Barings BDC, Inc. (BBDC) CEO Eric Lloyd on Q1 2022 Results - Earnings Call Transcript

May 06, 2022 4:00 PM ETBarings BDC Inc (BBDC)6 Comments1 Like
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Barings BDC, Inc. (NYSE:BBDC) Q1 2022 Results Conference Call May 6, 2022 9:00 AM ET

Company Participants

Eric Lloyd - CEO

Ian Fowler - President and Co-Head of Global Private Finance

Bryan High - Head, U.S. Special Situations and Co-Portfolio Manager

Jonathan Bock - CFO

Conference Call Participants

Casey Alexander - Compass Point

Paul Johnson - KBW

Robert Dodd - Raymond James

Operator

At this time, I would like to welcome everyone to Barings BDC, Inc. Conference Call for the quarter and year ending March 31, 2022. [Operator Instructions]

Today’s call is being recorded, and a replay will be available approximately 2 hours after the conclusion of the call on the company’s website at www.baringsbdc.com under the Investor Relations section.

Please note 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 the forward-looking statements. These statements are based on various underlying assumptions and are subject to numerous uncertainties and risks, including those disclosed under the section titled Risk Factors and Forward-Looking Statements in the company’s annual report Form 10-K for the fiscal year ended December 31, 2021, as filed with the Securities and Exchange Commission. Barings BDC undertakes no obligation to update or revise any forward-looking statements unless required by law.

At this time, I would like to turn the call over to Eric Lloyd, Chief Executive Officer of Barings BDC. Please go ahead, sir.

Eric Lloyd

Thank you, operator, and good morning, everyone. We appreciate you joining us for today’s call, and I hope you and your families are doing well. Please note that throughout today’s call, we’ll be referring to our first quarter 2022 earnings presentation that is posted on the Investor Relations section of our website.

On the call today, I’m joined by Barings BDC’s President and Co-Head of Global Private Finance, Ian Fowler; Bryan High, Barings’ Head of U.S. Special Situations and Co-Portfolio Manager; and the BDC’s Chief Financial Officer, Jonathan Bock. As we typically do, Ian, Bryan and Jon will review details of our portfolio and fourth quarter results in a moment, but I’ll start off with some high-level comments about the quarter.

After a record 2021, we carried that momentum into the first quarter of 2022 with strong net portfolio growth and expanded equity capital base following the close of the Sierra acquisition and strong performance from our direct lending and cross-platform investment strategies.

Let’s begin with the market backdrop shown on Slide 5 of the presentation. With rapid changes in the geopolitical and market landscape, broadly syndicated loan prices began to price an increased risk tied to both underlying inflation as well as concerns of an overly aggressive Federal Reserve. BDC equity prices also were not insulated from the current bout of market volatility, and we believe it is in these periods we’re well capitalized, disciplined and highly selective managers can source attractive risk-adjusted returns.

Moving to the fourth quarter highlights on Slide 6. Net asset value per share was $11.86 compared to the prior quarter of $11.36. Our net investment income remained at $0.23 per share unchanged from last quarter. This is despite raising approximately $527 million in new equity with the close of the Sierra transaction. It is important to note the underlying stability of our net investment income is further enhanced by our incentive fee structure as our earnings continue to exceed our new 8.25% hurdle rate and remain in the investment catch up.

As a result of these trends, our Board elected to increase our second quarter dividend to $0.24 per share equating to an 8.1% yield on our net asset value of $11.86. Regarding new investments, we had gross originations of $330 million in the first quarter on top of the $443 million portfolio acquired from Sierra income. This was offset by $173 million of sales and prepayments at $132 million of which were sold to our JVs.

Our investment portfolio continued to perform well in the first quarter with no new [bearings], loans on nonaccrual, and the portfolio remains valued above original cost. With the onboarding of the Sierra assets, total nonaccruals increased to 3% of cost from 2.2% of cost last quarter. However, on a fair value basis, total nonaccruals are just 1.8%. Ian will highlight later, our focus on select asset sales and restructurings in the acquired MVC and Sierra portfolios, as we continue to maximize shareholder value, while benefiting from the protection added by the credit support agreements.

Slide 7 outlines summary financial highlights for the quarter. In the first quarter, robust investment activity and continued strong performance from cross-platform investments offset negative earnings drag associated with the increased share count, as total net investment income per share was at the $0.23 per share level. Net unrealized depreciation was $3.5 million associated with select marks on the investment portfolio and realized losses totaled $1.4 million. Following this year acquisition, net leverage, which is leverage net of cash, short-term investments and unsettled transactions, was 0.89x, which is currently below our target leverage range of 0.9x to 1.25x. This attractive liquidity position allows us to look towards future growth with our portfolio of companies as well as selective opportunities in the current market environment.

In these periods of market uncertainty, you can expect us to remain disciplined, keeping a focus on our core markets, our incumbencies across 287 portfolio of companies and our cross-platform strategies. Additionally, our commitment to investor alignment further differentiates our focus on strong investor returns. Recall that Barings BDC incentive fee structure provides an earnings cushion against unperceived events when our net investment income exceeds our hurdle rate which increased to 8.25% in connection with the Sierra close, a decline in earnings caused by nonaccrual loans or yield compression, which first result in a lower incentive fee in slating investors from those negative items.

I’ll now turn the call over to Ian to provide an update on the market and our investment portfolio.

Ian Fowler

Thanks, Eric, and good morning, everyone. If you turn to Slide 9, you can see additional details on the investment activity that Eric mentioned. Our middle market portfolio increased by $125 million on a net basis in the quarter, with gross fundings of $261 million, offset by sales and repayments of $136 million. New middle market investments included 16 new platform investments totaling $164 million and $97 million of follow-on investments and delayed draw term loan fundings. We also had $69 million of net new cross-platform investments in the quarter.

Slide 10 updates the data we show you each quarter on middle market spreads across the capital structure. While we have witnessed volatility in the public markets, it is well understood that the private markets react to market volatility at a much slower pace. And further, the strength of the capital flows into the direct lending asset class may also offset the potential spread widening effects of a more fearful marketplace. As a result, market conditions remain generally competitive across direct lending as evidenced by generally stable spreads loosening terms and higher leverage levels.

Turning to Slide 11. A theme we outlined last quarter that continued in the first quarter, is that unitranche executions remain near all-time spread types when compared to first lien, second lien, traditional executions. And the level of Cov-Lite unitranche volume again was an all-time record. This is again a symptom of substantial capital inflows into direct lending, and I don’t expect it to slow down anytime soon. A bridge of our investment portfolio from December 31 to March 31 is shown on Slide 12.

On Slide 13, you’ll see a breakdown of the key components of our investment portfolio on March 31. As we have discussed in the past, the goal of this slide is to provide details on the key categories of our portfolio, which are now our [bearings] originated middle-market portfolio, the legacy MVC Capital and Sierra Income portfolios as well as our cross-platform investments. The middle-market portfolio remains our core focus and continues to grow. It makes up 53% of our portfolio in terms of total investments at fair value and 50% of our portfolio in terms of revenue contribution. Our Barings originated middle-market exposure is heavily diversified amongst obligors of 184 portfolio companies with a geographic diversification across the U.S., Europe and APAC regions.

Underlying yields on our middle-market investment portfolio of 7% and weighted average first lien leverage of 5.5x remain reflective of our boring-is-beautiful approach to credit. In addition to our middle-market exposure, we continue to draw upon Barings’ wide investment frame of reference to complement our core portfolio with $579 million of investments in the legacy MVC and Sierra portfolios and $546 million of cross-platform investments. As mentioned earlier, 2 of our legacy MVC assets were on nonaccrual at core end. And with the close of the Sierra transaction, we onboarded 5 additional assets on nonaccrual. As mentioned previously, total nonaccrual assets as a percent of fair value are 1.8%, all of which are covered by the respective credit support agreements with Barings.

Recall the Sierra transaction closed on February 25, raising $527 million in new equity, along with the onboarding of $443 million in new assets and $102 million of cash. The portfolio continues to perform well with continued paydowns in both the first and second quarters, with the proceeds being redeployed into Barings’ originated transactions. At quarter end, the current $430 million Sierra portfolio is spread across 55 obligors, the majority of which is first lien when including the senior loans and the Sierra JV. The average spread is 669 basis points for a total yield of 8%. The Sierra portfolio has approximately $14.6 million at fair value of nonaccrual and is supported by $100 million CSA.

Turning to the Barings portfolio. No Barings directly originated loans are on nonaccrual and the total portfolio had no material modifications to the cash payment terms of our debt investments during the quarter. Our total investment portfolio is now made up of 65% first lien assets. Slide 14 provides a further breakdown of the portfolio from a senior perspective. The core Barings originated portfolio, which makes up 76% of our funded investments is 73% first lien. This is down from 74% last quarter driven largely by additional joint venture investments.

Note the combined MVC Sierra portfolios are comprised of senior secured, equity, second lien and mezzanine debt investments, which brings the first lien component of the total portfolio down to 65%. Our top 10 investments are shown on Slide 15. Our largest investment is 5.2% of the total portfolio, and the top 10 investments represent 23% of the total portfolio. Recall our largest investment, Eclipse Business Credit, is backed by a large portfolio of asset-backed loans, conservatively structured inside of the collateral net liquidation value. The overall portfolio remains diverse from an industry’s perspective as well with 287 investments spread across 31 different industries.

I’ll summarize my market comments by saying when high levels of market uncertainty persists, managers are best served by being both highly selective and highly diverse. It is also a time to further drive benefit and origination from our incumbency advantages investing in names we know well. Furthermore, the strong performance of our cross-platform strategies create an optimal and unique asset mix that is difficult to replicate in the current market, ranging from unique infrastructure investments to attractive risk-adjusted returns and asset-based loans. We complement this unique portfolio with our aligned fee structure to drive strong shareholder returns.

As I said before, being unique is endemic to our culture and our platform, and I believe it is a key ingredient to achieving long-term success.

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

Jonathan Bock

Thanks, Ian. Turning to Slide 17. Here’s a full bridge of net asset value per share movement in the first quarter. Our net investment income matched our dividend, net realized gains and losses on our investment portfolio and foreign currency transactions drove a decrease of $0.02 per share, while our unrealized depreciation totaled $0.04 per share. The Sierra transaction, including the credit support agreement, accounted for $0.28 of share. Additional details on this net unrealized depreciation are also shown on Slide 18.

On the middle-market portfolio, price appreciation and credit performance resulted in $2 million of net depreciation with the remaining $4 million of depreciation due to FX moves, which are offset in our borrowings. Our cross-platform investments saw total appreciation of approximately $11 million, largely driven by the very strong operating performance in Eclipse Business Capital, our asset-based lender. The legacy MVC portfolio saw total net unrealized depreciation of $2.1 million. And near the bottom of Slide 18, you can see that the credit support agreement decreased by approximately $400,000 from last quarter.

Slides 19 and 20 show our income statement and balance sheet for the last 5 quarters. And as we’ve discussed, our net investment income per share remained stable at $0.23 per share for the quarter, driven by a $4 million increase in total investment income. The increase in interest income can be attributed to continued portfolio growth, as well as the Sierra assets being added to the portfolio on February 25. Higher dividend income from our investment in Eclipse Business Capital and 2 of our joint venture investments were also strong contributors to earnings in the quarter. The increase in total investment income was also met with higher interest and financing fees as well as an increased share count following the close of the Sierra transaction.

The first quarter also saw the payment of an incentive fee to the manager as pre-incentive fee net investment income exceeded our new 8.25% hurdle rate. From a balance sheet perspective on Slide 20, total debt to equity was 1.12x at March 31, although this level was artificially high given the timing of certain asset sales and was 0.89x after adjusting for cash, cash equivalents and unsettled transactions.

Turning to Slide 21, you could see how our funding mix ties to our asset mix, both in terms of seniority and asset class. Compared to the end of 2020, our reliance on secured bank debt has decreased as a result of the increases to our unsecured debt and private placements, which are now over $700 million, as we have continued to diversify our balance sheet to match our diverse portfolio of assets. Details on each of our borrowings are shown on Slide 22, which shows the evolution of our debt profile over the last 3 quarters.

Following the close of the Sierra transaction in February, we extended the maturity of our revolver and expanded the credit line from $875 million to $965 million via incremental commitments from all of our existing lead banks. And subsequent to quarter end, we further upsized our revolver by $100 million to its current size of $1.065 billion, on -- with the addition of a new lender to the bank group at a top-tier commitment. We continue to have additional commitment to raise up to $25 million of unsecured debt plus we have the available borrowing capacity under our senior secured credit facility.

Now jumping to Slide 23, you can see the impact of our net leverage of using our available liquidity to fund our unused capital commitments. Barings BDC currently has $201 million of delayed drop term loans, commitments to our portfolio companies as well as $20 million of remaining commitments to our joint ventures. This table shows how we have the available capacity to meet the entirety of these commitments, if called upon, while maintaining cushion against our regulatory leverage limit.

Slide 24 updates our paid and announced dividends since Barings took over as the investment adviser to the BDC. And as Eric mentioned, we previously announced our second quarter dividend -- second quarter 2022 dividend will be $0.24 per share, an increase of [$0.01] per share compared to the second quarter and an 8.1% distribution on net asset value.

Now turn with me to Slide 26., which shows a graphical depiction of relative value across the BBB, BB and B asset classes. Even with the near-term market volatility credit spreads across the liquid credit spectrum remain at or near their 3-year types. Now this drives investment in large dollar sizes to the private marketplace, the negative effects, which Ian outlined earlier. To further mitigate the negative effects of private market competition and remain prepared for the uncertain markets of the future, we’ll emphasize the following: one, we’ll seek to maintain credit discipline in our core business, seeking out attractive direct lending illiquidity premium per unit of risk; and two, we will ensure that both our liquidity and capital profile is sized to take advantage of the market opportunities as they present themselves; three, we maintain an investment focus across a wide range of cross-platform opportunities. We speak often of our pricing premiums relative to liquid credit, and this translates into the actual results shown on Slide 27, which outlined the premium spread on our new investments relative to the liquid credit benchmarks.

Barings BDC deployed $281 million at an all-in spread of 768 basis points, which represents a 293 basis point spread premium to comparable liquid market indices at that same risk profile. And diving deeper into our core middle-market segment across Europe and North America, we averaged 249 basis points spread relative to liquid market indices. For cross-platform investments, the spread relative to liquid indices was even greater at 387 basis points. And we continue to believe that our ability to invest across platforms and generate excess return via illiquidity and complexity premiums will be a key differentiator for Barings BDC in this current cycle.

I’ll wrap up our prepared remarks with Slide 28, which summarizes our new investment activity so far during the second quarter of 2022 and our investment pipeline. The pace of new investments remained steady compared to the last 2 quarters, with $174 million of new commitments, of which $141 million have closed and funded. Of these new commitments, 78% are first lien, senior secured loans, 20% are in cross-platform and 35% are in European or Asia Pacific originations. The weighted average origination margin or DM-3 was 7%, and we’ve also funded approximately $15 million of previously committed delayed draw term loans. The current Barings Global Private Finance investment pipeline is approximately $2 billion on a probability-weighted basis and is predominantly first lien senior secured. And as a reminder, this pipeline is estimated based on our expected closing rates for all deals in the pipeline.

And with that, operator, we’d love to open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Finian O’Shea with Wells Fargo Advisors.

Unidentified Analyst

It’s Jordan on for Finian today. I was hoping you guys could give us a little more context about Eclipse Business Capital. It looks like it’s been performing well. It looks like you took a bigger dividend this quarter. So is there anything you can add there on how that’s performing and whether this is kind of a run rate dividend or maybe it’s a catch up?

Jonathan Bock

Sure. So I’ll start with one item and then lateral to my colleague, Bryan, for the second as it relates to kind of the synergies between both ourselves and Eclipse. But the short line is, Jordan, in periods of market uncertainty or geopolitical volatility, what you’ll find is these underlying obligors that keep higher outstandings. And so as you have a higher level of outstanding plus a continued level of measured growth, the opportunity or profit effectively falls down to the bottom line. Our expectation on run rate, here, we were operating under-levered, and so we have the ability to increase the dividend payout. Typically, we like to profile at around an 8% cash distribution. And so you can kind of expect that, that will probably normalize over time, but the underlying cash generation, or the NAV of the business, still remains intact and also continues to be amplified by our strong partnership with Eclipse and our cross-platform and special situations team.

And Bryan, if you just want to outline that partnership and the growth in deal I think that would be very worthwhile.

Bryan High

Sure. Thanks, Jon. Yes. I think, generally speaking, the thesis is playing out on Eclipse. They have a strong management team and a platform that has a niche in the market and there’s a growing nonbank market, which is helping them with a little bit of wind behind ourselves, generally speaking. And then as Jon mentioned, the strategic fit from an origination perspective for both Eclipse and Barings, frankly, and seeing new deal flow that they otherwise wouldn’t see has been a consistent theme and the pipelines for both of us are growing as a result of that. And then if you just sort of think about the resilient performance that they have had and will have, given the underlying collateral base that backs their loans, we think it’s sort of a great place to be, given where we are in the cycle and they should continue to benefit from a rising rate environment as well. .

Unidentified Analyst

Okay. That’s helpful. And then it looks like you guys inherited maybe another JV this quarter from the Sierra transaction. Is that something that we can expect to be a permanent asset that will join the group of JVs that you have or -- is that something that maybe gets [wind] into another one? Just any color on how you’re going to manage that given you’re kind of against your non-qualifying bucket limit.

Jonathan Bock

Yes. Jordon, you can expect us to slowly wind that down. What we’ll do is maximize -- or sorry, minimize drag and maximize profitability off of the venture, but you can slowly expect it to be returned to us as those loans pay back. So this was an offshoot, and you can expect it to fall over time.

Operator

Our next question is from Casey Alexander with Compass Point.

Casey Alexander

Yes. First of all, congratulations on closing this year transaction on a timely basis. My first question is, if you were to see spreads start to really blow out in the liquid credit markets and the broadly syndicated loan market, would you still be open to taking advantage of that as a way of getting a little more deeper into your leverage ratio and then kind of waiting to directly originate when the directly originate markets kind of square up with liquid credit markets? Is that still an opportunistic strategy that the company would employ?

Jonathan Bock

Casey, this is Jon, and then I’ll lateral to Eric because when you think of the size and scope of Barings across the liquid platform, that can be a great opportunity. You saw us participate in the liquid credit category, particularly when spreads widened out as a result of COVID. We’re not near those levels, but we rely heavily on the expertise and the close partnership with our liquid counterparts, both publicly and privately. And that continues to be a very, very important part of our platform that we all benefit greatly from. But I know, Eric, we always remain very opportunistic across all areas of Barings.

Eric Lloyd

Yes. Casey, I’d say, the short answer is yes, we would look at that. As Jon said, the levels aren’t there right now. But if they were to get there, we absolutely would look at that. Making sure that you pick up a true illiquidity premium is really important, as we all know, on the illiquid assets. And when spreads widen out, but let’s just say, theoretically, right, the liquid spreads probably syndicated loans went to 700 over. All of a sudden, a 100 to 150 basis point premium on illiquid credit isn’t really attractive relative to when spreads are 300 over liquid credit and then all of a sudden pick up 150 or 200. They are attractive. So it’s making sure you really pick up a proportionate amount of that liquidity premium. So we stay very close to the liquid side. And between Bryan, I and Thomas involved in the BDC, we absolutely would look at that at that were to occur. .

Casey Alexander

All right. Great. That’s very helpful. My second question is you picked up a number of, I think, 5 companies that are nonaccrual at Sierra and have probably been on nonaccrual for quite some time. I’m just wondering if in your guys’ analysis and diligence, is there anything salvageable? Or are those pretty much just debt issues?

Jonathan Bock

We actually -- I mean kind of, look at the underlying collateral, believe that there are forward opportunities. You had to -- you have a good company, but also bad balance sheet. And so with a number of the individuals that also joined us from the Sierra platform, they’re very active in realizing that value. And because of the scale and size of the platform with which we’re working at similar to some of the other peers, Casey, that you follow, the probability of further driving a successful outcome over time, not today, but not forever -- or not never is much higher. So yes, and it’s a slow and steady wins the race on those names, at about $14 million of fair value. .

Operator

Our next question is from Paul Johnson with KBW.

Paul Johnson

Just following up on the assets that you inherited from Sierra, not just the nonaccruals, but really the entire book. I think it’s like $430 million or so that came over in the first quarter. Is the focus, I guess, to rotate out of these assets as you’ve kind of identified these opportunities? Or are you pretty comfortable with basically sitting on these assets and kind of allowing them to just sort of run off over time and focus on your other verticals that you’ve got going? .

Jonathan Bock

I’ll give one initial thought. So when we underwrote the transaction, you always underwrite to hold and invest. But at the same time, we were very focused in on a shareholder alignment, and so again, brought to use the innovative tool of the credit support agreement such that our manager retains the downside on that credit portfolio. Believe it or not, over time, we found even in the MVC portfolio here that there are going to be individual portfolio incumbencies you want to continue with. And then there’ll be ones where, in certain instances if you’re looking for the opportunities to exit, you can effectively raise your hand, and we’ve seen some of that as well.

I’d expect it to be measured. The yield profile that we’re receiving off of those loans is attractive, right? They were originated in prior time periods at relatively strong spreads. And so we’re starting to find a good level of income contribution. And so there’s no immediate rush except for some of the special situations where we might find that we just don’t like the underlying risk return, and we’ve been cycling out of those near term. It’s not necessarily a dollar-based question answer for you, Paul, but more a philosophical one. We’re happy to own them, but we also find that there are going to be select assets where, over time, we’re just looking forward to the exits, and we are starting to see that as well.

Eric Lloyd

Paul, I think the good news is when we announced the deal over 6 months ago and then we’ve inherited the portfolio that the portfolio is performing at least in line with what we expected, probably a little bit better than what we expected from the asset underwriting that we did. And as Jon said, some are a little worse, some a little bit better. Some will probably rotate out of, so are the ones we’re very comfortable with that company were to refinance of stepping in and continuing to support that company. So I think the good news, on a blended basis, is the portfolio is performing at least consistent with, if not better than what we originally underwrote when we announced this deal 6 months ago. .

Paul Johnson

Got it. Appreciate that. Then just going back to the -- I know you touched on what kind of drove the write-up for the Eclipse business and how things are going pretty well there. I’m curious, do you kind of see the increased dividend income that we got in the first quarter is something that’s sustainable from here on out? Or is that more kind of like a temporary effect, just based on what’s sort of going on in the ABL markets? .

Jonathan Bock

I think what it will outline is the underlying profitability of the investment, and that profitability shows up in BBDC’s income statement too -- or it shows up in BBDC’s financials 2 ways. It can be through dividend distribution or can also be through NAV growth. And oftentimes, we like to target on our cross-platform investments generally or JV typically an 8% distribution or cash distribution. It was higher this quarter just given the fact that we were operating from an underlevered base, given the $500 million in new equity that was issued with the Sierra deal. And so I’d say you could expect to see that the dividend income moderate, but the view into Eclipse is an operating business or a subsidiary shows that the underlying profitability is very strong. And so while you might not see less in dividend income, you can see it also growth in NAV in that underlying instant investment due to retained earnings.

Paul Johnson

Appreciate it. Last question, just kind of a bigger picture question, but wondering to get your guys’ views on basically Europe versus the U.S.? I know you deployed a little bit of capital there this quarter. How do you think about the spread opportunity here, just given obviously the recent invasion, the military buildup of Europe and proximity to the conflict over there? Just any kind of color on your views of the value opportunity there.

Ian Fowler

Yes, it’s Ian. I’ll take this and anyone else can jump in. It’s interesting in the first quarter in terms of deal flow and just being more robust in terms of the quality of the credits, in terms of the higher OID, lower leverage and higher spreads, Europe was just on a relative value basis, a much more attractive market than the U.S. And to your comment regarding the geopolitical risk, you would think that wouldn’t be the case, but we’re seeing really good businesses in Europe that are new platforms that are coming to market. And just given our position as one of the top leading lenders to private equity firms, we’re really well positioned to take advantage of them, and that really brings in the benefit of the platform and our wide range of opportunities that we can pursue. So I don’t know how long that lasts, but just on a relative basis, it’s just been more attractive than the U.S.

Unfortunately, on the U.S. side, we have our portfolio which has been really instrumental in terms of driving origination for our business. And quite frankly, going into a potential recession, being able to rely on add-on acquisitions, you’re basically looking at a portfolio that’s becoming larger in scale in terms of the business themselves and more diversified itself from a credit perspective that’s very attractive.

Operator

Our next question is from Robert Dodd with Raymond James.

Robert Dodd

Congratulations on getting the Sierra deal closed and the good quarter. First question, on the cross-platform, I mean, it’s about 1/3 of revenues now? I mean, it’s -- you are starting to bump up against the BDC limits about how much you can have in all these different JVs, which the JVs have a big advantage, right? They get you into markets that are potentially less competitive, not as crowded with some of the enormous pools of capital out there. Is it a view that you’d like to continue expanding the cross-platform mix of the portfolio? And if so, are you going to take -- there are obviously some -- I don’t want to call it a gimmick, but there are some ways to manage around the BDC nonqualified buckets with balanced -- end-of-quarter balance sheet management and things like that. Is that something we should expect to see? Or do you want to keep everything kind of plain vanilla on that side? .

Jonathan Bock

I think maybe just to dive into what the cross-platform investment bucket is, you can find that there is a healthy amount of which is qualified, right? And so the JVs, which you correctly pointed out, would be nonqualified given that’s how they are across all of the BDC space, but a number of the operating companies or in specific, some of the special situation or infrastructure opportunities, they certainly are. And so you’ll find us continue to manage diversification the way we always have. But at the same time, I think there are some growth opportunities that exist, Bryan, when you start to think of the infrastructure opportunities that exist in some certain areas across platform that are worth mentioning and at the same time, qualified investments. Bryan? .

Bryan High

Yes. I think in the infrastructure space, specifically, I think we’re very interested in finding opportunities that similar to Eclipse have real asset value behind them, especially in this sort of part of the cycle where we’re late stage and you have some real collateral to sort of clean on, and that can be across multiple different silos in the infrastructure space. And it’s something that is a decent chunk of our pipeline today and has been a place where we’ve been deploying capital more recently. And we think the underlying fundamental value supporting those investments make them attractive, risk-adjusted return, when you’re trying to sort of maximize your return per unit of risk.

Robert Dodd

I appreciate that. If I can one more since Ian mentioned the recession word. What’s the institutional view maybe on the economic outlook? I mean, obviously, with Eclipse, with ABL, right, that can do, as you pointed out, in volatile periods and the security is really good there. Some of the middle market, I’m not saying a pure cash flow loan tends to be, say, less recession resistant than an ABL loan. But what’s the institutional view of the economic outlook since the R word was said? .

Eric Lloyd

Ian, do you want to go through a little bit on [indiscernible], how we characterize the portfolio from an impact of potential rate rises or inflation. Because I think that gives a good idea as to how this portfolio is positioned. And before Ian does that, maybe, Robert, I’ll just say that every time we underwrite an asset, whether it be today, 6 months ago, 6 years ago, given the illiquidity nature of the asset, we always assume there’s going to be some type of economic or credit cycle during the course of that asset. That’s kind of how we underwrite credit.

And if you go back over time, I think they said the average leveraging the portfolio right now is about 5.5x through our assets. If you go back over time, it’s kind of always around that kind of 5.25x to 5.5x. We’re not going to chase it up into the 6s. We’re not going to see us scope down into the 4s. And we kind of feel like those type of companies can weather kind of a market cycle or an economic cycle well. Obviously, besides the recession, the rate environment, the positive is, right, asset prices are up, meaning the yields are up based on the rates. The negative is interest coverages are down for the borrowers, combined with some inflationary pressure that they have on input. So -- that’s kind of where we look at it overall. But Ian, maybe you can cover some of the stuff we talked about yesterday.

Ian Fowler

Yes. Sorry, Robert, I guess I opened a can of worms. I said potential recession. I didn’t say recession. But good question. And look, I mean, obviously, when we’re underwriting these deals, we’re very much focused on where we think yields and spreads could go and base rates could go and the impact to those companies’ ability to make their payments. I think just stepping back, one of the key things in this asset class is really being on top of portfolio. And I think, for me, just looking at previous cycles, right, it’s not an efficient market. You really have to be in touch with management teams. You need to find out how companies are performing. There’s a lot of like-work that has to be done. And you’ve got to have the team to get in there and connect with your management teams. We did this during COVID, and I think we were pretty proactive in terms of the way we were able to manage COVID and the impact on our portfolio.

Right now, our deal teams have been actively in contact with management teams. And obviously, we’re focusing on not just inflationary pressures, but there’s still some supply chain disruptions. There’s labor availability issues freight and commodity risk. And as we’ve gone through the portfolio, just in terms of breaking out into labor and then input costs on a labor basis, 71% of our portfolio, we believe, is very low risk to any labor market challenges and then 26% would be medium.

Probably the biggest issue with labor right now is just low skill labors and that’s often associated with lower EBITDA margin businesses, and we just don’t have those types of businesses in our portfolio, so think of like restaurants, retail, things like that.

On the input cost, we’ve looked at our portfolio and we believe 3/4 is really low inflationary risk because these companies are predominantly professional services businesses. So think of the cost of product is not tied or linked to a physical good in any material way. It’s more of a service business. 25% is, I would say, medium where there is some tied to a physical goods. So you’ve got the management to drive changes in pricing, for example, and dealing with potential inventory exposure. But at the end of the day, just going into any type of potential downturn, look at our interest coverage, it’s over 3.5x. I remember the Great Financial Crisis, where average interest coverage was in that 1x to 2x. So I feel like we’re much better positioned now than we were back then.

Also in terms of inventories, just actually a positive supply chain disruption is that inventories are pretty lean. So the carrying costs are low with inventory and borrowing costs that support that. And then also, what we’ve noticed is a lot of our private equity firms are proactively hedging their interest rate costs. And so again, I think we feel pretty good about where we are from a defensive position if we end up in our environment.

Robert Dodd

That’s really helpful. Thanks a lot for all the detail. If I can break the rules and ask one more because it relates to all of this and a comment you made earlier. How do you balance -- if spreads start to move, if a potential recession likelihood does increase or the syndicate spreads are likely to move wider, it creates that opportunistic potential. But how do you balance the fact that with liquid public credit, you get data quarterly with a lag probably versus middle-market loans, you get -- or getting it monthly, and you can just call the CEO in many cases, right? So you can get much more dynamic up-to-date data in the middle market than you can in the liquid credit markets -- and what’s the value of that data early if before we’re in a recession. If recession rallies are elevating more current data, I would think, would be worth more the relative premium between middle-market and liquid market begins to change a little bit in dynamics? Is that -- how do you manage that? .

Eric Lloyd

Look, I think that’s very fair, Robert. And I think it’s a balance of things, right? To your point, the information is sooner and you maybe have a more intimate relationship with the management team. That being said, we’ve got dozens and dozens of research analysts on the liquid side, who also know their industries and their portfolio companies and their management teams extremely well. And so I wasn’t trying to insinuate that we would go way, way, way into the broadly syndicated market if there were so. But part of the benefit, I think, of the Barings platform is that we do have such a deep liquid credit team and experience and a great track record that on the margin where we see those opportunities, we would step into it. That doesn’t mean that you’re going to see us make a wholesale change or anything like that. But on the margin, where we see those attractive opportunities as we’ve stepped in, taking into account information flow, value, price, relative value, illiquidity credit and all those other factors. .

Operator

We reached the end of our question-and-answer session. I would like to turn the conference back over to Eric for closing comments.

Eric Lloyd

Thanks, operator, and I appreciate it. And thank you all for participating in the call today. Please stay safe, and have a great day.

Operator

Thank you. This does conclude today’s conference. You may disconnect your lines at this time, and thank you for your participation.

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