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spk00: At this time, I would like to welcome everyone to the Barings BDC Incorporated conference call for the quarter ended September 30th, 2022. All participants are in a listen only mode. A question and answer session will follow the formal presentation. If anybody should need operator assistance, please press star zero on your telephone keypad. 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 www.barringsbdc.com under the Investor Relations section. 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 and 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. And the company's annual report on Form 10-K for the fiscal year ended December 31, 2021. and two quarterly reports on Form 10-Q for the quarter ended September 30, 2022. Each 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. At this time, I will turn the call over to Jonathan Bock, Chief Executive Officer of Barings BDC. Please go ahead, sir.
spk03: thank you operator and good morning everyone we appreciate you joining us for today's call and please note that throughout today's call we'll be referring to our third quarter 2022 earnings presentation that's posted on the investor relations section of our website i'm on the call today joined by bearings co-head of global private finance and president of bearings bdc ian fowler bearings head of capital solutions and co-portfolio manager brian high and the BDC's Chief Financial Officer, Jonathan Landsberg. And as is customary, Ian, Brian, Jonathan, and I will review details of our portfolio and third quarter results in a moment. And I'd like to start off with some high-level comments on the quarter. Let's begin with the market backdrop shown on slide five of the presentation. In a market where the unprecedented pace of interest rate hikes elevates volatility in both leveraged loans and BDC equity, Barron's BDC continued to generate consistent, stable economic results. Jump to the third quarter highlights on slide six. Net asset value per share was $11.28, compared with our prior quarter of $11.41, down approximately 1.1%, driven primarily by unrealized write-downs tied to macro market factors and spread widening, as opposed to fundamental credit-related factors. Our net investment income was 26 cents per share compared to 29 cents per share last quarter, impacted by sales and repayments that occurred early in the quarter, as well as a partial income incentive fee capped by our shareholder-friendly fee structure, which includes realized and unrealized gains and losses. Turning to new investments, we had gross originations of $234 million in the third quarter, primarily funding later in the quarter. And this was offset by $241 million of sales and prepayments for a net portfolio decline of $7 million. Our investment portfolio continued to perform well in the third quarter, including the acquired Sierra and MVC assets. Our total non-accruals are 2.8% of the portfolio on a cost basis and 0.7% on a fair value basis, all assets that are covered by our credit support agreement. And turning to forward earnings power, The increase in base rates has increased the weighted average yields on our middle market and cross-platform investments to 8.9% and 9.6% respectively. And we expect additional revenue contribution as we continue to gradually increase leverage within our target range. And with that as our frame of reference, we expect fourth quarter net investment income of at least 27 cents per share with further expansion into 2023. Additionally, Our board declared a fourth quarter dividend $0.24 per share, equating to an 8.5% yield on our net asset value of $11.28, which matches our industry-leading hurdle rate, and I'll have Jonathan Landsberg provide additional detail on our approach to dividend policy later in the discussion. Slide 7 outlines summary financial highlights for the previous five quarters. And as I mentioned, continued strong investment performance drove total investment income slightly higher quarter over quarter to $56 million, though the percentage increase in total revenue was muted by, one, earlier portfolio sales and repayments in the third quarter, two, later than anticipated fundings, and three, non-recurring $2 million in revenue in the second quarter tied to a large distribution from a CLO and wind down. Looking forward, as the impact of base rates drives total portfolio yield higher, we anticipate total investment income to be in excess of $60 million. Now below the line, net unrealized depreciation of $26 million was primarily a result of mark to market on our assets as a result of higher credit spreads. This unrealized depreciation had a positive impact on net investment income as Barings' incentive fee cap curtailed the quarterly incentive fee, further lowering expenses and elevating NII in the quarter to $0.26 per share. Now turning to liquidity, net leverage, which is leveraged net of cash, short-term investments and unsettled transactions, was 0.99 times, which is currently toward the lower end of our target range of 0.9 to 1.25 times. This attractive liquidity position allows us to remain steady partners with our existing sponsor clients, as well as look towards new investment opportunities that present themselves in the face of current economic uncertainty. And looking forward, we believe the investment environment to be ripe with opportunity. The delayed impact of increasing rates will continue to work its way through private markets, with many credit stresses yet to come, some of which are starting to arrive. That said, the ability of a manager to prosecute those opportunities will be directly correlated to how well they deployed capital in 2021. And our diverse portfolio approach and best-in-class level of investor alignment positions us well for both current and future market conditions, and we remain poised to take advantage of the current market. And with that, I'll turn the call over to Ian to provide an update on the market and our investment portfolio.
spk08: Thanks, John, and good morning, everyone. If you turn to slide 9, you can see additional details on the investment activity mentioned previously. Our middle market portfolio decreased by $14 million on a net basis in the quarter, with gross fundings of $163 million, offset by sales and repayments of $176 million. New middle market investments include 16 new platform investments, totaling $116 million, and $47 million of follow-on investments and delayed drop term loan fundings. We also had $51 million of net cross-platform investments in the quarter. We continue to remain active in our realizations and sales at both MVC and Sierra, and this quarter generated $44 million of liquidity via sales, paydowns, and prepayments. Slide 10 updates the data we show you each core on the middle market spreads across the capital structure and clearly investment spreads across public and private asset classes have widened. Most important, public market spreads now meaningfully exceed those of private middle market loans. This has two effects. On one hand, the illiquidity premium or the extra spread to take a deal private to loan investors remains much smaller than in the past. On the other hand, the relative attractiveness of the direct lending solution in today's marketplace for private equity sponsor is very high and more reliable. This relative attractiveness of direct lending loans can be shown on slide 11. Notice the current market clearing price for new issue leveraged buyout debt has averaged in the mid to low 90s, making the cost to issue and create this paper by banks and sponsors uneconomical. We expect this trend to continue given market uncertainties, which bodes well for future capital deployment across our origination footprint. A bridge of our investment portfolio from June 30th to September 30th is shown on slide 12. On slide 13, you will see a breakdown of the key components of our investment portfolio as of September 30th. As we have discussed in the past, the goal of this slide is to provide details on the key categories of our portfolio, which are the Barings-originated middle market portfolio, the legacy MVC capital, and Sierra income portfolios, as well as our cross-platform investments. The middle market portfolio remains our core focus and makes up 56% of our portfolio in terms of total investments at fair value. and 54% of our portfolio in terms of revenue contribution. Our bearings originate in middle market exposure. It's heavily diversified amongst all the goals of 211 portfolio companies with a geographic diversification across the US, Europe, and APAC regions. The underlying yield at fair value on our middle market investment portfolio of 9.2% up from 7.9% last quarter and weighted average first lien leverage of 5.2 times remain reflective of our boring is beautiful approach to credit. In addition to our middle market exposure, we continue to draw upon Barron's wide investment frame of reference to complement our core portfolio with $374 million of investments in the legacy MVC and Sierra portfolios and $652 million of cross-platform investments. To date, we have realized approximately $164 million in capital from both transactions and continue to drive realizations in today's environment. Turning to credit, two MVC assets and five Sierra assets remain on non-accrual. The total number of non-accrual loans is unchanged from last quarter. The one Sierra loan came off non-accrual as it was sold, while one new loan was added with a cost of $600,000. Additionally, subsequent to Core N, we place our debt investment in Core Scientific on non-accrual as the company undergoes a restructuring, with that position representing 1.2% of the portfolio costs. Slide 14 provides a further breakdown of the portfolio from a seniority perspective. The Core bearings originated portfolio 72% first liens. Note the combined MVC Sierra portfolios are comprised of senior secured, second lien, mezzanine debt, and equity investments, which brings the first lien component of the total portfolio down to 67%. Our top 10 investments are shown on slide 15. Our largest investment is 5.9% of the total portfolio, and the top 10 investments represent 23% of the total portfolio. Recall our largest investment, Eclipse Business Capital, is backed by a large portfolio of asset-backed loans, conservatively structured inside of the collateral net liquidation value. The Eclipse portfolio remains diverse from an industry perspective as well, with 44 investments spread across 17 industries. I'll summarize my market comments with the simple thought that preparedness for stress in today's market looks entirely different than it did in past cycles. EBITDA growth for portfolio companies, once thought always to be a secular phenomenon, will become more challenging. Expected acquisition synergies on deals may not materialize. Emphasis, which was once focused on growth and total addressable market, will now quickly shift to cash flow and liquidity. In short, the investment and social norms learned over the last 40 years will need to be unlearned. And this learning process will favor those with investment discipline and long institutional memory, deploying capital in inflationary environments. At Barron's, across our wide investment frame of reference, we demonstrate both. I'll now turn the call over to Jonathan to provide additional color on our financials.
spk05: Thanks, Ian. Turning to slide 17, here's the full bridge of the NAV for share movement in the third quarter. Our net investment income Net realized gains drove an increase of 7 cents per share, while our unrealized depreciation totaled 24 cents per share. Additional details on this net unrealized depreciation are shown on slide 18. Of the total 26 million unrealized depreciation in the third quarter, approximately 19 million was due to price or spread moves. The cross-platform portfolio contributed 11 million of the total price-driven depreciation, primarily tied to the more liquid investments Notably, the legacy NBC portfolio saw total depreciation of $6.5 million tied to underlying credit performance, while the Sierra portfolio had total depreciation of $7 million, $3 million of which was due to price movements predominantly tied to CLO equity positions in the Sierra JV. Near the bottom of slide 18, you can see that the credit support agreements increased $3 million as a result of investment marks. Slides 19 and 20 show our income statement and balance sheet for the last five quarters. Our net investment income per share was $0.26 for the quarter, driven by generally stable total investment income, as mentioned earlier by John, combined with a capped incentive fee resulting from unrealized marks on the investment portfolio. From a balance sheet perspective on slide 20, total debt-to-equity was 1.12 times at September 30th, although this level was elevated due to high quarter and cash balances and unsettled JV sales. Our net leverage ratio was 0.1%. in unsettled transactions, and we view this measure as more reflective of the true leverage position of the vehicle. Turning to slide 21, you can see how our funding mix ties to our asset mix, both in terms of seniority and asset class. Compared to the end of 2020, our reliance on secured bank debt has decreased, with the issuance of $725 million of unsecured debt in both the public and private markets, as we have continued to diversify our liabilities to match our diverse portfolio of assets. Details of each of our borrowings are included on slide 22, which shows the evolution of our debt profile over the last year. As of quarter end, over half of our funding was comprised of fixed rate unsecured debt with a weighted average coupon of 3.79%, and we have nearly three years until the next bond maturity. Turning to slide 23, you can see the impact to our net leverage of using our available liquidity to fund our unused capital commitments. Barings BDC currently has $232 million of unfunded commitments to our portfolio companies, as well as $67 million of remaining commitments to our joint venture investments. We have available cushion against our leverage limit to meet the entirety of these commitments if called upon, as well as over $400 million of available capacity on our revolving credit facility. Slide 24 updates our paid and announced dividends since Barings took over as the advisor to the BDC. As John mentioned earlier, the board declared a fourth quarter 2022 dividend of $0.24 per share and 8.5% distribution on net asset value. Looking forward, we anticipate that strong portfolio performance will sustain BBDC's earning power above our $0.24 per share dividend. So it begs a very important investor question. Why not pay out that increased income? To best answer that question, we outline our emphasis on margin of safety. Recall, Barings BDC operates under a best-in-class fee structure highlighted by our industry-high hurdle rate of 8.25% and a willingness to align the NOI incentive fee to credit performance, both realized and unrealized. As a result of aligning our dividend with our hurdle rate, Barings inflates the regular dividend distribution, which is 8.5% on NAV and 10.5% on a market price basis, with the incentive fee. Said differently, in the event of future unrealized or realized losses or the loss of income due to credit stress, the manager bears the cost via a lower incentive fee. In our view, this feature creates a very strong and resilient dividend yield profile that is less dependent on elevated base rates. With that strong dividend base, we then seek to further enhance shareholder value through a combination of share repurchases, growing dividend spillover, and steady and systematic special dividends. It is that consistent long-term approach combined with significant investor alignment and margin of safety that we believe drives down BDC yield risk premiums over time. Turn with me now to slide 26, which shows a graphical depiction of relative value across the triple B, double B, and single B asset classes. As Ian outlined, we saw wider spreads in the quarter across nearly all asset classes as a result of increased fears of stagnation or stagflations. to liquid credit benchmarks. Notice that our investment illiquidity premiums in the third quarter remained low for middle market transactions given the current BSL market dislocation. That said, in our cross-platform exposures, we've seen meaningful widening relative to liquid benchmarks. Excluding certain equity investments, Barings BDC deployed $232 million at an all-in spread of 931 basis points. at the same risk profile. I'll wrap up our prepared remarks with slide 28, which summarizes our new investment activities so far during the fourth quarter of 2022 and our investment pipeline. The pace of new investments remains steady compared to the last two quarters, with 131 million of new commitments, of which 103 million have closed and funded. Of these new commitments, 95% are in first lien senior secured loans, 23% are in cross-platform, and 20% are European or Asia pack originations. The weighted average origination margin, or DM3, was 8.2%. We've also funded approximately seven million of previously committed delayed draw term loans. The current Barings Global our investment pipeline. And with that, operator, we will open the line for questions.
spk00: Thank you. If you would like to ask a question, please press star 1 on your telephone keypad. The confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up the handset before pressing the star keys. Please ask one question and one follow-up question. Our first question is from Finian O'Shea with Wells Fargo. Please proceed.
spk02: Hi, everyone. Good morning. Mr. Landsberg, appreciate your commentary on the dividend policy there and preference toward margin of safety and so forth. Can you talk about the spillover that would in the event you eventually do generate a lot of spillover, if LIBOR stays high or goes up and there's still good credits into next year, what you would prefer to ultimately do with that spillover in the event it does build up? Would it be maybe a higher base dividend a few quarters from now or something like specials or supplementals?
spk05: Yeah, thanks, Gwen. Thanks, Finn. It's a great question. I think our preference here is to leave the base dividend set at our hurdle rate. We think the margin of safety that provides is really important. So if you look ahead, first, we do have quite a bit of available spillover to build. But we really kind of employ an all of the above approach to what we think of how we think about distributing that money. So it's really a combination of continued share purchases, Retaining some of the earnings to reinvest because we believe now is a really good time to be reinvesting in this environment But also supplementing that with you know fairly systematic One-off dividends or one-time dividend special dividends to ensure we're staying in compliance with all the required rules Great that's helpful all for me.
spk02: Thanks so much.
spk04: Thanks, man
spk00: Our next question is from Kyle Joseph with Jefferies. Please proceed.
spk01: Hey, good morning, guys. I appreciate the prudent approach of aligning the dividend with the incentive fee. Should we, given the timing of this, should we read this as a sign of you guys kind of battening down the hatches, or is it just more conservatism overall, just weighing that versus some of your peers, which have kind of increased their distribution is more consistent with kind of the rate curve.
spk03: Sure. Hi, Kyle. It's John. I wouldn't say it's a batten down the hatches approach. I'd start with how we normally look at things, which is investor alignment. And so our view is the earnings power and profile of the portfolio will continue to increase. But what's appropriate is to always look at the ability to build a best-in-class stable dividend profile aligned with your investment performance. And that is what's unique to us. And then, of course, at the same time, you can see us continue to drive additional equity value through reinvestment in our own portfolio and through repurchase of shares because now is an attractive time to do so.
spk01: Got it. Very helpful. And yes, like I said, I do definitely view the approach as prudent, particularly in this environment. And then, Ian, appreciate all the color you provided on the originations environment, but as we step back and look out into 23, obviously you guys have a tremendous amount of dry powder to deploy, more macro volatility, kind of fewer LBO transactions. How are you thinking about the level of potential originations in 23 and then weighing in kind of – behavior appears in the competitive environment and any changes you've seen there recently.
spk08: Yeah. Thanks Kyle. And, um, yeah, there's a lot there to unpack. I think, you know, 23 will be similar to 2022 for us, which is, you know, quite frankly, uh, when you look at the, at the market and the properties that were coming to market, You know, overall volume was down, obviously, compared to 21, which was expected because it just wasn't sustainable. But quality was kind of choppy. So the benefit of being a large platform and having a large portfolio is you get to reinvest in your portfolio companies. And I would say, you know, the percentage of origination coming from the portfolio has increased dramatically this year. And I would expect the same next year. you know, especially as private equity firms are trying to discover what's going to happen on the valuation side. So, you know, like this year where, you know, our origination is basically 60 to 70% coming from the portfolio, which is great because it's going into companies we know well. It's helping those companies become larger, helping them consolidate industries, becoming stronger competitors, more defensible, better credits, more diversified, and greater scale. So, you know, in terms of origination, I think that's where it's going to come from. You know, I think you have to, in our approach, it's definitely not batting down the hatches, but it's definitely prepare for the worst because, you know, none of us have a crystal ball and hope for the best. So from a liquidity standpoint, you know, we're very much focused on making sure that we have capital to support our portfolio through a downturn, first and foremost, from a defensive perspective. And then, of course, having capital to take advantage of opportunities, because, you know, having done this, this is my third decade in this asset class, it's really coming out of a conventional recession, if we have one, that you see the best opportunities in the marketplace. And, you know, we want to be well positioned to take advantage of those opportunities. That's great, Collin.
spk01: Thanks a lot for answering my questions.
spk08: Yeah, cool.
spk00: Our next question is from Ryan Lynch with KPW. Please proceed.
spk04: Hey, good morning, guys. Hey, first question I had, it's just I'm trying to understand what's going on in Thompson Rivers. That investment has been written down five or so million dollars sort of every quarter in 2022. And then when I look at the portfolio there, the portfolio has been shrinking pretty dramatically. It's about a third of the size it was sort of at the beginning of the year and the fair value is much lower than the cost there. So, you know, I would assume that rising rates on that mortgage book is not helping. So I'd just love to hear fundamentally what's occurring in that underlying portfolio of Thompson Rivers, and is it the plan? The portfolio is shrinking. Is that by design? Are you guys shrinking that sort of JV? What is the expectation for that going forward?
spk03: Sure, Ryan. This is John. So you can outline that given the investment in mortgages granted very short duration, it was really a targeting profile for to provide liquidity effectively to certain mortgage servicers. So where we would invest in early buyout mortgage originations, allow those to return, which are effectively FHA loans, which was 100% government guarantee. And when the underlying obligor returned to paying status, we would be able to resubmit back to the pool. And believe it or not, the credit performance of the underlying mortgages are strong. They continue to re-perform as the consumer returns back and we get to collect the back interest. But you have a time profile where the increase or rapid increase in rates push down the fair value slightly to the point now where you start to look at what we've invested and what we've pulled out in the form of dividends effectively matched. It's been a strong income provider. our expectation was to now look at that, recognizing that that environment, particularly with mortgage services now, with situations where they would not be looking to sell the underlying mortgage books that they have at depressed prices, you just wind it down. And so you'll see us effectively return our capital and match that dollar for dollar, and then, Ryan, redeploy that. And so our view is, while it provided a strong earning avenue, we also recognize in the current environment you can redeploy that and put it to more productive use at wider spread.
spk04: Okay, so that will be the expectations that will wind down.
spk03: It goes pretty quick too, Ryan. So interestingly, that's why they're very liquid and very rapidly pre-performing assets, which is why you're able to reposition that and get very, very close to your cost basis over time, particularly when you consider the dividends paid. and then redeploy that into corporate credit opportunities now, which have gapped out even wider.
spk04: Yeah. Okay. I understand. And then maybe following up, this is maybe for just more on kind of the market opportunity and how you guys are positioning the portfolio today. I mean, kind of in a simplistic way, the market opportunity has increased. The quality of deals in the market have increased substantially over But the outlook for the economy has also become significantly more shaky. So in this environment, and then obviously deal flow generally is down quite a bit because of those two factors. Is it your anticipation that you guys would like to be a net grower of your portfolio today, pending the market opportunities are there to deploy the capital or do you guys want to sit sort of at this current leverage range in anticipation for further dislocations in the marketplace and the economy?
spk08: Well, hey, Ryan, it's Ian. Maybe I'll start with the market and then I can throw it over to John and John to talk about, you know, the capital side of it. But, you know, like I said, I mean, Yeah, the terms today are getting better, right? Spreads are wider, leverage has come down, structural protection is definitely better. But again, I think when you look at what's happening in the market, right, between buyers and sellers of assets, we're going through this discovery because people don't know exactly what's going to happen overall with valuations. I mean, the reality is, Just given the increase in rates, the debt quantum is going to have to decline and that's going to change. Either sponsors are going to have to put more equity in or valuations are going to have to come down. I would say that unless there's something very unique to a certain transaction, the properties in today's market just aren't really great properties. Our view is that the risk return on those investments are less attractive than supporting our portfolio because again that's putting money to work with good market terms and ultimately making our portfolio more bulletproof as we go through this economy so that's kind of what we're we're focused on but again i think you know like i said as as we start to get through this whatever this dislocation is going to look like right and and the one you know having been through many cycles The only thing in common is the beginning and the end. It's the middle that's different. We don't know how the middle is going to play out here. So we want to be flexible to figure out where those opportunities are, but we're definitely willing and focused on taking advantage of those opportunities. Um, you know, in the middle market side, it's going to be looking for, you know, sellers that are, uh, of, uh, of good assets that need liquidity and on the cross platform side, it may be more opportunistic situation. So, you know, we want to be well positioned for those as they appear. And so that's our focus.
spk03: Ian put it really well. Ian put it really well, Ryan. And I think it might be, if you look on 27, When we start to look at the risk premiums that are available, right, clearly the stress or slight distress that exists inside of liquid assets has really limited the middle market premium. That doesn't mean you won't find good assets. You can. But then if you can see some of the situational opportunities that we'll find, and I'll just lob it over to Brian for a quick item, you can see in some of the certain cross-platform opportunities where those spreads relative to what you could find in the market have already gapped out sufficiently wide. But Brian?
spk07: Yeah, so I mean, if you think about what the cross-platform part of the portfolio provides, we're really looking for something that complements traditional direct lending. And even in this quarter, Bridger Aerospace is a great example of something where we're out there looking to be selective in opportunities that we think have a unique risk profile that is a little less correlated to the overall general economy. That's a company that is growing a fleet of super scooper aircraft to deal with forest fires, which, again, I don't think that that's as correlated to the general economy as maybe a traditional corporate borrower. So those types of opportunities are where we're looking to deploy capital and find unique risk-adjusted return, again, to complement kind of that broader book.
spk04: Gotcha. Makes sense. I appreciate the time today.
spk00: Our next question is from Casey Alexander with Compass Point. Please proceed.
spk06: Yeah, thank you. Most of my questions were answered, but I do have one. Are you saying that the difference between the cost and the fair value for Thompson is just rate driven and will climb back to cost as they repay? So credit is still good. This is just a mark to market?
spk03: Credit is still good, but, Casey, also as base rates effectively rise and mortgage spreads rise, once we have the asset and it's re-performing, we effectively own a lower rate mortgage coupon. But when we submit it back to the pool and you sell it back to the FHA, they're going to buy it back at the market price, which is now a lower. So really, in totality, when you think of all the income, you'd be re-pooling at a slight loss. which still nets with your income, you know, in a general attractive return. But right now, it's not one that you can sit and hold it for a long time. But if you did so, you'd be earning something that would be lower than what you'd be getting on a middle market loan, which is why we start to wind it down.
spk06: Okay. Thank you.
spk00: We have reached the end of our question and answer session. I would like to turn the conference back over to Jonathan Bach for closing comments.
spk03: Thank you so much for joining us today, and we are very, very thankful you all participated on the call, and we want to wish everybody a happy Veterans Day and want to thank folks for their service. Thank you very much for joining.
spk00: Thank you. This does conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.
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