Q3 2023 Barings BDC Inc Earnings Call
Participants
Bryan D. High; Co-Portfolio Manager & VP; Barings BDC, Inc.
Elizabeth A. Murray; CFO, COO & Controller; Barings BDC, Inc.
Eric J. Lloyd; Executive Chairman of the Board & CEO; Barings BDC, Inc.
Ian Fowler; President; Barings BDC, Inc.
Matthew Freund
Casey Jay Alexander; Senior VP & Research Analyst; Compass Point Research & Trading, LLC, Research Division
Kyle Joseph; Equity Analyst; Jefferies LLC, Research Division
Robert James Dodd; Director & Research Analyst; Raymond James & Associates, Inc., Research Division
Presentation
Operator
Greetings. At this time, I would like to welcome everyone to the Barings BDC, Inc. conference call for the quarter ended September 30, 2023. (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 quarterly report on Form 10-Q for the quarter ended September 30, 2023, as filed with the Securities and Exchange Commission. Barings BDC undertakes no obligation to update or revise any forward-looking statements unless required by law.
I will now turn the call over to Eric Lloyd, Chief Executive Officer of Barings BDC.
Eric J. Lloyd
Thank you, operator, and good morning, everyone. With it being Veterans Day tomorrow, I want to start off by thanking all the veterans that are on the phone and any of their family members or loved ones who supported veterans over the years. We're very grateful for your service and everything you've done for our country.
For everybody, we appreciate you joining us for today's call. Please note that throughout today's call, we'll be referring to our third quarter 2023 earnings presentation. that's posted on the Investor Relations section of our website.
On the call today, I'm joined by Barings Co-Head of Global Private Finance and President of Barings BDC, Ian Fowler; the BDC's Chief Financial Officer, Elizabeth Murray; and the BDC's Co-Portfolio Managers, Bryan High and Matt Freund.
I'd like to start by acknowledging that we have refreshed some of the presentation of our financial information and portfolio statistics. Over the course of the past several months, the team has been intentional about presenting information in a manner consistent with how we review and manage the portfolio. The strategy has not changed. Barings BDC was and remains an investor in the credit of companies engaged in the middle market. Our portfolio is predominantly sponsor-backed and is complemented by a selection of nonsponsored and platform investments. Our portfolio strategy is outlined in greater detail on Slide 5.
We will not spend time this morning discussing our approach. We hope our investors and partners understand that this strategy serves as our guiding light and as we continue to successfully invest throughout the market and deliver compelling returns to our shareholders.
And with the acknowledgment of a new stylistic deal out of the way, we will shift our attentions to the important matters at hand and discussing performance during the quarter. BBDC exhibited stability and strong operating results against the backdrop of significant economic uncertainty and macroeconomic volatility during the quarter ended September 30. Our focus on the top of the capital structure investments and sponsor-backed issuers is serving investors well in these uncertain times.
Net asset value per share was $11.25 compared to the prior quarter of $11.34 and $11.05 at December 2022, reflecting a year-to-date increase of 1.8%. Net investment income for the quarter was $0.31, unchanged from the prior quarter. Consistent NII was fueled by normalization of yields from rising base rates; secondly, continued strong credit performance within our portfolio; and third, lower incentive fees due to the incentive cap in our shareholder-friendly structure.
Our performance is a result of the focus on the top of the capital structure and within more defensive industries. We believe BBDC remains well positioned for any further volatility and uncertainty in the market going forward. Investment activity during the quarter reflected a modest degree of net deployments as we viewed certain opportunities in the market as some of the most compelling review during the year. As our shareholders know, we're actively working to maximize the value in our legacy holdings acquired from MVC Capital and Sierra Income and rotate them into compelling Barings originated positions.
Our investment portfolio continued to perform well in the third quarter. Including the acquired Sierra and MVC assets, our total nonaccruals are 2.5% of the portfolio on a cost basis and 1.6% on a fair value basis with 1 new nonaccrual book during the quarter. With the exception of 2 investments, all of our nonaccrual assets were from acquired portfolios and therefore, are covered by our credit support agreements.
BBDC shareholders continue to benefit from the credit support agreements provided by the manager. For the current quarter, the CSA valuation was approximately $54 million on a combined basis for the Sierra and MVC credit support agreements. They're designed to insulate shareholders from realized losses in the portfolio. The reduction in the CSA valuation quarter-over-quarter is primarily due to unrealized appreciation related to positions in the underlying Sierra portfolio. As investors know, when the issued collateral improves in value, the value of the insurance declines in vice versa.
To date, less than $35 million of net losses have been realized at the acquired portfolios. The remaining unrealized depreciation within the portfolio are spread across a wide number of issuers and to believe to reflect market discounts to par rather than anticipated impairments. Recall that the bulk of the Sierra portfolio was comprised of semi-liquid broadly syndicated loans that traded infrequently. Following the end of the quarter, 2 Sierra positions on nonaccrual were fully realized.
Turning to the earnings power of the portfolio. Increasing base rates continue to lift yields on our predominantly floating rate portfolio with weighted average yields on floating rate investments increasing to 11.2% from the prior quarter of 11.0%. We remain conservative on our base dividend policy, and our Board declared a fourth quarter dividend of $0.26 per share, consistent with the prior quarter. On an annualized basis, the dividend level equates to 9.2% yield on our net asset value of $11.25.
Looking at liquidity, net leverage, which is leverage net of cash and unsettled transactions, was 1.18x. This is within our target leverage range of 0.9 to 1.25x. We continue to prioritize risk management while balancing the deployment of capital into what has become a very attractive environment for private credit.
Before turning over the call, as many of you know, Barings BDC hosted our 2023 Investor Day in early October. We were grateful that many of our investors and partners were able to attend. The presentation shared at that event and replays of the content are available under the Investor Relations section of our website. For those of you who were unable to attend, we encourage you to review that if you're able.
I'll now turn the call over to Ian.
Ian Fowler
Thanks, Eric. Recall that BBDC is managed by Barings LLC, a credit-focused asset manager with more than $300 billion of assets under management. The bulk of our portfolio is sourced from the global private finance team, an organization with more than 100 investment professionals located around the globe, providing financing solutions to preeminent middle market companies sponsored by private equity firms.
BBDC's portfolio increased by $34 million on a net basis in the quarter, with gross fundings of $138 million offset by $104 million of repayments and sales, which included approximately $50 million of sales to our Jocassee joint venture. Activity during the year has been tempered as private equity buyers take a pause in this rising rate environment to likely determine any impact on valuations.
Investment bankers who serve as the tip of the spear, and a sell-side buyout have indicated they are sitting on record backlogs of new transaction opportunities. The messaging has been consistent for the past 12 months as more and more opportunities are being added to the backlog. However, sponsors appear reticent to bridge the valuation gap between 2021 purchase price multiples and today's range based on financing costs. The deluge of opportunities is being held up by the dam that is buttressed by a resetting of the cost of capital and general economic unease.
We have seen an increase in the number of early-stage opportunities within the platform, but unfortunately, conversion rates to close deals are trending towards historic lows. Sponsors continue to execute on add-ons for companies already within their portfolios, which makes sense as add-on multiples are below the original platform purchase price, in effect, enabling sponsors to reduce their cost basis and hedge against any compression and exit multiples. Investors in Barings BDC benefit by having a seasoned portfolio that provides opportunities to deploy capital into issuers, we already know well. We're not in a position to call the bottom.
There is a logical reason to believe transaction volumes improve in the months to come, namely a record backlog of sell-side mandates among the investment banking community and a need for private equity managers to show distributions to their LPs. Counter to those facts is a high level of uncertainty created by 2-arm conflicts, persistently high inflation, a rapid increase in interest rates and the forthcoming political cycle. When opportunities ultimately do convert into an increase in closed transactions, we will continue to use our disciplined underwriting strategy to invest capital in the most compelling opportunities.
Turning to our current portfolio. 74% consists of secured investments with approximately 67% of investments constituting first lien securities. Interest coverage within the portfolio stood at 2.3x, a modest decline from 2.5x a quarter earlier. We're forecasting a steady state, weighted average interest coverage for the portfolio will ultimately fall between 2x and 2.25x as the full impact of higher rates is reflected in issuers financials and performance.
Our avoidance of various industries prone to economic volatility, oil and gas, restaurants, retail, metals among them, has proven to be a sound strategy against a backdrop of less economic predictability. One of the benefits to a predominantly sponsor-backed strategy has proven out over the past several quarters, combined with what we believe were reasonable going in leverage multiples, the median gross margin in the North American Global Private Finance portfolio, similar to the BDC portfolio stood at 49%, up from 44% 1 year earlier. And gives us confidence that our issuers are successfully pushing through price increases to combat inflationary pressures in their businesses.
Adjusted EBITDA margins for the same sample were -- set were 21%, flat from a year earlier, believed to be a reflection of the fact that wage gains have consumed some degree of gross margin expansion previously noted. While not a perfectly comparable metric period-to-period as the volume of transaction activity in the past 5 quarters will skew these metrics somewhat, we believe we have reason to feel comfortable with the performance of the portfolio. The portfolio composition remains highly diversified, the top 10 issuers accounting for 21.8% of fair market value.
Recall that the 2 top positions within the portfolio, Eclipse Business Capital and Rocade Holdings, our platform investments, originating middle market loans. These positions have a number of underlying issuers, assets included in the other classification includes structure positions and certain acquired positions that will not be originated on a new issue basis going forward. We anticipate rolling out of these positions as market conditions allow in the quarters to come.
In addition to the new formatting, we're publishing a risk rating schedule for our shareholders. Risk ratings exhibit minimal movement during the quarter as our issuers exhibiting the most stress classified as risk ratings 4 and 5 were unchanged at 6% on a combined basis quarter-over-quarter. Encouragingly, we're -- we also experienced some positive movement as certain issuers performing consistent with expectations at underwriting have outperformed during third quarter. We remain confident in the credit quality of our underlying portfolio, but we do not -- but we do see increased volatility heading into 2024 for the reasons previously mentioned.
The uncorrelated nature and associated value of investments in Eclipse and Rocade should bolster the portfolio in the event the economy enters into a long expected recession. BBDC is committed to delivering an attractive risk-adjusted return to shareholders over a long time horizon. We're investors of credit and middle market companies. Our global reach and significant scale across asset classes gives BBDC a unique ability to select risk and return compared to other managers, but our core middle market credit is what we do.
I'll now turn the call over to Elizabeth.
Elizabeth A. Murray
Thanks, Ian. On Slide 15, you can see the full bridge of the NAV per share movement in the third quarter. Our net investment income exceeded the $0.26 per share dividend by 19%. Net unrealized appreciation from investments, CSA and FX listed NAV per share by $0.02 which was offset by net realized losses on the portfolio of $0.16 per share. The $0.16 per share realized loss was predominantly due to the exit of our investment in Carlson Travel and the restructuring of Learfield Communications, which were partially reclassified from unrealized depreciation.
We're very pleased with our portfolio's performance amid a backdrop of economic uncertainty, and this highlights our conservative approach to underwriting and portfolio construction. The valuation of the credit support agreements decreased approximately $6 million, which was driven by improved performance in the underlying Sierra position, as Eric mentioned.
Our net investment income per share was $0.31 for the quarter driven by higher base rates and lower incentive fees due to realized and unrealized losses in the quarter and the incentive fee cap. This was partially offset by lower dividends from our platform and joint venture investments.
From a balance sheet perspective, gross total debt-to-equity was 1.27x at September 30. Our net leverage ratio, which we view as more reflective of the true leverage position of the vehicle was 1.18x at quarter end, up modestly from 1.15x in the quarter ended June 30 and currently sits within our long-term target of 0.9 to 1.25x. We will continue to manage the capital structure in a manner that is consistent with our investment-grade rating profile.
Barings BDC is thankful that years of thoughtful stewardship of our liability structure leads us in the enviable position of avoiding issuance at historically high rates. Our funding mix remains highly defensible, both in terms of seniority and asset class, including the significant level of support provided by the $720 million of unsecured debt in our capital structure. As of the end of the third quarter, roughly half of our funding was comprised of fixed rate unsecured debt with a weighted average coupon of 3.79%. And we have approximately 2 years until the next bond maturity in August 2025.
Barings BDC currently has $338 million of unfunded commitments to our portfolio companies as well as $65 million of outstanding commitments to our joint venture investments. We have available cushion against our leverage limit to meet the entirety of these commitments if called upon.
As Eric mentioned earlier, the Board declared a fourth quarter dividend of $0.26 per share, a 9.2% distribution on net asset value. We consistently evaluate our dividend policy in the manner we manage our broader business, driven by stability. Given the higher level of earnings and the fact that base rates have remained higher for longer, shareholders should benefit an increase we announced at our June results remains appropriate. We believe our portfolio will continue to earn above the high hurdle in a normalized rate environment, and we expect that our platform investments, Eclipse and Rocade as well as our Jocassee joint venture will continue to generate significant dividend income.
These investments help highlight the importance of less correlated assets and the benefits of a diverse portfolio. I'll wrap up our prepared remarks with the note on our investment pipeline. Thus far in Q4, we have made $105 million of new commitments, of which $97 million have closed and funded. We've also funded $12 million of previously committed debt and equity facilities.
With that, operator, we'll open the line for questions.
Question and Answer Session
Operator
We will now be conducting a question-and-answer session. (Operator Instructions) Our first question comes from the line of Kyle Joseph with Jefferies.
Kyle Joseph
Ian, I appreciate the color you gave on the deal outlook into '24. It sounds like a little bit cautiously optimistic with a lot of dry powder out there, but an election cycle and some macro uncertainty. Just kind of want to pick your brain on what you see spreads doing. Obviously, we can look at the forward curve to see what base rates are expected to do. But given a lot of the moving parts in the market, just kind of want to see where spreads are in the context historically and where you could see those trending next year? And give us a sense for the portfolio yields as you look into '24, given market dynamics in the forward curve.
Ian Fowler
Yes. Sure. Kyle. Happy to do that. And I'll start off -- obviously, I don't have a crystal ball, and I have been doing this for 25-plus years, and this is definitely a little bit of a different market than I've seen over the 25 years. But I think you nailed it. I mean, right now, we're in this anemic environment in terms of deal activity because of this gap between buyer and seller on valuation and you can understand why private equity firms are hesitant to go all in right now because there's still obviously inflationary pressures out there. I think that it seems like the Fed's kind of backed off on telegraphing another 25, 50 basis points, but the higher and longer is -- elevated rates is definitely going to have an impact. And we really don't know where valuations are trading at because it's not a normal functioning market with a lot of deal flow.
So that -- like you said, that's the environment that we're in. I think to the extent we start to see some direction in terms of base rates, maybe getting closer to election pulling back a bit and then getting through the uncertainty of the election. I think that's when you might see. I'm not going to say floodgates open, but there is a ton of deals out there waiting to come to the market. So when you look at today's market and the deal activity that's out there, especially on the new platform side, there are law managers that don't have portfolios that they can rely on. 70% of our deal flow is coming from our portfolio, which is great because of all the economic uncertainty. It's nice being able to invest in companies you know and understand well. So that's very attractive.
But for new activity and with managers that don't have portfolios, they're being pretty aggressive on spreads. And so if it's an attractive property that's coming to market, we're seeing spreads compress anywhere from 50 to 75 basis points, maybe even as high as 100 basis points depending on the deal and the opportunity. But again, I think if you kind of look at -- this is my perspective over 25 years, if you kind of look at the all-in yields over 25 years, there's always been a little bit of a reversion to a mean as base rates go up, spreads come down, and we've just seen that historically in this asset class. So I'm not surprised by it, but at the end of the day, we're still generating extremely attractive all-in yields for first lien senior secured risk. So it's a great vintage for this asset class.
Kyle Joseph
Got it. Very helpful. And -- oh, sorry.
Ian Fowler
No, I was just going to say sorry for the long-winded answer.
Kyle Joseph
Oh, No. No. I was going to say I have a follow-up that keep your crystal ball out. But so in the context of potentially declining rates next year, how do you guys think about repayments? Obviously, the rate environment has muted repayments over the last, call it, 18 months. But as we go into a potentially declining base rate environment, obviously, these are floating rate assets, which probably provide some insulation. But obviously, if M&A were to pick up, that would offset that. But yes, kind of give us a sense -- repayments have been muted for a while now, but your outlook into '24.
Ian Fowler
Yes. So great question. I can use '21, the back half of '21 as a benchmark because obviously, different reasons, but same situation. The M&A market was stalled. And then once we came out of COVID, the floodgates opened and the back half of '21 was an incredible year in terms of volume and quality of deals that came to market. And if the crystal ball is true and it plays out that the Fed starts cutting rates close to the election and we go into '25, I would expect the same sort of situation to occur with the M&A market.
And I think to your point, right now, the benefit that we have, especially with our portfolio, which is performing really well, we have very low runoff. And so whatever new deal activity we have is actually allowing us to increase our AUM. This is across our platform. That will obviously change. We saw that in '21, where runoff increased pretty dramatically as properties were traded. So definitely would expect that to increase dramatically when the M&A market opens up. But on the flip side, as long as you have a strong origination team and a leadership position in the market, I think you'll be able to replace that runoff with new deal activity. So it'll be extremely busy just like it was back half of '21.
Operator
Our next questions come from the line of Robert Dodd with Raymond James.
Robert James Dodd
Congrats on the quarter. Another question for me. And probably in your prepared remarks, you said the conversion rates of actually -- deals actually coming to closing heading towards historic close. Can you give us any -- I mean, is that because sponsors are pulling deals because of the valuation? Is it the level of competition for the high-quality deals that still a lot of people don't want them? I mean can you give us any color on what's driving that all to historic low levels of conversion?
Ian Fowler
Sure, Robert. I can probably, at some point, get you an exact breakdown, but I mean, for sure, it's all of the above. I would say that it's not so much like the quality of deals, right, because those deals just aren't even making it through the screen, at least with the sponsors that we focus on. And so they're looking at properties that are high-quality properties. I think you have a couple of factors. I think definitely the valuation is an issue. And also, there's a catch-up, right? Because if you think about the elevated interest rate environment, you're not really seeing the full impact of that interest rate effect until you kind of get the next quarter's financials. And now we're kind of at this point where we're starting to see like the full year impact.
So if we kind of go back over the last 3, 6 months, there was a little bit of a catch-up because they're showing a quarter earlier and maybe the performance was much more decent. But now all of a sudden, performance is eroding a bit because of the inflationary and higher base rates and so then you get into this whole negotiation around valuation and deals kind of fall apart. So I've seen that for sure in a lot of situations.
On the competitive side, what's really unique, I think, right now in this deal environment, it's because there's not some -- there's not a lot of new properties coming to the market that are extremely attractive. So the compression of the deal cycle has really been reduced. And a lot of times, lenders are really not coming in or allowed to come in by the investment bankers to kind of the second stage because they're really trying to control these deals. And certainly, sponsors that are working these deals are trying to avoid losing to the competition. So it's fiercely competitive out there. We've got to be really responsive as a team to be working very quickly with these sponsors going through all the third-party diligence and doing our underwriting. So we're not slowing them down. But that definitely is an overall theme in the market.
Robert James Dodd
I appreciate that. Another one on different subject. On the buyback, obviously, you didn't buy back in the second -- third quarter, did in the second. Can you give us any -- I mean, was it blackout dates? Was it -- what would -- obviously, it wasn't year-end or anything, but you did have an Investor Day. Can you give us any color on why no buybacks in Q3 versus quite a lot in Q2 was done?
Elizabeth A. Murray
Yes, Robert, great question. And as we mentioned in our Investor Day, since 2019, we spent $73 million buying shares which equates to like 8 million shares. In 2Q, we bought 1.4 million shares at an average price of $7.75. As of yesterday, I think we were around $9.39 that's what we closed that. And this quarter, we had to balance leverage with some portfolio opportunities. And as we've always said, we're very shareholder-friendly. We're very committed to our share buybacks, but this just wasn't a quarter that it worked out, and you will see us in the market in coming quarters.
Since 2019, we've been in the market 11 out of 12 times when we weren't blacked out. So you can know that we're committed to it. This just -- we just had to choose different levers this quarter.
Operator
Our next questions come from the line of Casey Alexander with Compass Point.
Casey Jay Alexander
The 2 Sierra positions that were realized after the end of the quarter, can you tell us how -- what -- how they were realized just relative to what their marks were? I don't even know -- need to know the names, just if there's any additional gain or loss on those subsequent to the end of the quarter versus the 3 quarter mark?
Elizabeth A. Murray
Yes, Casey. So like you said, we exited 2. One, we exited, I want to say, about $20,000 above the mark. And the other one was marked at only $9,000 and we either exited that like right around the mark or slightly under. So very immaterial to the overall portfolio.
Casey Jay Alexander
Okay. That's fine. That's fine, Elizabeth. Then looking at Slide 13, we see what the portfolios are at. What is the mark-to-market loss on the Sierra portfolio and the MVC portfolio, just so that we can compare them to where the credit support agreements are valued?
Elizabeth A. Murray
So I'm going to give you a couple of data points, Casey, which I think will answer your question. If not, let me know. So MVC, the current portfolio is valued at $62.5 versus prior quarter was $72.4, where the CSA was valued at $16.8 versus $15.6. So that's the MVC portfolio.
Casey Jay Alexander
But that's not what I'm asking. What I'm asking is the CSA is -- for MVC is valued at $16.8. The top side of the CSA is $23 million, what is the actual current mark-to-market loss on the MVC portfolio?
Elizabeth A. Murray
Got you. So that's about $30 million, Casey.
Casey Jay Alexander
Okay. That's about $30 million. Okay. And what's the actual mark-to-market loss on the Sierra portfolio?
Elizabeth A. Murray
It was -- it's about $28 million.
Casey Jay Alexander
Okay. It's about $28 million. So all right. That's great. And then Ian, can you give us some view into security, which I understand is an MVC position, but it was marked down $10 million quarter-over-quarter. So that's a pretty big change in that valuation.
And then past that, I know you've got different guys who work on core. Core was marked up $6 million to 75% of par. I would be interested in hearing about the package of securities that you think you're going to receive on core that fed into your ability to market at 75% of par.
Ian Fowler
Yes.
Matthew Freund
Ian, let me answer that. Ian and I had the same thoughts. Casey, I appreciate the question. And so as you may recall, the position in security holdings is equity-oriented. During the course of the past quarter, there were some projects that unfortunately shifted to the right. And I think that the impact of the financials is that the EBITDA trended a little bit against us as you apply an enterprise value multiple to that figure, it just magnifies the impact of the timing dynamic associated with performance.
And so this is the unfortunate reality of equity positions whenever they constitute a portfolio. It's that they can be a little bit more volatile, and we were exposed on the volatility side this particular quarter. But don't have any reason to be concerned with respect to that position longer term and are optimistic that over an intermediate period of time, we'll see the recovery in the performance.
I'm actually going to turn the call over to Bryan to speak to core more specifically.
Bryan D. High
Yes. Thanks, Matt. Casey, in terms of core, so from a process perspective, they've reached an agreement with all parties. They still have to get disclosure statements approved and solicitation needs to go out for everyone to make elections in terms of how they want to vote as it relates to the plan.
As I know, you know, when we've talked about previously, there's a couple of different options in terms of what the equipment loan holders can receive, one of which is reinstated debt of roughly $0.80 on the dollar and the other is equity in the business on a go forward reorganized equity. So that solicitation process has not happened yet. We still have the ability to make an election there, and we're evaluating both of those options.
Operator
We have reached the end of our question-and-answer session. I would now like to turn the floor back over to Eric Lloyd for any closing remarks.
Eric J. Lloyd
Just thanks, everybody, for dialing in and everybody, have a wonderful weekend.
Operator
Thank you. This does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.
