Barings BDC, Inc.

At this time, I would like to welcome everyone to the Barings BDC Incorporated conference call for the quarter ended September 30th, 2019. All participants are in a listen-only mode. A question and answer session will follow the company's formal remarks. Today's conference is being recorded and a replay will be available approximately two hours after the conclusion of the call on the company's website at www.bearingsbdc.com under the Investor Relations section. If anyone should require operator assistance during the conference, please press star then zero on your telephone keypad. 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 annual reports, on Form 10-K for the fiscal year ended December 31st, 2018, and quarterly report on Form 10-Q for the quarter ended September 30th, 2019, each as filed with the Securities and Exchange Commission. Barings BDC undertakes no obligation to update or advise any forward-looking statements unless required by law. At this time, I will turn the call over to Eric Lloyd Chief Executive Officer of Barings BDC. Please go ahead.

Thank you, and good morning, everyone. We appreciate you joining us for today's call, and please note that throughout this call, we'll be referring to our third quarter 2019 earnings presentation that was posted on the investor relations section of our website. On the call today, I'm joined by Barings BDC's President and Barings Co-Head of Global Private Finance, Ian Fowler, Tom McDonald, Managing Director and Portfolio Manager of our Raleigh Syndicated Loan Assets and Global High Yield Group, and BDC's Chief Financial Officer, Jonathan Bach. Ian and John will review our third quarter results and provide a market update in a few minutes, but I'd like to begin today with some high-level comments about the quarter. Please turn to slide five of the presentation, where you'll see our third quarter highlights. Overall results were consistent with the second quarter as we continued to selectively increase our direct lending exposure while also maintaining a steady NAV per share. For the quarter, NAV per share was $11.58, while our net investment income increased by one penny, coming in at $0.16 per share for the third quarter versus $0.15 per share for the second quarter. We continue to have no loans on non-accrual, and the overall credit performance of our portfolio remains strong. Our middle market debt portfolio was valued at 99.7% of cost as of September 30th, and our broadly syndicated loan portfolio was valued at 96.3% of cost. The BSL portfolio decreased in value by approximately $2 million for the quarter, although we did see appreciation for roughly two-thirds of our investments, including names such as STI Packaging and Reynolds Group. This appreciation, however, was offset by volatility in a handful of liquid securities particularly in the energy and prescription drug industries, such as Seadrill, Fieldwood Energy, and Malintrub. The majority of the underperformance was focused within a few specific names, as we have only seven broadly syndicated loan investments out of 103 that were valued below 90% of cost at quarter end. Shifting gears for a moment, I'd like to focus investors on our investment ramp and transition from broadly syndicated loans to directly originated and proprietary investments. I'll characterize our investment ramp as both steady and deliberate. Since August, we've invested $490 million in middle market investments, averaging $90 million per quarter, with new middle market investments totaling $121 million in the third quarter. Additionally, we matched those third quarter originations with $130 million of net broadly syndicated loan sales in the third quarter and continued to selectively sell in the fourth quarter. bringing our broadly syndicated loan exposure to 61% of portfolio at September 30th. In short, from an origination standpoint, we're exactly where we said we would be, and we expect this steady and deliberate transition, averaging approximately $100 million of middle market and proprietary originations per quarter, to drive us towards an 8% yield. On slide six, we summarized some additional financial highlights for the last five quarters. Ian will discuss market conditions in more detail, but I'll say that our investment pace must also be measured against the market opportunity set. Let me be clear. We are operating in a challenging lending environment, and the wealth of capital aggressively pursues a finite set of quality investment opportunities. Additionally, lower LIBOR and tight investment spreads pressure market yields on all direct loans, and this may likely drive further competitive market behavior. In my view, investing in this competitive environment requires two very important actions to remain successful. First, managers should keep a wide investment frame of reference to ensure a proper focus on relative value. This includes a view of both liquid and illiquid assets, special situation investment opportunities, as well as multi-geographic focus to prevent being overly reliant on one asset class or category. Second, some periods have a fee structure and liability profile It gives the external manager the ability to focus on attractive risk-adjusted returns and limits seeking current income today at the expense of NAV deterioration in the future. Thankfully, Barings, as a $335 billion asset manager, has an extremely wide investment frame of reference across global markets and multiple asset classes. We've managed in many markets through many multiple cycles, all with the goal of delivering attractive risk-adjusted returns through recycles. Additionally, our unique ownership by MassMutual committed to investor alignment has led us to create a market leading fee structure. This fee structure gives us the flexibility to generate attractive risk adjusted returns to investors while at the same time focusing on high quality, true first lien senior secured investments. Before turning the call over to Ian, I will continue this point of alignment and update you on our share repurchase program. Please turn to slide seven. As a reminder, The share repurchase program we announced for 2019 aims to repurchase up to 2.5% of the outstanding shares when Barings BDC stock trades at prices below NAV, and repurchase up to 5% of outstanding shares in the event the stock trades at prices below 0.90 NAV, subject to liquidity and regulatory constraints. Based on how our stock is traded, the target amount for 2019 repurchases will likely be around 4.5%. Since the beginning of the program, The BDC has already repurchased 3.9% of the outstanding shares, and we fully expect to achieve our commitment target by the end of the year, continuing to demonstrate our strong alignment with our shareholders. With that, I'll ask Ian to provide an update on our investment portfolio and trends we are seeing in the middle market.

Thanks, Eric, and good morning, everyone. Jumping to slide nine, you can see a summary of our new investments and repayments for the third quarter. and net funding trends for the last five quarters. Our gross middle market fundings for the quarter of $121 million included 10 new platform investments and six follow-on investments. Included in these numbers are an additional $5 million for the joint venture, plus three European investments totaling $33 million. We look at our 10-plus year direct lending leadership position in Europe as an excellent backdrop for diversification. as it continues to be a growing opportunity for middle market direct lenders who hold roughly a 50% share of the current market and continue to take share from the large banks, a dynamic that creates a strong relative value proposition. Europe also provides an opportunity to make investments in strong middle market companies that have characteristics of much larger companies. Europe is not one single market, and barriers to entry within a single country can create competitive positions that middle market companies do not typically enjoy in the U.S. Furthermore, while a company's EBITDA profile of 30 million may classify the investment as a middle market company based on its size, the company's dominance in a niche market in a certain geography can be a characteristic normally enjoyed by much larger companies. And we will continue to utilize the Barron's platform to take advantage of these types of opportunities going forward. Turning to slide 10, you can see that as of September 30th, the BDC was invested in roughly $675 million of liquid broadly syndicated loans and $469 million in private middle market loans and equity, including $47 million of unfunded commitments. Overall, our portfolio consists of 98% senior secured, first lien assets. The broadly syndicated loan portfolio had a weighted average spread of 329 basis points and a yield at fair value of 5.6%. While the spread was up slightly from 327 basis points at the end of the second quarter, the yield was down from 5.8% due to lower LIBOR. The weighted average senior leverage for this portfolio remained relatively consistent with last quarter, at 5.1 times versus five times at June 30. Shifting to the middle market portfolio stats on slide 10. As of September 30, our 422 million funded middle market portfolio was spread across 38 portfolio companies, as compared to 352 million across 30 portfolio companies at the end of the second quarter. Underlying portfolio company fundamentals remain strong, with weighted average senior leverage of 4.6 times and weighted average interest coverage of 2.7 times. Of the 38 middle market investments, 36 first lien investments and two were selectively chosen second lien term loans. Average spreads were up this quarter from 500 basis points of June 30th to 519 basis points, at September 30. As with the broadly syndicated loan portfolio, however, overall yields declined to 7.2%, primarily as a result of lower LIBOR. A portion of the spread increase was due to higher spreads associated with the new European investments. As we have said before, our focus continues to be on credit spreads, as that is ultimately our compensation for risk. Our middle market portfolio remains well diversified, as the 38 investments are spread across 14 industries, with no single investment exceeding 2.2% of the total portfolio. Our top 10 investments are shown on slide 11. Now switching gears to the broader market, please turn to slide 13, where we show current yields earned in the large corporate market compared to middle market syndicated and middle market direct lending transactions. In short, the spread premium enjoyed by the middle market lenders relative to the large corporate market remains at all-time tights. This is driven by continued capital flows into the middle market in light of a generally average level of M&A volume relative to 2018, as well as widening spreads in liquid loans as a result of technical outflows. What's more, the tightening illiquidity premiums on the middle market asset class require an extreme focus on ensuring illiquid credit is priced appropriately relative to its liquid counterpart. This is where varying scale and depth in numerous asset classes comes into play, as this allows us to properly price and drive attractive relative returns across multiple asset classes and geographies in search for relative value. As you can see on slide 14, true first lien middle market spreads are currently averaging 538 basis points. And looking at our first lien deployments, we've kept the focus on quality, where our average first lien spread since externalization is approximately 510 basis points. Additionally, investors may notice that Unitron spreads have tightened materially and now sit on top of first lien senior loans. This serves as a reminder that it is important to look at each issuer and capital structure individually, focusing on the true security position rather than simply a name or a category. On slide 15, we show leverage trends in the broader marketplace, not specific to our portfolio. While the traditional first-lane mezzanine and first-lane, second-lane structures remain elevated in the third quarter, They were relatively consistent with second quarter levels. The senior and Unitron categories, however, rose to their highest measured levels since this tracking began. I think it's also interesting to note that both first lien and total leverage hit new record highs of four and a half times and five times for middle market sponsored transactions in the third quarter. with 53% of mill market-sponsored deals having total leverage of greater than five times. Today's lending environment affords investors many opportunities to relax standards on leverage in order to compete for deals, which once again emphasizes our earlier points about investing focus, discipline, and diversification. We will continue to focus on finding quality transactions over meeting yield expectations or deployment targets, which we believe will ultimately be best for long-term shareholder returns. I'll now turn the call over to John to provide more color on our third quarter results and the opportunities presented by our joint venture.

Thanks, Ian. Turn to slide 17. Here you're going to see a bridge of the companies that asset value per share from June 30th to September 30th. One penny decline in NAV to $11.58 per share was primarily driven by two cents of net realized losses and four pennies of net unrealized depreciation on our investment portfolio and foreign currency borrowings. Speaking of the realized losses for a moment, approximately one penny was related to royalty payments due from a legacy TCAP portfolio company. And we do not anticipate any material write-offs from this type of legacy position going forward. Now, the remaining penny of net realized losses was primarily attributed to net losses on the sales of BSL portfolio investments. Now, for the net unrealized depreciation, roughly $0.07 relates to the decline in two of the BSL portfolio investments that Eric mentioned, Malin, Crott, and Seadrill, which were partially offset by $0.03 of net unrealized appreciation across the remainder of the portfolio in our foreign currency borrowings. These declines in NAV were partially offset by our third quarter NII exceeding our quarterly dividend by $0.02 a share and a $0.03 per share increase due to accretion from the share repurchase plan. Slides 18 and 19 show our income statements and balance sheets for the last five quarters. That's when Barrings took over as investment advisor for the BBC. Just a few things to point out here. You can see on the income statement that our third quarter total investment income decreased $300,000 compared to the second quarter. While our middle market portfolio grew during the quarter, sales and repayments within our BSL portfolio and lower LIBOR drove the investment income decrease. These same factors drove an offsetting decrease in interest expense quarter over quarter, which included a $100,000 impact due to the contractual uptick and the unused fee on our corporate credit facility, 50 basis points, in mid-August. The increase in net investment income to $8 million in the third quarter was impacted by lower general administrative expenses, as the BDC incurred lower direct and indirect charges during the quarter. Now, as a reminder, general administrative expenses include expenses incurred under our admin agreement with bearings, and other expenses such as D&O insurance costs, legal and accounting fees, and valuation expenses. You can see on slide 19 there were no significant changes to our balance sheet during the quarter, although borrowings have continued to shift from our BSL facility to our corporate credit facility. Details on each of our borrowings are shown on slide 20. Now, given the BSL sales and repayments, we further reduced the total commitment under our BSL facility to $177 million in August, and $7.5 million of the CLO Class A1 notes were also repaid during quarters. Our leverage at set 30 was 110 times debt-to-equity, or 0.94 times after adjusting for cash, short-term investments, and net of unsettled transactions. Slide 21 shows our paid and announced dividends since Barron's took over as the advisor to the BDC. We announced yesterday that our fourth quarter dividend of 15 cents will be paid on December 18th, and that's our fifth consecutive increase, to align our dividend with the earnings power of our portfolio. Turning to the remainder of the year, slide 23, here this summarizes our investment activity since September 30th. And in the fourth quarter, we've made approximately $69 million of new middle market private debt commitments, of which $25 million have already closed and funded. All of these investments were first lien, floating rate loans, and they had an average three-year discount margin of 6.2%. Now our profitability weighted pipeline is shown on slide 24. And you can see our current global private finance investment pipelines are around $1.05 billion on a probability-weighted basis, and it's heavily focused on first-lane senior security investments across a variety of diversified industries. And that compares to a pipeline of approximately $420 million that we discussed on our last earnings call. Now, as a reminder, this pipeline is an estimate, and it's based on our expected closing rates for all deals in our pipeline. Also, I'd like to provide some additional color on our joint venture with the state of the South Carolina retirement system. From the beginning, our plan has been to build credibility during our first year as an investment advisor, during which time we would design a vehicle that would allow us to leverage the broad expertise and investment expertise of Barings while effectively managing investment diversity within Barings BDC. This vehicle is our joint venture. which we utilize to help drive shareholder returns through the effective use of our non-qualified asset bucket. And that's across a wide variety of liquid and illiquid asset classes across multiple geographies. As the JV ramps, its benefits are both direct and indirect. On a direct basis, the JV is targeting 10% return on its equity, but also on an indirect basis, the JV allows the BDC to share in certain non-qualified assets allowing the BDC to benefit from diversity and high-quality return while also maintaining proper diversification. As we've discussed, the JV has a very wide investment mandate, and the BDC also has the opportunity to participate in certain of these investment opportunities. We're going to continue to evaluate each opportunity in areas such as European credit, structured credit, and make investments in these areas if they have attractive risk-adjusted return profiles. various wide investment frame of reference enables the JV and the BDC to participate in these opportunities. And we said that it's a key differentiator in today's dynamic lending environment. And with that, operator, we'll open the line for questions.

Thank you. At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star then 1 on your telephone keypad. A confirmation turn will indicate your line is in the question queue. You may press star then two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please while we poll for questions. Your first question comes from Mickey Schleen from Leidenberg. Please go ahead.

Yes, good morning everyone. Eric, a question for you. When we look at the performance of larger companies, we're seeing fairly consistent deterioration in fundamentals, and that's showing up in many metrics, like the proportion of leveraged loans that are being downgraded. On the other hand, middle market companies continue to do well. So I'd like to ask you, what do you attribute that divergence to at this point in time?

Thank you for the question. This will be a little bit of Eric Lloyd's opinion relative to an overall context of the management team, but I think it's consistent with what we've seen. I think there's a couple of things at play here. Most of our middle market companies are primarily or almost exclusively tied to the US economy. They have much less of a global or multiple geographic footprint. If you look at the US economy relative to other economies in the world, most people would say it's outperforming other economies in the world. Tom can speak to the larger markets, but our average EBITDA size of our broadly syndicated loans in this portfolio is about $300 million, or about 10 times the size of our middle market assets from an EBITDA perspective. Those companies are much more likely to have a much more multinational or global footprint. more impacted by tariffs or imports or exports or have businesses that are more tied to economies that are outside the US that maybe are just a slower economic growth cycle than what's in the US.

Eric, just to follow up. In the past, we've tended to see trends in the larger, more liquid markets eventually work their way down to the middle market. I'd like to understand whether you think that's also the case for what you just discussed and how that's impacting your investment strategy.

Yep. So I'd say I think Ian characterized it well in that, you know, on the private companies, as you know, sometimes we get monthly financials for those companies. Sometimes we get quarterly financials for those companies. But we're in constant dialogue with management teams to understand performance. And I would say – As Ian represented, the portfolio companies in general, we see continued attractive performance or strong performance. But I would tell you that on an organic basis, it's a little slower this last 2019 than what you would have seen in 2018, not in some material way. And it's hard to kind of really, with a lot of acquisition roll-up companies that are out there, it's hard to really get at the data behind it to get the really comps to comps. But as you talk to management teams and the like, I'd say it's still positive, but it's definitely less positive than what it would have been in 2018. So whether that's the larger market dynamics coming into the middle market, whether that's a slowing of the U.S. economy in some general way, maybe it's a combination of those factors, I don't know. But we're seeing that. So what does that mean for our investment performance? First of all, as we articulated in August of last year, We underwrite every deal assuming there's going to be an economic and a credit cycle during the life of that asset. Our typical loan is somewhere between five and seven years in length. We don't know when that next cycle is going to come. We know we're closer to it today than we were in August last year, but we always assume we're going to have that economic or credit cycle during the time that we own that asset. From a bottoms-up perspective, it's not really changing what we're doing in any material way. There are certain industries as you go longer into an economic recovery that you say, maybe I want to shy away from even more than I have in the past. Let's use consumer discretionary as an example, right? Coming into an economic recovery, consumer discretionary is going to perform differently than going potentially into an economic recession. So on the margin, you do take industries and make them a little more or less out of favor, but we don't whipsaw things one way or the other. What it does mean, and I think we've tried to highlight this multiple times on this call, is a couple of things you have to do in this environment. It really is about discipline, selectivity, and then ultimately running a very diversified portfolio. I think as John referenced or Ian referenced, our single largest investment I think is about 2.5% of our portfolio. That's deliberate on our part. We don't want to have an investment that's, you know, 6%, 7% of our portfolio when you look at that because you just don't know which of these ones will end up being a challenging situation. But we just know we'll have one eventually.

That's really helpful, Eric. Those are all my questions. I appreciate your time. Thank you. Absolutely, Mickey.

Thanks for dialing in.

Thank you. Your next question comes from Tino Shea from Wells Fargo Securities. Please go ahead.

Hi, guys. Thanks for having me on. Just a couple of questions on your portfolio earnings ramp. First, on the liability side, it looks like a challenge here is coming from the unused fee on the middle market facility commitments. So looking at the three facilities you have, it looks like you're reducing, as John mentioned, the BSL facilities commitments. But then, you know, the static CLO goes down as it does, but the question is, are you going to replace that financing with another unsecured or securitization, or are you going to transition entirely to the middle market revolver?

If you look at the inflection point where the unused fee becomes less onerous, that's about One-third utilization of the facility, which is roughly $150 million of net middle market originations that show up on that line. Remember, the way we fund those middle market securities, we do it both through a combination of BSL sales as well as middle market borrowings on the ING line. Where we're coming out is, I'd imagine you'd see additional sales and reductions in that line near term, right, as opposed to a full-on extension.

Tim, I'll tell you, this is Eric. I mean, you know, I mentioned after we closed the facility that, you know, we went out for a smaller number. We had really attractive response from lending providers, and we went for a larger number. You know, at the time I represented, I made the decision that, It would be potentially a small drag on earnings, but that incremental liquidity going into tying back to Mickey's question, what could potentially be a challenging economic environment was worth the tradeoff. And, you know, time will tell whether that was a smart decision or not, but I believe that, you know, term liquidity for these type of vehicles, I believe long-term is an attractive way to finance them.

very well, appreciate the color. And then on the portfolio side, you're staying conservative on new origination, which is good. But at this point, LIBOR is an obvious headwind, and that's happened since you formed your strategy on the BDC. So how do you think about your earnings ramp there for while you're staying conservative on new origination? Is this going to delay your earnings ramp more, or are you able to offset this in other ways?

Listen, I think, Finn, I appreciate you asking. I think that's kind of the heart of the issue right now for us, right, which is we've represented that we have a long-term goal of an 8% ROE to investors. As you represented, there's some headwinds that are in the face of that, That being said, you know, excuses are not what people are looking for. And so let me try to address this issue straight that on. You know, the first year we came out, so from kind of August until really kind of the last quarter, as we referenced, it was really about building trust with the shareholder base, transparency with the shareholder base, and establishing a liability structure and a fee structure that we believe is attractive over time. And we have very limited use of our 30% bucket outside of some really syndicated loans that we would purchase that were not for private companies. But if you think of other ways of using the 30% bucket that other people do, we've had extremely limited use of that. Tying that back to Barings, right, a $335 billion asset manager that invests in multiple different asset classes across multiple geographies, there is a way to supplement our middle market exposure on the first lean that would make up again the 70% plus bucket with investments in that bucket that will be accretive to ROE and in some cases accretive to ROE in a reasonable materiality way. Combine that with if you take our average spread we have today at 519 of the spread that we have on our middle market assets which is on in our document that we put forth on our investor presentation and the average upfront fees. If you take that for the vast majority of our portfolio at current LIBOR plus some use of the 30% bucket for other things that Baring does well, whether that be some European transactions, structured credit, special sets, there's a whole host of things that we've done improving our track record over time we could do. We do see a path to that 8 ROE that we've communicated to investors. I think we've represented to shareholders that we have strong alignment with shareholders, and we have levers we can pull to help position us towards that 8 ROV also. I hope that addresses the question head-on. If it doesn't, please ask again so I make sure I do.

No, no, that's all for me. Thank you for the color.

Thank you. Your next question comes from Ryan Lynch from KWB. Please go ahead.

Hey, good morning, and thanks for taking my questions. First one just has to do with the JV. Obviously, there's a wide variety of assets that can go into that entity that Barings invests across the platform, being liquid, non-liquid, European, US, structured products, special situations, et cetera. Those are investments that are already going into the Barings platform, and the JV could potentially participate and take a slice of those investments. Obviously, Barings as a platform thinks those are good investments to invest in. My question is, how is the JV determining which of those investments that Barings is investing in, which out of those investments are right fit for the JV for the BDC?

Sure. Great question, Ryan. This is Bach. I'll say that the decisions get made, there's a board for the joint venture that includes both three members from our JV partner as well as three folks from Barings that look at asset allocation in the context of return or net ROE per unit of risk, right? And you can measure risk a couple of different ways, but being how we're owned, et cetera, we typically look at credit rating as a potential or good proxy or measure for risk. And as you start to look at different asset classes on different yield profiles, not applying any of the constraints of the BDC structure, you can start to lay out that, generally speaking, there's some cases to own a number of different asset classes with some tactical weights one way or the other. But generally speaking, you're able to go across the liquid and illiquid markets and make decisions on that basis. And so what you see is you can see our kind of joint venture, as it's ramped, you can see the assets in terms of how it's been deployed quarter as of SEP 30. You'll see more representations of how we're looking at it on that basis, given that some assets can be levered more, some can be levered less, right, depending on the yield profile, but it always comes to a true return per unit of risk, right, per asset class. And that's something that permeates across Our platform is we always want to price everything appropriately relative to its underlying risk profile. So it's made by the Board of Governors, and it's fairly broad in scope, but you have to apply a couple key components. What the asset class return is, what the expected loss is, how it can be levered appropriately, and then at the same time, how the all-in risk and volatility of that investment ties into play.

So, Ron, Tom McDonald is here with us, and Tom is one of the board members of that JV. And he's also on our high-yield strategy and allocation committee that's been a long-standing committee and has responsibility for managing portfolios that include European and U.S. liquid loans, structured credit, and European and U.S. high-yield bonds. And that group has looked at relative value across those various asset classes for years, and Tom's a voting member of that committee. And that's one of the perspectives he brings to that JV board as we sit around and talk about relative value.

Great. That's helpful, Keller. Kind of following up on the ROE question, if I look at kind of what is the long-term ROE that this entity can generate, you know, when I look at your – and I appreciate, Eric, your comments you mentioned earlier. But, I mean, if I look at your portfolio yield and your middle market loans today of about 7.2%, Even with, you know, you said a point and a half upfront fees that are amortized, you know, maybe that's 30, 40 basis points on top of that 7.2% yield on your middle market loans once you rotate the portfolio. Given the headwind that LIBOR has already had and is, you know, going to have for the foreseeable future as these loans start to reset, you know, when I run the math, it looks more like a mid-7s kind of percent ROE. Now, when you guys talked about the 8% ROE, that was a much different interest rate environment, you know, a year, a little over a year ago. LIBOR was about 40 basis points higher and was heading upward. Now we're 40 basis points lower and it's trending downward. So, you know, I guess at what point does that math given where LIWR is moved, start to change and that 8% ROE is not attainable because it seems pretty hard to obtain from the math that I'm running.

I'll start and then I'll kick it over to Eric. First on just the math point, Ryan, when you look at a math at a 519 spread, given an L225 cost to borrow, at the same time at a point and a half up front, and the fees that are charged with G&A that's charged as well, you get above the 8% hurdle, which generates an 8% ROE. Now, that's clearly on just a middle market basis, and the portfolio itself is shifting in that regard to a full middle market portfolio over time. So I'd say that's one point, at least as we've looked at the math, how that works on an individual investment basis. The next question this goes to, if you're building a portfolio and you're slowly moving towards that trend, that L519 can also be supplemented from a number of different attributes across the Barings franchise in terms of a wider investment frame of reference. But also, there's another point I think it's important to get across. Because really what happens is, if a portfolio yields, is a proxy for a BDC's ROE, which essentially if you're generating 7.2% yield, but you're paying a 7.2% ROE, what that at its core means is that shareholders are not benefiting from leverage, which at the end of the day isn't really part of the investment game. What you'd expect is to see leverage be an enhancement of return to the shareholders, which given our alignment and how we're owned is extremely important. So we tend to take all that into context. And so on an individual investment math basis, we see the eight. I also want to point out that if portfolio yields match folks ROEs, then there's no benefit to shareholders described through the leverage. And then from a long-term perspective, it would probably be good to have Eric give us a just general sense of the ways we tend to look at alignment as well as our investment management profile going forward to get exactly to your question.

I think John answered the specifics well. I would tell you, is it harder today than what we thought we were just signed up for in the environment 12 months ago, 15 months ago? Absolutely, to your point, right? Spreads have been under pressure. The market's more competitive. LIBOR's lower and trending in a different direction, right? So what does that mean for us, right? We didn't want to change from what we said going into this the first year. Again, it was establishing trust and credibility and transparency with the investor base. We've had group offsites where we've talked about what do we want to do from a portfolio strategy perspective, not to increase risk, but to add assets to the portfolio that we believe, given the liability structure we have, will be diversifying and ROE enhancing beyond the traditional middle market first lien expenditures that we have. And this group of people that involves multiple people from our high yield liquid team, Tom McDonald is an example, Brian High and others, other people from our private assets team that include assets across there, to say consistent with the risk profile we've communicated to shareholders, what other opportunities such are out there? The combination of those factors, I believe if people give us the time to show, prove it out, will be accreted to shareholders and get us towards that number that we've talked about. I can't control what LIBOR does, right? If LIBOR goes to 1%, will it make it more difficult?

Yes.

If LIBOR goes to 3%, will it make it easier? Yes. We referenced earlier, one of the things we believe at our core is we're paid for credit spread performance primarily. That's what we can control. And so I tell our team we're not going to chase risk just to get there, but we are going to look at what other asset classes we can use to supplement or complement core of the portfolio.

That's a really helpful color all around. I appreciate those comments. Those are all my questions today. Thanks.

Thank you. Your next question comes from Robert Dodd from Raymond James. Please go ahead.

Hi, guys. Morning. One question first on the P&L, and then I've got a few other questions as well. Just the other OPEX, I mean, Jonathan, you made some comments and you prepared remarks as well, and obviously it was down at $1.2 million this quarter. There's some seasonality to that. But that's now at 45 basis points of assets. The prior two quarters, it's been 65. Can you give us any color on that? Is that just a seasonal benefit, or is that either on a run rate dollar basis or percent of assets or however you want to Is that kind of directionally what we should be looking for going forward?

Sure, just context on G&A overall. So one, your first and second quarters are generally heavy as it relates to audit and proxy costs. Your third quarters can be generally light. That being said, if I were going to be an African analyst or give some expectation on how those things trend out, I'd be saying that as a number of legal legacy costs continue to roll off that were apart from the TCAP purchase, you'd probably see some additional enhancement and improvement in that line on a go-forward basis. So from a modeling perspective, you can see it's kind of stable to improving slightly as it relates to expense. Does that help? That is very helpful. Thank you.

And then on a question for whoever wants to take it, to be honest. The broadly syndicated loans, I mean, she sold down quite a chunk in the third quarter. Result was net portfolio shrinkage. Obviously, I mean, your middle market, very good originations. So on the BSLs, is this, and also in the October period, you've sold down more BSLs than you've funded on your originations, right? So, you know, is this a decision given the volatility and maybe the global sensitivity that you talk about, Eric, with the BSLs to maybe they're more sensitive to global weakness than your middle market? Should we expect continued maybe net portfolio declines as BSL sell downs exceed middle market originations?

Yeah. So, this is Tom. You know, I'll speak a little bit to that, what we're doing on the BSL side. So, As you mentioned early in October, we did take advantage. The market was strong coming out of September, so we did take advantage of that and sold down some BSLs there as well. What we do look for is we're in close contact with these guys. Whenever we see strength in the market, and in particular names, where we're above our cost basis, we'll notify them. They get to make the decision about do we pull the trigger on that based on liquidity needs. That's typically how it's worked And I think that's going to be the way we do it going forward.

And then from a funding standpoint, Robert, the question was, you know, how do BSLs match the middle markets? And we try to keep them fairly close. That being said, if there's an updraft, and I know our liquid teams always see this, to the extent that super high-quality companies continue to fetch a bid that's in excess of the price, we lower – you know, we'll sell into that, right? And so we'll try to keep them closely matched, but when the opportunities present themselves – to further reduce as they did in September as they're currently doing today, you can probably expect to see us being a little bit more aggressive because what matters to us in terms of ROEs and that question is portfolio rotation is critical, it's important, and it should be done deliberately as well as tied to our middle market originations as well.

Got it, got it. I appreciate that. Then just on the kind of the unfunded side, obviously at the end of Q3 you had $47 million in unfunded. There's another... 45 so far in October, if I've done my math right. So, I mean, that's pushing, you know, that's about 90 million on a portfolio that's 450 funded, right? So, about 20% of wealth. 500 unfunded. So, Tom, is there any color you can give us on the unfunding? I mean, are they revolvers? Are they going to get funded? Is it timing? How's the dynamic on that going to work? So we all understand.

Knowing that you're looking at a lot of folks that kind of refer to it differently, this is not going to be a revolver or a venture-driven type – venture-debt-driven type of funding where you make a commitment and it might not fund, right? When you see commitments for us, that means that we've been mandated on the transaction, we've received an allocation, and we're effectively waiting for that transaction to close. So those commitments aren't – in any way, shape, or form lower than expected fundings. Those do translate into fundings over time, so you can see that as net portfolio growth in the future. We just choose to point out it really is a commitment, and it hasn't funded yet, but there's a timing difference.

And so, Robert, to put a little more color on that, just to make sure we're crystal clear, they're not revolvers. It is typical in today's environment that a sponsor in a transaction, if there's a $100 million funded term loan, that that may be in our unfunded that we're going to be committed amount. As Jonathan said, we've already committed to that. But it also happens where in that $100 million term loan, there might be a $20 million delay draw tranche of that term loan, right? So therefore, you're in the funded part, but then you have some delay draw part that typically has a couple of years to draw. So the sponsor has not committed capitals. And I'd say that's more the norm today than what you would have seen three or four years ago.

Got it, got it. I appreciate that. And then one more, if I can, maybe for Ian. If I look at page 15, and you gave us some color on First Lean, Mez, slash Unit Ranch, whether they're hitting peaks or not. In the past, you've occasionally given us a chart on this with sectors as well. I mean, is there any sector that stands out as either particularly better on either leverage or yields, or to your point, return per unit of risk? Are there any that stand out as with deterioration or improvement?

Yeah, great question, Robert. And, you know, I think as we've talked about in the past, the average purchase price in today's market is, you know, somewhere around 11.5, 12 times. And what you've seen is in certain industries, particularly technology, and I would also say healthcare has been a you know, very prolific industry in terms of LBOs. And because of that, you're seeing the purchase price multiples in both of those sectors widen. And so typically, a lot of those deals are following those sectors in particular. And I think this all ties back to this LTV issue. And, you know, that's obviously one factor that we look at in any transaction is we're thinking about it and pricing risk is we're looking at LTV. But the reality is, LTV doesn't pay back your loan, it's not cash. And at some point, you cross a line where you're so deep in the capital structure that you've got to bifurcated out into more traditional structure versus a senior structure.

Got it. I appreciate that. Thank you.

Thank you. Just confirming, Mr. Dodd, you have now finished your questions? Yes, yes. Thank you. Your next question comes from Kyle Joseph. Please go ahead.

Hey, good morning, guys. Thanks for taking my questions. Most of them have been answered, but just to follow up on the broader environment, you guys have commented how it's very challenging just step back. How have you seen competitors react? Is it getting more competitive? Have you seen some guys step to the sidelines given it's more challenging? If you could just give us some color on your competitors, that'd be helpful.

I'll jump in and then Ian can add some color to it because he's frankly in the market day in and day out. I think it kind of varies depending on where you are in the direct lending business. I think We try and stay true to exactly what we have done for years and years and what we've communicated to people. That $15 to $50 million EBITDA business is what we try and own. Are we going to do some deals that are smaller for key strategic sponsors? Yes. Will we do some deals that are larger for key portfolio company sponsors? Yes. In this space, what we're seeing, where we operate day in and day out, I would say for the most part, the competition has increased and not stayed stable. It's somewhat tied, I think, at times with people's different fundraising and where they are in fundraising. For some managers, other people like us have a much more diversified pool of capital, so they're less reliant on a single big fund that they raise at any one point in time. I would just tell you, I don't know how I would say anything more than it was competitive a year ago. It's at least as competitive as not more competitive today. Up to what margin, it's really hard to say. No, I mean, I totally agree with that.

And, you know, quantitatively, it's hard to answer that question. You know, intuitively, we don't see anyone really stepping aside. You know, we have walked away, for example, you know, I would say, you know, the two items that have been areas where there's been degradation, one has been in documentation, and structural protection. And we have walked away from transactions, unfortunately, because we just weren't comfortable with the documentation at the end of the deal. And so I think a lot of direct lenders have focused on documentation to be more competitive and give on terms. And quite frankly, a lot of us have gone through cycles and know that those terms are really critical in terms of ultimate recoveries. And so we're being disciplined around that, as Eric said earlier on. I think what you're seeing now, maybe a little bit more on a quantitative basis, which, you know, goes back to the question that Robert asked, is you're starting to see leverage creep up. And I think it's selective in certain industries, as he alluded. But I think that could be a growing trend where, you know, we probably – I've seen the degradation we're going to see in the documentation, and now people are focusing on leverage. And in terms of documentation, our focus has always been in the middle of the middle market where we feel like we get the best documentation for companies of scale. And so we're just being disciplined around that.

That's very helpful. Thanks very much for answering my question.

Thank you. Once again, if you wish to ask a question, please register by pressing star then 1 on your telephone. Your next question comes from Bryce Rowe from National Securities. Please go ahead.

Thanks. Good morning. Good morning, Bryce. I was curious with the drop in LIBOR, is there a point at which you'll get some level of protection from possibly pricing floors that you've got baked into, you know, at least the middle market loan portfolio? Or am I wrong assuming that?

No, you're right. I mean, I won't say in all cases, but in the vast, vast, vast majority of our cases, we have a 1% LIBOR floor. So we've still got a ways to go to hit there, but we do have some protection. And the few European deals that, you know, we've referenced earlier, we typically have a floor of zero in those deals to really protect us from negative base rates.

Got it. That's helpful. Then I guess a question on Europe versus the US. Obviously, you highlighted the spread increase within the middle market loan portfolio and European investments having or playing a part in that. Can you speak to the differential and spreads between US and European investments?

These won't be specific to the transactions in our portfolio. I'll talk a little bit about what the two market comparisons look like because on a go-forward basis, if we do a few more, I don't want to just look at a fact set of a couple and extrapolate that out. I'll give you a couple of differences that occur. First is upfront fees. If you look at our typical upfront fees in the US, they would average in the mid-ones from an upfront fee perspective. you would add around a point to that in Europe from an upfront fee perspective. So kind of a mid-twos perspective. So that's one differential. So obviously, faster prepays in Europe lead to higher IRRs than in the US because you monetize that fee over a shorter period of time. Second one that I'd say is separating out the upfront fees just on a spread-to-spread basis. The spread's a little bit higher in Europe. If I had to say for a like-for-like deal, I'd probably say it's around 50 to 75 basis points for a like-for-like deal. When combined with the higher upfront fees, you're probably talking about 100 to 125 basis points, depending on your views of return and repayment structures, of differential between those two. And part of that is just, you know, the absolute return that an investor needs with a base rate basically at negative or at zero over there. The second part of it is it's in the vast majority of deals in Europe, there's one single tranche of debt. So from dollar one to basically the last dollar of debt is one tranche of debt. There's almost no mezzanine or almost no second lien market. In the U.S., right, depending on the industry and a whole host of things, the size of the company, you know, even in the middle market, you see some deals that even in today's market have some mezz or some second lien in there. And so on average, your attachment point is a little deeper in the European market than it is in the U.S. And that should be compensated a little bit more for spread. For our portfolio, that incremental leverage from U.S. to Europe is about a half return of leverage. And we believe this incremental return compensates us for that. Second thing I'd say is given where base rates are there, your interest coverages in Europe are more attractive than they are in the U.S. So the offset of having a negative base rate from a return perspective for an investor, the positive for the company, even at a 0% floor in their loan, the interest coverages and the fixed charge coverages are quite attractive.

That's really helpful, Eric. I appreciate it. I had one more question around kind of leverage levels. Obviously, you guys have identified a longer-term leverage target for your balance sheet. I was curious how you're thinking about that targeted leverage near term, given the macro environment, would you prefer to operate with lower leverage today and maybe build it out as the environment improves over time? Thanks.

Yep. Yep. Bryce, let me tie it back to a little bit of what Tom said and the question he got around selling the broadly syndicated loans. And it's not that we're some macro market timer, but Kind of like, and I'll tie it back to my answer to Finn's question too, right, which is I believe unused liquidity over the coming couple of years is going to be your ally. And so in today's environment, when we see the opportunity to sell broadly syndicated loans above our purchase price in order to generate liquidity, if the smartest thing to do is to pay down borrowings, right, then that's what we'll do. We don't go into this with a targeted leverage level that we're going to be at every single quarter regardless. On the margin, I would tell you we're airing towards a lower leverage scenario than a higher leverage scenario really to buy that optionality. The position we want to protect ourselves from is volatility in the broadly syndicated loan market where those trade down similar to what they did last year. We have leverage levels at a level that are at our target level already. and we have middle market originations that we want to fund, then we really have two options. Take our leverage above our targeted level or sell the broadly syndicated loans at a realized loss. Neither one of those are places we want to do, so we want to buy the optionality to have that leverage flexibility to the extent we have some volatility on our broadly syndicated loans.

That's helpful. Thank you very much.

You got it.

Thank you. Your next question comes from Casey Alexander from Compass Point. Please go ahead. Pardon me, Casey, your line is now open for questions.

Maybe we answered all the questions that he had. Hello?

I'm sorry. Everything is stacked up on top of each other today. And I had a callback come in right when you guys queued me up. I'm very sorry. And I pushed that off for 15 minutes. And again, I missed this in your earlier remarks, and so this is just a maintenance question. Apparently, you sold down some more BSLs in October, and I came in after you made that. Did you specify how much you sold in October of BSLs?

Yeah, roughly, Casey, slide 23, roughly $47 million.

$47 million additional after the $130 million the previous quarter.

That's exactly right.

Again, if you addressed this in your previous remarks, I'm sorry, but in the JV, how do you anticipate dividend payments from the JV developing over the next several quarters? Obviously, you're just getting started. And beyond that, you sold 10 million of loans from the BDC to the JV in this last quarter. Do you have to take loans on your balance sheet first, then wait for a quarter end, and then sell them to the JV? How functionally does that work?

Yeah, sure. So from an operating perspective to the latter part of your question, a direct loan is that is originated by our teams of the US or Europe, has to come in through the BDC subject to the fact that the BDC is part of our exempted application. And all joint ventures across platforms are not. They're separate. There are a few folks in Washington that are working to effectively make that the case. But right now, you have to have that separate directly originated transaction to avoid some of the affiliate issues that exist. There's that component. In terms of the first part of your question, Casey, which part was that? I want to make sure I got it right.

That was, how do you anticipate dividend stream developing from the JV to the BDC? You've now two quarters dedicated 10 million of your assets. You're getting a contribution from South Carolina. as you go, but you didn't really pay much dividend income this quarter. So how do you expect dividend payments from the JV to develop to the BDC over time?

You know, that'll be subject to the Joint Venture Board. I'll say from an accounting perspective, you'll find that A, if a dividend payment was not paid, what happens is there is a corresponding increase to your NAV of the underlying equity in the JV. Kind of like kind of like retained earnings, I'm going to refer to it that way, which can generate more return in the future if you can summon that vehicle and then disperse it. Our goal is to distribute it, but of course that can be subject to our partner. We wouldn't want to speak for our partner, but at the end of the day, everyone understands there will be cash flow coming off this vehicle. It's going to be one or two quarters before the streams flow in, of course, but at the end of the day, expect steady and stable returns. And more importantly, if you have the ability to increase that slightly as a result of this ramp, you could do that because from a cash earnings perspective, which is really important, we don't have any pick, we have a really healthy amount of cash earnings to supplement our dividend profile. So the goal is if you want to keep the cash retained and earning more and perhaps getting reinvestment, getting compounding, You'd do that for a while until you'd ever run into a cash situation where you then might dividend it up, but that's all subject to our partner. So that's context. It's not the exact answer. Expect it to come, but the exact quarter, I wouldn't want to speak for our partners, but expect it in the future.

All right, great. Thank you for answering my question, sir.

I appreciate it. Thanks, Casey.

Thank you. We have reached the end of the question and answer session, and I will now turn the call over to Mr. Lloyd for closing remarks.

Well, I know it's a busy day for all the analysts out there and all the shareholders, so I really appreciate you prioritizing us and making us part of your day to dial in and ask your questions, and hopefully you got all the answers that were clear and transparent. If they weren't, you know where to find us, and we're happy to answer any other follow-up questions you have. Thank you very much.