Kayne Anderson BDC Inc
NYSE:KBDC
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Hello, and welcome to Kayne Anderson BDC, Inc.'s Third Quarter 2024 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded.
It is now my pleasure to turn the conference over to Frank Karl, Senior Vice President of KBDC.
Good morning, and welcome to Kayne Anderson BDC, Inc.'s Third Quarter 2024 Earnings Call. Today, I'm joined by Doug Goodwillie and Ken Leonard, Co-CEOs of KBDC; as well as Terry Hart, CFO and Treasurer of KBDC. Following our prepared remarks, we will be available to take your questions. Today's call may include forward-looking statements. Such statements involve known and unknown risks, uncertainties and other factors, and undue reliance should not be placed thereon. These forward-looking statements are not historical facts, but rather are based on current expectations, estimates and projections about the company, our current and prospective portfolio investments, our industry, our beliefs and opinions and our assumptions. These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond our control and difficult to predict. Actual results may differ materially from those expressed or forecasted in the forward-looking statements.
We ask that you refer to the company's most recent filings with the SEC for important risk factors. Any forward-looking statements made today do not guarantee future performance and undue reliance should not be placed thereon. The company assumes no obligation to update any forward-looking statements at any time. Our earnings release, 10-Q and supplemental earnings presentation are available on the Financial section of our website at kaynebdc.com.
With that, I'd like to turn the call over to Doug.
Thank you, Frank. Before I provide an overview of our performance during the quarter, I want to provide a quick reminder on our strategy at KBDC. First, we believe that the core mid-market represents the most attractive risk-reward area in which to invest in direct lending. We define this market as including borrowers ranging in size from $10 million to $50 million in EBITDA. This market segment generally includes more lender-friendly documentation and the ability to lend at lower leverage while still maintaining strong yields in those investments. Within this segment of the mid-market, we focus on stable, slower-growing industries where the winners and losers have generally been decided, as you can see in our industry diversification chart summarized later.
Within these industries, we identify companies that have specific attributes that have been shown to be present in companies that have successfully survived multiple cycles. If an investment does not exhibit these attributes, we will not pursue it. From a structuring perspective, our portfolios have lower average leverage of approximately 4x, well below most other publicly traded BDCs. Consequently, that leads to industry high weighted average interest coverage ratios with modest average loan-to-value below 45%. The combination of these factors results in a credit selection process that creates attractive risk-adjusted investment portfolios across all of the vehicles within our credit platform.
Finally, we are the lead or co-lead agent in approximately 75% of our private middle market investments with the vast remainder as part of a small club of lending groups. This puts us in a position to structure and manage these investments proactively, avoid large bank group consensus risk and obtain the best economics. We believe that the third quarter of 2024 represents a continuation of this strategy, and I am pleased to provide an overview of our portfolio, recent investment activity and then turn it back to Frank to discuss the market before Terry Hart covers KBDC's financial results for the third quarter of 2024.
As of September 30, KBDC's portfolio includes 110 individual portfolio companies, representing approximately $1.94 billion of fair value funded investments. We have another approximate $179 million of unfunded commitments comprised of a mix of unfunded revolvers and delayed draw term loans for total commitments in excess of $2.1 billion. Since September 30, 2024, KBDC has closed or is in the final closing process on an additional $180 million plus of commitments with another 6 weeks left in the quarter, evidencing continued strong origination volumes in 2024. The KBDC portfolio was purposefully constructed in a defensive manner in order to outperform in high interest rate environments and through periods of economic instability or uncertainty.
Investments in KBDC's portfolio, excluding a handful on our watch list, have weighted average leverage of 4.2x, interest coverage of 3.1x and loan-to-value of approximately 42%, again, evidencing our conservatism in loan structuring. We think these credit statistics are a material positive factor for our favorable portfolio outlook, particularly in an elevated interest rate environment and that these statistics compare favorably to virtually all other public BDCs of a scale similar to us. We also have built a diversified portfolio with an average position size of approximately 0.9% of fair value and where our top 10 investments represent only 19% of our portfolio.
Outside of the specific credit statistics associated with our portfolio, our investments are well structured. 98% of our portfolio is invested in first lien securities and 99% of our middle market investments are backed by private equity sponsors. Additionally, all of our core first lien private middle market investments have financial covenants. We think that this combination of being in the lowest risk portion of the capital structure in businesses that are supported by committed private equity capital with financial maintenance covenants represents the most attractive way to invest in our market. We also believe that our portfolio is positioned appropriately for potential changes in the interest rate environment with 100% of our debt investments being floating rate. This also mirrors our liabilities where the vast majority of our debt funding utilizes floating rate borrowings. Our portfolio has also performed very well to date with only 1% of total debt investments at fair value on nonaccrual represented by only 2 positions out of 110.
And lastly, we have built this conservative portfolio with a healthy weighted average yield of approximately 11.3% on fair value of investments. This yield has been achieved with approximately 14% of our portfolio in broadly syndicated securities, such that we have positioned the portfolio for upside in spreads relative to our competitors over the next few quarters as we rotate out of these lower spread broadly syndicated investments. Our portfolio is diversified by end market and industry with a focus on stable, slower growing segments of the U.S. economy. As you can see in our earnings presentation, our largest industries are distribution, food products, business/industrial services and containers and packaging with the largest representing only 14.6% of the total portfolio. Financing businesses in these stable, lower growth industries with typical enterprise values in the 8 to 10x range allows us to build portfolios with more conservative leverage and better interest coverages.
Turning to our private middle market investment activity in the third quarter of 2024, we made $183 million of total commitments across 14 different businesses during the period, of which $161 million was funded. In addition, $24 million of our existing unfunded commitments were funded or partially funded during the quarter, representing a combined gross fundings of $185 million. This was a meaningful uptick in activity relative to the third quarter of 2023, where gross fundings were $42 million. We did see a slight uptick in the amount of private middle market repayment activity totaling $83 million of gross repayments during the period, up from $41 million in Q2 2024, but still only 4.4% of average funded investments.
During the third quarter, our broadly syndicated loan portfolio experienced no new fundings and $2 million of repayments. We currently hold approximately $270 million in broadly syndicated loans across 22 borrowers. In coming quarters, we expect to generate enough privately originated mid-market loan volume to rotate out of these broadly syndicated loan investments while still maintaining leverage inside our target ratio of 1.0x to 1.25x.
Now I will turn it back to Frank to discuss the market.
Thanks, Doug. And turning to the market. Since the second half of 2022, we have been operating in a lender-friendly environment when it comes to pricing and terms for middle market financings. That said, there were substantial declines in M&A activity during that period, leading to somewhat depressed financing volumes. That has changed somewhat over the last 9 to 12 months as the macroeconomic picture continues to exhibit resiliency and M&A activity has increased somewhat. For the market as a whole, through the first 3 quarters of 2024, middle market sponsored loan volumes have increased substantially with commitments increasing approximately 65% versus the same period in 2023. We believe a substantial driver in this uptick in activity has been the private equity community moving to transact after a period of lower M&A volumes over the prior 1 to 2 years.
Additionally, we see substantial transaction flow from our existing portfolio investments, both as part of supporting acquisition activity and in certain instances, financing the same company through a change of control with different private equity sponsors. Our portfolio of over 100 investments help support new investment flow regardless of new platform investment activity. KBDC's existing portfolio of private middle market investments has an average spread over SOFR of approximately 625 basis points. While we've seen some market compression, most of the new transactions we are reviewing today have a spread over SOFR of approximately 550 basis points and our private middle market investments in the year-to-date 2024 period have an average spread of approximately 590 basis points. While we cannot predict where spreads will go in the future, we have seen signs that spreads have begun to stabilize, coupled with accelerating loan volumes.
Regardless, we still see expected yields on our new investments of nearly 11%, which remains incredibly healthy, particularly as compared to a longer-term historical view. We have always believed that our market represents an all-weather investment product, particularly for seasoned private credit platforms in lower-risk portions of the capital structure, and we believe that remains the case today.
With that, I'll turn it over to Terry Hart to discuss KBDC's third quarter 2024 financial results.
Thanks, Frank. Starting with our income statement. During the third quarter, we earned net income per share of $0.53 compared to $0.46 during the second quarter and net investment income per share was $0.52 compared to $0.51 in the prior quarter. Total investment income for the third quarter was $57.8 million as compared to $52.5 million in the prior quarter. The increase to income was primarily driven by the additions to the portfolio during the third quarter, slightly offset by a decrease in our average portfolio yield. It's worth noting that substantially all of the decrease to the portfolio yield was related to lower reference rates.
Total expenses for the third quarter were $20.8 million compared to $18.1 million for the prior quarter. The increase was primarily from higher interest expense resulting from additional borrowings on our credit facilities to fund investment activity during the quarter. As a reminder, in connection with our IPO, Kayne Anderson instituted a 25 basis point fee waiver of our base management fee through May 23, 2025, and a full waiver on income-based incentive fees through the end of 2024. During the third quarter, we had unrealized gains on the portfolio of $0.5 million compared to unrealized losses of $3.1 million in the prior quarter. The unrealized gains were the result of origination activity during the quarter and to a lesser extent, changes in the fair value of some of our investments. There were no realized gains or losses recognized during the third quarter.
As of September 30, total assets were $2.03 billion and net assets were $1.2 billion. As of that date, our net asset value was $16.70 per share, an increase compared to $16.57 at the end of the second quarter. The $0.13 increase is attributable to generating net investment income in excess of our base dividend as well as the $0.01 increase related to unrealized gains during the quarter. At the end of the third quarter, we had debt outstanding of $788 million, and our debt-to-equity ratio was 0.66x, which is an increase from the 0.53x at the end of the second quarter. We expect to continue the growth of our portfolio over the coming quarters to achieve our debt-to-equity target range of 1.0x to 1.25x. And as Doug mentioned, the fourth quarter is off to a good start.
During the third quarter, we continued to increase credit facility borrowings, improving the utilization of our facilities and are in active dialogue with the lenders in our corporate credit facility to extend the maturity and improve pricing of that facility. Looking forward, as we increase leverage on our credit facilities over the balance of 2024 and into 2025, we'll be monitoring and evaluating the unsecured notes market and reviewing other opportunities to enhance our debt capital stack.
I'll conclude with a few items related to our declared dividends. On November 6, our Board of Directors declared a regular dividend for the fourth quarter of $0.40 per share to shareholders of record on December 31, 2024. The regular dividend represents a 9.6% dividend yield based on NAV per share at quarter end, and our dividend yield based on annualized net investment income for the quarter was 12.5%. As of September 30, our estimated spillover of net investment income was $0.32 per share. As a reminder, just prior to our IPO, our Board of Directors declared 3 $0.10 per share special dividends to be paid in December 2024, March 2025 and June 2025. The first of these payments has a record date of December 5, 2024. Following the payment of these special dividends, it will be our dividend policy to distribute a portion of any excess earnings over and above our regular dividend on a quarterly basis, and we plan to distribute excess earnings through an annual special dividend.
With that, operator, please open the line for questions.
[Operator Instructions] And we will take our first question from Finian O'Shea with Wells Fargo.
I wanted to ask about some of the opening remarks on the lower middle market being better. It looks like you're definitely getting enhanced spreads, OID, shorter tenure and so forth, even against your peer set. So are you going very lower middle market, like $10 million? Or is -- are perhaps some of the EBITDA sort of abstract or the companies maybe might go through a challenge and you'll work them out? Or how would you describe your flavor of higher returns?
Yes. This is Ken Leonard. Thanks, Finian. I think if you look at how we stratify our average EBITDA is north of 50. The median is in the high 30s. But the majority of what we're doing are financing platform companies that are benefiting from buy-and-build strategies. And again, we are a platform that while we're significant in the middle market, we're nimble enough to be able to select what we want to do. So if you look at the broad scale of $50 million and below, we're at platform-wide below 3x in leverage and a turn below the market and commensurately priced. And we do this by focusing on selectivity and not necessarily focusing on buying the market averages. So it's really a combination of our long-term strategy of being a value-oriented lender, being very selective in terms of the sponsors we work with and then focusing on buy and build where you tend to get less spread compression over time and benefit from a more diversified and larger business and continue to be able to scale up in an agency position.
And the other component is the fact that 3/4 of what we do we are agent or co-agent, so we're in a better position to benefit from the highest fees being paid and to have an influence over how that deal is priced.
Okay. That's helpful. But I guess just to press a little more here, there's one -- not asking you to go too far in a name, but M2S this quarter that was syndicated, you bought it at a big discount. That means like a lot of people looked at it and didn't want it at par. It's just -- are these -- is there some level of -- some area of complex -- is it just roll-up style complexity? Or how much deeper does it go?
Yes. Ken, I can start on that, and then, Frank, you can hit that specific deal. This is Doug Goodwillie, Fin. I think really when it comes to the strategy, it's everything Ken mentioned, but it is what we call value lending. So again, staying in industries that are lower growth, stable, staple, maybe get looked over versus some of our competitors that focus on higher growth industries. And like Ken said, we're not an index fund. So we're doing 20 to 30 new platforms a year. We can stay very disciplined on price. And we're not doing a ton of unitranche. So we're keeping leverage multiples low that way. We will, in certain instances, embrace complexity. By no means, Fin, is that looking at stressed companies at all. But if there is some complexity, we will dig into it in certain instances, and I think you can get paid for that as well. And then, Frank, you can, at a high level, maybe cover a specific instance that Finn brought up.
Yes. I think just to cover that, Doug, Fini, we think about a bell curve approach to how we look at pricing. So the majority of things are going to be, we think, at or above market pricing. And then there's going to be some things that we're going to opportunistically do that are going to be well above the market. And there's going to be some things we're going to do for sponsor relationships or deals that we think have very strong risk-adjusted returns that we're going to dip down below the 5 handle and go into the 4s. And it's really just sort of a bell curve approach. And we've always done it that way. And what you'll find if you look at the portfolio broadly on the BDC or any of our other vehicles is that's very consistent. So you won't see us dipping down the 475 in this market very often, but we do want to take advantage of sponsor relationships, different opportunities and also not passing up good well-priced deals, particularly as we're also trading -- trying to trade out of the BSL portfolio over the next few quarters.
Okay. Just one more. On a lot of these, you're getting good OID. Is there also a meaningful call protection component?
Yes. I would say in the majority of our transactions in the core middle market, we're seeing 2 in the first year and 1 in the second year. On occasion, we'll get 3, 2 and 1. That's been less commonplace in recent quarters. But I would say in almost all of our deals, we are getting 2 and 1. And then if there's extensions, we're renewing that call protection wherever we can.
How like above market is that right now, the 2 and 1?
I'd say that's pretty much on market. I think it's a little hard to go off market on call protection. I think some sponsors are less sensitive to it. Some lenders are less aggressive about asking for it. So on the margin, I would say we're pretty aggressive about trying to obtain it. But for the most part, that's what the market is giving when it's providing for it.
And we will take our next question from Doug Harter with UBS.
You talked about the fourth quarter being off to a good start. Can you just talk about your updated timeframe and when you think you can achieve target leverage?
Sure. Thanks, Doug. I think as you're aware, the nature of the business is such that projecting and originating repayment activity with specificity any given quarter is always a bit of a challenge. That said, we feel that on the whole, we've continued to execute on our origination plan following the IPO and have increased our debt-to-equity ratio quarter-over-quarter in an environment where we're seeing continued upticks in total activity. Doug previously mentioned, the fourth quarter is typically a seasonally active quarter for us, and we're already north of $180 million of gross new commitments closed or in closing for the fourth quarter, and that's with a substantial pipeline of new opportunities beyond that, some of which we expect to fund in that fourth quarter. Obviously, offsetting some of that will be realizations, which while accelerating the recognition of fee income will be an offset to that portfolio growth.
I think in total, we feel really good about the current trajectory of portfolio growth without sacrificing our investment philosophy. Additionally, we really share the same bullish view on outlook you're hearing from others. We're very, very busy right now in terms of deals reviewed, screens of committee and deals in closing. And we really don't see signs of that slowing in recent weeks given the activity we've seen and the dialogue with sponsors and investment bankers on our pipeline. Our view right now and going into 2025 is that this is all -- this activity level is being driven by a combination of factors, including pent-up demand from a slower 2023, lower rates and spreads, which should drive M&A, a strong economy, a settling in the political outlook post-election, along with a potential cap gain expiration in 2026, which should drive some acceleration.
We see this as a really nice setup for a robust '25. And additionally, all of that should put a floor under the spreads and the talk of spread compression that you're hearing. So without being too specific, we feel bullish on being able to achieve that in the coming quarters.
And we will move next to Kenneth Lee with RBC Capital Markets.
Just one on the portfolio yields. You mentioned in the prepared remarks that most of the impact was due to lower base rates. Wonder if you could just remind us again what the typical lag or terms in terms of floating rate adjustments you have across the portfolio of debt investments there.
So yes, thanks, Ken. First of all, in terms of like proactive pricing changes outside of M&A, we've only had 5 out of 10 -- so feel very good about the stability of pricing. Obviously, nothing you do about SOFR, everyone is subject to that. In terms of spread compression, we -- I think we've commented on that, and it's been, I think, relatively modest compared to what's going on in the larger market and some others have reported. So I think in terms of -- and then in terms of -- if your question was around SOFR, CFOs are locking in. And so depending on whether they're locking in for 1 month, 3 months or 6 months, there's going to be a roll-off as SOFR changes and a slower decline to the new normal as those come off. And that's obviously a relatively complicated formula because within each loan, they're may be locking in some 1 month, some 3 months, some 6 months -- some even lapse if they don't lock into a prime rate, you get the benefit there as well.
Got you. Very helpful there. And then in terms of the prepayment activity and obviously, more difficult to forecast. I wonder if you could just remind us again how KBDC could benefit in terms of fee income as prepayments pick up potentially over the near-term.
Yes. Terry, why don't you cover that, if you won't mind.
Yes, sure. So just the way that we account for those accelerations would be if there is any of that OID that's remaining at the time of the prepayment, then all of that's accelerated into current income. So this quarter, in fact, there was a bit of that. We had 2 repayments in the portfolio, there was about $1 million of accelerated OID or $0.014. So of that $1 million of accelerated approximately $700,000 was due to those 2 exits and then refi and then the rest was just kind of normal course paydown activity.
And we will take our next question from Derek Hewett with Bank of America.
So Terry, you had mentioned in your opening remarks that you were exploring unsecured notes potentially in 2025. So any progress on obtaining a rating from one of the major agencies? And then how long do you think it would take to do an institutionally sized deal?
Yes, sure, Derek. As you know, we do have the rating from KBRA. And so I think we can move forward with one of those larger rating agencies at any time. But I do believe that the strategy that we would probably go forward with is an additional private placement. But as I said, we're still exploring this. Right now, we have $75 million of notes outstanding. If we were to do another private placement, it would get us closer to that $300 million mark that you need to do the institutional type of a deal -- or a public type of a deal. And so I think we would likely leg into that size over time. And at that time, whenever we have that total amount of closer to $300 million, whenever that matures, then we would do a larger deal. So that's our current thinking as to how we leg into that strategy.
And it appears that we have no further questions at this time. I will now turn the program back to Ken for additional or closing remarks.
Great. Thank you. Well, we appreciate everybody participating in the call. We're very proud of the quarter and as being public here in 2024 and very excited about our progress, in particular, the strength of the portfolio, the low nonaccruals, the velocity we're seeing from sponsors and new sponsors as well as the stability in pricing and the minimal nature of the restructuring. So we're -- as we've mentioned before, we're very bullish about the current activity as well as activity going into 2025. And we're excited to talk to you again next quarter, and appreciate your support. Thank you very much.
Thank you. This does conclude today's presentation. Thank you for your participation. You may disconnect at any time.