BBDC - Barings BDC: An Attractive 10.8% Yield Along With Some Downside Protection

Summary

• Barings BDC, Inc. is an externally managed closed-end fund that is regulated as a BDC. It provides financing to small and medium-sized companies.
• The current book value is $11.28 per share as of Sept. 30, 2022.
• BBDC generates a 10.80% dividend yield on the share price and trades at a 21% discount to book value.
• Institutional ownership is 50%. The largest holder is parent company Barings LLC.
• Share buybacks and credit support agreements provide some downside protection if we head into a recession.

Written by George Spritzer, co-produced by Alpha Gen Capital

(Data below is sourced from the Barings BDC website unless otherwise stated.)

Barings BDC Inc. ( BBDC ) is a business development company or BDC that focuses on providing financing to small and medium-sized companies. The company's investment portfolio includes a variety of securities- senior secured loans, mezzanine debt, and equity securities.

BBDC has an experienced management team. Barings is a $347 Billion global investment manager with a long history of investing in the middle market.

BBDC's portfolio is diversified across a wide range of industries, which helps to mitigate single sector risk. The company's portfolio is currently invested in industries such as healthcare, business services, and consumer products.

BBDC's performance has been a bit disappointing since its IPO in 2007. But it is a good conservative holding. Its underlying portfolio tends to have better interest coverage than many of its BDC peers. It also has a low price to NAV ratio, large insider ownership and a shareholder friendly structure.

In 2018, BBDC was holding a very large allocation to cash because of acquisitions. As they have gradually transitioned the portfolio into investments, they have been able to steadily raise the quarterly distribution.

Recent Distribution History

The table below shows recent quarterly distributions paid by BBDC. Note that the quarterly distributions have been gradually increasing over time.

The company's dividend yield currently stands at 10.8%, which is higher than the average for similar BDCs.

Comparison To Some BDC Peers

Source: cefdata.com

BBDC Performance Record versus BIZD ETF (as of Feb. 3, 2023)

Source: morningstar.com

BBDC has lagged the BIZD over the last 5 years in performance. This is partially because of two large mergers during that time period. But it has a fairly strong performance over the last 15 years of around 7% a year.

MVC Merger

In 2020, BBDC merged with MVC. As part of the merger, Barings entered into a credit support agreement with BBDC, for the benefit of the combined company, to protect against net cumulative unrealized and realized losses of up to $23.0 million on the acquired MVC investment portfolio over 10 years after the merger.

Barings LLC also amended its investment management agreement with Barings BDC to lower the base management fee to 1.25%, down from 1.375%.

Sierra Income Merger

On February 25, 2022, BBDC completed its merger with Sierra Income with BBDC surviving the merger.

Following the closing of the merger, Barings LLC and BBDC entered into an updated investment advisory agreement that increased the incentive fee hurdle rate from 8.00% to 8.25% annualized. Barings LLC also entered into a credit support agreement with BBDC to protect against net cumulative unrealized and realized losses of up to $100 million on the acquired Sierra investment portfolio over 10 years after the merger.

Share Repurchase Program

In connection with the closing of the merger with Sierra Income, BBDC's board announced an open market buyback program of up to $30.0 million whenever the shares trade below 90% of BBDC's NAV. Repurchases can occur during the 12-month period starting on April 1, 2022.

As of November 10, 2022, the Company repurchased a total of 2,263,496 shares of its common stock in the open market under the authorized program at an average price of $9.69 per share, including broker commissions.

Credit Support Agreement

On February 25, 2022, right after the Sierra Merger, BBDC and Barings entered into a Credit Support Agreement whereby Barings agreed to provide credit support of up to $100.0 million relating to the net cumulative realized and unrealized losses on the acquired Sierra investment portfolio over the next 10 years. Here is a link to the details of the agreement:

https://ir.barings.com/all-sec-filings/content/0001140361-22-007670/0001140361-22-007670.pdf

Barings contributed $3.4 million to BBDC in the third quarter of 2022 because of this credit support agreement. The credit support agreement along with the authorized share buybacks provide some downside protection to investors, if we go into a recession.

During the last earnings call, management commented on the future expectations of distribution payments:

"Looking forward, we anticipate that strong portfolio performance will sustain BBDC’s earning power above our $0.24 per share dividend. So it begs a very important investor question, why not pay out that increased income?

To best answer that question, we outline our emphasis on margin of safety. Recall, Barings BDC operates under a best-in-class fee structure highlighted by our industry high hurdle rate of 8.25% and a willingness to align the NOI incentive fee to credit performance, both realized and unrealized.

As a result of aligning our dividend with our hurdle rate, Baring insulates the regular dividend distribution, which is 8.5% on NAV and 10.5% on a market price basis, with the incentive fee. Said differently, in the event of future unrealized or realized losses or the loss of income due to credit stress, the manager bears the cost via a lower incentive fee.

In our view, this feature creates a very strong and resilient dividend yield profile that is less dependent on elevated base rates. With that strong dividend base, we then seek to further enhance shareholder value through a combination of share repurchases, growing dividend spillover and steady and systematic special dividends. It’s that consistent long-term approach, combined with significant investor alignment and margin of safety, that we believe drives down BDC yield risk premiums over time."

One of the reasons I like BBDC is because of their parent Mass Mutual, which has been a leader in the private placement and high yield markets for many years. BBDC is 50% owned by institutional investors. Here are some of the top holders:

Source: nasdaq.com

BBDC is fairly liquid and usually trades about 400,000 shares a day. The bid-asked spread is usually only a penny, although it can widens when markets get volatile. It is fairly easy to buy BBDC using smaller market orders or limit orders.

For those in a high tax bracket, it is probably best to own BBDC in a tax deferred retirement account.

In conclusion, Barings BDC Inc. is an attractive investment opportunity for income-focused investors, with a strong track record of performance, an experienced management team, and a well-diversified portfolio. The share buyback program and credit support agreements provide some support in case we go into a recession. The company's high distribution yield with gradually increasing distributions, makes it an attractive investment.

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