Barings BDC - Earnings Call - Q3 2018

Transcript

Speaker 0

At this time, I would like to welcome everyone to the Barings BDC Incorporated Conference Call for the Quarter Ended September 3038. All participants are in listen only mode. A question and answer session will follow the company's formal remarks. Today's call is being recorded and a replay will be available approximately two hours after the conclusion of the call on the company's website at www.baringsbdc.com under the Investor Relations section. 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 ks for the fiscal year ended December 3137, and quarterly report on the Form 10 Q for the quarter ended September 3038, each as filed with the Securities and Exchange Commission. Barings BDC undertakes no obligation to update or revise any forward looking statements unless required by law. At this time, I would like to turn the call over to John Bach, Chief Financial Officer.

Speaker 1

Thank you, Daniel, and good morning. We appreciate everyone joining us for our first quarterly earnings call at Barings BDC. And please note, copies of our third quarter earnings release and investor presentation are available Relations section of the website, as it was mentioned, www.baringsbdc.com. Now we'll be referencing the presentation during the call. And on the call today, I'm joined by Barings BDC's CEO and Head of Global Finance, Eric Loy President and Co Head of North American Private Finance, Ian Fowler and Tom McDonnell, Managing Director and Portfolio Manager of Barings Global High Yield.

And as you saw in our earnings release and 10 Q filed yesterday, the first two months since externalization have been extremely active. So we're going to cover a lot, we're going to be efficient with your time. Jump to Slide three for a road map of the call. To start, I am going hit a few summary points on the quarter. Next, Eric Loyal will discuss the broader Barings platform, the private finance team and the BDC's fit within the Barings franchise.

Then Tom McDonald and Eve Fowler are going to discuss our BSL strategy and our private investment efforts. And finally, Eric and I are going to wrap up the call with a discussion on third quarter financials, business investment activity since quarter end and our thoughts on alignment just before we open it up for Q and A. So jump to Slide four. As you know, on August 2, we closed our externalization transaction with Triangle Capital, where Barings assumed the investment advisory role over at BDC with an all cash portfolio. Now here is a list of a few summary highlights for that short stub period.

I'd say there is two main points to take away. First, our portfolio ramps underway. As of September 30, we have closed roughly $1,000,000,000 in senior secured loans across liquid BSL and traditional middle market transactions. Now second, that better than expected deployment managed by our leading liquid credit team, that gave us the ability to generate a better than expected $06 a share of net investment income during the period between that closing and September 30, and that exceeded our dividend of $03 a share. But while we're pleased to see a building ramp, we know that investor trust is really a function of: one, steady and stable operating results two, best in class investor alignment and three, increased visibility and transparency into the breadth and depth of the platform and how we actually drive long term investment results.

And to speak to that platform, me now turn over the call to Eric Boyd.

Speaker 2

Well, the good news is that ended. And all the good news is alarm bells are not what we're going to talk about here today. So apologies to everybody for that. Thanks, John. And first, again, let me reiterate how excited we are opportunity to manage the BDC.

We appreciate the trust shareholders have placed in us to serve as your investment adviser. Referring to Slide six, the strong start that John referenced for the company following the externalization was enabled by our very experienced high yield team within Barings. On this slide, we show a high level overview of Barings with over 1,900 professionals across 16 countries worldwide. Importantly, Barings is a wholly owned subsidiary of MassMutual and this relationship provides a level of platform support and long term stability that is unique within the BDC marketplace. Also, Barings is a deep and experienced credit manager with over $310,000,000,000 of investments under management worldwide, including over $229,000,000,000 invested across various fixed income markets.

It's this strong partnership between our liquid and illiquid credit teams that further differentiates our underwriting and sourcing with a perspective that reaches across all credit classes. Turning to Slide seven. You'll see members from our liquid credit team led by Martin Horn. They have over $69,000,000,000 in AUM. On Slide eight, you'll see the scope of our private finance group as well as the executive management team of the BDC.

Barings BDC is supported by a team of 200 professionals around the world that have been investing in middle market companies in North America since the early 1990s. Slide nine outlines the key aspects of our leading franchise. Namely, first, we're global. Our platform finances private equity sponsor backed deals worldwide in multiple currencies. Second, we're aligned.

You'll hear the word aligned a lot today. Barings and MassMutual remain the single largest investor in Barings BDC shares and also invest in deals originated by this private credit platform. Three, we're experienced. We've originated sponsored transactions across the senior and mezzanine portions of the capital structure for a very long time. And MassMutual, our parent company, has been a long term investor in the middle market for over thirty years.

Lastly, we're flexible. Our platform is not a one product business. We're capable of financing up and down the capital stack to meet sponsor needs as we have a wide variety of institutional accounts and mandates. Now let's move to Slide 10 for a few financial highlights. Our $1,000,000,000 investment portfolio was partially supported by $210,000,000 of borrowings under a new $750,000,000 credit facility, resulting in ending debt to equity of 0.34x or 0.69x when adjusted for unsettled transactions.

As a reminder, our shareholders approved the reduction in our minimum asset coverage ratio from 200% to 150%. Notably, our private predominantly first lien floating rate senior secured debt strategy fits well with increased leverage levels. Additionally, we look to manage our leverage prudently over time, balancing the desire to deliver a levered return while also ensuring adequate liquidity to take advantage of market downturns. Slide 11 outlines our investment deployments and repayments for the third quarter. As you can tell, it was a very active quarter.

Yet to give more detail on the investment portfolio, I'd ask you to refer to Slide 13. As of September 30, our investment portfolio was invested in approximately $950,000,000 of liquid broadly syndicated loans and $86,000,000 in private middle market loans. These do include some delayed draw term loans. Recall, it is our intention for the BDC to invest primarily in private directly originated senior secured investments over time. However, it takes time to originate these high quality attractive risk return investments.

As a result, we are currently in a transition period during which the company has invested in liquid broadly syndicated loans. While these investments generate a slightly lower yield, they are associated with large issuers in resilient industries that we know very well within

Speaker 3

the industry.

Speaker 4

May I have your attention please? I have your attention please?

Speaker 2

We're glad to that.

Speaker 4

Your attention please. The building emergency condition has been cleared. You may return to your normal activities. May I have your attention please? I

Speaker 2

your your attention May I please? So well, that will be the second and the last interruption we'll have. But as I said, you never do know what will happen on calls. So what I said is these liquid broadly syndicated loans, they generate a little bit lower yield because but they're associated with larger companies and resilient industries that we know very well within our Barings global high yield franchise. Instead of hearing from me on this, I'd actually turn it over to one of our most senior portfolio managers on liquid credit, Tom McDonald, to discuss the BDC's portfolio ramp and these liquid broadly syndicated loans.

Thank you, Eric. It's a pleasure to join the call today to discuss the Barings BDC portfolio and showcase our liquid credit capabilities, which

Speaker 5

are central to our middle market portfolio transition. The background, Barings manages over $69,000,000,000 in loans and bonds globally and has 72 professionals on our high yield investment team. We adhere to a strict bottom up fundamental approach to investing and have a twenty year track record of investing in the liquid credit space. As Barings became the BDC external advisor, I worked very closely with both Eric and John to formulate the proper risk return parameters in constructing the company's liquid portfolio during this initial phase. Looking at the liquid credit BSL stats in the BDC portfolio on Slide 13, I'll point out that all investments are first lien loans with a weighted average spread of three thirty two basis points and yield of 5.6%.

In addition to our focus on adequate risk per unit of return, we are strong proponents of diversification with 120 issuers in the portfolio. Our average liquid credit position is 75 basis points of portfolio assets, and our holdings are well diversified by industry. More importantly, these are credits that our liquid team knows very well, that

Speaker 6

we own across the firm

Speaker 5

and often in sizable amounts. Taking a closer look at the portfolio, you'll see relatively modest issuer level leverage with blended weighted average senior leverage of 4.9 times. Taking a moment to discuss liquid credit fundamentals. Overall, corporate credit quality remains very strong. We experienced very strong earnings growth in the first and second quarters of this year with a slight moderation in earnings growth thus far in the third quarter.

Importantly, our expectation for defaults remains low as we expect default rates in the 2% range for the next year. From a technical perspective, loan demand remains strong from CLO buyers, institutional investors and retail investors through the third quarter, and we don't expect this to change as we look forward to the fourth quarter and beyond. Let me now turn it over to Ian, who works who leads our private investment efforts for a discussion of the middle market assets.

Speaker 6

Thanks, Tom, and good morning, everyone. Staying on Slide 13 for a moment, I'd like to direct your attention to the middle market column. As of September 30, RVDC had approximately $86,000,000 of middle market assets spread across six portfolio companies. 100% of our middle market assets this quarter were in first lien investments, with an average senior leverage profile of 4.6 times and an average total leverage profile of 5.1 times. Note that the median EBITDA size of our middle market exposure is approximately $40,000,000 Similar to our liquid credit team's focus on capital preservation through meaningful diversification, Our average position size in middle market credit is 1% of the total portfolio size, with our top exposure at just 1.7% as outlined in our top 10 exposures on Slide 14.

Jumping to Slide 16, it might be helpful for investors if I walk through a few market slides and put into broader context our narrative and how we look at current trends in yields, leverage, risk adjusted return and ultimately portfolio construction. In terms of evaluating individual credits and how they relate to portfolio construction, let me say that diversification is key and must be achieved through multiple lenses, including position size, origination sources, industry, portfolio company EBITDA and most importantly, risk adjusted return. You can't just look at the yield of first lien middle market loans without considering the risk profile and how deep you are in the capital stack. Third party data from Reuters on Page 16 illustrates the quarterly middle market yields across the capital structure from first lien to mezzanine. The trend to focus on here is that senior debt yields on average have been rising gradually since the beginning of the year.

Middle market institutional term loan yields are currently 7.4%, up from 6.1% at the beginning of the year. Now to be clear, the LIBOR component has risen, but spreads have generally widened slightly as well. Here at Learnings, we do not assign much meaning to the various categories of first lien debt. Terms like unitranche are widely used, but they can mean a multitude of things in reality. So we prefer to look at each issuer and capital structure individually.

We focus on if we have true first lien security or not. We focus on the strength of our structural protections and we focus on other risk factors like the strength of our sponsor. On Slide 17, you'll see that leverage has been trending up on average across the board as well as over the last few years, including 2018. Slide 18 shows a similar trend in purchase prices for middle market LBOs across various end markets. In this environment of high purchase prices and leverage, we believe it is important to maintain discipline and deploy capital prudently rather than relaxing standards on leverage returns just for the sake of doing deals.

Lastly, Slide 19 provides support for my statement earlier that there is not one single definition of unitranche. Some deals that are classified as unitranche look like deals classified as all senior and vice versa. So you really can't rely on these definitions to tell you about the true risk return of the underlying loans in the portfolio. Still amidst these broader market trends, there remain many high quality borrowers in the market, and investors should consider the following: is the lender appropriately incented and designed through its platform to originate the right types of loans to these high quality companies in a competitive marketplace. Investors should consider the DNA of the platform.

And we, as a principal investor, embedded in a large globally diversified asset manager with the backing of MassMutual, who's been an active investor in this asset class for over fifty years, is appropriately placed to generate strong investor returns while also continuing to adhere to our core philosophy of fundamental credit selection, diversification and capital preservation. I'll now turn the call over to John to provide additional color

Speaker 7

on our financial results for the quarter.

Speaker 1

Thanks, Ian. And if you turn to Slide 21, you are going to see the company's net asset value as of September 30 was $11.91 per share and this is the NAV bridge again. Three important points to make, right? First, Triangle Capital's June 30 NAV of $13.7 that was reduced primarily due to their sale of the investment portfolio at a realized loss as well as employee severance and transaction related expenses and debt extinguishment costs, right? Second, once the Barings transaction closed on August 2, we, Barings, as the adviser, took over management of the company at an intra quarter NAV of roughly $11.72 per share.

Now that's our starting point. And the third, since we took over as the adviser, NAV increased to $11.91 a share primarily through the BDC's tender offer as well as net investment income in excess of our quarterly dividend. If you jump to Slide 22, you are going to see our income statement for the third quarter as well as some pro form a income statement for the beginning on August 3, the first full day of our operations for Barings BDC with Barings as the external adviser. Now on a GAAP basis, including Triangle Capital results, BBCs net investment generated net investment loss per share of roughly $0.60 for the quarter. But once you exclude TCAP's legacy results, you can see BBDC earned NII of roughly $06 a share.

And I also want to draw investors towards our calculation of base management fees for a moment. As many of you know, the management fee calculation approved by shareholders is really based on an average of gross assets, excluding cash, at the end of the two most recently completed calendar quarters. Now given that Ehring's BDC's balance sheet was effectively reset intra the third quarter, I. E, it just became all cash after the closings of the asset sale, we, Ehring's, believed it was appropriate to calculate the management fee based on the post transaction balance sheet, resulting in a fee waiver of roughly $1,000,000 for the quarter. Now additionally, we generated net realized gains of $575,000 during the post transaction period as we sold a portion of our highest quality low risk broadly syndicated loans at bids above our entry level.

Now Slide 23 shows our balance sheet as of September 30. Now we ended the quarter with an investment portfolio of over $1,000,000,000 And note that our investment transactions are booked based on the trade dates. And they typically settle seven or a few more business days after resulting in payables and receivables from those unsettled transactions on our balance sheet. The only third party debt for the quarter is $210,000,000 of borrowings under our new $750,000,000 credit facility and that was executed immediately post the closing of the externalization transaction. That given the large number of unsettled transactions and the requirements for readily available liquidity, there are days when we have both cash on hand and borrowings under our credit facility as we expect meaningful settlements to occur as they come in, and that was actually the case at the end of the third quarter.

Now Slide 24 shows our paid and announced dividend since the closing of the externalization transaction. Our $03 dividend paid on September 27, that's an affirmation of our desire to align our dividend policy with the true cash earnings power of the investment portfolio. Now in that same vein, we announced on October 11 that our fourth quarter dividend of $0.10 is going be paid on December 21. Now our objective is not to lock the company into a particular dividend level, but rather simply just pay out our net investment income as we earn it. Now Eric is going to close it out with some thoughts on subsequent investment activity for remodeling as well as some

Speaker 2

of our views on investor alignment. Thank you, John. Slide 26 shows our investment activity since September 30, which includes new middle market commitments of $80,000,000 with a weighted average yield of 8.9% and net new broadly syndicated loans of approximately $60,000,000 Slide 27 shows our North America private finance investment pipeline of roughly $859,000,000 Importantly, this represents the pipeline available to all vehicles managed by the Barings Global Private Finance platform, including the BDC, but there can be no assurances that all these deals actually close. Finally, I'd like to conclude with a few comments and views on investor alignment and how important that is to our investment philosophy. As many of you know, Jonathan Bach is a sell side analyst, was a very strong proponent of BDC shareholders.

Importantly, both I, Mike Frino, Tom Fink and Barings share in these long held beliefs of alignment, and because of that, I want you to turn to Slide 29. To focus on long term alignment post transaction, we made a $100,000,000 investment in Barings BDC at NAV at close of the transaction. In short, we feel it's important to be aligned with shareholders from day one. To further outline our level of commitment to shareholders, Ferring BDC repurchased in its tender offer of $50,000,000 of stock at $10.2 a share. Through that, we generated $0.13 in NAV accretion for shareholders.

Beyond our original investment and the tender offer, we remain active in our 10b5-one purchase plan with purchases of $19,000,000 in BDC stock as of November 7. Barings is the single largest shareholder in the company, owning approximately 20% of the outstanding shares of Barings BDC. Expect this percentage to grow as we fulfill our commitment to purchase $50,000,000 of Barings BDC stock pursuant to this plan. Barings also has a firmly grounded belief that BDC's fee structures influence the type of assets that BDCs choose to originate. As a result, we felt it important to design a long term fee structure that allows for a strong risk adjusted ROE to shareholders, but also complements our ability to originate first lien senior secured investments.

Once ramped, this fee structure fully aligns our incentive fee with the actual credit performance of the asset. Also, our decision to establish an 8% hurdle rate is an important factor as we believe it is important to not collect an incentive fee until we've generated strong long term shareholder returns of 8% on senior secured collateral. Let me close by saying this. This is just the start. Long term success in lending is a marathon that requires strong credit discipline, a focus on asset liability management, a leading investment platform and a deep commitment to long term investor alignment.

It's my sincere hope over the next several quarters and years, we'll be able to demonstrate all these attributes to you. And we thank you for your trust and time you spent with us this morning. With that, operator, we'll open the line for questions.

Speaker 0

Thank Our first question comes from Ryan Lynch with KBW. Your line is now open.

Speaker 8

Hey, good morning guys and thanks for taking my questions. Congrats on officially closing the transaction and getting off to a fast start. John, I would say given you've punished so many on calls for so long, I'm looking forward to asking you a question on this call. I understand that you like math and you like fee structures and you've written a little bit about these topics in the past. So do you believe that the fee structure that BBEC has put into place with assuming one to one leverage is now appropriate given that now you guys can go to two:one leverage once you're fully ramped into middle market assets?

Speaker 1

Well, first, Ryan, I thank you for actually reading those extremely boring reports. Maybe what I'll do is I'll take a step back and I'll go to an overall theme that we're trying to get across on this call, and that's one of alignment. And if you look at some of the analysis that we've done in fee structures over time, right, if you're very focused on aligning your credit results, that's extremely important. But two, I want to outline how important the hurdle rate actually is. So if you realize, as we see moving from a one:one to two:one environment, hurdle rates matter a lot.

And importantly at Barings, what we've chosen to institute was a hurdle rate that is exactly aligned with what we would expect our long term dividend yield payout to be, 8%. Which basically means this, right? We won't earn $00 an incentive until we've delivered what we promised investors. And so that doesn't really change whether it's one:one or a two:one environment. But then I'll give you kind of two second points that go along with that.

If you realize the hurdle rate is the one of the primary drivers of fee take as well as driver of net return to investors, Because remember, it's so important that once you exceed that hurdle, 100% of that income is subject to a full catch up to the manager. If you get that right, you'll find that both base and incentive fee gets a little less impactful relative to where you choose that hurdle rate. So what we'll say on a go forward basis, alignment absolutely matters, number one. And number two, you start with the hurdle rate and you'd say that today, is the fee structure appropriate, our view to do what we do? The answer is absolutely yes.

Thankfully, over time, we'll have more opportunity to keep delivering on alignment across a number of different categories. But I'd say it starts first looking at where you set that hurdle and where you set your incentive. But I'd also say it's more important for me to also have Eric outline our view on incentives as well. Yes. I mean

Speaker 2

it's really consistent with what John said. I think it's a package of fee structures, not one piece in isolation. And I think importantly that just a few months ago, we got approval by shareholders for the IMA in totality. Obviously, we talked about alignment a lot. And I think you'll see over time, whether it be through share repurchases, whether it be through our investment in the BDC, whether it be through other attributes, we hope then taking into totality, people view us as a best in class alignment with shareholders.

Speaker 8

That's helpful. And I think that makes sense. You guys have quickly built a diversified BSL portfolio and really ramped to a nice leverage level at the end of the quarter. It appears so far from the activity in the fourth quarter that the BSL activity has slowed down in the fourth quarter. So is this the size of the portfolio and the leverage level that you intend to operate at during the time period where you're rotating from BSLs into the private credit process?

Or should we expect additional BSLs, a larger portfolio and a little bit more leverage over the coming months or quarters? Basically, how does that shake out? What leverage levels you guys plan on operating on a portfolio size during this rotation process?

Speaker 2

Yes. So Brian, I'll make sure I answer your questions. If I don't, please keep making sure I get it directly. As we look at the current return in BRELI syndicated loan assets that are appropriate for the liquidity profile and risk profile for the BDC, we don't see a material increase to net dividend yield to shareholders by increasing the size of the AUM. And so the way we would increase the size of the AUM would obviously be by taking leverage up.

So under the current risk return environment we're seeing on the broadly syndicated loan side, we don't see a benefit to shareholders to take AUM up because the net return to them is not any higher. And yet the inherent risk to NAV is higher, right, by taking leverage up. If we were to see a benefit of having the market conditions such that there is a benefit to dividend yield to shareholders, we may consider then taking leverage up in order to broaden the size of the portfolio. But for us, this is not ramping AUM up to some maximum level to collect fees and the like. It's really about making sure we're doing a prudent liquid portfolio that allows us to get into and out of those assets at the best way that also benefits shareholders in the best way.

And as I said, today's yields just don't generate an incremental dividend. Therefore, it's just not prudent to take the leverage up.

Speaker 8

That makes sense, and that's really thoughtful response considering shareholders trying make sure that they get the benefits from the higher AUM, if there is any. Kind of a maybe a broader term question. You guys have executed a nice credit facility right away, which has given you guys some runway as you guys have ramped the portfolio. But maybe longer term, sure you all know and I know John knows, having a diverse liability structure is very prudent. We saw that during the last downturn.

So longer term, what is kind of your philosophy regarding building out your liability structure?

Speaker 1

So I'd argue Brian, this is Bach. What I'd say is we absolutely share in your views on diversified liabilities. And a couple of points because, over time, you'll make sure that you're going to structure a partnership with your credit stakeholders. It's going to be beneficial to your shareholders, beneficial to your shareholders as well as beneficial to the operator, which is ourselves as the manager. And I'd say that you probably will see over time a line of progression of trying to close one item as it relates to revolver financing and then on a go forward basis, additional layers of liabilities that go into part of that.

And maybe more importantly than that, Verint has a significant amount of experience structuring and managing a number of levered facilities across the platform. So whether it's middle market CLO financing, whether it's revolver SPVs, etcetera, the breadth and depth of the platform is already in place. So you can imagine, too, with Chris Carey, who arguably he is the one individual that touched and influenced all BDC liability structures, Having him as a part of management of this process and our long term liability strategy is a key competitive advantage. And you'll see us execute that on the coming quarters. Couldn't agree with you more.

Speaker 8

Okay. And then that's helpful. And then just one last one, if I can, just because you guys are so new to the space. I want to hear a little bit more your investment philosophy. I mean, I know you guys want to focus on senior secured given where we are in the credit cycle and the riskreward dynamics there.

But can you just give us a flavor of kind of your target market, where you guys are going to focus from maybe an EBITDA standpoint for middle market private credit, how you define that because that's really defined differently by every BDC? And then can you maybe speak to the hold size that you guys would ideally like to hold on the balance sheet as well as I know you have exemptive relief to invest across the Verint platform. So how much you guys could actually hold across platform? I'm trying to get a sense of what sort of solution size you guys could provide to borrowers.

Speaker 6

Thanks Ryan. It's Ian Fowler. I'll start and then maybe throw it over to Eric if he wants to add anything. So in terms of the target market that we're focused on, it's really companies from 10,000,000 of EBITDA up to $50,000,000 ish million. Now the reality is and what we've seen over the last five to seven years is a lot of these sponsors are buying platforms, growing the platforms through add on acquisitions.

And so what we like and what is very attractive to us is actually supporting these companies as they grow in size. So we do end up with some companies that have EBITDA as high as we've had deals as high as $100,000,000 before they go broadly syndicated. And so that's the targeted market that we're focused on. And I would say, as part of that, as we look at the market, we're very focused on we call it the three legs of the stool. So we focus the company fundamentals.

We focus on the equity ownership. And then we also focus on the structure. And one of the issues as you move into the larger market is you start losing some of the structural protection that we have. And so the other thing in terms of hold size, I guess the way to answer that is if you look at our platform in terms of our focus, We're looking for, obviously, attractive credits. And as we think about competing in the marketplace, I would say that a number of things are important, including hold size.

So as you look at the marketplace today, sponsors want lenders that can eliminate the execution risk on their deals. And so the key criteria that you need, competitive advantage that you need in this marketplace, number one is hold size. So that target range that I talked about, 10 to 50, we can basically, as a platform, if we like the attracts if we like the deal, we can effectively hold that whole deal or speak for that whole deal. The reality is that most sponsors want to diversify their funding sources. And so they're going to bring in partners that are going to take part of that away.

If we really like the credit, we're

Speaker 2

going to

Speaker 6

try to get as much as we can, but it's fungible. It's going to move around. And I guess the other point I would make is along with that, being a capital solution provider in this market is really critical because for a couple of reasons. One, it makes you more relevant to the sponsors. And also, deals can move around.

They can start off traditional, first lien, second lien, and then they can move into a unitranche. And if you can't do the other, then you kind of lose that opportunity. So if you're kind of a one trick pony or a one product pusher in this market, then you're kind of dealing with adverse deal selection.

Speaker 8

Great. That's helpful. Those are all my questions. I appreciate the time today, guys.

Speaker 2

Thanks, Ryan. Thanks, Ryan. Thank you.

Speaker 0

Thank you. And our next question comes from Fin O'Shea with Wells Fargo Securities. Your line is now open.

Speaker 7

Hi guys, good morning and thanks for having me on. I want to start just to kind of continue that dialogue Ryan and Ian were just having on the platform's value proposition. You did give us a lot of color on the opening remarks and in that dialogue. But as to the competitive edge of the Barings platform, you principally outlined your hold size. And as we know, there are many lenders who can offer 100,000,000 200,000,000 $300,000,000 So can you go a little bit more into what brings you into the fold to get good first looks for sponsored transactions?

Speaker 6

Yes. So again, Ian Fowler speaking. So I think you have to break it down a couple of ways. And let me just start off by saying, I'll talk about from the marketplace and how we compete in the marketplace as an originator. But I also think just to back up a little bit and make it a little broader, I think we should talk about it also from an investor perspective.

So and I think that's important because and I alluded to this in the comments, the DNA of the platform as an asset manager really does influence your credit selection and your strategy. So as you think about us as a platform, Barings is a platform, our DNA is in asset management, but we also are, a principal investor embedded in that asset manager. So that means that we're investing our own dollars. So we're in alignment with our investors. We have real dollars at risk, and we're focused on capital preservation.

And also, we have a lot of resources. So we work with Tom's group a lot in terms of looking at broadly syndicated loans, looking at comps so that we can focus on that illiquidity premium. We have over 40 high yield industry experts that we can dial into. So in terms of the credit selection, we're leveraging those resources that the firm brings to the table. On the origination side, you're right.

And I would say historically, if you go back pre crisis when the industry was much smaller, it was basically all relationships. So as you spoke to managers, they would tell you that I get deals because I have a better relationship than someone else. And really what's happened since the crisis is you've had a fragmentation of managers in the marketplace and those relationships have been diluted. So relationships are spread around and you can't rely on that relationship anymore entirety for winning that transaction. But if you don't have that relationship, it's really hard to get in the door.

And so from a sponsor perspective, if you have relationships with multiple lenders, you're getting multiple calls. So if I'm the sponsor and I have an opportunity and I'm getting calls from 20 people, I don't want to spend time talking to 20 people. I don't want to spend time talking to a handful of people. So the things the sponsor is looking at are the following. First of all, hold size, like I mentioned, can you speak for the whole transaction?

If the structure changes, can you move with that change in the structure? Another area where we differentiate ourselves is on our international capabilities, not only just on cross border deals, but also if you think about these sponsors, a lot of them are doing add on acquisitions overseas, and we can actually provide financing for those sponsors as they look at acquisitions overseas. We have one facility that's got six different currencies that we're funding. I would say that your portfolio if you're a new player in this space, it's really tough to compete. We have a portfolio that's well over 200 companies that basically becomes a source of origination for us where we're the incumbent.

Team experience, so think about the team having diverse skill sets, reputation, relationship. We've been in this asset class for a long time. That's important. And finally, I would say sponsors do care that we have our own capital and that we really are committed to the space. So the analogy I use to bring it to a head is, it's like your deep sea fishing.

You got eight lines in the water. All these are different advantages that we bring to the table. If you're a lender that only has one line, we have a better chance of catching the fish.

Speaker 7

Thank you. That's very much appreciated. I'll move on to Eric on the subject of Alignment. This might be a bit long winded, but I'll start by saying that the series of commitments from the sponsor level, buying in at NAV, the accretive tender offer, in parts and as a whole. This was truly a first for the industry.

And I think we're all hopeful that it moves the bar going forward. Now that said, you're at a discount about 85 as of yesterday's close, believe, which is moderate, but still surely worthy of consideration to put more capital there. Also, we understand BDCs trade at discounts for different reasons. For some, it's alignment, credibility. For some, it's credit.

Neither of those are the case for you, I'd assume. But rather, today for Barings, it's an earnings ramp issue. And another part of your commentary touched on a slow measured ramp of the portfolio, which means that this discount might persist even though it may be transient. So with those points in context and as your 10b5-one runs its course, how do you look at share repurchases during this earnings ramp period as it may keep a discount in the market over that time?

Speaker 2

Yes. Thanks, Vince. And so first to ramp, because I think that's an important thing for us to address. We are not going to be beholden to some August, June, July, October ramp, right? As Ian said, we originate and underwrite assets that we think are prudent risk adjusted returns for our capital and our clients' capital.

The reason we put the pipeline in here was our intention is to do that every quarter so that people can see exactly how we have ramped and what the go forward pipeline looks like so that they get a sense as to what that the time to get transitioned from liquid to illiquid credit will look like. So that being said, to your point, I think at the heart of your question is basically BDC shareholder tender versus the outside capital that we purchased. And I guess I'd ask to take a step back and just to your point, look at things in totality at this stage, right? The fact we put $100,000,000 in at NAV, we didn't put it in at market knowing that it could be likely to trade down. We did the $50,000,000 tender at the time within the BDC.

We're investing another $50,000,000 I guess what I really hope does to shareholders is allow them to see that we're putting our own capital right there and trying to make good prudent long term shareholder decisions. And probably give us some time to see what we can do and to prove out our strategy. I think that as we hopefully have shown good stewardship of capital and a good alignment of interest, I mean I think that hopefully through that we'll have time to prove out our strategy. We think that people who stick with us over time long term, that gap will narrow and the yield will increase. That being said, right, we have to be good stewards and allocators of capital.

So we'll always evaluate what we should do with your capital because ultimately it's the shareholders' capital, of which we're the largest shareholders. So we're going to be there doing what's in the best interest of that. But I think it's a balance of that with time right now. And I hope that what we've done is shown how important it is to have that alignment though.

Speaker 7

Thank you, Eric. And one more, I'll involve Jonathan Bach here. You spent the better part of your career, John, digging deep to learn the mysteries of BDC collateral. Or actually, really, you would just usually have me do it. But if you were to leave us with one thought for the industry with how underwriting is done in today's market, I would appreciate that.

Speaker 1

Thank you, Fin. And there's no doubt, we both have worked a lot on the BDC collateral piece. So to be clear, Ian really dug deep into the collateral itself, in particular, sometimes the misnomers and more importantly, over time, how things can get mispriced. What I'd probably say is something that, Fin, that you and I probably we've worked together on a lot and you continue and as well as the sell side continue to kind of put forth. It's more of an incentive perspective.

And so if I was going to give one thing on the collateral, my point is that collateral at times is the output and sometimes not the input. Most folks want to come and say, Look at our assets, and if we put these assets in, they're going to generate a set return. Unfortunately, the BDC space, you start by promising a yield, applying a fee, applying leverage, right? And you'll see that over time, the tail at times can wag the dog, meaning that assets get originated in order to fit the fee structure as well as the set dividend yield and not necessarily tied to the exact risk adjusted return of the credit. So if there's one point that matters a lot to me coming from public to private, it's that you always want to make sure that you test not only the platform, the depth, etcetera, people work with sponsors because of the nice haircuts they have or whatever the case may be, but it's also a function of the incentives that go into what creates that risk adjusted returns.

At Barings, we talked about the hurdle rate. Can You look at our set fee structure and you know the deeply embedded beliefs that we all share, particularly through alignment. I'd argue that flexibility on the management fee and our focus on alignment can give us an opportunity to finance the right type of assets at this point in the cycle, which is extremely important when a number of folks will be looking for higher spread collateral and may not be pricing that risk appropriately. Does that help?

Speaker 7

It does, John. And thank you, for taking my questions.

Speaker 1

Thank you.

Speaker 0

Thank you. And our next question comes from Mitchell Penn with Janney. Your line is now open.

Speaker 9

Thanks guys. Just you guys manage a lot of assets in your platform. Where do you think we are in the economic cycle? And can you talk about how it's impacting your investment strategy? And yes, that'd be great.

Speaker 2

Okay. This is Derek. I think a couple of fundamental premises of Barings, whether it be our illiquid team, as you heard Tom reference or refer to some of the investments today, who's partnering with us or our illiquid team, we're really all about capital preservation in our debt investments, right? We're not the firm who's looking to kind of shoot for the moon on things. It really starts with capital preservation.

That's our philosophy. Second, we're a committee based structure across all of our investment classes. So we don't have kind of the STAR PM model. Those are a couple of our fundamental thoughts. But getting specifically to your question as to where we are and what we're seeing in the economy, I'll really focus on given those two fundamental premises, right, of capital preservation.

On the illiquid side, we underwrite every asset assuming there's a credit in an economic cycle during the life of that asset. So that was true five years ago, four years ago, three years ago, two years ago today because what we don't know is when that cycle is going to happen. So we always underwrite assuming that cycle is going to happen. Obviously, we're closer to that next downturn than what where we were a year or two ago. So what does that mean?

First of all, it means, in our opinion, more highly diverse portfolios are critical. It would usually, when you look at a debt portfolio, it's that diversification that protects you from the unknown. Diversification, we referenced it here earlier today, asset level diversification, industry level diversification. On our origination side, sponsor diversification, all of those are key elements. And then also the correlation of those assets or industries are important when you think of the diversification.

So we're running more diversified portfolios today on the illiquid side than we were even a couple of years ago. That's one way we've protected around it. And then two, there just are obviously certain industries that have more cyclicality that you probably avoid in all markets, but you just have a heightened level of avoiding them today. Did that answer your question?

Speaker 9

Yes. No, that's great. Just one last one. You guys are affiliated with MassMutual. Do you guys do they have any they have a lot of resources.

Can you talk about the impact that the relationship's had on the BDC?

Speaker 2

I don't want to go relationship with the BDC as much as just kind of bearings, right? Bearings. So we're wholly owned by MassMutual. They're our parent company and they're also our client. And so it's an arm's length relationship where we manage money on their behalf and are held to performance on their behalf.

And I believe that ownership by Mass is a positive for shareholders given the capital and the resources around it. But to be really clear, Barings is an independent entity that operates with our employees and our business as an asset manager on behalf of them and the capital for them and on behalf of all of our third party clients.

Speaker 9

Got it. Thanks, guys.

Speaker 0

Thank you. Our next question comes from Mickey Schleien with Ladenburg. Your line is now open.

Speaker 10

Yes. Good morning, everyone, and congratulations on your first earnings call. I wanted to ask about the co investment policy. When we see BDCs as part of large platforms, that tends to be very beneficial. I just want to understand whether it's purely based on available liquidity and investment objective?

Or is the BDC receiving some sort of preferential treatment to help it ramp up?

Speaker 2

This is Eric, and I'll take that one. To be specific with your the second part of your question, the BDC does not get any form of preferential treatment for it to ramp up. We treat all third party clients the same. And so here's how that operates from a co investment perspective. We generated an asset of a certain return profile, certain leverage characteristics and all the other attributes that would come to play.

We then look at our third party accounts as well as our including in that as MassMutual as a third party account of what the investment guidelines for each account are and whether they match the asset that we've underwritten and originated. And if it's eligible for that particular portfolio, that creates think of it as the pool of capital or resources that could invest in that asset. Let's just say for sake of argument, that adds up to $125,000,000 in a given deal when you look across all of our various accounts. Then what is to happen is assume that we get we invest $100,000,000 to Ian's point that sometimes the sponsors today want to diversify their investment base. Instead Instead of having $125,000,000 we get $100,000,000 of that asset.

All the vehicles get their pro rata share of that investment. We don't pick winners and losers or rotate around allocations. Everybody gets their pro rata share. Now to your point, some vehicles may be at the end of the life of their liquidity, right? What we do on that, just so you know, if we look at the aggregate amount size of the fund, we don't look at the remaining liquidity within that fund.

Speaker 10

All right. That's very helpful. For those of us that are maybe newer to the story, it might be helpful if you could just describe the scope of your middle market origination team and their go to market strategy because that tends to differentiate one BDC from another?

Speaker 6

Yes. So this is Ian. I'll take that question. So our middle market North American middle market team is close to 40 people. We have both everyone on the team is focused on relationships with the sponsor.

But I would say that to become efficient and effective, we do break out the team into risk and origination. And what's really important on the origination side is having diverse skill sets. So we have people that have senior secured experience. We have people that have mezzanine experience. And we actually have brought on a number of folks from the private equity world, which has really been helpful because they bring with them relationships with investment banks, and we've been able to leverage our relationships with the investment banks and the sponsor in auctions to win transactions.

And also they've sat on the other side of the table. So they really understand what's critical and important for the private equity firm. So and the one thing I'll say about all originators is they all have an investment background, really important, because, a, you need credibility when you're out there talking to sponsors about transactions and what you can do and how to look at companies and whether they're financeable or not. And B, internally, to make us more efficient, we can't have people throwing deals at the wall. So we really require our origination team to desk kill deals that just aren't appropriate and will gum up the system.

On the risk side, we've got a deep bench of folks that have a lot of experience. I can tell you in today's market, documentation is extremely challenging and complicated. And we've got folks that have decades of experience negotiating contracts or documents and credit agreements. We have people that we have one person on our team that was a Chief Restructuring Officer during the last downturn. And so again, at the end of the day, everyone is rolling in the same direction.

Everyone is focused on the customer. But there is and they work as one team from beginning to end on deals, even if we have a deal that's a focused credit, the originator is right there with the risk team. But it's all about diversity of skill set.

Speaker 2

I'll add, Derek, two things to what Ian said. First, on the 40 people he referenced, that's on our investment team side. It's a much broader team when you include compliance, risk, finance, all the partners that we work with, which is an important part of what the Barings platform brings to shareholders. The second one, as Ian was talking about, origination and risk, it's an integrated deal team and they all own the performance of that asset from origination through resolution of that asset. And so it is a one team philosophy that everybody is part of the origination and part of risk, but they have primary responsibilities within those two.

Speaker 10

That's great. One last question, sort of a follow-up. I think in your prepared remarks you mentioned 40 industry analysts, if I recall correctly. My question is the following. You know, everybody is seeking, you know, late cycle deals.

So software is very popular or healthcare with low reimbursement risk, things of that nature. So what I'd like to understand is how, you know, the person responsible for covering that sector is going to be a very popular person right now within, you know, your platform or any platform. So how does that person's time get allocated amongst all of these various platforms in terms of analyzing deal flow?

Speaker 2

This is Eric, and I'll take a crack at it and then see if Tom wants to supplement what I said. These are public side research analysts who primarily have responsibility to support our liquid broadly syndicated loan and high yield teams. That's their primary responsibility. What Ian was referencing is at times we'll get deals in the middle market that have an industry angle or the importance of industry knowledge is more enhanced than certain other industries. We have a process internally that allows us in a compliance appropriate way to work with that research analyst to get their perspective on how that company can fit within the industry or the sub sector of that industry and maybe some areas to focus on due diligence within that.

We do not have that industry analyst supplement the underwriting and like join the team. It's really a resource that provides industry expertise to our underwriting team as a resource. So their primary responsibility is on the liquid side, but I one of the things I hope we show over time is really it's a hard thing to quantify for people, but the way we work with lines of businesses and our resources internally, we all come at the business doing our job is to make the best investment decisions on behalf of our clients. And whether that means the resources sitting in private finance or liquid credit or structured credit, right, we need to make sure we're bringing those resources to bear. I think Tom and Mike and others have created a culture by which we work well when the client is appropriate across those lines of business to make sure we're sharing information that help us make the best decisions that we can make on behalf of our capital and others' capital.

Speaker 10

Okay. I appreciate that. It's a good answer. It's very clear. Thanks for your time this morning and again congratulations on such a great start.

Speaker 2

Thanks so much.

Speaker 0

Thank you. And our next question comes from Robert Dodd with Raymond James. Your line is now open.

Speaker 3

Hi, guys. Hope you can hear me. Going back to one on the dividend policy, obviously, declared $03 for third quarter, $0.01 0 for the fourth. John, you made a comment about not wanting to lock in a particular dividend level, but also target is to pay out NII as it's earned. So as a long term policy, is that an indication that we should expect the dividend to vary quarter to quarter depending on earnings?

Or is that just a transitional issue? And just kind of what's the right framework to think about the dividend policy Thanks, going

Speaker 1

Robert. And to be clear, I mean, the work that you and Leslie have done that effectively outlines that $1 or $00 of NAV is effectively worth $0.02 a share in stock price really ties into this. In terms of variability, you can look at it this way. The dividend is set to a conservative level to mimic our earnings power, and it always is going to have a, what we'll call it, a lag to the effective return of the portfolio. Because what you don't want to do is effectively give investors their a return of capital, particularly when you're paid to manage it.

So the way I'd outline it is expect the dividend yield to go towards where we guided our target return of 8% over time. But also realize that in the event the markets choose to show us that it is a poorer idea to be originating in a set part of the stack that you do not want to originate given your yield profile. We fundamentally believe that massive credit mistakes are made when folks choose to strictly adhere to a set dividend, not taking into account the industry changes, right? And what matters to us is preservation of your capital as well as the return. And so the idea is to target exactly what we've stated on the call, the transaction call in April, see no changes to that.

But we're also smart enough to realize that if the market does change dramatically, we want to make sure we adapt to it to preserve folks' NAV over time because NAV is really easy to lose. It's really hard to get to build and to get back. Does that answer it?

Speaker 3

Yes, absolutely. That answers it. Perfect. Thank you. And then on the buyback question, obviously, the manager, the parent is buying back stuff, which I think is a positive and aligns, obviously, the manager interest and the shareholder interest.

But going back to a point, Eric, that you made that right now, I mean, obviously, BDC has available capital. You adjusted 69 leverage with a max at two and you've drawn two ten of the seven fifty credit facility, right? So you have available capital. But to the point that John has been making about fee alignment and Eric, you said incremental growth in the BSL side of the business right now just doesn't make sense because it doesn't generate incremental earnings to shareholders. It just generates fees to the manager.

So I respect that. I think that's a very important point to make. The second point being, though, obviously, you have available capital. The other way to utilize that would be to buy back stock, which does generate an incremental return to shareholders through growing NAV. And I realize you talked about the patience, etcetera.

We're remarkably impatient people when it comes to analysis. And you showed an awareness of the importance of that at the beginning of this transaction with the tender, which grew NAV $0.2 roughly from when you took over to where we are today. So can you explain to us why you wouldn't use the incremental capital you have available right now to generate economic return to shareholders when you consciously and deliberately don't want to use it in the BSL market for appropriate reasons, but you have the opportunity, why not do it?

Speaker 2

So I apologize, I wasn't clear earlier. I'll try and continue to refine my answer on this. But I am going to take a step back and say, yes, the math today would generate that type of return. And I'm respectful of that and understand that stewards of capital, we need to be good allocators of capital. But I am going to ask everybody to take a step back and look into totality, right?

$100,000,000 at NAV, dollars 50,000,000 tender within the BDC, it was a 1.3% increase to NAV, dollars 50,000,000 of incremental 10b5 that were one plan we're purchasing today. I think we need to get through those stages of equity purchases, allow shareholders to see our investment strategy play out. We will always evaluate, right, what's prudent and beneficial to our capital as a single largest shareholder as well as other shareholders. But as we sit here today, we believe in a short period of time of just a couple of months, we believe we've shown a number of actions that are consistent with shareholders. And I believe if they stay with us over a long period of time, they'll be rewarded.

We will evaluate this like we will everything, everything all the time. But as we sit here today, I think we're kind of focusing on getting through the 10b5-one plan and then we'll look forward to looking at everything in totality.

Speaker 3

I appreciate that. And I do believe you deserve a lot of credit for how you structured things and what you've done. The only sidebar I'd like to say when I get into a car and somebody else is driving, I hope they're looking through the front and not watching the rearview mirror all

Speaker 11

the time.

Speaker 3

Moving on to the next question. On credit facility, you partially answered this, John. I mean, obviously, I presume the $210,000,000 outstanding is the Class A-1s, which have a maturity in 2020. Obviously, historically, BDC is having a liability, an asset liability mismatching durations haven't done so well. You do today.

That's obviously not the long term plan. Can you give us a little bit more color on time frame before investors won't have that shorter liability duration and asset duration to worry about?

Speaker 1

Absolutely. And given a focus on asset liability mismatch, you can kind of see it go a couple of ways. First is, a, you establish the revolver and you establish the revolver on market terms that are going to be beneficial for both the lender as well as us, the borrower. Two, after once that's structured, can imagine we will take a very hard look at the liability side on our BSL. And to that point, I'll make one comment is there's a couple of ways to effectively deal with that mismatch over time.

And more importantly, our strong partners on the lending side, We have been able to go over that in grave detail. You want to set up your revolver first and then effectively at the same time come and fix what we'll argue is really temporary. But to be clear, let's outline this. When you think of liquidity, you do want to measure kind of what's owned against that facility. And so we at Barings took a very hard look at what our liquid credit team was originating, where they were focused and paid particular attention to make sure that the assets met both a high liquidity profile as well as a high credit profile as well.

So we absolutely understand that's the part of our liability strategy as we move on. This was just a temporary ramp. And we also made sure that what's pledged against that facility is of a high degree of liquidity over time that will allow us to manage that asset liability match well in the future. But the point is still made, and you'll see the liability strategy come forth in the next quarter or two.

Speaker 3

Okay. I appreciate that. One more, if I can. Kind of you gave a lot of color on the market. Maybe this question is more for Ian.

But how should investors investors view the credit risk in the portfolio? And you gave a lot of color on that. Given that the relative, at least going forward on the middle market, I mean, BSL market, they're not all 18 vintages, obviously, because you can provide them in the liquid market. But going forward on the middle market side, there's going be a lot of vintage concentration in twenty eighteen and 2019 vintages, presumably. Looking at Page 17 and through twenty nineteen of the presentation, we've got record high attachment points.

We've got record low structural protections. We've got record uncertainty on what first lien really is on whether it's a stretch, unitranche, etcetera. But how should investors view that credit risk given the trends and the fact the trends in the slides that you show us and the fact that a lot of this portfolio is going to be built on the far right of those sides of those business charts?

Speaker 6

Yes. So Robert, there's a couple of things here to think about. One, which we've discussed and mentioned multiple times is just it's a large part of its portfolio construction, right? And so and diversification and as I mentioned, probably one of the most important things is just diversification of risk return profile. So think about a portfolio where you have a foundation of sleep at night loans that low volatility, low leverage, yes, maybe you're getting a little less return on those, but it creates stability in the portfolio.

And then the job of the manager is to opportunistically find situations where you can generate a little more return. So that might be proprietary deals. It might be industry where we have an edge. We have a lot of expertise and we can leverage that. And we're willing to go deeper in the capital stack.

It might be a company that we financed in the past that we see an opportunity to finance again, and we've gone through a cycle. So it's all of those things from a portfolio standpoint that are really critical, and that we focus on as we think about this portfolio construction. To me, portfolio construction is the key. And if you're just one dimensional and you're just focused on that return, as you go deeper in a credit cycle, you're going to have more risk in that portfolio because the correlation of that risk is 100%. So you need to have the diversification of that risk return.

Speaker 3

Got it. Got it.

Speaker 6

And I'm sorry, the other thing I would say is it's we look very closely at some pretty key metrics as we evaluate portfolios. So we focus on the fact today, our senior leverage, our first lien investments are at 4.6 or 4.6x. So that tells you where we're invested from an attachment point. Look at the total leverage of the companies that we're invested in. It's just over 5%.

It's not 4.6% in companies that are invested that are leveraged 7x. And so we look at the senior leverage attachment point, we look at the total leverage attachment point. Yes, enterprise value is and purchase price multiples are up today, but I would argue that the increase in the purchase price multiples have far exceeded the increase in the leverage that's provided to those companies. And I'll use software as an example. I mean you have deals out there that are 20 times EBITDA.

We're not chasing the market like Eric said. We're not swinging for the Fed and providing a seven or 7.5 times unitranche because we feel like from an LTV perspective, that's comfortable. So we're not going to chase deals, and we're going to focus on structural protection. We can we're focused on the right things in terms of structural protection, and we can find deals that we're very comfortable from a structural protection standpoint.

Speaker 3

Got it. Got it. If I mean on the topic Slide nineteen, one of the things you talk about is senior loans with embedded GREW risk or embedded GREW risk. How are your shareholders and investors going to be able to see that in your metrics? I mean, as you say, about 4.6 times attachment point right now.

What should we look for, so to speak, call you out? If that goes up too much, what is too much where it becomes embedded to the risk embedded in the portfolio? Should we look for on that side?

Speaker 1

Well, what I'd argue I'd be looking at would be, Robert, with the flexibility that's offered to originate loans. And I'd say yield is an important component, right? So at times, you'll find if we're dictating that we want to operate in a conservative leverage profile, particularly for the industry, that we want to be really, really boring in our portfolio construction or diversification, you could arguably understand that there's not going to be a significant amount of movement over time, particularly in those average points. So I'd probably say that it's a difficult item to easily look on the other side just given the fact that no BDC provides every individual portfolio company EBITDA with the name and their sponsor, etcetera. But you can understand that given how we're incented and how we choose to, and who our backer is and how we choose to look at the market, that, that is arguably going to get you 95% of the way there, right?

If you realize that incentives drive results, a study of the incentives will probably over time show you where folks are going be willing to take risk adjusted return. And our focus on incentive and alignment is arguably going to be, putting us right in the case where capital preservation is the goal. So I appreciate the question, Robert. Also understand that we'll happily take your questions on this every quarter, but it will really be more philosophical than something that's easily identified from the data that gets provided by any BDC for that matter.

Speaker 3

And that's a very, very fair point in terms of the average. To your point, Jonathan, I mean, credit issues don't come from the 95% core though, right? They're from the average and the median. They come from the edges usually. So that's the one thing here.

You look at Page 34

Speaker 10

in your queue, you know,

Speaker 3

in in your first lien BSL portfolio, the higher tax rate is 8.5. That's significantly higher as opposed to double the attachment point on your average attachment point in the middle market. So I mean is there given the distinctions that you've given us, is there more embedded risk in the edge of that portfolio than the averages make it seem?

Speaker 1

No. I mean, I'll add you see 8.1x on an illiquid loan, right? Now granted there's always structural industry factors, that's one thing. What we would outline too is when you look at the BSL portfolio overall and kind of its barbell approach, there is always going to be a name that maybe is a higher more profitable software company, etcetera, but that has a high degree of liquidity that offsets what you would argue is presumably higher on the face of it, higher credit risk. I'll let Tom speak to that.

But the point generally is that even if you think of the 5% loan basket, which is not, right, the point of alignment and more importantly, if you think of the long term fee structure that effectively outlines our performance fee versus your results and effectively subordinates that incentive fee to the credit performance of this BDC, I'll argue that anything that goes into this portfolio is arguably going to have a high degree of focus on capital preservation over time. So there's no strategy to take high risk or low risk. Risk has always been the same. But I'll have Tom actually outline kind of a view as it relates to leverage in that liquid market and that trade off.

Speaker 5

Yes. Thanks. So in certain names like the ones where we have higher attachment points, we look at first of all, usually there is a little bit of a credit story there. But the reality is we have a lot of subordinated capital still behind that. And for every investment that we put into this portfolio, we own it elsewhere on our platform.

So a couple of the names in the platform have higher leverage, but it's an improving credit story. So using our team, using our analysts, looking at forward looking for a year to twenty four months, we expect a deleveraging profile there. So that would probably be some of what you're seeing. And those though, again, the outliers that you referred to will be some of our higher conviction names across our platform where we see some real upside and would like to take advantage of it in this framework.

Speaker 3

Thank you. And I appreciate the responses and congrats on your first quarter as Darren's BDC.

Speaker 0

Thank you. Our next question comes from Christopher Testa with National Securities Corporation. Your line is now open.

Speaker 11

Hi, good morning. Thanks for taking my questions. Just wanted to discuss a little bit on the difference between the broadly syndicated and middle market. When you guys are assessing both of these at the time of underwriting, obviously the former has less protections but more staying power of larger borrowers. How do you look at this and the difference and how you stress test both of these with the potential of a credit cycle?

Speaker 5

Yes. So I'll start with on the broadly syndicated side. So as I mentioned, we have the largest team when you look at it globally. Our research analyst portfolio managers, we have the largest team that's out there that underwrites credit on the broadly syndicated side. So by doing that, we have roughly 40 to 45 credits per analyst.

So we can we do take that very deep dive into our view of it. And ultimately, what we require analysts to do is to have a forward look of what we think these companies will do. For an industry where it's cyclical, we'll look at how will this company perform in a downside scenario and how much cushion do we have, what does liquidity look like, where can leverage go. And from there, we make a judgment call on where we think this thing may trade. So there's a lot of work that goes into it on the front end that ultimately gets us comfortable about holding that position on the broadly syndicated side of things.

And we have a long history of doing it over twenty years of doing that through multiple cycles.

Speaker 6

Yes. And I would just say on the middle market side and again, the big difference between the two, right, is liquidity. So on the middle market side, you don't have liquidity. So we focus on things like structural protection, doesn't have covenants, is there any leakage, definition EBITDA, things like that. Capital structure, we like simplified capital structures, so that if there's an issue, all the lenders are in alignment and you can work through any issue.

And critically, I think the sponsor is really important. We underwrite every sponsor that we do business with. And so if you have a problem, we are working with sponsors that are have a history of supporting their companies either operationally or with capital to get that company through an issue or over equitize an acquisition. They just do the right thing. So those would be kind of the key things that we focus on in the middle market.

Speaker 11

Okay. Thank you. That's helpful. And are all the broadly syndicated loans that were on the balance sheet in the quarter, are all of those held by bearings in either the CLO or a different account?

Speaker 5

Yes. So yes, they are on our platform. Most of what we did is we ramped in the secondary. So they are all existing positions that come off of our investment committee approved buy list.

Speaker 11

Got it. Okay. That's helpful. And obviously, the target for the BDC is to be mostly middle market, and I know that these are largely placeholder assets. What do you guys anticipate being the pace of you kind of getting the middle market to be at least over 50% of the portfolio as you kind of look ahead at the pipeline and the ability to sell off some of the broadly syndicated products?

Speaker 2

Yes. That's one we talk about a lot, which is what's the pace of that transition. The frank answer is we don't know, right, what it will be because we don't know what the market environment will be and whether our sponsors win and the like. The reality of it is our broad origination network though and our current pipeline would say that kind of $100,000,000 ish million a quarter is a very achievable goal on an average basis. We're going to have some quarters less than that.

We're going have some quarters more than that. But history is a good guidepost. We'd say that the BDC, taking its back to the question we had earlier about the co investments, the BDC's portion of their origination using around 100 per quarter is probably a good proxy for what it would look like going forward. So that ties into leverage, right, as to what you'd have on the leverage given the equity. I originally talked about in our transaction description when we first announced the deal, August ramp.

We had a one to one leverage then. As I said earlier, we're not going to be beholden to eight quarters or six quarters or nine quarters. It will be what makes sense. But if you're looking for kind of 50% plus, I would kind of model out that $100,000,000 per quarter as the best guess. And we'll just update you every quarter on exactly where that stands and we're going to update you with our pipeline.

And through that hopefully the transparency we provide will give you a good ability to model this out

Speaker 6

going forward.

Speaker 11

Got it. Okay. That's very helpful. And just touching a little bit on the co invest AUM. I know Barings obviously is a really large platform.

What's the exact AUM that DVDC is able to co invest across?

Speaker 2

The exact AUM, I wouldn't want to give you a specific number. And the reality is it could move, right? You sit here today, right, we have liquid assets, as Tom referenced earlier, that on a blended basis have about a three thirty over spread. So as we're originating middle market deals, deals that have a 400 to four twenty five spread that we have, to Ian's point, high conviction of their foundational part of a portfolio, economically makes sense to trade out of that liquid asset into this L400 to four twenty five asset. I could fast forward four years from now and the market could look materially different.

We could have a portfolio that's all, let's just use, on average, L plus $5.25. And that same L400 million or L425 dollars asset that today makes sense from a portfolio perspective may not make sense at that point in time. And also the reality is that number moves, right, as private commingled funds we have ramp and then they pay down as separately managed accounts become more or less active. So the hard number is not one that I could provide tangible. I think to Ian's question around hold size is probably the best proxy, which is our average leverage, he referenced at 4.6 times in this portfolio is consistent with our platform.

The average EBITDA size on the median in that 30,000,000 to $40,000,000 range is consistent with our platform. And so our ability to speak for $100 plus million in those deals and really drive the lead is what's critical. What percentage of each of those deals we get, I just frankly, is as much up to the sponsor as anything else.

Speaker 11

Got it. Okay. And last one for me. Just philosophically, we're just obviously, Barings is a large group and has been around for quite some time. And you guys now have a public vehicle with the BBBC product.

Just curious kind of what the thinking was on having a public vehicle and what your thoughts are there?

Speaker 2

Okay. This is Eric again. And I'll take a step back. So we do believe having diversity capital for our platform is important, and that comes in a couple of different ways. First, it really comes in the diversification of the risk return within our capital providers.

So on one end, let's think of a middle market CLO, right, that could take a L-four 100 asset, right, at a very low OID and a diversified pool of that could make a lot of sense, all the way ranging out to a mezzanine strategy that we've been doing for over twenty five years in The U. S. And have strong returns in that. And so having the diversity of capital back to Ian's point really gives us the flexibility to speak across the capital structure, across multiple deals with our private equity clients. So I think that's kind of the first thing I would say.

Second, within the diversity of capital, we operate third party co mingled funds that are private funds. We operate separately managed accounts on behalf of clients. And those clients also would come from LPs or separately managed accounts from across the globe, from our distribution network and our relationships there. So really, the part that we didn't have was a listed public vehicle to complement our private third party funds and our separately managed accounts. And so strategically, we made the decision prior to this transaction, Tom Fink, our CEO Mike Freeno, who runs Global Markets and myself to look at a permanent capital vehicle as a proactive strategic effort.

This was not a reaction to the fact that Triangle put itself up for strategic review. It was something that we had intended to do and wanted to look at a BDC. Then it really came down to an unlisted private one versus the purchase of one. And we felt like this was attractive to get a listed vehicle where we were able to have a third party purchase the portfolio and frankly start from scratch. One of the things I love about this transaction is typically when you buy a portfolio, all the good deals are your deals and all the problems were the prior person's, right?

The good news on this is it's going to be really clear how we perform to ourselves and to our shareholders. And that transparency and that clarity is something we're very comfortable with.

Speaker 11

Got it. Okay. That's great detail and appreciate your time this morning.

Speaker 0

Thank you. And our last question comes as a follow-up from Fin O'Shea with Wells Fargo Securities. Your line is now open.

Speaker 7

Hi, guys. Thanks so much again for having me on. I just want to circle back to both John and Eric on the issue of buybacks again before you go home for the weekend. So just putting everything together we heard today, I'm again agreeing with you that the totality perspective is impressive on your behalf and also that at this juncture, it is appropriate for you to have your shot at portfolio construction to ramp your return and bring the discount in that way. That may be even the best value proposition to shareholders at the 85 of NAV context.

Shareholders, of course, accepted your proposal to manage the BDC, and it's reasonable that you should get a shot at expanding before being asked to contract. So that said, please give us some texture on what standard you're setting for yourself in terms of the time line of a ramp to deliver a closing of that discount to shareholders through a higher return before you would then say, hey, we couldn't hack this. We'll buy back more stock.

Speaker 2

Hey, Fin, it's Eric. And I appreciate how you answered asked the question really very much. And I think it gets to the heart of it, right, which is and I said earlier, we're not going to chase a quarterly target or say we're going to generate X amount of directly originated middle market deals and put ourselves in that kind of box. If we wake up in 2020 or some time frame down the road and we have not proven our ability to ramp the portfolio with illiquid credit at a measured pace and risk return that we believe makes sense, we're still trading at this type of a discount. We have to ask ourselves the question that you just asked us, right?

Does it make sense? Is it the best interest of our capital as a shareholder and our other shareholders to do something else other than what we've done? I'm not I can't tell you that's going to be the 2019 or 2019 or 2020. What I look forward to is every single quarter sharing what that ramp looks like. Every single quarter, let's look at where the stock is trading and what the go forward pipeline looks like.

And our team collectively internally, I believe has shown to what you said, the willingness and the ability to invest our capital to shrink the corpus of the BDC to benefit shareholders and to make what's in the best decisions of long term shareholder value. So it's not a hard date for you, but that is kind of the philosophy of how I'm coming at it.

Speaker 7

Thank you, guys. I appreciate that.

Speaker 0

Thank you. Ladies and gentlemen, that concludes our question and answer session for today's call. I would now like to turn the call back over to Eric Lloyd for any further remarks.

Speaker 2

Thank you, operator. And on behalf of all of my team members at Barings, I want to say thank you to all of you who participated in today's call and all of you who've entrusted your money for us to manage. We look forward to continuing our discussions in the future. Have a wonderful day, and thank you for dialing in.

Speaker 0

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program and you may all disconnect. Everyone, have a wonderful day.