Earnings Call Transcript - KBDC Q2 2025

Operator, Operator

Hello, and welcome to Kayne Anderson BDC, Inc.'s Second Quarter 2025 Earnings Call. As a reminder, this conference is being recorded. It is now my pleasure to turn the conference over to Andy Wedderburn-Maxwell, Managing Director. Please go ahead.

Andy Wedderburn-Maxwell, Managing Director

Good morning, and welcome to Kayne Anderson BDC, Inc.'s Second Quarter 2025 Earnings Call. Today, I'm joined by Doug Goodwillie and Ken Leonard, co-CEOs of KBDC; Frank Karl, Senior Vice President; and Terry Hart, CFO. 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 on them. 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. Now I'd like to turn the call over to Ken Leonard.

Kenneth B. Leonard, Co-CEO

Thank you, Andy, and thank you, everyone, for joining the call today. I'd like to start with an overview of our financial results before discussing investment activity during the second quarter, current market conditions, and our recent investment in SG Credit, announced just after the quarter end. I'll then turn over the call to Frank Karl to go over our portfolio makeup and performance. And finally, Terry Hart will conclude with details on KBDC's financial results. As of the close yesterday, we reported solid second quarter results, generating stable net investment income of $0.40 a share and net income of $0.35 a share, representing a 9.8% annual return on equity. During the quarter, we distributed $0.40 per share regular dividend and a $0.10 per share special dividend in conjunction with the final of three lockup releases occurring on May 21. Our NAV at quarter end was $16.37, a 0.8% decline quarter-over-quarter, due in part to our final $0.10 special dividend payment, coupled with some minor unrealized losses. At quarter end, our estimated spillover in net investment income was $0.12 per share. Despite the trade and policy-related disruptions across most markets during Q2 '25, we had $129 million of gross new private credit investments. In the quarter, we also funded a total of $129 million, of which $101 million represented new investments and $28 million represented existing previously unfunded commitments. This is in line with private credit fundings from Q2 '24 of $136 million. While Q2 '25 generally represented something of a market-wide slowdown, we remain quite active, particularly in the latter part of the quarter. We firmly believe that our ability to execute on our strategy even in challenging market conditions is representative of our value-add to our private equity clients and shareholders alike. While Q2 '25 was a slower quarter industry-wide, we're seeing signs of an improving market landscape for transaction activity. Our deal team has seen a noticeable uptick in market sentiment in recent weeks, and we have seen a significant increase in total activity to match. We believe this will lead to a solid second half of the year, anchored by a reasonably attractive macroeconomic backdrop, along with rate cut prospects, but tempered by the likely continuation of tariff noise. Transactions that we have reviewed recently and in Q2 '25 mostly have average spreads over SOFR in the 500 to 600 basis point range. Our second quarter middle market loans had an average spread over SOFR of approximately 540 basis points. As always, we remain very selective and disciplined in our capital allocation. Repayment of private credit loans during the quarter totaled $72 million, up from $41 million in the second quarter of 2024, but down from $86 million in the first quarter of 2025. Given the continued relative strength of the broadly syndicated markets and our success in originations, we continued our previously stated strategy to reduce the size of our broadly syndicated loan portfolio and replace those lower-yielding credits with higher yielding loans within our lending strategy. In the second quarter of 2025, we had repaid or sold down $47 million of broadly syndicated loans and have continued to strategically exit these investments in the third quarter. We remain focused on winding down our broadly syndicated loan portfolio and rotating into wider spread private credit loans over the balance of the year. When considering all funding and repayment activity, net investment activity for the quarter was $10 million. This increase raised our debt-to-equity ratio to 0.91x, above our first quarter 2025 debt-to-equity ratio of 0.86x. The third quarter is off to a strong start, bolstered in part by our previously reported investment in SG Credit, which we'll discuss later. We feel we're on pace to hit our target leverage range of 1x to 1.25x in the third quarter, also continuing the execution of our arbitrage with respect to exiting our remaining broadly syndicated loans. Shifting to the portfolio, we are very pleased with the performance and health of our loan book, which remains conservatively positioned with 98% first lien senior secured loans with an average loan-to-value of approximately 43%. As a percentage of fair value, investments on nonaccrual were flat quarter-over-quarter at 1.6% of fair value, although we did add one very small position on nonaccrual status in the quarter. Given the high proportion of investments where we are a lead or co-lead, coupled with our highly experienced workout team, we believe we are well positioned to drive positive outcomes for our shareholders in these situations. Turning to events post-quarter close, in mid-July, we announced an investment into SG Credit, a leading lower middle market credit platform. The investment, which is structured as an $80 million term loan structured inside of NAV with a $34 million delayed draw facility, is immediately accretive to earnings with a yield on funded debt north of 11%. KBDC made a $12 million equity investment for 22.5% ownership of SG Credit. Lastly, on August 5, we launched a private placement unsecured notes offering, and we'll provide further details post-pricing. Given the recent strength in the private placement market with spreads near their tightest levels compared to public markets, we felt this was an opportune time to continue to diversify our sources of funding.

Frank P. Karl, Senior Vice President

Thanks, Ken. Turning to our portfolio composition. As of June 30, 2025, KBDC's portfolio included 114 individual portfolio companies, representing fair market value of approximately $2.2 billion of investments. We have another $251 million of unfunded commitments, comprised of a mix of unfunded revolvers and delayed draw term loans for a total commitment of approximately $2.5 billion. Since June 30, KBDC has closed or is in the final closing process on an additional $176 million of fundings, highlighting the continued improvement in market conditions previously touched on by Ken. This number also includes the investment into SG Credit. We have a number of other higher probability investments in process such that we think there is a reasonable amount of upside to third quarter 2025 originations relative to these amounts. As of June 30, 2025, investments in KBDC's portfolio, excluding those on watch list, have a weighted average leverage of 4.3x, an interest coverage ratio of 2.5x, and a loan-to-enterprise value of approximately 43%. We've also built a diversified portfolio with an average position size of 0.9% of fair value, and our top 10 investments represent only 18% 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 private middle market investments are backed by private equity sponsors. Additionally, all of our core first lien private middle market investments have financial covenants. 100% of our debt investments are floating rate, which mirrors our liabilities, where the vast majority of our debt funding utilizes floating rate borrowings as well. Credit performance across our portfolio remained strong to date with only 1.6% of total debt investments at fair value on nonaccrual, represented by only five positions out of those 114. Lastly, we've built this conservative portfolio with a healthy weighted-average yield of approximately 10.4% on fair value of investments. This yield has been achieved with approximately 8% of our portfolio still invested in broadly syndicated loans. While we have continued to rotate out of these positions, we still have some upside as we reinvest this capital into higher-yielding private middle-market investments. I want to take this opportunity to provide some additional context around our recent investment into SG Credit. The company was founded in 2013 and has originated over $1 billion in commitments and more than 200 companies across its three lending verticals: commercial finance, consumer products, and software and technology. The core lending strategies are focused primarily on asset-backed facilities, recurring revenue loans, and some cash flow lending, all in what we would consider the lower middle market. Kayne Anderson has a long history with many of the principles of SG Credit, including having overlapped at previous institutions. SG Credit has built a solid diversified portfolio of loans to businesses in the smaller end of the market, with an underwriting strategy and credit philosophy that mirrors much of what we do at KBDC. We believe that the investment we structured here represents a measured first step into this market, where we can create indirect exposure for KBDC shareholders into a differentiated and attractive segment of the lower middle market via what is mostly a debt investment into a commercial finance company. The capital provided by KBDC to SG Credit will be used mostly for growth purposes on a fully funded basis. This investment will be approximately 5% of our portfolio. Switching gears to at least touch on the tariffs issue. We've continued to monitor our portfolio company's performance as tariff policies have evolved. Deal teams are in regular dialogue with management teams, and we still feel confident that most of our borrowers will be largely unaffected by the policies since most are domestically focused, both in terms of revenue and sourcing, resulting in minimal direct tariff exposure. For those businesses that do have direct or indirect exposure through their supply chains, we believe that most have pricing power to pass these increased costs on to buyers. With only one new nonaccrual representing 0.2% of our portfolio at fair value this quarter, we continue to see credit events as one-offs as opposed to a part of any meaningful trend. Looking ahead, while we expect some further volatility in markets, we're very happy with the increased level of investment activity so far in the third quarter. The strength of our originations, along with our extensive network of private equity relationships, means we can maintain a healthy pipeline of opportunities at attractive risk-adjusted returns. We believe our portfolio remains well positioned for continued earnings upside in the future as we finalize our rotation out of our remaining broadly syndicated loans and increase leverage to our stated target range of 1 to 1.25x. With that, I'll turn it over to Terry Hart to discuss KBDC's second quarter 2025 financial results.

Terry A. Hart, CFO

Thanks, Frank. Let's first review results of operations. During the second quarter, we earned net income per share of $0.35, and net investment income per share was $0.40 compared to $0.40 in the prior quarter, fully covering our dividend. We were able to maintain net investment income at this level through higher interest income resulting from rotations out of the lower-yielding broadly syndicated loans into middle-market loans and despite the partial expiration of the base management fee waiver. 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. Total investment income for the second quarter was $57.3 million as compared to $55.2 million in the prior quarter. As mentioned, the increase to investment income was primarily driven by the portfolio rotation and the full quarter impact of net additions to the portfolio during the first quarter. These additions were partially offset by the $0.2 million impact of placing Bell USA on nonaccrual status during the quarter. Our portfolio yield was unchanged quarter-over-quarter, and PIK interest remains relatively low at 3.6% of interest income for the quarter. PIK income was elevated from prior quarters because year-to-date interest income from Centerline Communications was converted to PIK during the second quarter. Additionally, during the second quarter, we had approximately $0.5 million of accelerated amortization of OID as a result of realization activity. Total expenses for the second quarter were $28.6 million compared to $26.5 million for the prior quarter. The increase was primarily related to higher average borrowings on our credit facilities and the partial expiration of the base management fee waiver. During the quarter, our incentive management fee was reduced by the 12-quarter look-back incentive fee cap. During the second quarter, we had a small realized loss of approximately $10,000 primarily related to the sale of several broadly syndicated loans, and we had net unrealized losses on the portfolio of $3.5 million compared to unrealized losses of $6.5 million in the prior quarter. The unrealized losses were primarily the result of negative fair value changes related to our investments in Trademark Global, Sundance, and Siegel Egg, partially offset by positive marks on our broadly syndicated loan portfolio and Arbor Works. Additionally, we had $0.3 million of deferred income tax expense related to unrealized gains on equity investments held in our taxable subsidiary. As of June 30, total assets were $2.3 billion, and net assets were $1.2 billion. As of that date, our net asset value was $16.37 per share. The decrease of $0.14 from $16.51 per share as of March 31 was primarily a result of paying the final special dividend related to our IPO of $0.10 per share during the quarter and $0.06 per share related to net unrealized losses during the second quarter. Notably, during the quarter, we had $0.01 of accretion related to our share repurchase program. At the end of the second quarter, we had debt outstanding of $1.054 billion, and our debt-to-equity ratio was 0.91x, which was an increase from 0.86x at the end of the first quarter. We anticipate achieving the low end of our debt-to-equity range of 1x to 1.25x in the third quarter of 2025. During the second quarter, we continued to increase credit facility borrowings and improve the utilization of these facilities. The higher utilization of our credit facilities resulting from robust origination during the third quarter should be beneficial to net investment income over the balance of the year. As Ken mentioned earlier, during the third quarter, as we increase our leverage on our credit facilities and achieve the low end of our debt-to-equity target range, we plan to opportunistically issue unsecured notes to provide additional credit facility flexibility and capacity. Now turning to our distributions. On August 5, our Board of Directors declared a regular dividend for the third quarter of 2025 of $0.40 per share to shareholders of record on September 30, 2025. As of June 30, our undistributed net investment income was dividend, reflecting the continued ramp of our portfolio to achieve target leverage ranges and the strategic rotation out of our lower-yielding broadly syndicated loan investments into middle-market loans. We believe our dividend yield and dividend coverage will more accurately reflect our steady-state operations when KBDC is operating at its leverage target with a portfolio fully invested in middle-market loans. With that, operator, please open the line for questions.

Operator, Operator

Our first question will come from Doug Harter with UBS.

Cory Johnson, Analyst

This is Cory Johnson on for Doug Harter. I just wanted a quick point of clarification just to see if I heard this correctly. So I think you have about $180 million less in syndicated loans on the portfolio. Did you say that you believe you'll be out of those loans by the end of the year?

Frank P. Karl, Senior Vice President

Thanks, Cory. Yes, this is Frank. Just to put a bit of a finer point on it. So in Q3, we've already exited an additional about $100 million of that book. I think the Q2 number was still remaining about $176 million. So we're down into the, call it, low or mid-$70 million of that portfolio. We'll look to strategically exit those throughout the rest of the year. Long way of saying, yes.

Cory Johnson, Analyst

Got it. Just one follow-up. Do you think you'll reach your target leverage by the next quarter? Looking a bit further ahead, once you achieve that, where do you expect it to settle? Do you think it will be closer to the midpoint of that range, or do you believe you can operate at the higher end? Where do you think that will ultimately end up?

Douglas L. Goodwillie, Co-CEO

Yes, Cory, this is Doug Goodwillie. Thank you for the question. Given the investment activity we've observed in the third quarter and what we see in our immediate pipeline, we expect to reach 1.1% during this quarter, as Terry mentioned. We anticipate operating in that range of around 1.1% over the long term. While it may fluctuate based on investment activity, we expect to remain in that range of 1.1% in the long run.

Operator, Operator

Our next question will come from Kenneth Lee with RBC Capital Markets.

Kenneth S. Lee, Analyst

Just 1 on SG Credit. Could you talk a little bit more about how you view the relative risk and return profile for originations within that business versus the rest of your core middle-market investments?

Douglas L. Goodwillie, Co-CEO

I'll start on that. This is Doug, Ken. Thank you for the question. I think SG Credit, as Frank touched on, focuses on the commercial finance business, consumer ABL as well as the recurring revenue loan product. And they focus really in what we would consider the lower mid-market. If our average EBITDA median is usually in the high 30s in our direct lending product, they're focused on a different subset of the market, typically somewhere between $0 to $10 million in EBITDA. And again, they're focused on the asset-based side of that in many of those companies. So they tend to be smaller growth-related businesses. They have a great proprietary origination system that they source over 1,000 deals a year, and their return profile has been really strong, frankly, with gross returns in the 15% range supported by two family offices in the past. Obviously, our investment, both in the term loan as well as in the equity, will help grow that platform from a loan perspective as well as investing into the actual structure and people of the business.

Kenneth S. Lee, Analyst

I appreciate that insight. I have a follow-up question. It seems like this will be structured with a terminal component, indicating that it's a strategic equity investment. From the prepared remarks, it appears there might be opportunities for additional capital allocations over time. How significant could the total allocation to SG Credit be in the long run? I'm looking for a bit more detail on that.

Douglas L. Goodwillie, Co-CEO

Yes. I'll begin with that, and Frank can add his insights since he was involved in the deal with me at SG. We have a substantial delayed draw term loan to support that business's growth, and we believe it serves as a strong platform that allows us to invest more equity to further enhance its development. We consider this an appealing investment in terms of the term loan. Typically, our equity investments are smaller and done alongside sponsor-backed transactions, but in this case, we view it as a strategic long-term investment in SG. I don't anticipate the investment exceeding 10% of the overall portfolio. Nevertheless, we find it to be a very compelling investment from both the debt and the smaller equity perspectives.

Frank P. Karl, Senior Vice President

Yes, I want to reiterate that we have fully funded our current commitments to that vehicle, which makes up about 5% of the portfolio. While there is some capacity beyond that figure, we do not anticipate exceeding that mid-high single digits percentage of the portfolio in the near term, and it will take time to reach that point. Therefore, in the immediate to medium term, a 5% allocation is likely a reasonable assumption.

Operator, Operator

Our next question will come from the line of Paul Johnson with KBW.

Paul Conrad Johnson, Analyst

Just a few more on SG Credit. Maybe you can just kind of help us understand, I guess, what is the benefit of structuring the transaction with SG within the BDC versus maybe structuring something at more of the adviser level in sharing the benefits like a JV structure or just deal flow or something of the like? Is it just the economics are better? Or what makes it more, I guess, beneficial for the investment to be placed in the BDC?

Douglas L. Goodwillie, Co-CEO

I'll start on that and then Terry and Frank can elaborate on some of the consolidation and non-consolidation issues. Paul, you've seen before that other BDCs have invested in commercial finance companies, as it's an efficient way to invest. We find it appealing to invest in a strong cash pay debt security within the actual NAV of SG, along with a $12 million investment into the finance company for minority ownership. From a return perspective, we see this as a very attractive investment for the BDC, providing long-term ownership and a term loan to support the business's growth. Frank and Terry, you can provide further comments on the structure and how being a BDC without facing consolidation issues makes it an attractive investment strategy and your thoughts on leverage charges.

Frank P. Karl, Senior Vice President

At a high level, structuring this is not necessarily simple and straightforward when considering regulated vehicles. However, for us as a platform, the most straightforward way to invest in a business that we see as clearly beneficial was through the BDC, aligned with our return targets, strategy, and hold size. I believe the best option for this investment is within KBDC.

Terry A. Hart, CFO

Yes. And the only thing I would add, as Doug mentioned, we did structure this in a way that it won't be consolidated on the books of the BDC. And so it will look very much like any other investment that we have. We'll have additional disclosure just given the size of the investment. But yes, pretty straightforward.

Paul Conrad Johnson, Analyst

Appreciate that. And how do you feel, I guess, longer term about the ability to basically refinance that loan if that were ever something that you needed to do or get the loan paid off? I mean, you feel pretty good about the ability, if anything were to happen down the road where this partnership just didn't work out as planned? How do you feel about the refinancing of the debt investment?

Douglas L. Goodwillie, Co-CEO

We view this investment similarly to our other investments, recognizing that it is a finance company rather than a typical operating business. It involves an illiquid loan to a privately-owned company, but we believe it is a strong loan. Throughout this process, their Chairman, Mack McNair, noted significant interest in investing in this debt security. It aligns well with our goals at SG; we aim to be more involved in the asset-backed sector and have deep familiarity with the founders and principles through decades of collaboration, including at Cerberus. While we see strong interest, it is important to emphasize that this remains an illiquid loan, much like our other private credit investments. Nonetheless, we plan to hold it and expect it to perform well.

Paul Conrad Johnson, Analyst

Thank you for that information. I appreciate it. Lastly, regarding the comment about earnings being positively impacted by SG Credit, can you clarify if this means that the return on equity or the returns from the overall investment exceed those generated by the on-balance-sheet portfolio? Also, could you provide any information about the current yield on that debt investment?

Frank P. Karl, Senior Vice President

Yes, this is Frank. We mentioned that it has a fixed rate of 11% stream rate. There are also fees associated with that, which will be amortized over the life of the loan. Therefore, on the debt side, that 11% is accretive to the book.

Operator, Operator

And that will conclude our question-and-answer session. I'll hand the call back over to Doug Goodwillie for any closing comments.

Douglas L. Goodwillie, Co-CEO

Thank you. I want to thank everybody for joining us on the call today. We look forward to another strong quarter of KBDC investment activity in Q3 and also look forward to our next earnings call in mid-November. Thank you.

Operator, Operator

This concludes today's call. Thank you all for joining. You may now disconnect.