Fitch Ratings has affirmed Barings BDC, Inc.'s (BBDC) Long-Term Issuer Default Rating (IDR), senior secured debt rating and senior unsecured debt rating at 'BBB-'.

The Rating Outlook is Stable.

Today's rating actions have been taken as part of a broader review of business development companies (BDCs), which included 18 publicly rated firms. For more information on the peer review, please refer to 'Fitch Ratings Completes 2023 BDC Peer Review,' available at www.fitchratings.com.

Key Rating Drivers

The rating affirmations reflect the strength of BBDC's relationship with Barings LLC (Barings), a subsidiary of Massachusetts Mutual Life Insurance Company (MassMutual; Long-Term IDR AA/Stable), the first-lien focus of the investment portfolio, a relatively strong track record in credit in vehicles with similar strategies historically, sound risk management, relatively low leverage, a solid liquidity profile, strong dividend coverage and sound funding flexibility.

Rating constraints specific to BBDC include its relatively short operating history as a BDC, above-average exposure to non-qualifying assets, which could yield more valuation or performance volatility, and credit risks associated with the acquired portfolios of MVC Capital, Inc. (MVC) and Sierra Income Corp. (Sierra). However, this is partially mitigated by the presence of a credit support agreement (CSA) from Barings, which will absorb initial losses on both portfolios up to a certain amount.

Rating constraints for BDCs more broadly include the market impact on leverage, given the need to fair-value the portfolio quarterly, dependence on access to the capital markets to fund growth, a limited ability to retain capital given distribution requirements. Additionally, Fitch believes BDCs will experience weaker asset quality metrics in 2023 amid macroeconomic headwinds and higher debt service burdens and slower growth prospects at portfolio companies.

Fitch views BBDC's affiliation with Barings and MassMutual as a rating strength, as it provides access to industry knowledge, relationships with sponsors and banks, investment management resources, distribution and deal flow. Barings and MassMutual have also supported BBDC financially, investing in the stock and unsecured private placement notes, reducing the management fee and increasing the incentive hurdle rate, providing a CSA in support of the MVC and Sierra acquisitions and directly funding $107 million, in aggregate, of the acquisition costs.

At Dec. 31, 2022, BBDC's portfolio was comprised largely of first-lien loans, representing 69% of the portfolio. First-lien exposure was down from historical levels following the MVC and Sierra acquisitions, but increased in recent quarters as sales and repayments were reinvested into first-lien assets. Fitch would view an increase in first-lien exposures favorably, particularly if BBDC is operating at the upper-end of its targeted leverage range.

BBDC's exposure to non-qualifying investments was 25.9% at Dec. 31, 2022, above the peer average, due to its investments in joint ventures and exposure to international investments. While these investments can provide diversification benefits and potentially higher returns, they can add incremental risk to the portfolio if not appropriately managed.

BBDC's asset quality has been sound historically, although seven investments were on non-accrual status at 4Q22, representing 3.9% of the portfolio at cost. Six of these names were in connection to Sierra and MVC acquired portfolios where CSAs are in place to absorb the first $123 million of losses, minimizing potential exposure to BBDC. Net realized gains were above the peer average in 2022, at 0.6% of the average portfolio at value, as the firm benefitted from foreign exchange movements and a sizeable dividend from a single portfolio company which was recognized as a gain. Partially offsetting this was net losses following the sale of investments in the loan portfolio.

BBDC's core earnings yields are in line with the peer group, improved yoy on higher base rates, continued portfolio rotation out of broadly syndicated loans, as well as increased scale and realized operating efficiencies following the Sierra acquisition.

Leverage (par debt-to-equity) was 1.2x at 4Q22, or 1.1x adjusting for short-term investments and net receivables for unsettled transactions, which was above the rated peer average but within the firm's long-term target of 0.9x-1.25x. The adjusted leverage ratio implied a Fitch-calculated asset coverage cushion of 20.9%, which was within Fitch's 'bbb' category leverage benchmark range of 11%-33%. Fitch expects BBDC to manage leverage at a level appropriate to account for the risk profile of the portfolio.

At 4Q22, 49.9% of BBDC's outstanding debt (at par) was unsecured, consisting of five private placements and an inaugural public note issuance with maturities ranging from August 2025 to February 2028. The unsecured funding mix is marginally below the rated peer average, and atop Fitch's 'bbb' category benchmark range of 35%-50%. Fitch would view continued access to the public debt markets favorably and expects BBDC will maintain unsecured funding within-or-above the 'bbb' category range long-term.

Fitch believes BBDC's liquidity position is sound. At 4Q22, the firm had $139.4 million of cash and $335.9 million of undrawn revolver capacity. NII coverage of the dividend has been solid since inception, amounting to 123% in 2022, despite steady growth in dividends per share.

The Stable Rating Outlook reflects Fitch's expectations that the proportion of first lien investments will increase over time as BBDC rotates out of legacy investments from Sierra and MVC, the asset coverage cushion will be maintained at an appropriate level for the risk profile of the portfolio, unsecured funding will remain above 35% and BBDC will maintain sufficient liquidity and solid dividend coverage.

Rating Sensitivities

Factors that could, individually or collectively, lead to negative rating action/downgrade:

A sustained increase in leverage above the targeted range. deterioration of the portfolio risk profile, such that first lien positions decline materially as a proportion of the overall portfolio, spike in non-accrual levels, meaningful realized or unrealized losses, reduction in unsecured debt to below 35% of total debt, weaker cash-based NII coverage of the dividend, or an impairment of the firm's liquidity profile.

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Differentiated credit performance of recent underwriting vintages, demonstrated economic access to unsecured funding through market cycles, sustained increase in unsecured debt approaching 40% of total debt and a reduction in leverage that is not accompanied by an offsetting increase in the portfolio risk profile. An upgrade would also be conditioned upon an increase in the proportion of first-lien loans in the portfolio back to historical levels, consistent core operating performance, and the maintenance of solid liquidity and dividend coverage.

DEBT AND OTHER INSTRUMENT RATINGS: KEY RATING DRIVERS

The equalization of the secured and unsecured debt ratings with the Long-Term IDR reflects solid collateral coverage for all classes of debt given BBDC's funding mix and the fact that the company is subject to a 150% asset coverage limitation.

DEBT AND OTHER INSTRUMENT RATINGS: RATING SENSITIVITIES

The secured and unsecured debt ratings are sensitive to changes in the Long-Term IDR and the firm's funding mix. A material increase in secured funding could result in the unsecured debt being notched down from the IDR.

Best/Worst Case Rating Scenario

International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

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