Barings BDC, Inc. (NYSE:BBDC) Q1 2024 Earnings Call Transcript

Barings BDC, Inc. (NYSE:BBDC) Q1 2024 Earnings Call Transcript May 8, 2024

Barings BDC, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: 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. All participants are in a listen-only mode. A question-and-answer session will follow the company’s formal remarks. [Operator Instructions] Today’s call is being recorded, and a replay will be available approximately two hours after the conclusion of the call on the company’s website at 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.

Joe Mazzoli: Good morning, and thank you for joining today’s call. Please note that this call may contain forward-looking statements that include statements regarding the company’s goals, beliefs, strategies, future operating results, and cash flows. Although, the company believes these statements are reasonable, actual results could differ materially from these 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 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.

Eric Lloyd: 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 Barings’ Head of Global Private Financial and BBDC 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, 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 predominately sponsor-backed, and is complemented by a selection of non-sponsored and platform investments. Our portfolio strategy is outlined in greater detail on slide five. 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 two years.

Net investment income for the quarter was $0.28 and out-earned our quarterly dividend by 7.6%. Perhaps most importantly, and a metric that we are particularly proud of, our non-accruals during the quarter declined to 0.3% of the fair market value of the portfolio, a level we consider to be best-in-class especially in light of the inconsistent economic backdrop. Our performance is the result of our focus on the top of the capital structure and within more defensive industries. We believe 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 and the legacy holders acquired from MVC Capital and Sierra Income, and rotate them into compelling Barings originated position.

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, and is reflected in the health of the BBDC portfolio today. Including the acquired Sierra and MCV assets, our total non-accruals are industry-leading 0.3% on a fair value basis, and 1.5% of the portfolio on a class basis. This is down from 1.5% on a fair value basis and 2.5% on a cost basis as of December of 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 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 a net asset value of $11.44. We believe the best measure of the portfolio’s performance, non-accruals, net asset value, and NII were extremely compelling for the March quarter and anticipate continued strength in the quarter’s 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 employees more than 1800 professionals dedicated to investing in our core strategies and driving long-term value for our clients and sponsors. Third, we are wholly-owned subsidiary of MassMutual’s and have been investing in private credit on its behalf for more than three decades. We also want to emphasize that when it comes to private credit specifically, BBDC is just one part of the Barings global platform, which also includes its other BBDCs 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 receive resignations of a number of members of the investment team within the global private finance organization. Six of these individuals are focused on the North American strategy. Out of the total North American investment team of 56, we have successfully executed retention strategy across the entirety of the remaining global investment team. BBDC investors know that the principal investment strategy for the BDC portfolio includes sponsored investments, non-sponsored investments, and platform investments. Furthermore, BBDC status as a business development company regulated under the 1940 Act has always necessitated that the portfolio tilt primarily towards North American assets. As a result of the overwhelming stability of the global private finance North American investment team and uninterrupted focus on North American investment opportunities, and in combination with the fact that the BBDC resource assets are driving 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 and the business. MassMutual intends to continue to actively invest with Barings in the middle market direct lending sector, reflecting their ongoing confidence in both the value and performance of the asset class and our capabilities. With that said, we know that many of you have reached out with questions regarding the personnel changes.

As we look ahead, we see incredible opportunity to leverage the strength of our scaled private credit franchise and leveraging the resources that support more than $300 billion of credit investments. Our investment process and philosophy remain unchanged, and our deep venture talent continues to leverage our origination network, and deployed 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.

Matt Freund: 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 8th. I’m happy to share that over the past two 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 funding 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 closed 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 basis and hedge against any compression and 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 refinancings is not solely isolated to the broadly syndicated markets. We have started to witness the competitive dynamics in the direct lending ecosystem as well, though it appears most acute for issuers with EBITDA of $75 million and above at the moment. Baring’s commitment to the core of the middle market is anticipated to serve investors well as the terms of large issuers gravitate towards the terms offered by broadly syndicated markets and we’re able to preserve some pricing protection in the core of what we focus on. Turning to our 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 2.2 times, in line with the fourth quarter.

It’s fair to say that the full impact of an increase in the interest rates has now been reflected within the cash flow metrics of the portfolio. The stabilization of the interest rate coverage are at the high-end of our previous guidance, ranging between 2 and 2.25 times, 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 two positions within the portfolio, Eclipse Business Capital and Rocade Holdings, are 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 non-accruals 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 and 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.

Elizabeth Murray: 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 31st, which is an increase of 1.4% over the prior quarter and an increase of 2.4% year-over-year. Our net investment income exceeded the $0.26 per share just in by 7.6%, Net annualized depreciation from investments CSA and FX was just NAV per share by $0.34 cents, 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 portfolios 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 31st. During the first quarter, the Sierra portfolio had sales and repayments of approximately $15 million, and we have 36 positions remaining in the portfolio. The fair value of the NBC CSA decreased from $17.3 million to $16.1 million, with four positions remaining in the portfolio, and we anticipate the sale of NBC audit 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 1.17 times at quarter end, up modestly from 1.15 times at the quarter-ended December 31st, and currently sits within our long-term target of 0.9 to 1.25 times. 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 31st, 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 of call to bonds.

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 the $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 one 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’ll open the line for questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question is coming from the line of Finian O’Shea with Wells Fargo. Please proceed with your question.

Finian O’Shea: Hey, everyone. Good morning. Eric, couple of the opening remarks on strategic changes, can you update us on the LP, the funds business? I think it was reported that you voluntarily halted investing there. Is that still the case? And ultimately how the conversations are going with existing and new LPs for — and the GPF for direct lending business? Thanks.

Eric Lloyd: Yes. That will be two things. So, we did. So, when the resignation came in at Friday, leadership — executive leadership here at Barings made a decision to pause investing in certain accounts. But 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 had communications with investors. There is kind of two — a couple of different buckets from those LPs’ perspective. There’s things that SMAs or funds of one that are more of bespoke discussions that we have with that one counter party. And then, there is really the co-mingled funds.

So, funds that might have 10, 20, 30 investors in there that have things like [LPACs] (ph) and other things that we have to manage through, that have different kind of timelines and times we [require] (ph) things from a key person perspective. What I can represent to you is that a number of our funds of [warranted] (ph) SMAs have allowed us to continue invest at this point in time. And I also can represent to you that our hold level and North America is generally consistent today with what I was prior to the events of March the 8th. And that hold level allows us to continue to lead deals in our core middle market franchise between $15 million and $75 million EBITDA. Certain other vehicles are continuing to go through their normal process as far as cure periods with key persons.

And we are up with that LP base along those lines. But again, a number of the funds of warranted SMAs, we continue to invest in.

Finian O’Shea: Thanks, that’s helpful. And a small follow-up, I forgot to throw in there. Looks like Jocassee has slowed down or stopped investing, is that the case for Jocassee and the BDC?

Eric Lloyd: Our relationship with the Jocassee Partners is very constructive. And, it’s one that we believe will continue to be an important part of the BDC. But, that’s kind of discussion we have had with them. And, we feel good about where that relationship is.

Finian O’Shea: Okay, thanks. I’ll do actually one more if I may? Sorry. It 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 in investment committee and so forth that BBDC has announced thus far is expected to be permanent? And that’s all from me. Thanks.

Eric Lloyd: Yes. So, the investment committee that we have stated is a permanent investment committee. We have also stated that we expect to add to that investment committee over time. The North American investment committee is four individuals as it sits today. Our prior committee was six. The number along those lines would be something we could look at over time as we add people. I would say the hires origination is something I highlighted, but I want to 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 two months from sponsors. Those relationships have been incredibly constructive. And I think you’ll see some hires here in short order that we’ll be able to announce. And I think that one of the things 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.

Matt Freund: If I may, Eric, the BBC 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.

Finian O’Shea: Thanks, everyone.

Operator: Thank you, our next question is coming from Kyle Joseph with Jefferies. Please proceed with your question.

Kyle Joseph: Hey, good morning guys. Thanks for taking my questions. 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 is some portfolio growth that look like yields are stable. That kind of just fee income driven, is that timing of deployments and repayments, or and then I think you did mention Eclipse dividend income impacting that as well.

Elizabeth Murray: Sure. Thanks, Kyle. Yes, interest income went 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’s more of the 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.

Eric Lloyd: But I just want to highlight the lack of or 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.

Elizabeth Murray: Yes. And yes, you should see it back at a more normalized level for the second quarter.

Kyle Joseph: Yes, got it, helpful. And then, a follow-up for me, probably for Matt, 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 and we talked about yields being stable, but give us a breakdown between base rates and the spreads you’ve been seeing in recent quarters.

Matt Freund: 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 end of 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 of EBITDA, I think the median issuer in the portfolio is just over 30, that isn’t really a competitive threat. But the banks don’t provide a competitive threat to the same degree. To be very candid with you, 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.

Eric Lloyd: Kyle, 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 two years ago. That is just generally going to lead to some form of spread compression in some shorter term period of time. But over time, we’re seeing kind of reasonable stability in kind of what that spread level is, because there’s an absolute return that needs to occur for private credit investors overall.

Kyle Joseph: Very helpful. Thanks for answering my questions.

Matt Freund: Thank you.

Operator: Thank you. Our next question is coming from Robert Dodd with Raymond James. Please proceed with your question.

Robert Dodd: Good morning, everyone, and thanks for all the color about the events of March 8th. On just one quick one for me. Matt, you mentioned that conversion rates or closed rates for transactions are trending towards the start, but can you give us any color on the drivers there? Is it bid asks on valuation for transactions not closing sufficiently informed through the last minute? Is it failures in due diligence as you get more advanced? I mean, any color you can give us on what’s the driver there.

Matt Freund: Yes. 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 three and six 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 that process. And so, as these kind of sell side transactions have evolved, you get part of the way through and you recognize that your cost of capital isn’t ultimately what you had 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 10 times or 12 times. And so, ultimately, our view on the credit profiles don’t often change, but there obviously is some capital below us, and when that cost of capital is changed, it creates revisionist 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 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.

Robert Dodd: Got it. Thank you.

Operator: Thank you. We have no additional questions at this time, so I’d like to pass the floor back over to management for closing comments.

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

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