Q3 2022 Barings BDC Inc Earnings Call
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 dot.
Barings should be D. C E dot com under the Investor Relations section. Please.
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 visitable actual results could differ materially from those projected in forward looking statements.
These statements are based on various underlying assumptions and.
They 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-K for the fiscal year ended December 31st 2021.
And two quarterly reports on Form 10-Q for the quarter ended September 30th 'twenty 'twenty. Two each has fought 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.
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 various co head of global private finance and President and Barings BDC, Ian Fowler Barings head of capital solutions and co portfolio manager, Brian Hi.
The Bdc's Chief Financial Officer, Jonathan Landsberg, and as is customary in Brian Jonathan and I will review details of our portfolio in 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 elevated volatility in both leverage loans and BDC equity.
Barings BDC continue to generate consistent stable economic results jumped the third quarter highlights on slide six now.
<unk> value per share was $11 28, compared with our prior quarter of $11.41 on approximately one 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.
Sure compared to 29 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 MCC assets, our total non accruals or two 8% of the portfolio on a cost basis and 7% on a fair value basis, all assets that are covered by our credit support agreement now 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 eight 9% at nine 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.
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 <unk> 24 cents per share equates to an eight 5% yield on our net asset value of $11.28, which matches our industry leading.
Hurdle rate and I'll have John Landsberg provide additional detail on our approach to dividend policy later in the discussion.
Slide seven 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 to later than anticipated fundings and three non core nonrecurring 2 million dollar revenue 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 and 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 bearings incentive fee cap curtailed the quarterly incentive fee further lowering expenses and elevating NII in the quarter to 26 cents per share now turning to liquidity net leverage which is leveraged net of cash and short term investments an unsettled transactions was <unk> 99 times.
<unk>, 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 toward new investment opportunities that present themselves in the face of current economic uncertainty.
Looking forward, we believe the investment environment to be right with opportunity the delayed impact of increasing rates will continue to work its way through private markets with many credit stresses yes. It comes some of which are starting to arrive and that said the ability of our manager to prosecute those opportunities.
<unk> will be directly correlated to how well they deploy capital in 2021.
Our diverse portfolio approach and best in class level of Investor alignment.
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.
Yes.
Thanks, John and good morning, everyone.
Turning to slide nine 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 in delayed draw 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 N B C and Sierra.
And this quarter generated $44 million of liquidity via sales pay downs in prepayments.
Slide 10 updates of data we show you each quarter on the middle market spreads across the capital structure and.
Clearly investment spreads across public and private asset classes have what most.
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.
Two loan investors remains much smaller than the past.
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 of current market clearing price for new issue leverage buyout debt has averaged in the mid to low nineties.
Making the cost to issue and create this paper by banks and sponsors.
And on the call.
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 September 30th.
So on slide 12.
On slide 13, you'll 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 bearings originated middle market portfolio, the legacy M B seed capital and Sierra income portfolios as well as our crowd cross platform investments.
The middle market portfolio remains our core focus it makes up 56% of our portfolio in terms of total investments at fair value.
54% of our portfolio in terms of revenue contribution.
Our bearings originating middle market exposure, it's heavily diversified amongst all the doors up 211 portfolio companies with a geographic diversification across the U S Europe and APAC regions.
The underlying yield at fair value on our middle market investment portfolio of nine 2% up from seven 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 barings' wide investment frame of reference to complement our core portfolio.
$374 million of investments in the legacy M B C and CRE portfolios.
$652 million of cross platform investments.
Date, we have realized approximately 164 million of capital from both transactions and continue to drive realizations in today's environment.
Turning to credit to M. D C assets in five Sierra assets remain on nonaccrual with total number of nonaccrual loans is unchanged from last quarter.
The ones here along came off nonaccrual as it was sold well one new long was added with the costs of 600000.
Additionally, subsequent to quarter end, we place our debt investment in core scientific on nonaccrual as a company on a go through restructuring was that position representing one 2% of the portfolio of course.
Slide 14 provides a further breakdown of the portfolio from a seniority perspective.
The core birth bearings originated portfolio was 72% first lien.
Note the combined M. D C. 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 five 9% of the total portfolio.
And the top 10 investments represented 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 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.
The preparedness for stress in today's market looks entirely different than it did in past cycles.
EBITDA growth for our portfolio companies.
One thought always to be secular phenomenon will become more challenging.
Expected acquisitions synergies on deals may not materialize.
Emphasis which was once focus on growth and total addressable market will now quickly shift to cash flow and liquidity.
In short the investment in social norms learned over the last 40 years will need to be on learned and this learning process will favor those with investment discipline and long institutional memory deploying capital in inflationary environments.
Barings 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.
Thanks Ian.
Turning to slide 17, here's the full bridge over the NAV per share movement in the third quarter, our net investment income exceeded our dividend per.
For sure share repurchases added another two cents per share.
Realized gains drove an increase of seven cents per share while our unrealized depreciation totaled 24 cents per share.
More details on this net unrealized depreciation are shown on slide 18.
Of the total $26 million unrealized depreciation in the third quarter.
$19 billion was due to price or spread moves the cross platform portfolio contributed $11 million total price driven depreciation primarily tied to the more liquid investments in such a situation would be yourselves, where select mortgage assets.
Notably the legacy MAA portfolio total depreciation of $6 5 million type of underlying credit performance, while Europe portfolio had total depreciation of $7 million 3 billion of which was due to price movements predominantly tied to your equity positions in this year a JV.
He was the bottom of slide 18, you can see that the credit support agreements increased $3 million as a result of the investment marks.
In 19, and 20 show our income statement and balance sheet for the last five quarters.
Net investment income per share was 26 cents for the quarter driven by generally stable total investment income as mentioned earlier by John .
Finally, the capped incentive fees, 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 end cash balance isn't until JV sales. Our net leverage ratio was <unk> 99 times after adjusting for cash and unsettled transactions and we view. This measure is more reflect.
But the true leverage position of the vehicle.
Turning to slide 21, you can see how our funding mix tied 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.
Continue to diversify our liabilities to match our diverse.
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 provided was comprised of fixed rate unsecured debt with a weighted average coupon of 379% and we have nearly three years until the next bond maturity.
Turning to slide 23, you can see the impact to our net leverage using our available liquidity to fund our unused capital commitments. Various BDC. Currently has 232 million of unfunded commitments to our portfolio of companies as well as $67 million of remaining commitments to our joint venture investments.
I'm available Cushing I can start 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 dividend since barings took over as the advisor to the BDC.
John mentioned earlier, the board declared a fourth quarter 2022 dividend of 24 cents per share and eight 5% distribution on net asset value.
Looking forward, we anticipate a strong portfolio performance will sustain be bdcs, earning power of all of our 24 cents per share dividend. So it makes it 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 pro rate of eight 5% and a willingness to align the NOI incentive fee credit performance, both realized and unrealized.
As a result of aligning our dividend with our hurdle rate very insulates. The regular dividend distribution, which is eight 5% on average 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 lower incentive.
And our view is creating this feature creates a very strong and resilient dividend yield profile that is less dependent on an 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 is that.
Consistent long term approach combined with significant investor alignment and margin of safety and we believe drives down BDC yield risk premiums overtime.
Turn with me now to slide 26, which shows a grasp a graphical depiction of relative value across the triple B double b and single B asset classes.
While we saw spreads we saw wider spreads in the quarter across nearly all asset classes as a result of increased fears of stagnation or stagflation.
Slide 27 outlines the premium spreads on our new investments relative to liquid credit benchmarks noticed 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 the benchmark.
Excluding certain equity investments Barings, BDC deployed $232 million and all in spread of 931 basis points, which represents a 284 basis points spread premium to comparable liquid market indices at the same risk profile.
I'll wrap up our prepared remarks, with slide 28, which summarizes our new investment activity. So far during the fourth quarter of 2022, and our investment pipeline and the pace of new investments remained steady compared to the last two quarters with $131 million of new commitments of which 103 million have closed and funded.
New commitments, 95% are in first lien senior secured loans, 23% on a cross platform and 20% of our European European or Asia Pac originations the weighted average origination margin or D. M Street was eight 2%. We've also funded approximately 7 million of previously committed delayed draw term loans.
The current Barings global private finance investment pipeline is approximately $1 8 billion on a probability weighted basis and is predominantly first lien senior secured investments as a reminder, this pipeline is estimated based on our expected closing rates for all deals in our investment pipeline and with that operator, we will open the line for questions.
Thank you yeah, if he would like to ask a question. Please press star one on your telephone keypad.
<unk> tone will indicate your line is in the question Kim You May Press Star two if he 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.
Hi, everyone. Good morning.
Mr. Landsberg appreciate your.
Commentary on on the dividend policy, there and <unk>.
Preference toward margin of safety and so forth can you talk about.
The spillover that would.
You know in the event you you eventually do generate a lot of spillover if LIBOR stays higher goes up in and Theres 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 you know, maybe a higher a base dividend.
A few quarters from now or something like specials or supplemental <unk>.
Yeah. Thanks, Greg Thanks, Ben its 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 as you look ahead first we do have quite a bit of available spillover to built.
But we really kind of employing 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 repurchases.
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 fairly systematic.
One off dividends are one time dividends special dividends to ensure we're staying in compliance with all of the required referrals.
Great. That's helpful. All for me thanks, so much.
Thanks Brent.
Our next question is from Kyle Joseph with Jefferies. Please proceed.
Yeah, Hey, good morning, guys.
I appreciate the prudent approach of aligning the the dividend with the incentive fee and you know 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 you know weighing that versus you know some some of your peers, which is kind of an increase.
Their distribution is more consistent with kind of the rate curve sure and Kyle. This is 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 industrial 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 went through.
The repurchase of shares because now is an attractive time to do so.
Got it that's very helpful and yes, like I said I do definitely view the the approach it as prudent, particularly in this environment and then he and I. Appreciate all the color you provided on the originations environment, but yeah, as we step back and look out into.
23, obviously, you guys have a tremendous amount of dry powder to deploy them more macro volatility kind of pure LDL transactions.
You know how how are you thinking about the level of potential originations in 'twenty three and then weighing in kind of the behavior appears in that competitive environment and any changes you've seen there recently.
Yeah, Thanks, Kyle and 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 when.
When you look at the at the market and the properties that were coming to market.
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 as you get to reinvest in your portfolio companies and I would say you know the.
The percentage of originations coming from the portfolio has increased.
Dramatically this year and I would expect lets say next year.
Especially as a private equity firms are trying to discover what's going to happen on the valuation side.
So like this year, where our origination it's 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 are becoming stronger competitor compared.
Deters, a more defensible better credits more diversified at greater scale. So.
You know in terms of origination I think that's that's where it's going to come from.
Thank you have to in our approach Ah, it's definitely not battened down the hatches.
But it's definitely a prepare for the worst because you know none of us have a crystal ball.
And hope for the best so from a liquidity standpoint.
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.
Did that was great color. Thanks, a lot for answering my questions.
Yeah cool.
Okay.
Our next question is from Ryan Lynch with <unk>. Please proceed.
Hey, Good morning, guys, Hey, first question I had is just I'm trying to understand what's going on in Thompson reverse.
That investment has been breakdown five or so million dollar sort of every quarter.
In 2022, and then when I look at the portfolio there the portfolio.
Has been shrinking pretty dramatically its about a third of the size. It was sort of at the beginning of the year and the fair value is much lower than our cost there. So.
You know I would assume that rising rates on that mortgage book is not healthy. So I'd just love to hear fundamentally what's what's occurring in that underlying portfolio of Thompson rivers and is that the plan. The portfolio is shrinking is that by design or are you guys shrinking that that's sort of JV what is your expectation for that going.
Forward.
Sure Ryan This is John so if you could outline that given the investment in mortgages granted very short duration. It was really targeted profile to provide liquidity that can be just certain mortgage servicers to where we would invest in early buyout mortgage originations allow those to return which are effectively.
FHA loans, which led to a 100% government guarantee.
And when the underlying obligor return 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 right as the consumer returns back end and we get to collect it back interest, but you have a time profile, where the increase a rapid increase in rates.
Pushed down the value fair value slightly right to the point now where you start to look at what we've invested in what we pulled out in the form of dividends effectively matched its been a strong income provider. Our expectation was to now look at that recognizing that that environment right, 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.
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 are our our view is while it provided a strong rating Avenue. We also recognized in the current environment, you can redeploy that and put it to more productive use of wider spread.
Okay. So that that would be the expectation is that that will wind down.
It goes pretty quick too Ryan So interestingly, that's why they're they're very liquid and.
You know that very rapidly.
Re performing assets, which is why you were 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.
And enter into corporate credit opportunities now, which have gapped out Mcguire.
Yeah Okay.
Understand and then maybe following up this is maybe maybe for for.
I'm just more on a kind of a 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 but the outlook for the economy has has also.
Significantly more shaky. So in this environment and then obviously deal flow are generally is it is down quite a bit because of those two factors.
Is it your anticipation that you guys would like to be.
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 and anticipation for further dislocations in the marketplace and the economy.
Well, Hey, Ryan I'd see them, 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 what.
Well like I said I mean, yeah. The terms today are getting better right spreads are wider leverages come down structural protection is definitely.
Definitely better.
And but again I think when you look at what's happening in the market right between buyers and sellers of assets, where 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.
Given the increase in rates.
The debt Quantum's gonna have to decline and that's going to change either sponsors are gonna have to put more equity in their valuations are going to have to come down. So you know I I would say that.
Unless there's something very unique to a certain transaction.
<unk> in today's market just aren't really great properties and you know our view is that the risk return on those 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 bullet proof as we go through this economy. So that's kind of what where we're focused on but again I think.
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 and 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.
The opportunities are but we're definitely.
Willing and focused on taking advantage of those opportunities you know in the middle market side, it's going to be looking for you know.
Sellers that are of Oh, good assets that need liquidity and on the on the cross platform side. It maybe more opportunistic situations. So we might be well positioned for those as they appear and so that's our focus.
So I put it really well.
You can put it really well Ryan and I think it might be and if you look on 27, when we start to look at the risk premiums that are available right clearly are the distressed or or slight distress that exist 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're going to see some of the situational opportunities that will find you know there's a lot of that over to Brian for a quick item you can see in some of the certain cross platform opportunities where.
The spreads relative to what you can find in a real good market have already gapped out sufficiently wide, but Brian yes.
Yeah. So I mean, if you 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 you know even in this quarter.
Aerospace is a great example, it's 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.
As growing our fleet of Super Scooper aircrafts to deal with forest fires, which again I don't think that that's you know as correlated to the general economy as you.
Maybe a traditional corporate borrowers so those types of opportunities are where we're looking to deploy capital and finding the risk adjusted return to get to complement kind of that broad book.
Gotcha makes sense I appreciate the time today.
Yeah.
Our next question is from Casey Alexander with Compass point. Please proceed.
Yeah. Thank you most of my questions were answered, but I do have one or are you, saying that the difference between the cost and the fair value for Thompson as just rate driven and will climb back to cost as they repay and so credit is still good. This is just a mark to market.
Credit is still good but Casey also as base rates secondly, rise in mortgage spreads rise once we have the asset and its re performing we effectively own a lower rate mortgage coupons, but when we submit it back to the pool and you sell it back to the FHA theyre going to buy it back at the market price, which is now.
<unk> are lower so so so really in totality. When you think of all the income you'd be retooling at a slightly slight loss, which still that's what your income you know what in 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.
Okay. Thank you.
We have reached the end of our question and answer session I would like to turn the conference back over to Jonathan for closing comments.
Thank you so much for joining us today and we are very very thankful you all that participated on the call and we want to wish everybody a happy veterans day and want to thank folks for their service. So thank you very much for joining.
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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