Business context and reporting period
Barings BDC, Inc. is an externally managed business development company (BDC) investing primarily in senior secured private debt for middle-market businesses, with additional equity, structured-credit and joint-venture investments. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2023. Amounts below are in U.S. dollars; financial statement amounts are generally in thousands unless stated otherwise.
Financial performance and position
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Investment income | $75.3 million | $55.6 million | $142.5 million | $99.4 million |
| Operating expenses | $41.5 million | $23.8 million | $81.0 million | $48.6 million |
| Net investment income after tax | $33.6 million | $31.8 million | $61.1 million | $50.8 million |
| Net increase (decrease) in net assets from operations | $40.1 million | $(25.0) million | $79.8 million | $(4.0) million |
| Net investment income per share | $0.31 | $0.29 | $0.57 | $0.52 |
| Distribution per share | $0.25 | $0.24 | $0.50 | $0.47 |
At June 30, 2023, total assets were $2.730 billion, investments at fair value were $2.506 billion, and net assets were $1.208 billion. NAV was $11.34 per share, up from $11.05 at December 31, 2022. The quarter-end stock market price was $7.84, a substantial discount to NAV.
Cash and foreign currencies totaled $80.3 million. Borrowings under credit facilities were $772.1 million and notes payable, net of financing fees, were $719.8 million. The company reported a 180.6% asset coverage ratio versus its 150% statutory minimum and said it was compliant with its credit-facility and note covenants. Its revolving credit facility was amended in May 2023 to extend the revolving period to February 2025 and maturity to February 2026.
For the six months, operating activities used $27.2 million of cash and financing activities used $31.9 million; cash and foreign currencies declined by $59.1 million. Distributions paid were $53.6 million, share repurchases were $10.9 million, and net credit-facility borrowings were $35.0 million. The company stated that available cash, borrowing capacity and expected operating cash flows should meet needs for at least 12 months.
Material changes versus comparable periods
- Investment income rose 35% in Q2 and 43% for the six-month period year over year. Management attributed the increase mainly to higher base rates, a larger average portfolio, increased dividends and higher payment-in-kind (PIK) income. Debt-investment weighted-average yield, excluding non-accrual assets, was 10.4% at June 30, 2023 versus 7.6% a year earlier.
- Expenses increased faster than income: Q2 operating expenses rose to $41.5 million from $23.8 million, including $10.1 million of incentive fees versus none in Q2 2022, and higher financing costs. The weighted-average rate on the revolving facility was 6.8% at June 30, 2023 versus 2.9% a year earlier.
- Operations turned profitable compared with Q2 2022, principally reflecting a swing to $55.1 million of net unrealized appreciation from $44.7 million of depreciation. The six-month change similarly included $77.0 million of unrealized appreciation versus $41.2 million of depreciation in 2022.
- Q2 and six-month results included a $43.6 million realized loss from exiting Custom Alloy debt investments. The filing says this loss was reclassified from unrealized depreciation; it is not a separate new decline in value for the period.
- Non-accrual investments involved six portfolio companies at June 30, 2023, down from seven at year-end. Their fair value was $26.6 million, or 1.1% of portfolio fair value, compared with $24.3 million, or 1.0%, at year-end. The reported cost declined from $98.8 million to $51.3 million.
- The portfolio’s fair value increased to $2.506 billion from $2.449 billion at year-end. Equity shares rose to 14% of portfolio fair value from 12%; subordinated and second-lien debt fell to 10% from 11%. The portfolio included 328 companies versus 322 at year-end.
Outlook, commentary and risks
Management provided no specific earnings or portfolio guidance. It described continued investment in middle-market senior secured debt and selected differentiated opportunities. Subsequent to quarter-end, the company reported $23.6 million of funded new investments and $8.4 million of previously committed delayed-draw loans; the new debt investments had a weighted-average yield of 11.6%. On August 9, 2023, the Board declared a $0.26-per-share distribution payable September 13.
Key risks include borrower credit deterioration and defaults, recession and inflation, changes in interest rates, foreign-exchange exposure, and the complexity of transitioning legacy LIBOR-linked contracts. Management noted that lower rates could reduce investment income. Much of the portfolio is valued using Level 3 inputs and unobservable assumptions, so realized outcomes can differ from reported fair values. PIK income is non-cash when recorded but may contribute to taxable income and required distributions. Unfunded financing commitments were $338.3 million at June 30; management considered available resources adequate to meet them. The company also disclosed a €9.9 million guarantee related to MVC Automotive credit facilities. It reported no material pending legal proceedings and no material changes to previously disclosed risk factors.
Credit support agreements with Barings cover certain acquired MVC and Sierra portfolios, with caps of $23 million and $100 million, respectively. These agreements are valued as derivatives and are not equivalent to immediate cash protection; their terms include settlement conditions and potential termination if the advisory relationship ends in specified circumstances. The Adviser determines fair value for many investments, subject to Board oversight. Non-qualifying investments were 26.5% of total investment fair value; BDC rules constrain additional non-qualifying investments if qualifying assets fall below the applicable threshold.
Important facts for investors to verify
- Whether increased floating-rate income can continue to outpace financing costs, management and incentive fees, particularly if benchmark rates decline.
- The credit quality, recovery prospects and valuation assumptions for non-accrual and other materially discounted holdings, including Core Scientific, Legal Solutions Holdings and Custom Alloy.
- The composition and cash collectability of reported income, including $5.1 million of Q2 PIK interest and the effect of PIK and non-cash taxable income on distributions.
- Liquidity and leverage headroom after the $338.3 million of unfunded commitments, distributions and repurchases; verify covenant compliance and asset coverage as conditions change.
- The sustainability of the $0.26 quarterly distribution and whether it is supported by recurring cash income rather than unrealized gains or non-cash accruals.
- The valuation and eventual settlement conditions for the Adviser’s credit support agreements, and the sensitivity of reported NAV to Level 3 valuation inputs.