Barings BDC, Inc. (BBDC) Q1 2024 Earnings Report, Transcript and Summary

At this time, I would like to welcome everyone to the Barings BDC, Inc. conference call for the quarter ended and year end March 31, 2024. [Operator Instructions] Today's call is being recorded, and a replay will be available approximately 2 hours after the conclusion of the call on the company's website at www.baringsbdc.com under the Investor Relations section. At this time, I will turn the call over to Joe Mazzoli, Head of Investor Relations for Barings BDC.

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. I'll now turn the call over to Eric Lloyd, Chief Executive Officer of Barings BDC.

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 Baring's Head of Global Private Finance and BBDC's portfolio manager, 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 will 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 BBDC's performance. BBDC 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 nonsponsored and platform investments. Our portfolio strategy is outlined in greater detail on Slide 5. This strategy serves as our guiding light as we continue 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 $11.28, reflecting a year-over-year increase of 1.4% and this is the highest NAV the portfolio has exhibited in the past 2 years. Net investment income for the quarter was $0.28 and outearned 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 we consider to be best-in-class and especially in light of the inconsistent economic backdrop. Our performance is a result of our focus on the top of the capital structure and within more defensive industries. We believe BBDC 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 risk for BBDC investors. Our investment portfolio continued to perform well in the first quarter. There is no substitute for fundamental credit analysis, which has been core to Barings underwriting style since the early 1990s as reflected in the health of the BBDC portfolio today. Including the acquired Sierra 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 value basis and 2.5% on a cost basis as of December 31, 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 NII were extremely compelling for 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 31, 2024. Second, Barings directly employs more than 1,800 professionals dedicated to investing in our core strategies and driving long-term value for our clients and sponsors. Third, we are a wholly owned subsidiary of MassMutual, and have been investing in private credit on its behalf for more than 3 decades. I also want to emphasize that when it comes to private credit specifically, BBDC is just 1 part of the Barings global platform, which also includes its other BDCs and the entire private assets business and which Barings remains fully committed to and is actively investing in. As you may be aware, on March 8, 2024, Barings received 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, BBDC's 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, an uninterrupted focus on North American investment opportunities and in combination with the fact that the BBDC resource assets from a variety of other investment teams within Barings, BBDC management believes we are well positioned to deliver compelling risk-adjusted returns for shareholders in the quarters ahead. The 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 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 in 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 skilled 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 origination network and deploy capital consistent with our stated strategy. Most importantly, our commitment to our investors is unwavering and is as strong as it's ever been. I'll now turn the call over to Matt.

Thanks, Eric. To begin discussing market activity, I would first like to give an update on inbound deal volumes post the resignations that were received on March 8. I'm happy to share that over the past 2 months, we have received inbound deal volume in line with the levels experienced historically. Moving to specifics during the quarter. BBDC'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 transactions. 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 makes logical sense as 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 in Barings BDC benefit by having a seasoned portfolio that provides opportunities to deploy capital into issuers we already know well. While new LBOs are below historical averages, refinancing activity has increased, which started in the liquid markets in early 2024. The recent wave of refinancing 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 with EBITDA of $75 million and above at the moment. Barings' 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 on. Turning to our current portfolio. 72% which -- turning to the current portfolio, 72% of our investments consist of secured investments with approximately 66% being first lien securities. BBDC experienced a stabilization of interest coverage during the quarter and finished the quarter with a weighted average interest coverage of 2.2x, in line with the fourth quarter. It's fair to say that the full impact of an increase in the interest rates has now 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 2x and 2.25x serves as another data point of the strong credit quality within the book. 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 were reasonable going in leverage multiples, the median gross margin in the North American Global Private Finance portfolio, a portfolio similar to BBDC, 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. The portfolio composition remains highly diversified, with the top 10 issuers accounting for 22.6% of the fair market value. Recall that the top 2 positions within the portfolio, Eclipse Business Capital and Rocade 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 exhibiting the most stress classified as risk ratings 4 and 5 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 as certain issuers performing consistent with expectations at 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 Rocade continue to provide exposure to additional middle-market lending markets within industries not suited well to conventional cash flow loans. BBDC is 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 gives 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.

Thanks, Matt. On Slide 15, you can see the full bridge of NAV per share movement in the first quarter. NAV per share was $11.44 as of March 31, 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 NAV per share by $0.34, which was offset by net realized losses on the portfolio and FX by $0.20 per share. The 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 unrealized depreciation. The valuation of the credit support agreement decreased by approximately $6.3 million which was driven by unrealized appreciation in the underlying portfolio and an increase in the applicable discount rates during the quarter. The fair value of the Sierra CSA decreased from $40.5 million in the fourth quarter to $35.4 million as of March 31. During the first quarter this year, our portfolio had sales and repayments of approximately $15 million, and we have 36 positions remaining in the portfolio. The fair value of the MVC CSA decreased from $17.3 million to $16.1 million with 4 positions remaining in the portfolio and anticipate the sale of MVC 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. The increase in NAV, 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 1.17x at quarter end, up modestly from 1.15x at the quarter ended December 31 and currently sits within our long-term target of 0.9x to 1.25x. Our funding mix remains highly defensible, both in terms of seniority and asset class, including the significant level of support provided by the unsecured debt in our capital structure. At March 31, our unsecured debt accounted for $1 billion of our funding and equated to 70% of our outstanding debt balances. As you may recall, during the first quarter of 2024, Barings BDC issued a new $300 million senior unsecured note to enhance the flexibility of our capital structure. The note issuance was significantly oversubscribed and 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 if called upon. 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 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 plan. The 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 1 example of BBDC's thoughtful approach to aligning our interest to shareholders. I'll wrap up our prepared remarks with a note 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.

[Operator Instructions]. Our first question is coming from the line of Finian O'Shea with Wells Fargo.

Eric, to a couple of the opening remarks on strategic changes, can you update us on the LP or the funds business? I think it was reported that you voluntarily halted investing there. I think that's still the case. And ultimately, how the conversations are going with existing and new LPs for -- in the GPF or direct lending business?

Happy to, Fin. So we did. So when the resignations came in at Friday, leadership, executive leadership here at Barings made the decision to pause investing in certain accounts that 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 2 -- a couple of different buckets from those LPs perspective. There's things that are SMAs or funds of 1 that are more bespoke discussions that we have with that 1 counterparty. And then there's really the commingled funds. So funds that might have 10, 20, 30 investors in there that have things like LPACs and other things that we have to manage through that have different kind of timelines and times we would cure things from a key person perspective. What I can represent to you is that a number of our funds of 1 or SMAs have allowed us to continue to invest at this point in time. And I 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 8. And that hold 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 running with that LP base along those lines. But again, a number of the funds of 1 or SMAs, we continue to invest in.

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

Our relationship with Jocassee Partners is very constructive, and it's 1 that we believe will continue to be an important part of the BDC, but that's kind of discussion we've had with them, and we feel good about where that relationship is.

Okay. I'll do actually 1 more, if I may, sorry. It sounded like in the staffing or hiring part, the focus would be on adding originators and just seeing if that implies that the repositioning of the leadership and investment committee and so forth the BDC have announced thus far is expected to be permanent. And that's all for me.

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. The North American investment committee has 4 individuals as it sits today. Our prior committee was 6. The number along those lines would be something we could look at over time as we add people. I would say the higher origination is something I highlighted, but I want to just take a step back and say, the most important thing for us 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. We want to make conscious, deliberate hires that fit our culture and our credit philosophy, first of all. And then second of all, that bring origination 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 2 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 that's been humbling in this process has been the amount of people who have reached out to us that have interest in joining the platform because of the strength of the platform.

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 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 is an incredibly productive one with respect to our shareholders.

Our next question is coming from Kyle Joseph with Jefferies.

Kind of shifting back to the model, Elizabeth, I think you mentioned this, but just wanted to talk about the decline in investment income in the quarter. I know there was some portfolio growth, it looked like yields were stable. Is that kind of just fee income driven? Is that timing of deployments and repayments? And then I think you did mention Eclipse dividend income impacting that as well.

Sure. Thanks, Kyle. Yes, 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. In addition, dividend income was down quarter-over-quarter due to Eclipse. We also have lower dividend income at Sierra JV. For the Sierra JV, 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 you can expect that the Sierra dividend should be more normalized throughout the remainder of 2024.

I just want like the lack of a decrease in dividend off of Eclipse is not anything related to performance of Eclipse. It continues to be an incredibly strong performer for us. It's just timing of distributions.

Yes, you should see it back at a more normalized level for the second quarter.

Got it. Helpful. And then a follow-up for me, probably for Matt. I appreciate the market commentary you gave. But from our side, we've been seeing different headlines about banks exiting the space from Basel III Endgame or getting back in via BSL. But just give us a sense for competitive trends you've been seeing recently in kind of -- we talked about yields being stable, but give us a breakdown between base rates and the spreads you've been seeing in recent quarters.

Yes, happy to comment on it. And 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 impacted is going to just be the larger into the ecosystem. And I would tell you that our larger competitors who are competing squarely against the banking institutions are frankly, have a 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, $150 million EBITDA platform that is kind of deciding between a broadly syndicated execution or a privately placed solution, 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 the core of the markets in which we participate, call it sub $50 million of EBITDA, I think the median issuer in the portfolio is just over $30 million, 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, although we are seeing more private credit fund formation. And so we are aware that, that may provide some 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.

Kyle, it's Eric, if you think of kind of supply demand, right, just there's an increase of private credit managers in general over the last couple of years, and M&A activity is lower than what it was 2 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 in kind of what that spread level is because there's an absolute return that needs to occur for private credit investors overall.

Our next question is coming from Robert Dodd with Raymond James.

Just one quick one for me. Matt, you mentioned that conversion rates or close rates for transactions are trending towards historic lows. Can you give us any color on the drivers there? Is it a bid asks on valuation because of the transactions not closing sufficiently for the last minute? Is it failures in due diligence as you get more imbalanced? I mean any color you can give us on what's the driver there?

Yes. 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. And so I'm sure everyone knows that these processes take between 3 and 6 months by the time you launch a transaction to when you actually close it. We're somewhere to the middle of the beginning or somewhere between the beginning and the middle of the 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 budgeted for. And I think that, that creates some downward revisions on enterprise values. And as we think about it, that obviously impacts the equity pretty substantially, but we generally feel pretty comfortable regardless of whether someone is paying, call it, 10x or 12x. 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 has changed, creates revisions to expectations with respect to underlying EVs. 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 performance metrics. But I think overwhelmingly, it's been a cost of capital discussion and a misalignment of expectations on the bid-ask spread.

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

Well, first, I want to thank everybody for dialing in and taking the time to listen to what we communicated today. To the 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 to report to you over the course of the next quarters. Thanks so much.

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