second half of 2025 and maintain a ladder of maturities out to 2029.
Barings BDC currently has $215 million of unfunded commitments to our portfolio companies as well as $65 million of outstanding commitments to our joint venture investments. We have available cushion against our leverage limit to meet the entirety of these commitments. As mentioned earlier, the Board declared a second quarter dividend of $0.26 per share, a 9.1% distribution on net asset value and is consistent with our first quarter of 2024 dividend during our earnings call in February, we disclosed the Board authorized a 30 million share repurchase plan for 2024.
We continue to be active users of our share repurchase first quarter was no exception as we repurchased more than 115,000 shares during the quarter and exhibited continued momentum of repurchase activity after purchasing 1.8 million shares in 2023. Our focus on share repurchases is one example of BBDC.'s thoughtful approach to aligning our interest to shareholders.
I'll wrap up our prepared remarks with an update on our investment pipeline. Thus far in the second quarter, we have made $11 million of new commitments and funded $9 million. With that, operator, we will open the line for questions.

Question and Answer Session

Operator

(Operator Instructions) Finian O'Shea with Wells Fargo.

Finian O'Shea

Hey, Ron, good morning. Bear air. So a couple of the opening remarks on strategic changes to you update us on the LP or the funds business. I think it was reported that you voluntarily halted investing there. Is that still the curious and ultimately how the conversations are going with existing and new LPs for the GPF., our direct lending business.

Eric Lloyd

Thanks is up double-digits and so on. We did so with acquisitions came in that Friday leadership, executive leadership here at Barings made a decision to pause investing in certain accounts. We didn't have to pause the investing in those accounts, but we decided to do that because we always remind ourselves, right? It's not our money. It's other people's money that from an investing perspective.
So we decided to make that pause and then have communications with investors, there's kind of two a couple of different bucket from those LPs perspective. There's things that are SMAs or funds of one that are more bespoke discussions that we have with that one counterparty. And then there's really, really the co-mingled funds. So funds that might have 10, 20, 30 investors in there that have things like O. packs and other things that we have to manage through that have different kind of time lines and times we cure things from a key person perspective.
What I can represent to you is that a number of our funds have won or SMAs are have allowed us to continue to invest at this point in time and also can represent to you that our hold level in North America is generally consistent today with what it was prior to the events of March the date. And that whole level allows us to continue to lead deals in our core middle market franchise between [$15 million] and $75 million of EBITDA. Certain other vehicles are continuing to go through their normal process as far as cure periods with key persons and we're working with that LP base, a lot of along those lines. But again, a number of the funds have won the SMAs. We continue to invest in.

Finian O'Shea

And I think that's helpful. And a small follow-up I forgot to throw in there. It looks like Joe, Kathy has slowed down or stopped investing. Is that the case for Joe? In the BDC?

Eric Lloyd

Our relationship with Tasly partners, very constructive. And it's one that we believe will continue to be an important part of the BDC. But that's kind of a discussion we've had with them and we feel good about where that relationship is.

Finian O'Shea

Okay, thanks. I'll do actually one more, if I may. Sorry. It started like in the the staffing or hiring part, the focus would be on adding originators. And just seeing if that implies that the repositioning and of the leadership and investment committee and so forth, the BDC you've announced that they announced thus far it is expected to be permanent, and that's that's all for me.
Thanks.

Eric Lloyd

Yes. So the investment committee that we have stated is a permanent investment committee. We have also stated that we expect to add to that investment committee over time North American investment committee. As for individuals, as it sits today, our prior committee was six number along those lines would be something we could look at over time as we add people.
I would say that the hires of origination is something I highlighted, but I wanted to take a step back and say the most important thing for us to on the hiring perspective is making sure we find a the right cultural fit and we don't rush into any type of hires we don't need to make hires to fill in some kind of gap or some kind of shortfall that we have here. Some we want to make a conscious deliberate hires that fit our culture and our credit philosophy, first of all, and then second of all, they bring originations, sponsor relationships that are additive to the existing platform that we have today as Elizabeth highlighted.
I mean, we've seen a number of deals over the course of the last past two months from sponsors. Those relationships have been incredibly constructive. And I think you'll see some hires here in short order that we'll be able to announce. And I think that one of the things has been humbling and this process has been the amount of people who have reached out to us that interest interested joining the platform because of the strength of the platform.

Matt Freund

If I may, Eric, the BDC management team as it sits today is substantially unchanged from where we were a year ago. And that's whenever we put in place the kind of refined go-forward investment strategy that has been consistent for the past 12 months I would say that in light of the fact that the overwhelming majority of the investment team is unchanged, we have no reason to change our strategy on a go-forward basis. And so while there may be some some management modifications throughout our manager, it's important to note that we don't have reason to change our strategy and feel like the strategy we put in place. He's an incredibly productive one with respect to our shareholders.

Finian O'Shea

Thanks, everyone.

Operator

Kyle Joseph with Jefferies.

Kyle Joseph

Please proceed with your question and on Damang as they should take my questions kind of shifting back to the model a little bit. I think you mentioned this, but just wanted to talk about the decline in investment income in the quarter on either some portfolio growth, it looks like yields are stable, that Canada's fee income driven. Is that timing of deployments and repayments? Or and then I think you did mention the Eclipse dividend income and impacting that as well?

Elizabeth Murray

Sure.
Thanks, Hal.
Yes, and interest income was down slightly quarter over quarter, and that really was related to the fact that we had late fourth quarter sales and repayments early first quarter repayments, and then we redeployed those later in the first quarter. So that was more of a timing issue from the interest income perspective. And in addition, dividend income was down quarter over quarter due to Eclipse.
We also have lower dividend income at Sierra JV for the CRJV., we decided to take some of the proceeds from investment income and repayments and pay down part of the leverage facility we have there. So we can expect that this year, our dividend should be more normalized throughout the remainder of 2024.

Eric Lloyd

With that, I just want to highlight that the leftover decreased dividend off of Eclipse is not anything related to performance of Eclipse. That continues to be an incredibly strong performer for us. It's just timing of distributions.

Elizabeth Murray

And yes, you should see it back at a more normalized level for the second quarter and yet as a.

Kyle Joseph

And then a follow-up for me, probably for Matt, appreciate the margin commentary you gave. But from our side, we've been seeing different headlines about banks exiting the space from Basel three endgame or getting back in. We have DSL.
But just give us a sense for the competitive trends you've been seeing recently in kind of a we're talking about yields being, say stable would give us a break down between base rates and the spreads you've been seeing in recent quarters?

Matt Freund

Yes, happy to comment on it. So I think that what we're observing in the marketplace is kind of a bifurcation based on size. And so the first group of issuers that I think has been more substantively impact is going to be the larger end of the ecosystem. And I would tell you that our larger competitors who are competing squarely against the banking institutions aren't frankly, have a more more robust opportunity set from an issuance perspective than they have over the past few years.
And so as we think about your $120 million and $150 million EBITDA platform that is kind of deciding between a broadly syndicated execution or a privately placed solution that those terms in our experience are looking closer and closer to parity than they have over the past few years.
Now, whenever we start looking at at the core of the market in which we participate, call it sub [50] of EBITDA, I think the median issuer in the portfolio is just over [30]. That isn't really a competitive threat, but the banks don't provide a competitive threat to the same degree to be very candid with you, though, we are seeing more private credit fund formation. And so we are aware that that may provide some competitive competitive headwind here in the quarters to come.
But based on what we experienced during this particular quarter. We feel very encouraged. And so as we kind of set our path forward for the balance of 2024, I think that what we're anticipating is to see a highly competitive environment on the larger end of the ecosystem and perhaps a little bit more kind of price stability as it were with respect to what we define as the core of the middle market because are you thinking of kind of supply demand, right?

Eric Lloyd

Just there's there's a increase of private credit managers in general over the last couple of years. And M&A activity is lower than what it was two years ago. That is just generally going to lead to some form of spread compression in some shorter term period of time. But over time, we're seeing kind of reasonable stability and kind of what that spread level is because there's an absolute return that needs to occur for private credit investors overall.

Kyle Joseph

Very helpful. Thanks for answering my questions.

Operator

Robert Dodd with Raymond James.

Robert Dodd

Morning, everyone, and thanks for all the color about the events of magic on. Just one quick one for me, Matt, you mentioned the conversion rates or close rates for transactions on a trending towards historic levels. Can you give us any color on the drivers?
There is a bit. We have been asked some valuations for transactions not closing sufficiently important to the last minute. Is there failures in due diligence as you get more advanced? I mean, any color you can give us on what's the driver there?

Matt Freund

Yes. I are the most common response that we're getting is that there just seems to be a bid-ask differential that I think a lot of folks anticipated a reduction in interest rates would have helped bridge until you recall, I'm sure everyone knows that these processes take between three and six months by the time you launch a transaction to when you actually close it. We're somewhere in the middle of the beginning or somewhere between the beginning in the middle of that process.
And so as these kind of sell-side transactions have evolved, you get part of the way through and you recognize that your cost of capital isn't ultimately what you had had budgeted for. And I think that that creates some downward revisions on enterprise values. And as we think about it that obviously impacts the the equity pretty substantially, but it's but we generally feel pretty comfortable regardless of whether someone is paying, call it 10 times or 12 times.
And so ultimately, our view on the credit profiles don't often change, but there obviously is some capital below us. And when that cost of capital is changed, it creates revision its expectations with respect to underlying EBIT. So that's our leading contender right now. Of course, there are going to be transactions where they ultimately fall apart over kind of credit or other what other performance metrics. But I think overwhelmingly, it's been a cost of capital discussion and I omitted misalignment of expectations on the bid ask spread.

Robert Dodd

Got it.
Thank you.

Operator

Thank you. We have no additional questions at this time. So I'd like to pass the floor back over to management for closing comments.

Eric Lloyd

Well, first, I want to thank everybody for dialing in and taking the time to listen to what we communicated today. To extent you have follow-up questions or conversations you'd like to have, please make sure you reach out to us and the team. We want to make sure we're transparent and communicative as we go forward over the course of the next quarters. Thanks so much.

Operator

Ladies and gentlemen, this does conclude today's teleconference. We thank you for your participation and you may disconnect your lines at this time.