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Edited Transcript of TCAP earnings conference call or presentation 28-Feb-19 2:00pm GMT

Q4 2018 Barings BDC Inc Earnings Call

RALEIGH Mar 14, 2019 (Thomson StreetEvents) -- Edited Transcript of Barings BDC Inc earnings conference call or presentation Thursday, February 28, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Eric J. Lloyd

Barings BDC, Inc. - CEO & Interested Director

* Ian Fowler

Barings BDC, Inc. - President

* Jonathan Gerald Bock

Barings BDC, Inc. - CFO

* Michael Freno

Barings BDC, Inc. - Chairman of the Board

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Conference Call Participants

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* Casey Jay Alexander

Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst

* Christopher Robert Testa

National Securities Corporation, Research Division - Equity Research Analyst

* David Brian Miyazaki

Confluence Investment Management LLC - SVP and Portfolio Manager

* Finian Patrick O'Shea

Wells Fargo Securities, LLC, Research Division - Associate Analyst

* James Young

West Family Investments, Inc. - Investment Analyst

* Mickey Max Schleien

Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst

* Robert James Dodd

Raymond James & Associates, Inc., Research Division - Research Analyst

* Ryan Patrick Lynch

Keefe, Bruyette, & Woods, Inc., Research Division - MD

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Presentation

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Operator [1]

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At this time, I would like to welcome everyone to the Barings BDC, Inc. Conference Call for the Quarter and Year Ended December 31, 2018. (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.

Please note that this call may contain forward-looking statements that include statements regarding the company's goals, beliefs, strategies, future operating results, and cash flows. Although the company believes these statements are reasonable, actual results could differ materially from those projected in forward-looking statements. These statements are based on various underlying assumptions and are subject to numerous uncertainties and risks, including those disclosed under the sections titled Risk Factors and Forward-Looking Statements in the company's annual report on Form 10-K for the fiscal year ended December 31, 2018, 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 would like to turn the call over to Eric Lloyd, Chief Executive Officer, Barings BDC.

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Eric J. Lloyd, Barings BDC, Inc. - CEO & Interested Director [2]

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Thank you, Donna, and good morning to everybody who joined us for the call. We appreciate everyone joining us for the call, and please note that throughout this call, we'll be referring to our fourth quarter 2018 earnings presentation that is posted on the Investor Relations section of our website.

On the call today, I'm joined by Barings BDC Chairman and Barings Head of Global Markets, Mike Freno; the BDC's President and Barings Co-Head of North America Private Finance, Ian Fowler; the BDC's Chief Financial Officer, Jonathan Bock; and Tom McDonnell, who is the Liquid Credit PM for the BDC.

On our call today, we're going to review our fourth quarter results and market trends. However, I'd like to start with a few comments about the fourth quarter volatility.

As you see on Slide 5, in the fourth quarter, the liquid credit markets and the BDC stock prices experienced their worst quarter since the financial crisis, falling roughly 4.5% and 15% respectively. The reasons for the market selloff ranged from heightened fears of a global economic slowdown to indiscriminate ETS selling of leveraged loans and high-yield bonds. Notably, this year-end market decline appears less correlated to corporate fundamentals, as the underlying performance of our portfolio companies remained strong, and I'll let Ian discuss that point in a minute.

Still, there's a broader takeaway I'd like to outline, and that's tied to the high correlation of liquid credit spreads to that of BDC stock prices. As you see on the slide, BDC's stock price movements correlated to liquid credit spreads in the fourth quarter. Price declines amongst the BDCs were surprisingly consistent at a roughly 15% decline, and that was regardless of whether one held middle-market collateral or liquid collateral. In our view, just as the equity markets revalued risk in the BDC space in the fourth quarter, we, too, should be reflective of those price movements in our net asset value.

On Slide 6 you'll see our fourth quarter highlights. At the top left, you'll notice that we marked the Barings BDC NAV down 7.8% to $10.98 per share, primarily due to unrealized marks as a result in the fourth quarter spread movements. Our view on this mark to market is simple. First, it's technical. The NAV decline is predominantly driven by the movement in credit spreads and not a result of the deteriorating fundamentals. Second, it's inclusive. As you look through our schedule of investments, you'll see write-downs across our books of liquid and illiquid directly-originated middle market loans. And third, it's intuitive. Like all credit investors, Barings invests in a wide array of credit assets across our $300 billion platform, and as such, we have an extremely wide frame of reference on asset pricing.

Thus, to us, it's intuitive that as the prices of risk assets fall, BDC NAV should fall as well. Our NAV should be no exception. This gives our investors an opportunity to invest in a technically lower NAV, and more importantly, it allows the manager to build NAV through share repurchases.

Turning to the operating results for the quarter. I'm very proud to say we continued to gather momentum in our middle-market ramp. In the fourth quarter, net investment income was $0.16 a share, an increase over the $0.06 per share earned during the third quarter, and also in excess of our fourth-quarter dividend of $0.10 per share.

During the quarter, we made 13 new and 1 follow-on middle-market investments totaling $162 million, bringing the total value of our middle-market portfolio to over $230 million at year-end. Note that these are predominantly lead manage, directly originated loans sourced with highly respect private market sponsors.

Slide 7 shows some additional financial highlights for the fourth quarter compared to the third quarter compared to the third quarter. Here, you will see the $52 million of net unrealized losses that drove the net income and NAV declines. While the fourth quarter was challenging based on widening credit spreads, prices have recovered and roughly 60% of unrealized losses have been recouped so far in 2019. Our $1.1 billion investment portfolio was partially supported by $570 million of borrowings under our broadly syndicated loan facility. In addition, we recently entered into an $800 million corporate revolving credit facility with a syndicate of 17 banks. Suffice it to say, this facility fits well with our predominantly first lien, floating rate, senior secured debt strategy.

I'd now like to turn the call over to Ian to provide some additional information on our investment portfolio and investing in the middle market.

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Ian Fowler, Barings BDC, Inc. - President [3]

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Thank you, Eric, and good morning, everyone.

Slide 9 summarizes our new investments and repayments for both the third and fourth quarters. As Eric mentioned, the fourth quarter was active for a middle-market portfolio, with $162 million of new, opportunistic, directly originated (inaudible) $75 million in the third quarter. The increase in funding reflected heavier middle-market activity in the fourth quarter. Additionally, we had net sales of broadly syndicated loan portfolio investments of $56 million, as we were able to opportunistically exit certain investments during what was a challenging quarter for BSL prices.

Turning to our portfolio composition on Slide 10. As of December 31st, the BDC was invested in roughly $846 million of liquid, broadly syndicated loans and $249 million in private middle-market loans, including delayed broad-term loans. As we have previously discussed, we are currently going through a transition period during which the company is primarily invested in liquid, broadly syndicated loans as we build our private middle-market loan portfolio. These BSLs are a diverse portfolio of 120 investments across multiple industries and are all first-lien loans with a weighted average spread of 327 basis points and a yield at fair value of 6.1%. Senior leverage for this portfolio remains consistent with last quarter, with a weighted average of 4.9x debt to EBITDA.

Focusing on the middle market column on Slide 10, as of December 31st, the BDC had approximately $249 million of middle-market assets spread across 19 portfolio companies, as compared to $86 million across 6 portfolio companies at the end of the third quarter. Over 20% of our total portfolio is now comprised of middle-market loans. Company fundamentals remain relatively consistent with last quarter, with weighted average senior leverage of 4.6x and a median EBITDA size of $38 million. Of the 19 middle-market investments, 17 are first-lien investments and 2 are second-lien term loans that we feel provide good risk-adjusted returns.

Our diversification theme continues with our middle-market portfolio as the 19 investments are spread across 12 industries and no investment exceeds 2.5% of the total portfolio. Our top 10 investments are shown on Slide 11, and I'll point out that our top 3 investments were all originated in the fourth quarter.

Turning to Slide 13. Let me outline a few market trends we saw in the fourth quarter and how these trends affect our portfolio. This slide is an update of a slide we shared last quarter with the third-party data from Refinitiv showing middle-market spreads across the capital structure. Senior and unitranche spreads were relatively flat during the quarter, with the biggest moves in mezzanine and second-lien structures, albeit in opposite directions, as mezzanine continued to tighten and second-lien spreads widened. For additional color on this divergence, we believe volatility in the liquid market had a spillover effect on middle-market second liens, causing second-lien spreads to widen as a result. Mezzanine debt is most prevalent in the lower end of the middle market and is thus more insulated from volatility in the liquid market. Plus, mezzanine is competing against unitranche structures with further pressure mezzanine spreads as the unitranche market remains competitive.

Slide 14 shows that leverage has been trending upward over the last 4 years, and the fourth quarter saw very slight upticks in the unitranche and first-lien, second-lien categories. Additionally, on Slide 15, we outline leverage across industries. We continue to believe that investors should be careful when looking at technology companies, as leverage levels in the industry were by far the highest during 2018. We like credit characteristics of software deals, but are cautious chasing enterprise value through a cycle. As opposed to deep unitranche, our preference is to structure levered deals in a bifurcated, traditional, first-lien, second-lien structure where the risk-adjusted return is more attractive. Importantly, this allows us to consider where true value sits.

Taken as a whole, I would say our overall view of the middle market has not changed materially since last quarter. Given yield trends and leverage levels, investment discipline and patience is critical, but we believe quality investments can still be found. We continue to focus on finding these quality transactions with appropriate risk-adjusted returns and not focus on specific investment targets or deployment timelines.

I'll now turn the call over to Jon to provide additional color on our financial results for the quarter.

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Jonathan Gerald Bock, Barings BDC, Inc. - CFO [4]

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Thanks, Ian. Guys, turning to Slide 17. You're going to see a bridge of the company's net asset value per share from September 30th to December 31st. Now I'll start saying that the primary component of the NAV decline was unrealized depreciation on our investment portfolio of about $1.02 a share. Now this decrease in NAV was partially offset by our net investment income for the fourth quarter exceeding our quarterly dividend by $0.06 a share. And as Eric mentioned, roughly 60% of the decline's already recovered in 2019.

On Slide 18, you'll see our income statement for the fourth quarter, as well as a third-quarter pro forma income statement.

Now Slide 19 shows our balance sheet as of both December 31st and September 30th. We ended the year with an investment portfolio of over $1.1 billion, and with borrowings of $570 million under the company's BSL facility, year-end leverage was 1.01x, or 0.92x debt to equity, after adjusting for cash, short-term investments, and net unsettled transactions. This $750 million BSL funding facility was reduced to a total commitment size of $600 million following the closing of the company's new $800 million senior secured middle market credit facility just last week.

Now details regarding both credit facilities are shown on Slide 20. Our new 5-year credit facility will be the primary borrowing mechanism for the company on a go-forward basis, but we will continue to leverage the BSL facility near term, as we transition from a portfolio of primarily BSL investments to middle-market investments. Now locking up this $800 million long-term source of liquidity was a critical step for our middle-market portfolio expansion, and we are excited to work with such a diverse group of quality lenders, including 2 partners, both of sizeable commitment, that made Barings BDC their inaugural BDC investment.

Slide 21 shows our paid an announced dividends since the closing of the externalization transaction. The increase in dividend is consistent with our desire to align our dividend policy with the earnings power of the business and the investment portfolio, and we announced yesterday that our first quarter dividend of $0.12 is going to be paid on March 20.

Now I'd like to turn to our investment activity subsequent to year end and our pipeline on Slide 23. We started 2019 with roughly $44 million of new middle-market investment commitments and an average 3-year discount margin of 5.8%. Of those $44 million, $16 million have already funded, and suffice to say, it was an active fourth quarter of middle-market closings, and that really pulled forward demand and led to a slower origination start for the entirety of the middle market for the first quarter. That said, we're seeing the investment pipeline build meaningfully, and that brings us to Slide 24.

So Slide 24 shows our North American private finance investment pipeline probably-weighted on deals that we would believe to close, and that's at roughly $543 million and growing. Now our pipeline remains heavily first-lien senior secured across a variety of diversified industries. And additionally, I think it's important to outline that in addition to our middle-market loans, what we're looking to do is also drive shareholder returns not just through traditional middle-market investments, but through effective use of our non-qualified asset bucket via a joint venture with a respected institutional investor in 2019. The joint venture will be structured similar to those JVs currently outstanding in the BDC space, and we'd expect that to have a wide investment mandate.

It's our intention that the BDC's investment of JV would be approximately 4% to 6% of our asset base over time. Now, look, there's no assurance that a JV materializes in 2019, but it's our point, so that we believe these programs can offer very compelling differentiated investor returns to shareholders.

And with that, I'll now turn the call over to Mike Freno, Chairman of the Board of Barings BDC as well as the Head of Global Markets of all of Barings.

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Michael Freno, Barings BDC, Inc. - Chairman of the Board [5]

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Thanks, Jon, and good morning, everyone. Please turn to Slide 26 of the presentation.

Hopefully, as most of you are now familiar with the Barings organization, you're taking away an appreciation for our distinct competitive advantages that exist in the credit asset management space. First, we're global, with the unique ability to drive risk-adjusted returns in both liquid and illiquid credit across geographies. Second, we're highly diverse in our approach and ability to provide capital solutions across the stack to core sponsors. Our sizeable capital base with both captive and third-party capital, as well as various investment mandates, allow us to serve our sponsors' needs from revolvers to mezzanine debt, and everything in between. This generates greater looks and deal flow from sponsor community. And finally, we're aligned. As many may know, Barings is wholly owned by a Fortune 100 mutual life insurance company, and this unique ownership structure allows Barings to truly manage for the long-term benefit of our clients.

Taking those differentiators into account, jump to Slide 27. On this slide, you'll see Barings BDC price to NAV and notice that the fact that as the portfolio remains in the ramp phase, the stock trades at a discount to NAV. In our view, the stock price trading below NAV creates the opportunity to drive shareholder returns at BBDC via share repurchase. As a result, we are proud to announce that we have received board approval for a share repurchase plan in 2019, where Barings BDC aims to repurchase 2.5% of the outstanding shares when its stock trades at prices below NAV. Additionally, Barings BDC aims to purchase 5% of the outstanding shares in the event its stocks trade at prices below 0.9 NAV, subject to liquidity and regulatory constraints. Moreover, we will sure to assess this each year to determine the most effective level of buybacks to drive long-term shareholder value. At Barings, we believe share repurchases are an important part of any long-term capital allocation philosophy.

Slide 28 summarizes 4 core beliefs that drive this view. First, there's clear shareholder benefit to purchasing shares below net asset value, as it is accretive to all shareholders. This is even more impactful when net asset value is under technical pressures due to market forces. Second, repurchases demonstrate belief in underwriting. Third, we believe that repurchases need to be consistent. Repurchases at a current discount-to-book value is the tangible equivalent in investing in a loan yielding double to mid-teens type returns. To the extent these opportunities exist, Barings should consider repurchases as part of its capital allocation in a given year. And finally, repurchases need to be long-term. Permanent capital vehicles require a permanent view towards generating shareholder value. As we navigate 2019, we look forward to reporting our progress on this buyback each quarter.

I'll end with Slide 29, a slide that is familiar to many of you, to give investors a sense of the totality of the approach to alignment. Since becoming manager of the BDC in August of 2018, Barings now owns more than 26% of BBDC shares through a combination of a $100 million investment in NAV and $50 million in open purchase via a 10b5-1 plan. We operate under a market-leading fee structure with a high hurdle rate. And finally, we outlined on this call a long-term share repurchase philosophy designed to drive shareholder returns and demonstrate a belief in our ability to underwrite credit over market cycles.

I'll wrap up our prepared remarks by saying that while a tremendous amount has been accomplished since we became the advisor to the BDC 7 months ago, we continue to maintain a long-term focus that leverages the capability of Barings while aligning with the interest of our shareholders. We hope that the actions we have taken over the last 7 months demonstrated this commitment, and we will strive to continue what we have started during 2019.

With that, operator, we will open the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is coming from Fin O'Shea of Wells Fargo.

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Finian Patrick O'Shea, Wells Fargo Securities, LLC, Research Division - Associate Analyst [2]

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I'll start with the new buybacks just outlined, which I'll first say is refreshing in its high-level approach and with the detail you offered on the 12b5-1 parameters. So that said, what we see in the market today is that even with these 12b5-1s, the algorithms will tend to shut off when the wind blows. So the question I'll pose, Mr. Bock and Freno, is appreciating the detail that you buy back more below 90, how can we view the program in terms of the actual teeth it will have in, say, another market dislocation.

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Jonathan Gerald Bock, Barings BDC, Inc. - CFO [3]

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This is Bock. I'll start with a commentary on some of the mechanics, and then Mike can finish with a philosophical point on how we're kind of approaching this. So we're going to utilize both 10b5-1, which is the programmatic means, as well as 10b-18, which is the one that's subject to blackouts. Our point is this, is we always want to create a moment where we're going to be in the market for our shares to the extent the market gives us an opportunity to purchase them at attractive discounts. And so you could say that we have it weighted where, to the extent it trades at a deeper discount, that more shares would be bought. That being said, the major concern of folks announcing share buybacks and not using them, our point just gets to putting out the target and allowing you to judge us. And that kind of comes from the philosophy that Mike and others have imparted on us at Barings to always make sure that we're considering this as part of a holistic capital allocation policy, and we have no problem putting out kind of our intentions.

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Michael Freno, Barings BDC, Inc. - Chairman of the Board [4]

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Yes, and I think I would agree with Jonathan on the mechanics of it. And again, what we want to highlight here is this is a philosophy that we believe we should be long-term buyers of our stock price to the extent it trades below NAV. And in full transparency, we'll be reporting each quarter how effective we are in executing on those share repurchases.

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Finian Patrick O'Shea, Wells Fargo Securities, LLC, Research Division - Associate Analyst [5]

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And I'll follow with a question to Mr. Fowler on the markets. Noticing in your slides with the Refinitiv data by industry, what we notice here is that tech deals are being leveraged at much higher attachment points, and this is seemingly a growing part of the private credit index. So can you give us any color on, aside from these leverage levels, any potential degradation in term structure for the industry, and then perhaps ways that you, therefore, can protect downside, given your higher attachment points for these issuers?

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Ian Fowler, Barings BDC, Inc. - President [6]

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Yes, so a couple things. I think what we're saying, just in general terms, is that when it comes to technology -- and we do like the credit fundamentals of technology companies, the recurring revenue, embedded, sticky software businesses, steady cash flow, high retention, low churn, all those things -- that fundamentally, it's an attractive business. I think what we're saying at the end of the day is, as you look at these deals and you look at where purchase price multiples have one, and we are seeing purchase price multiples as high as 20x, there just is a point in time when a unitranche deal is so deep in the capital structure that it's really not senior debt anymore. You're really taking a fundamental, junior capital risk. And so all we're saying is, when it gets to that inflection point, you need to bifurcate the structure into a first-lien, second-lien deal, and then you can look at the risk-adjusted return on the first lien and the second lien and decide where you want to play.

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Operator [7]

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Our next question is coming from Mickey Schleien of Ladenburg Thalmann.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [8]

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I apologize if you've covered the following issue in your prepared remarks, but I'm juggling 2 earnings calls. Just curious, given the breadth of your platform, I'd like to ask about your thesis on the economy in your underwriting. Most of the market seems to be lending based on the assumption that we're late in the credit cycle, but frankly, that assumption has been in place for many years and it's been wrong, so folks have been leaving money on the table. Obviously, your BDC is new to the market -- we understand that -- and it seems that you're underwriting also based on this assumption. So my question is, how wide would second-lien spreads have to get for you to see good risk-adjusted returns in that market and perhaps improve portfolio yield?

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Eric J. Lloyd, Barings BDC, Inc. - CEO & Interested Director [9]

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Mickey, this is Eric. I'll take that and I'll try and address -- I think there kind of maybe 2 questions in there as far as the ramp of the middle market versus where we are in the cycle, and then also second-lien spreads. Focusing on the middle market and the illiquid yields that we directly originate, typically they're 5 to 7 years [of stated] maturity. And whether it be in 2019 or 2015, we underwrite every deal assuming that there is an economic and credit cycle during the life of that asset. We do not try and time the market as far as we're going to be more involved or less involved, depending on our views of the economic cycle or the credit cycle. So we don't know when that next cycle will happen. Obviously, we're closer to it, and people have been predicting it for a while, but we don't try and market time that way. So that's the first thing on our directly originated deals. As far as second-lien spreads, I think it's really 2 elements within second lien. It's both the attachment point that you're in the second lien, i.e. how deep is the first lien in front of you as well as your leverage, in addition to the return profile of that. And then the third element is really the documentation of that second lien, and does that second-lien documentation look a lot more like mezzanine, or does it look a lot more like traditional second lien? And so, for us, it's really all of those components. It's the absolute return. It is the leverage of where you are in the asset, but also how deep the first lien is in front of you, as well as the documentation component. So I can't give you a clear spread answer of what they need to do to get there, because we literally look at all 3 of those components when we're evaluating any type of second-lien opportunity.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [10]

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Okay, I appreciate that. And my follow-up question, for some time, we've been concerned about how portfolios will behave and how borrowers will behave as LIBOR increases. But taking into account what you just said, the eventuality of a decline in the economy, I'm curious how you're managing the downside risk to LIBOR and portfolio yield, apart from LIBOR floors.

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Eric J. Lloyd, Barings BDC, Inc. - CEO & Interested Director [11]

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Great question. This is Eric again. I would say as we think of LIBOR, I think there is an element of this occurring in the market where the [only] return is staying maybe consistent because you've seen an increase in LIBOR, and therefore, potentially, decrease in spreads. I think there's kind of 2 questions in there, again, as I think of it. The first one is portfolio construction, and I should have addressed that when you asked your first question. As we get deeper into a credit cycle or an economic cycle, portfolio diversification becomes ever more important. And so, if you look at our traditional vehicles, as we referenced here, I think the largest position we have is right around 2% of our outstandings, and you should expect to see that stay consistent with us. That would tell you that that's a minimum of a 50-name type of portfolio, and I think you'll expect it over time to be larger than that, and so that diversification is important. Now specifically, as it relates to LIBOR, we do maintain LIBOR floors in our deals, but it is true that if LIBOR were to decrease from the current levels back down to levels we saw 2 or 3 years ago, the yield on the portfolio will also decrease. The offset to that is our leverage that we've locked in also LIBOR based. It's not a fixed-rate liability that we have, therefore you should see some offset to that decrease of asset-level return by the liability cost also decreasing.

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Operator [12]

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Our next question is coming from Christopher Testa of National Securities Corporation.

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Christopher Robert Testa, National Securities Corporation, Research Division - Equity Research Analyst [13]

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I just wanted to discuss, obviously you guys got the approval for reduced asset coverage. I was just wondering as you're now over 1:1, although not on a net basis, should we look at you to go over 1:1 just opportunistically in times of severe dislocation? And also, are you potentially maybe looking at reducing fees over 1:1?

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Jonathan Gerald Bock, Barings BDC, Inc. - CFO [14]

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Chris, this is Bock. Thanks for the question. What I'd start with is how we kind of look at leverage, and I'd start, first point again, by when you look at the portfolio that we're developing, our job and our alignment kind of allows us to focus on super (inaudible) portions of the capital stack. And our view is, is that you can bring up leverage slightly on those lower-risk investments to generate a superlative return, and you target about an 8% return over time if you kind of go back to our Investor Day. So that's step one. And then, if you look kind of the bifurcated what you do going above 1:1, et cetera, I actually kind of take a step back and you have to look at, really, what incentives force managers to do starting with point A, the hurdle rate. And that's kind of what matters the most, right? Before you start diving into individuals of what's the base above a certain amount, you'll find that a hurdle rate at 6 is entirely different than a hurdle rate set at 8. And so our view on the fee is pretty simple, right? We set a hurdle rate at 8. We'll have leverage kind of moving up slightly over time, and that leverage can go up 2 ways, through additional investment, through rotation and through stock repurchase. But you'll kind of find that the all-in fee structure itself still allows for us to, even at the current set fee rate, to originate the type of risk-adjusted return that we want in the most senior portion of the stack in true first-lien senior secured debt. So it's really a function of starting with what primarily drives return as opposed to looking about what it does on the edges. And so, in terms of leverage, I think in prior calls we've talks about over about 1.25x, which is on par with what a lot of other folks have done. The difference is just how we choose to get there and what our current fee structure and hurdle rate is in order to generate those set returns. Does that help, Chris?

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Christopher Robert Testa, National Securities Corporation, Research Division - Equity Research Analyst [15]

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Yes, absolutely. And I know you guys have mentioned the JV, although it might initially be a small portion of the assets. But to the extent that you get a good partner and you're looking to make that a bigger portion of the (inaudible) bucket, would that make you actually kind of go well under the 1.25 as the JV, if it grows meaningfully, could take your economic leverage significantly above 1:1?

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Jonathan Gerald Bock, Barings BDC, Inc. - CFO [16]

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Yes, another good question. I mean, our view on JVs is they're good return diversifiers. So the job isn't to own something with a partner and move in a direction of significant risk on a low-spread asset. The view is there are a number of great verticals that exist within this very large, very sophisticated asset manager, and our job is to make sure that we design mechanisms that bring those all to bear for the BDC. JV is a way to do that, and a way to do that smart and in a diversified returning manner. So if you think about what Barings is really, really great and capable at, whether it's global private loans, global liquid loans, secured-type product, real estate debt, you name it, that kind of comes to the point of our JV intention is something with a wide mandate. But let's be clear: we're not here to design something to allow the tail to wag the dog. It's core return. It's first-lien senior secured. And I hate saying it this way, but it's the right, it's extremely boring.

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Christopher Robert Testa, National Securities Corporation, Research Division - Equity Research Analyst [17]

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Right. Okay, and just one more, if I may. Looking at your funding sources, I know you guys added the additional credit facility. Given Barings is a brand name in the market and certainly in the syndicated and CLO market, are there any thoughts on doing a securitization, where you guys would probably be able to drive very low cost of liabilities and obviously have more flexibility than you otherwise would with a bank revolver?

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Jonathan Gerald Bock, Barings BDC, Inc. - CFO [18]

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Yes.

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Operator [19]

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Our next question is coming from Casey Alexander of Compass Point.

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Casey Jay Alexander, Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst [20]

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You just answered my question on the JV, so I'll step back out. Thank you.

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Operator [21]

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

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [22]

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Going to portfolio structure, obviously, I mean, like you said, a couple of second liens in the portfolio now, global trends and, what is it, smart [bear], L plus 8. So presumably, my guess is maybe the first lien underneath is kind of an L plus 4, so the middle-market borrower, probably a higher credit quality borrower than the average middle market, obviously maybe more risk with a second lien. So can you talk us through the view on -- and you mentioned the missed (inaudible), obviously -- but the view on could we see second lien grow as a portion of the portfolio as we get later in the credit cycle, precisely because perhaps the underlying borrower, the first-lien tier borrower, is a higher credit quality business? And I guess the ultimate question is, what's better to be in later in the credit cycle? Is it a higher credit quality business, even if you're taking a little bit more structural risk, or a little weaker credit quality, but with more structural protection.

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Eric J. Lloyd, Barings BDC, Inc. - CEO & Interested Director [23]

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Robert, this is Eric. I'll start with that and then turn it over to Ian for any specifics. We're always going to evaluate where the best risk-adjusted return is, in our opinion, in the market. But we also want to stay very true to the strategy that we've communicated to all of our shareholders, which is a predominantly first-lien senior secured focused strategy. When we see pockets of opportunity like we saw in these 2 specific credits where we think between the size of the company, the relative value, how deep you are as a total leverage, but also where the firs-lien attachment point is, we will opportunistically put some of those assets into the BDC. But our strategy as we sit here today is not to have some rotation going forward, where you would see a significant portion of the assets be second lien. Yes, they could generate a little higher pure dividend return, but our real focus is a consistent dividend performance over time that will grow. Ian can address anything specific.

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Ian Fowler, Barings BDC, Inc. - President [24]

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I'll just point out a couple things on these 2 specific deals that are in the portfolio. One, as we've mentioned, we comp to the liquid market to focus on the illiquidity premium, and we saw in the fourth quarter the widening of second-lien spreads over the spillover from the BSL, and so we saw an opportunity to take advantage of the widening spreads. Second, both of these deals are strong and attractive credit profiles, and in the case of the [3PL] logistics business, we have a lot of expertise in our team in that space, and we're very comfortable with that credit. Both those opportunities, we were co-lead and we were able to finance and add on acquisitions, so we could actually see the performance of that company historically under that sponsor. And then, finally, from a portfolio construction perspective, these were pretty small positions.

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [25]

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Got it. I appreciate that color. Also on portfolio construction but from a different angle, you've talked about tech and the higher attachment points and credit characteristics. Obviously, we go back a decade, tech was a relatively smaller part of the (inaudible). Now it's maybe 20% of new originations across the board. And obviously, we don't have a portfolio mix, industry mix for you guys in the last recession because you weren't running a BDC. But if you were to -- you were running credit, obviously. If you were to take a view on how you think the industry mix this time or at this point in the market, right, because the market mix has shifted, versus where let's say was 10 years ago, how do you think you're going to adjust that? And do you think that industry mix has embedded materially higher risk kind of across the board.

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Unidentified Company Representative, [26]

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Great question, Robert. I'll start and I'll pass it over to Eric. You pointed out something that, if we look at the last 10-plus years, there really wasn't a lot of financing of tech businesses prior to the last cycle. And, again, I think you can look at these companies, especially the SaaS model, and get very comfortable with the fundamental characteristics of those businesses. But I think when you're a senior debt lender, you really need to think about -- especially in the context of the portfolio construction, as you're focused on -- not overweighting that industry, because we just don't have the historical perspective that you're referring to. And, Eric, I don't know if you want to weigh in.

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Eric J. Lloyd, Barings BDC, Inc. - CEO & Interested Director [27]

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I think the only thing I would add to that, Robert, is that as we think of industry diversification within our portfolio, it's not just the industries that are highlighted as far as on the page, but it's also the correlation across multiple industries. As we saw in the last downturn, building products, home building, you name it, were highly correlated and what you might have thought was 10% of your portfolio really was correlated at a much higher percentage. And so we do believe asset-level diversification, as well as industry-level diversification, is a critical element of proactive portfolio construction.

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Unidentified Company Representative, [28]

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And I guess I would just point out as we look at our tech, and I'm talking about the broader platform here, it is a mix of first lien and second lien. It's not all 7x unitranche.

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [29]

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Right, right, right. So yes, and I appreciate that, and no question, but thumbs up on the buyback. Obviously, I think that can generate incremental value to shareholders, so thanks for your approach on that.

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Operator [30]

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Our next question is coming from Ryan Lynch of KBW.

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Ryan Patrick Lynch, Keefe, Bruyette, & Woods, Inc., Research Division - MD [31]

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I was looking at Slide Number 11, which has your top 10 investments you guys outlined. Obviously, the 3 largest investments in your portfolio today are all brand new investments you originated in the fourth quarter that are middle-market investments, kind of part of your core strategy going forward. Obviously, all of these -- those 3 investments are all in different industries, but I was wondering, are there any common characteristics of those underlying investments that could maybe just give us some insight into why you chose to provide capital to these borrowers in this environment and that will just help us get some insight into your investment philosophies?

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Unidentified Company Representative, [32]

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First of all, as we look at any opportunity, and we're really focused on fundamental bottom-up credit, so we're not benchmark investors. So in each 3 of these deals, as we look at any credit, we focus on 3 things. We focus on the equity. So we underwrite the private equity firms that we target. We focus obviously on the company and the credit fundamentals of the company. And then we focus on the third leg of the stool, which is the structure. And it's the combination of those 3 things that determines, through a probability of default and [loss-given] default lens, whether we're comfortable. And if we're comfortable, where is the relative value in those deals? So just at a high level, in the first one, it was a space that I think I just mentioned we have a lot of expertise in that space. We know the industry really well. We were able to move quickly in that deal and we were able to provide a leadership role in the financing there because of our industry knowledge and our ability to basically provide all the capital in that transaction, even though at the end of the day we're never going to be able to invest all the capital because they're going to want to bring in other lenders into the mix. The second deal, the sponsor is an expert in the industry. This company has a differentiated product, fundamental reason to exist as a niche market leader, so very attractive company, very attractive structure, and the sponsor focuses on that industry. And then the third was an opportunity where it says automotive, but this is a business that is more of a hobbyist type of business tied to racing and hobby-goers in the auto space in terms of carburetors and fuel injection and things like that, so we don't really see that as a cyclical business. But it's with a great sponsor and a very attractive deal.

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Ryan Patrick Lynch, Keefe, Bruyette, & Woods, Inc., Research Division - MD [33]

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That's really helpful color. My follow-up question would be on portfolio growth and leverage utilization. I mean, when you guys took over this BDC, the plan was to deploy capital, probably syndicated loans, increase leverage, and then start rotating out into more core middle-market credit. Obviously, there has been a lot of volatility in the credit markets. Leverage loan prices and probably syndicated loans have traded down. I'm wondering, does that affect or change your thoughts on portfolio rotation? Does it make it harder? Should we expect further portfolio growth to just come from further leverage utilization versus maybe selling off broadly syndicated loans? So any color on kind of the portfolio rotation plan from here, given the market volatility, and potentially further leverage utilization would be helpful.

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Jonathan Gerald Bock, Barings BDC, Inc. - CFO [34]

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Ryan, this is Bock. So I'd say in terms of (inaudible) out of the broadly syndicated loans, believe it or not, given the rally back, that's a great source of liquidity for us and you're going to see us sell that down. But, really, when we approach the middle-market portfolio, our view is to always provide a levered return on those highly secure, first lien, very boring type assets. So the answer really is, Ryan, you're going to start to see a mix of both. Not all middle-market fundings are going to come from BSL sales because we want to deliver a levered return, and so you'll see a mix shift of both go over time and our focus will just be on properly ensuring that the broadly syndicated loans are levered to an extent that deliver a good return. And then, we've kind of bought ourselves additional optionality to move out of them over time if things even get really, really frothy, which they haven't yet. So it's all a function of time. The answer is, they'll be both, but no, nothing is put our growth agenda in any way, shape, or form different. Remember, this is a big platform, and while folks like to focus singularly on a BDC, over $15 billion across a variety of investment mandates, and so we're always in the market with sponsors, and the BDC will always be a part of those activities.

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Eric J. Lloyd, Barings BDC, Inc. - CEO & Interested Director [35]

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Ryan, it's Eric. I'd add to Jon's comments, too. If you look at what Tom McDonnell and the team have done on the liquid side, from the time we closed the transaction in August to today, our actual realize impact in NAV on our liquid portfolio by sales is actually a positive number. And I think that that's just a testament that when the market did have that volatility, right, we managed our leverage in a way that we were not having to be a forced seller for newly originated middle-market loans, and the integration between the 2 teams I think really kind of speaks to that. So I think realized NAV destruction is really the core of what we want to prevent, and then Tom and his team have done a fantastic job of avoiding that.

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Operator [36]

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Our next question is coming from David Miyazaki of Confluence Investment.

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David Brian Miyazaki, Confluence Investment Management LLC - SVP and Portfolio Manager [37]

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First, just to begin with, a comment that I really applaud the buyback approach that you're putting in place here. I think that considering buybacks versus new loans really reflects thoughtfulness around the incremental use of capital, and that, to me, is the essence of real capital allocation discipline. I think the transparency and the commitment that you're outlining here basically allows the public market to sort of front-run your program, and I think that's going to accrue a lot of potency to the buyback program over time. With that, Eric, one of the comments that you made early on, and I appreciate you marking you book to market, even though the fourth quarter was not a great time to do that. But a skeptic of investing in BDCs could say well, if the correlation between net asset value of a BDC is very high relative to the broadly syndicated loan market, why wouldn't I just take a leveraged position in leveraged loans, get the same kind of volatility or correlation to BDC, and I could just leverage things up however I saw fit. What is the value-add for the BDC industry, or more specifically, for Barings versus that approach?

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Eric J. Lloyd, Barings BDC, Inc. - CEO & Interested Director [38]

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Dave, if I don't answer your question, please come back and make sure I do answer it, because I think it's kind of a broad question comparing the 2 asset classes. And the reality is, here we manage leveraged vehicles that are focused exclusively on liquid collateral. We manage vehicles that are leveraged that focus exclusively on illiquid middle-market collateral, and we manage vehicles that are a hybrid of those 2, as the BDC is currently today. I think at any one point in time in isolation, one of those different 3 buckets could be more attractive or less attractive relative to the other ones, and they each, frankly, can have some different strategies. I think what Bock was trying to point out in the correlation there was that what we saw in the fourth quarter, as we have predominantly a liquid portfolio as we went into the fourth quarter, it is very natural that our mark on our liquid collateral would be highly correlated to spread widening or prices falling on those broadly syndicated loans. Different managers have different valuation policies within their illiquid collateral. We take a market input into our illiquid collateral as we then look at valuing that. If you booked an asset today at LIBOR plus 550 and the broadly syndicated loan market went to an [L550] type of asset, it's hard to argue that illiquidity premium from -- let's say went from 400 over to 550 over -- it's hard to argue you still have the same value of that asset. It doesn't mean you don't believe you won't get par eventually, which is why I said really realized impact to NAV is the key thing as opposed to unrealized impact to NAV. And that's where I hope and I believe that you'll see the differentiation, is realized impact to NAV. I think this next downturn will be -- we're looking forward to it. I think it will lead to some shakeout of managers because I think, in that next down scenario, that's really where the managers will prove themselves and their ability to manage risk.

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David Brian Miyazaki, Confluence Investment Management LLC - SVP and Portfolio Manager [39]

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Okay, great. I have my own views on that, and I think it has a lot to do with the value-add that the manager is delivering through underwriting through asset selection and capital allocation. But, just interested to hear your perspective on that. My follow-up question is related to what all of your thoughts might be on the regulatory landscape with regard to comments on AFFE and the 3% rule. Do you have any thoughts or observations on the regulatory front?

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Jonathan Gerald Bock, Barings BDC, Inc. - CFO [40]

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AFFE constrains capital, it eliminates the BDC's participation in the larger indices that we all know help drive institutional capital formation. And so, extremely supportive of adjustments as it relates to AFFE in order to kind of break the logjam of, shall we say, kind of less sophisticated investment, and more importantly, some of the perils that come around not having a really good institutional core group, given some of the issues put out by AFFE and the restrictions that come out from the SEC. And those were unintended consequences, to be clear. The second, as it relates to the 3% rule, also very attractive, one that kind of allows us to think about activism in a different light, and that will be, shall we say, over time a very transformative event to the extent it occurs. Our job's not to predict; our job's to manage a really boring book of assets to deliver a pretty set return, and to know what we are and say what we do and do what we say. So at the end of the day, happy to see all those transitions and happy to see the states move in a better direction, but our focus is really on our own portfolio and ourselves.

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Operator [41]

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We're showing time for one last questioner today. Our last question will be coming from Jim Young of West Family Investments.

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James Young, West Family Investments, Inc. - Investment Analyst [42]

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You allude to the global nature of the various platform, and my question is, what percentage of your assets today are coming from outside of the U.S., and what do you expect (inaudible) going forward in that regard?

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Eric J. Lloyd, Barings BDC, Inc. - CEO & Interested Director [43]

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So Barings overall, if you think of it as about -- we manage a little over $300 billion. I could answer that either the firm overall or within the private asset part. Is there a specific area you want me to ...

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James Young, West Family Investments, Inc. - Investment Analyst [44]

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From the BDC.

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Eric J. Lloyd, Barings BDC, Inc. - CEO & Interested Director [45]

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From the BDC perspective? So today, the BDC is U.S. assets is what we have in the BDC. As far as our global private finance platform, we do have a similar -- so Ian Fowler, who is on the phone here, who co-heads our North America business, has a peer, Adam Wheeler, who runs a business for us in Europe and Australia. So if you look at the mix of our assets, we really run some strategies that are exclusively Europe, exclusively U.S., and we run some that are global or basically integrate those 2 businesses. Currently, Europe would represent around a little over 20% of our actual invested AUM within our global private finance business. That is a very similar strategy to what we've articulated here. It's almost exclusively first-lien, senior secured floating rate investments to companies of similar size to what we do in the U.S.

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James Young, West Family Investments, Inc. - Investment Analyst [46]

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And so I'm hearing that the BBDC structure will retain and keep its 100% U.S.-focused orientation.

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Eric J. Lloyd, Barings BDC, Inc. - CEO & Interested Director [47]

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No, so I said currently that's what it is. We do have the opportunity, if you think through the JV. I think Bock referenced that the JV could have liquid or illiquid collateral, U.S., Europe, mentioned structured credit, mentioned real estate debt. I don't want to represent that the 30% basked or the JV will current -- it is currently, but that it will stay at 100% U.S. going forward. What we'll do, similar to as Mike answered with the share repurchase, is each quarter, you'll have transparency on that, right? And if we see value, or if for some reason we make an investment in that 30% basket that's different than what it is today -- again, primarily U.S. first-lien senior secured -- we'll articulate the logic we had behind that on each quarterly call.

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James Young, West Family Investments, Inc. - Investment Analyst [48]

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And my other question is that, regarding the shareholder-friendly management fee structure that you alluded to in the press release, could you just further delineate and quantify how you would define that for us, please?

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Jonathan Gerald Bock, Barings BDC, Inc. - CFO [49]

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So if I were to think about fee structures and kind of where friendliness sits, right, I mean, at the end of the day, it always starts with appropriate capital allocation management. But then, always look at what the incentives to an individual manager are and kind of where that drives their investment. Hurdle rate starts as one of the largest differentiators of risk/return, largely because 100% of pre-incentive fee net investment income gets captured between the low hurdle and then the high hurdle rate, right? Which means that if you are setting a low hurdle, to the extent that you have a loan that generates a, let's say mid-ish, 8-ish percent, 9% return, a good majority of those economics get eaten up by the catch-up, which means you have to invest at an even higher rate in order to deliver returns promised to an investor. So I always kind of look at it in simple terms. Hurdle rates are extremely important and drive it, because 100% of the economics on the incentive fee get caught up. That's really important. Then it falls down to the base fee. How reasonable is the base? And then, finally, you go down to the incentive fee and the [caption], right, that 20 or 17.5, et cetera, if I were to rank it that way. We can walk through individual math. There's a lot of analysts that do it out there. But our view is it starts with the hurdle rate, and then you back in to really what a manager needs to invest at to deliver on their returns promised to you, Jim.

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Operator [50]

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At this time, I would like to turn the floor back over to Mr. Lloyd for any closing comments.

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Eric J. Lloyd, Barings BDC, Inc. - CEO & Interested Director [51]

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I just want to wrap up by thanking everybody for the trust you've put in us to manage your capital, the time you take today to ask questions and listen to what we've had to say, and we look forward to any follow-up that anybody has.

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Operator [52]

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Ladies and gentlemen, thank you for your participation. This concludes today's conference. You may disconnect your lines at this time, and have a wonderful day.