Bain Capital Specialty Finance - Earnings Call - Q1 2022

Transcript

Speaker 0

Good day, and welcome to the Bain Capital Specialty Finance First Quarter Ended 03/31/2022 Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Ms. Kathryn Schneider, Investor Relations. Please go ahead.

Speaker 1

Thanks, Jennifer. Good morning, and welcome to the Bain Capital Specialty Finance First Quarter 03/31/2022 Conference Call. Yesterday, after market closed, we issued our earnings press release and investor presentation of our quarterly results, a copy of which are available on Bain Capital Specialty Finance's Investor Relations website. Following our remarks today, we will hold a question and answer session for analysts and investors. This call is being webcast and a replay will be available on our website.

This call and the webcast are property of Bain Capital Specialty Finance and any unauthorized broadcast in any form is strictly prohibited. Any forward looking statements made today do not guarantee future performance and actual results may differ materially. These statements are based on current management expectations, which include risks and uncertainties, which are identified in the Risk Factors section of our Form 10 Q that could cause actual results to differ materially from those indicated. Bain Capital Specialty Finance assumes no obligation to update any forward looking statements at this time unless required to do so by law. Lastly, past performance does not guarantee future results.

So with that, I'd like to turn the call over to our CEO, Michael Ewald.

Speaker 2

Thanks, Katherine, and good morning, and thank you, everyone, for joining us on our earnings call this morning. I'm joined today by Mike Boyle, our President and our Chief Financial Officer, Sally Dorness. I'll start with an overview of and financial results in greater detail. So yesterday after market close, we delivered strong first quarter results to our shareholders. Q1 net investment income per share was $0.34 driven by solid net investment income earned by our portfolio investments.

Dollars and 22¢, reflecting a 1.1% increase from our NAV as of December 31. We are pleased to demonstrate continued gradual improvement in our NAV for the seventh consecutive quarter.

Speaker 3

Yesterday, after market closed, we delivered strong first quarter results to our shareholders. Q1 net investment income per share was $0.34 driven by solid net investment income earned by our portfolio investments. Our net investment income covered our dividend by 100%. Q1 earnings per share were $0.52 driven by net realized and unrealized gains across our investment portfolio. Net asset value per share as of March 31 was $17.22 reflecting a 1.1% increase from our NAV as of December 31.

We are pleased to demonstrate a continued gradual improvement in our NAV for the seventh consecutive quarter. Subsequent to quarter end, our Board declared a second quarter dividend equal to $0.34 per share and payable to record date holders as of June 3022. This represents a 7.9% annualized yield on ending book value as of March 31. During the first quarter, we witnessed lower activity levels overall in the middle market against the backdrop of a slow growth economy with rising interest rates, increasing inflation, and growing geopolitical tension. While our platform has been actively investing in Europe, particularly over the course of 2021, given the increased attractiveness of this market we saw relative to The US, we've seen a slowdown in new activity levels from our European offices as a result of the volatility stemming from the war in Ukraine.

Importantly, we have no direct or significant exposure to companies located in Russia, Ukraine, or Eastern Europe across the portfolio. Overall, fundamentals remain healthy across our portfolio as credit quality continued to improve during the quarter as reflected in our net portfolio gains and a decrease in our watch list or risk rating three investments. As of quarter end, no investments were on nonaccrual status for another consecutive quarter. Notwithstanding the strength and health of our portfolio, we remain watchful of inflationary impacts across our portfolio as the COVID-nineteen pandemic has created supply and demand imbalances across a number of industries. In particular, we have observed an acute impact in the transportation industry and companies which rely heavily on trade and transportation.

The transportation sector has seen large price increases over the last year as a result of a confluence of unprecedented freight premium and price increases over the last year, and supply chain disruption. In addition, we have observed labor cost increases across service based businesses due to labor market tightness from staff shortages and increased demand. This current market environment underscores our long standing approach to investing in defensive sectors such as technology, healthcare, and business services while avoiding cyclical, commodity, or noncritical businesses. We believe the company is well positioned to benefit from the rising interest rate environment as the majority of our assets are invested in floating rate loans, while a large portion of our debt capital consists of fixed rate debt. We also remain focused on the impact of rising interest rates to our middle market borrowers to ensure there is sufficient cash flow coverage of our debt.

We typically underwrite investments to interest coverage ratios between two and three times, and we believe our borrowers can withstand a gradual increase in base rates in the current environment. Furthermore, this has proven to be manageable for our portfolio companies as observed most recently during the prior period of rising interest rates in 2017 through 2019. In February, we announced the formation of our second joint venture, the Bank Capital Senior Loan Program or SLP. This program is focused on senior secured loans to U. S.

Middle market borrowers. As we discussed with our shareholders briefly during last quarter's earnings conference call, the SLP provides us with increased capacity and balance sheet flexibility to invest in senior middle market loans, which we believe should enhance our capabilities and scale in the current market environment. During the first quarter, the SLP acquired an initial portfolio of primarily first lien senior secured loans that were contributed by BCSF. The SLP benefited from the seed portfolio and the current financing in place on the investment through our existing 20 eighteen-one CLO facility, allowing our investment to produce an attractive return to BCSF. BCSF's investment in SLP represented 2% of the total portfolio of March 31.

Based on the initial capital commitments to the SLP, BCSF investment size in the SLP can grow to almost 10% of the portfolio as we find attractive new investment opportunities. The target return on our SLP investment is in the mid teens. We believe one of the key benefits of this investment for our shareholders is that we can drive higher levels of dividend and interest income to BCSF as we grow this investment over time. While our platform had an active quarter of new originations that we'll discuss in greater detail, the contribution of assets from BCSF's balance sheet to SLP resulted in our balance sheet declining quarter over quarter. As of March 31, our debt to equity leverage ratio was 0.99x on a gross basis and 0.89x net of cash.

This was down from a net debt to equity ratio of 1.12x as of the fourth quarter. Looking forward, we believe the company is well positioned with capital and liquidity as we continue to execute on our long standing strategy of directly originating loans to middle market companies. We remain focused on operating within our stated target leverage range of one point zero to 1.25 times. Lastly, we announced in April that the company received an investment grade rating from Fitch Ratings. We now have investment grade credit ratings from two leading rating agencies, which we believe is a reflection of the demonstrated credit performance across our diversified portfolio of first lien loans and access to the broader bank capital platform, including the breadth of resources, capabilities, and expertise from which the company benefits.

During the quarter, our platform remained active notwithstanding what is typically a slower first quarter from a seasonality perspective and coming off of a very busy end to last year. Q1 new investment fundings were $371,000,000 across 42 portfolio companies, including $247,000,000 in 11 new companies, dollars 72,000,000 in 29 existing companies, dollars 11,000,000 in the ISLP and $41,000,000 in SLP. Sales and repayment activity totaled approximately $170,000,000 resulting in net investment fundings of $2.00 1,000,000 In addition, the company contributed $351,000,000 of investments to SLP, resulting in our net funded portfolio declining by $150,000,000 quarter over quarter. Our new originations were comprised of a diversified set of middle market borrowers across a broad range of over 20 industries. In the current market environment, we remain focused on investing in defensive industries such as business services, aerospace and defense, and technology.

As Mike mentioned earlier in the call, our new investing activity levels slowed in Europe relative to recent quarters last year. During the first quarter, our new investments at new companies were comprised 72% of North American borrowers, 17% in Europe and 11% in Australia. The Bain Capital Credit platform remains well positioned in this market to source attractive new investment opportunities on behalf of our shareholders. Our long standing global presence provides us with a large pipeline of investment opportunities to source from, and we remain selective within the investment opportunities that we choose to pursue based on the relative attractiveness of each investment. Having a global footprint enhances and further diversifies our deal flow, especially given the increased competition we've seen in The US in recent years.

We continue to favor middle market companies within the core of the middle market, which we define as companies with $25,000,000 to $75,000,000 of EBITDA and is evidenced with our median EBITDA of $43,000,000 in our portfolio. Serving as a lender to these middle market businesses provides us the ability to control the tranche and set appropriate financial covenants at a reasonable level of budgeted plans as compared to covenant light structures that are prevalent in the upper middle market and broadly syndicated loan markets. Turning now to the investment portfolio. At the end of the first quarter, the size of our investment portfolio at fair value was $2,200,000,000 across a highly diversified set of 115 companies across 29 different industries. We remain focused on investing in first lien senior secured loans to sponsor backed middle market businesses.

As of March 31, 70% of the investment portfolio at fair value was invested in first lien debt, 5% in second lien debt, 2% in subordinated debt, 3% in preferred equity, 9% in common equity interest, and 10% across our joint ventures, split between 8% in the ISLP and 2% in the SLP. As of 03/31/2022, the weighted average yield on the investment portfolio at amortized cost and fair value were 7.98.1% respectively, as compared to 7.67.8% respectively as of 12/31/2021. 96% of our debt investments bear interest at a floating rate positioning the company favorably as we have recently witnessed interest rates rising beyond the reference rate floors across our loan. ISLP's investment portfolio at fair value as of March 31 was approximately $520,000,000 comprised of investments in 27 portfolio companies operating across 11 different industries. 100% of the investment portfolio was invested in senior secured floating rate loans, including 97% in first lien and 3% in second lien.

As of March 31, SLP's investment pardon me, SLP's investment portfolio at fair value was approximately $372,000,000 comprising investments in 41 companies operating across 21 different industries. 100% of the investment portfolio was invested in senior secured floating rate loans, including 97% in first lien and three percent second lien. Moving on to portfolio credit quality trends. Within our internal risk rating scale, credit quality trends improved quarter over quarter. As of March 31, 91.5% of our portfolio at fair value was comprised of risk rating one and two investments, with a risk rating one being the highest risk rating in terms of positive credit performance.

Risk rating three investments comprised 8.5% of our portfolio at fair value, down from 10% as of December 31. There continues to be no investments classified as a risk rating four, our lowest risk rating in terms of credit quality. The continued improvement in our risk rating three investments contributed to our positive NAV growth this quarter. In particular, we saw positive improvements from select investments within the aerospace and defense and travel sectors. While recovery in air travel was slower than expected in 2021 due to headwinds from various COVID-nineteen variants, air traffic volumes have continued to increase as a result of the gradual increase in business and international travel.

As of March 31, our risk rating ones and two investments had a weighted average fair value mark of approximately 99 of par. Our risk rating three investments have a weighted average fair value mark of approximately 83% of par. We continue to believe our remaining risk rating three investments have the potential to contribute to future NAV appreciation as we expect our original investment thesis to remain intact. No investments were on nonaccrual as of March 31. Sally will now provide a more detailed financial review.

Speaker 4

Thank you, Mike, and good morning, everyone. I'll start the review of our first quarter twenty twenty two results with our income statement. Total investment income was $46,000,000 for the three months ended 03/31/2022, as compared to $51,500,000 for the three months ended 12/31/2021. The decrease in investment income was primarily due to lower prepayment related income and dividend income. Total expenses for the first quarter were $24,300,000 as compared to $29,600,000 in the fourth quarter.

The decrease in expenses were driven by lower interest and debt financing expenses, primarily due to a decrease in total principal debt outstanding and an improvement in our overall cost of debt resulting from the new Sumitomo credit facility that we put in place at the end of the fourth quarter. Net investment income for the quarter was $21,700,000 or $0.34 per share as compared to twenty one point nine million dollars or $0.34 per share for the prior quarter. Our net investment income covered our dividend by 100% and continues to not be reliant on fee waivers by our advisor. During the three months ended 03/31/2022, the company had net realized and unrealized gains of $12,000,000 GAAP income per share for the three months ended March 31 was $0.52 per share. Moving to our balance sheet.

As of March 31, our investment portfolio at fair value totaled 2,200,000,000 and total assets of $2,300,000,000 The total net assets were $1,100,000,000 as of March 31. NAV per share was $17.22 up from $17.04 at the end of the fourth quarter, representing a 1.1% increase quarter over quarter. At the end of Q1, our debt to equity ratio was 0.99x, down from 1.3x at the end of Q4. Our net leverage ratio, which represents principal debt outstanding less cash, was 0.89x at the end of Q1 as compared to 1.12x at the end of Q4. As Mike mentioned earlier during the call, we formed a senior loan program during the first quarter with BCFF contributing approximately $350,000,000 of investments at fair value.

This was the primary driver of our balance sheet and leverage ratios decreasing quarter over quarter. Available liquidity consisting of cash and undrawn capacity on our credit facilities was $392,000,000 against our $235,000,000 of undrawn investment commitments. This represents coverage of 1.7 times as of March 31. For the three months ended 03/31/2022, the weighted average interest rate on our debt outstanding was 2.9% and unchanged as of the prior quarter end. Looking across our debt maturities, we have $112,500,000 remaining principal value of our 2023 unsecured notes that are callable at par in June.

This provides us with a near term opportunity to further reduce our overall cost of debt. Lastly, we wanted to spend a minute on the company's positioning in a rising interest rate environment. The vast majority of our debt investments are invested in floating rate loans. These loans typically have a reference rate floor of 75 to 100 basis points. With three months LIBOR now above 1%, would expect to see an increase in interest income across our portfolio toward the second half of this year, given the timing lag of reset periods on our loans.

Our liabilities are comprised of a mix of fixed and floating rate debt. As of March 31, 65% of our outstanding debt was in fixed rate and 35% in floating rate debt. Unlike the majority of our assets, our floating rate liabilities typically have 0% floors. As of March 31, holding all else constant, we calculate that 100 basis point increase in rates could increase our quarterly earnings by approximately $04 per share. Our Form 10 Q provides further detail on our sensitivity to various changes in interest rates.

With that, I will turn the call back over to Mike for closing remarks.

Speaker 2

Thanks, Sally. And thanks to Mike Boyle for covering for some technical issues I was experiencing earlier. In closing, we are pleased to deliver a strong quarter of earnings and NAV growth to our shareholders, driven by the improving credit quality trends across our diversified portfolio of middle market borrowers. We believe the company is well positioned in the current environment to capitalize on attractive opportunities, notwithstanding the broader macroeconomic and geopolitical backdrop. We remain focused on maintaining our selectivity and discipline when choosing new investments to underwrite.

We thank you for the privilege of managing our shareholders' capital. And Jennifer, please open the line for questions.

Speaker 4

Thank you.

Speaker 0

Again, press star one to ask a question. We'll pause for just a moment to allow everyone an opportunity to signal for questions. We'll go first to Finian O'Shea with Wells Fargo.

Speaker 5

Sorry. I was on mute. Hi, everyone. Good morning. Mike, to your closing remarks on the the NAV improvement, can you add some color to what what drove that across the portfolio and if there were any any puts and takes there given we've seen most BDCs take NAV down a bit this quarter due to due to higher discount yields based on higher market spreads, LIBOR expectations, and so forth.

Speaker 3

Sure. So the primary driver of the NAV increase was improvement in our aerospace and defense and travel, investments. Those had been marked in the mid eighties. And as we've seen, the the market for those companies pick up meaningfully, those marks, moved up quarter over quarter, contributing to that north of 1% NAV improvement. Across our standard first lien investments, they were about flat quarter over quarter.

So at around 99¢ mark both last quarter as well as as well as March 31. So so we ended up holding those those yields flat from a from a NAV perspective.

Speaker 5

Sure. That's helpful. Thanks. And just to follow on on on leverage with the the drop down being complete, can you remind us what your what your target leverage will be, you know, given the the joint venture setups are complete? And in you know, does that change with today's funding market?

Obviously, unsecured is presumably much more expensive at, you know, today, and the the bank lines will be, you know, more immediately impacted by by LIBOR. So just any updated thoughts on how you're thinking about leverage with current market conditions?

Speaker 3

Sure. So we're still targeting leverage between one and one and a quarter, at the at the balance sheet level. We are just, south of one time at at March 31, so there's plenty of room for us to grow and take advantage of the current opportunity set looking forward. Right now, we're we're quite pleased that we have the fixed rate liabilities in the in the bond market that, you know, that are funding the majority of our of our balance sheet. And so we do but we do have revolver capacity to grow at to the top end of that leverage range up to that one and a quarter.

So as we look ahead at the, you know, new investment environment, we'll decide where to, you know, how much to invest and and where to, where to end up in that one to one and a quarter target range.

Speaker 5

Great. That's all for me. Thanks so much.

Speaker 0

We'll go next to Ryan Lynch with KBW.

Speaker 6

Good morning. First question I had was, it was kinda interesting when I was looking at your investment fundings for It was up pretty meaningfully versus the 2021 even when you back out your your contribution to the ESLT in the quarter. That was very different than than the trend I think we saw broader in the BDC space where fundings were down in q one after a very robust third and fourth quarter of twenty twenty one. So can you just speak to to to what what caused kind of the ramp up in in q one versus q four when I think overall market activity is down?

Speaker 2

Yeah. Ryan, thanks for the question. I think it's a a little bit idiosyncratic. I I think it's a great answer there. When you think about it, the we did have a number of deals that we've committed to in the fourth quarter that that leaked into the first quarter a little bit for us, and that just happened to be with the the deals that were in our pipeline.

I think the the other point there is that, there are a number of other BDCs that I would argue participate in a somewhat slightly different segment from ours that are, more on the larger cap side of things rather than the true middle market. And I think the dynamics in that market were just a little bit slower than they were in that core middle market where we tend to participate.

Speaker 6

Okay. Gotcha. Maybe the the similar response, but, you

Speaker 3

know, you talked about sort of

Speaker 6

seeing a slowdown in opportunities, you know, across Europe. And, again, maybe this is just because it kinda happened later in the in the quarter, but you guys actually grew the portfolio in the ISLP in the quarter. So I was also a little bit surprised to see that given what's going on over there that there was actually growth and your commentary of slowdown that that there was growth. So I'm not sure. Can can you reconcile that with that kind of with that growth more first half before all all the issues started, or or what was the driver behind that?

Speaker 2

I I think that's, a bit timing. If you recall that The US, had a bit of a flurry of activity in the fourth quarter given some concerns around increasing capital gains taxes that led to a lot of deals being pulled forward, if you will, which I think also led to a bit of an air pocket in in q one in The US. That same stress or pressure wasn't accident in Europe at the time. And so, the deals that did close in the quarter tended to be ones that we had seen and committed to back, last year. So as you look forward, that's really what we're talking about in terms of Europe.

There's not a lot of new deals that have come out here in in February, March, April, for example, since, since the since the war in Ukraine began.

Speaker 6

And then, you know, you mentioned in your prepared comments, you know, so you're gonna Russia, Ukraine, or or even Eastern Europe. But but you do have, you know, exposure in in that area. And and, obviously, we're still trying to work through, but, you know, what are gonna be the ramifications of everything, which we probably won't know for for months on all the trickle down effects. Even if you don't have correct exposure in those those countries, it feels like Europe is gonna have some some meaningful impact to to to other countries from from the the geopolitical issues going on over there. I guess, have you how much have you had there?

In your evaluation of your company? How confident do you feel that those, you know, companies are set up to to continue to perform fine through this? And what's your confidence level yet knowing that, you know, we're so early in sort of the discovery process and, there's still really just so many uncertainties out there of of how all this plays out and then the ultimate ramifications.

Speaker 2

Yeah. Look. I I I think you're you're certainly right there, Ryan. There's a lot a lot to come there. But, either way we look at it is really, two ways.

One is direct exposure, and one is more knock on effects, which I think is what you're talking about. And and one of the obvious knock on effects is the increase that we've seen across the board in energy prices, oil and gas prices. It has increased as obviously Russia is a fairly large exporter of, of those sorts of assets. So I think that is a going to be a global effect that impacts everybody as opposed to one that that that's really targeted to to Europe specifically. So that's something we've been dealing with even prior to the war, but, obviously, that that war has exacerbated that.

In terms of other knock on effects, I mean, as it turns out, Russia really isn't a particularly large trading partner of anybody in the world. The economy just isn't that big relative to to the global marketplace. I mean, think about it. It's actually smaller than than the state of Texas, the entire Russian economy is. So I think that's really helped mitigate some immediate effects around sanctions and things like that.

They are very important in terms of certain metals that are mined there that are hard to find elsewhere. So we're certainly keeping an eye on that. And then in terms of immediate effects, I I think, you know, we we did spend a lot of time looking at individual company exposure. And so I think that the impact there is pretty well understood. We had or the handful of companies in our European book who had sales offices in either Ukraine or Russia.

We might have one, two, or three sales representatives there. But the overall sales contribution from Russia or Ukraine or even Belarus, quite frankly, was generally in the, like, one to two or 3% range. So we know the direct effects aren't gonna be that big. We do have one company that's most impacted in that they have sub assembly for one of their components happening in a in a factory in Western Ukraine. Amazingly and and my hat my hat goes off to, to the folks back in Ukraine.

Amazingly, that factory is actually still up and running. Workers are showing up, and the components are being made. How how they can manage that in the midst of a war is just mind boggling to me personally, But that is still actually happening. And in that instance, the company has actually identified, two alternative sites within Poland, to to make that sub assembly work in case, that that plant does end up getting shut down, bombed, whatever the case may be. So I think we've got a pretty good handle on the, on the immediate impact.

Speaker 6

Okay. That's that's that's really helpful color and details, you know, on on that knowing that a lot of it is still kinda, you know, the ramifications are to be determined,

Speaker 2

but it sounds like the

Speaker 6

direct impacts are are pretty limited. That that's all for me. I appreciate the time this morning.

Speaker 2

Thanks, Ryan.

Speaker 0

And at this time, there are no further questions.

Speaker 2

Great. Well, thanks, Jennifer, and thanks everyone for for listening in today. Appreciate the questions as well. We are obviously in the midst of working hard here in the second quarter and look forward to delivering those results to you in in due course. Thanks, everyone.

Speaker 0

This does conclude today's conference. We thank you for your participation.