Bain Capital Specialty Finance - Earnings Call - Q3 2021

Transcript

Speaker 0

Good day, and welcome to the Bain Capital Specialty Finance Third Quarter Ended 09/30/2021 Earnings Conference Call. Today's conference is being recorded. And at this time, I'd like to turn the conference over to Kathryn Schneider, Investor Relations. Please go ahead, ma'am.

Speaker 1

Thanks, Emma. Good morning, and welcome, everyone. Yesterday, after market closed, we issued our earnings press release and investor presentation of our quarterly results, a copy of which is 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 Zane 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.

With that, I'd like to turn over the call to our Chief Executive Officer, Michael Ewald.

Speaker 2

Thanks, Katherine, and good morning to all of you. Thanks for joining us on our earnings call here today. I'm also joined by Mike Boyle, our President and our Chief Financial Officer, Sally Dorness. I'll start with an overview of the results of our third quarter ended 09/30/2021, and then provide some thoughts on the overall market environment and our relative positioning. Thereafter, Mike and Sally will discuss our investment portfolio and financial results in greater detail.

So beginning with our third quarter results, Q3 net investment income per share was $0.34 Our net investment income covered our dividend bubble by 100% for another consecutive quarter. And we are pleased that our NII dividend coverage was not reliant on fee waivers by the advisor this quarter as a result of the progress that we've made over the past year in growing our earnings power. Net asset value per share was $17.03 as of September 30, a modest increase of approximately 10 basis points from our NAV as of June 30. Subsequent to quarter end, our Board declared a fourth quarter dividend equal to $0.34 per share and payable to record date holders as of 12/31/2021. This represents an 8% annualized yield on ending book value as of September 30.

So during the quarter, we continue to see high volumes of new loan origination in the middle market driven by favorable macro environment backdrop and elevated sponsored M and A activity. Q3 gross originations were $286,000,000 approximately 35% higher than Q2 gross origination volumes. Our portfolio also continued to exhibit a healthy amount of sales and repayment activity totaling $255,000,000 and in line with the prior quarter. As a result of this activity, our net investment activity totaled $31,000,000 While the current market environment remains competitive, BCSF benefits from Bain Capital Credit's private credit group platform, which has a track record of investing in the middle market for over twenty years and has developed long staying relationships with our global sourcing partners over this time. Our team is further augmented with the greater resources of the broader Bain Capital platform as we utilize the deep industry expertise within Bain Capital Credit's industry research team to uncover companies and niche industries and can leverage insights and relationships across the firm, providing us with a competitive edge when performing diligence.

Bain Capital's global platform has allowed BCSF to maintain its selectivity and discipline when choosing which new investment opportunities to underwrite. Recently, have viewed the relative value as being more attractive in Europe given the frothiness of The U. S. Market leading to higher levels of investing activity out of our European offices. These trends have persisted throughout the year and continued here into the third quarter with approximately two thirds of our new originations being comprised of companies domiciled outside of North America.

Having a local team there and a longstanding presence across two offices in Europe has allowed us to uncover leading players in their niche markets where we are finding more attractive relative risk return trade offs. Importantly, our underwriting standards have not diminished despite the increase in competition in the space. 100% of our new originations to new companies during the quarter benefited from financial covenants, which is consistent with our overall portfolio where about 95% of our debt investments also have covenants. Similarly, our credit quality trends remain stable. Company performance for the vast majority of our portfolio has been better than expected in 2021 and we have not witnessed a second wave of defaults or amendments as demonstrated by there again being no investments on nonaccrual status as of quarter end.

Turning now to our liabilities, we've remained hard at work on improving our liability structure. During the quarter, we repurchased 25% of our $150,000,000 8.5% notes as we were able to take advantage of an opportunity to reduce a portion of this relatively expensive debt at a discounted price to our make whole premium prior to maturity. This allowed us to reduce the weighted average interest rate on debt outstanding to 3%, an improvement of approximately 20 basis points quarter over quarter. It is also worth mentioning that the remaining $112,500,000 of this debt matures in 2023 and our non call period expires in June 2022, representing an opportunity to further reduce our aggregate weighted average cost of debt. Subsequent to quarter end, we continue to enhance the right side of our balance sheet as we took advantage of low treasury rates and strong investor demand levels in the institutional unsecured debt markets.

In October, the company issued $300,000,000 of investment grade 2.55% unsecured notes maturing in October 2026. These notes are 40 basis points tighter than the 2.95% March 2026 notes that we issued earlier this year. Pro form a for this issuance, unsecured debt represents approximately 53% of the company's debt outstanding as of September 30, a significant improvement from 30% as of September which enhances the company's balance sheet flexibility. We continue to look for ways to further optimize our financing flexibility and costs in order to drive earnings accretion for our shareholders. I'll now turn the call over to Mike Boyle, our President to walk through our

Speaker 0

investment portfolio in greater detail.

Speaker 3

Thanks, Mike. Good morning, everyone. I'll I'll start with our investment activity for the third quarter and then provide an update on our portfolio. Q3 new fundings were $286,000,000 across 39 portfolio companies, including $229,000,000 in 10 new companies, dollars 46,000,000 in 28 existing companies and $11,000,000 in the ISLP. Sales and repayment activity totaled $255,000,000 As Mike highlighted earlier during the call, our new investment activity this quarter benefited from Bank Capital Credit's global sourcing capabilities as approximately 65% of our new originations were sourced from our offices in Europe.

Our largest new investment commitment during the quarter was an investment source from our London office. The company is an Israel based global provider of an on the move broadcasting technology for news and sports reporters. Our ability to win this investment was driven by the early insights and knowledge that we were able to obtain through leveraging Bain Capital Credit's industry research team in the broadcasting sector. These early insights were very valuable in our diligence at the outset of our investment in the company, and our ongoing relationship with the management team enabled us to successfully retain our financing incumbency as the company was recently sold to another private equity buyer during the quarter. Given the higher levels of investing activity from our European offices, we increased the size of our investments to the International Senior Loan Program or ISLP during the quarter.

As of quarter end, ISLP represents the company's largest investment at 6.1% of the total portfolio at fair value, an increase from the prior quarter end at 5.7%. The company earned approximately 10% annualized return on this investment during the third quarter. While this is in line but on the lower end of our double digit return objective, we estimate this to improve in the coming quarters based on the continued ramp of the portfolio. The company's total equity commitment to the ISLP also allows for this investment to grow over time with the potential to drive greater net investment income to BCSF. Turning to the investment portfolio.

At the end of the third quarter, the size of our investment portfolio at fair value was $2,400,000,000 across a highly diversified set of 105 companies operating across 29 different industries. Our investments largely comprised of first lien loans to sponsor backed middle market businesses. As of September 30, 80% of the investment portfolio at fair value was invested in first lien debt, 5% in second lien debt, 1% in subordinated debt, 8% in equity interest and 6% in the international senior loan program. Portfolio yields were relatively stable quarter over quarter. As of 09/30/2021, the weighted average yield of the investment portfolio and amortized cost and fair value were 7.57.6% respectively as compared to 7.57.7% respectively as of 06/30/2021.

We remain focused on improving the yield of our total portfolio to an 8% yield target while maintaining our focus on senior secured loans. Moving on to portfolio credit quality trends. Credit metrics at our borrowers were stable quarter over quarter. The median leverage through our investment was 5.1 times, an improvement from 5.3 times as of June 30. The portfolio median EBITDA was $45,000,000 highlighting our focus on the core middle market.

This is a market segment that we continue to favor in which we can win deals based on sponsor relationships and diligence capabilities rather than solely competing on pricing and terms. Within our internal risk rating scale, credit quality trends were stable. 90% of our portfolio at fair value was comprised of risk rating one and two investments, with the risk rating one being the highest risk rating in terms of positive credit performance. The percentage of the portfolio was modestly up from 89% as of prior quarter end. Risk Rating three investments comprised 10 of our portfolio at fair value, down from 11% as of prior quarter end, driven by a reduction in the number of companies due to positive underlying credit performance.

There continues to be no investments classified as a risk rating for our lowest risk rating in terms of credit quality. Our risk rating one and two investments have a weighted average fair value mark of approximately $0.99 on the dollar, reflecting a continued gradual improvement of approximately 40 basis points quarter over quarter. Our risk rating three investments have a weighted average fair value mark of approximately $0.84 of par and this was relatively flat to prior quarter end valuations at 84.5% of par. While a handful of these companies have had to amend forecasts again due to the impacts of the delta variant, we continue to see strong sponsor support for these COVID rebound names and importantly, liquidity has not been an issue. Many of these companies are starting to see demand return and adjust to more normalized levels.

We continue to believe these investments have the potential to contribute to NAV appreciation as we expect our original investment thesis to remain intact. Non accrual trends within our portfolio were favorable as this metric was stable quarter over quarter. As of September 30, we had no investments on non accrual status. 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 third quarter twenty twenty one results with our income statement. Total investment income was $49,500,000 for the three months ended 09/30/2021, as compared to $46,500,000 for the three months ended June 30. The increase in investment income was primarily due to an increase in prepayment related income and other income. Total net expenses for the third quarter were $27,800,000 as compared to $24,600,000 in the second quarter.

The increase was driven by an increase in investment advisory fees as a result of no fee waivers by the advisor during the quarter. As we have discussed with our shareholders in previous quarters, we have been focused on driving higher net investment income without the need for fee waivers to cover our regular dividend. This quarter, we are very pleased with our ability to achieve this for our shareholders given our continued focus. The net investment income for the quarter was $21,800,000 or $0.34 per share as compared to $21,900,000 or $0.34 per share for the prior quarter. During the three months ended 09/30/2021, the company had net realized and unrealized gains of $1,600,000 including $4,100,000 of net gains across investments and 2,500,000 realized loss from the partial extinguishment of our eight point five percent 2023 notes.

This onetime impact is offset by the improvement to our financing costs in future quarters. GAAP income per share for the three months ended 09/30/2021 was zero three six dollars per share. Moving over to our balance sheet. As of September 30, our investment portfolio value totaled $2,400,000,000 and total assets of $2,500,000,000 Total net assets were $1,100,000,000 as of September 30. NAV per share was $17.03 as compared to $17.01 at the end of the second quarter, representing a 0.1% increase quarter over quarter.

Our gains were attributed to broad based net gains across the portfolio and partially offset by the realized loss from the extinguishment on our debt as mentioned earlier. At the end of Q3, our debt to equity ratio was 1.23 times compared to 1.2 times at the end of Q2. Our net leverage ratio, which represents principal debt outstanding less cash, was 1.15 times at the end of Q3 as compared to 1.12 times at the end of Q2. Our net leverage ratio continues to be in line with our stated target range of between one and one point two five times. Turning to our capitalization and liquidity.

Available liquidity consisting of cash and undrawn capacity on our credit facilities was $355,000,000 against our $225,000,000 of undrawn investment commitments. This represents coverage of 1.6 times as of September 30 as compared to two times as of June 30. Pro form a as of September 30 for our October 2026 notes offering, our coverage is back to over two times. For the three months ended 09/30/2021, the weighted average interest rate on our debt outstanding was 3%, an improvement from 3.2 at the prior quarter end, driven by our notes repurchase. As Mike mentioned earlier, our team remains focused on ways to further improve the cost of our liability structure in order to drive value for our shareholders.

As of 09/30/2021, the company was in compliance for all terms under its secured credit facility. With that, I will turn the call back over to Mike for closing remarks.

Speaker 2

Thanks, Sally. We were very pleased to have demonstrated some progress for our shareholders this quarter through higher interest income and an improvement in our liability structure in order to drive higher earnings. We believe the company remains well positioned to source new middle market lending opportunities given our global footprint and deep industry expertise while remaining disciplined in our credit selection. As always, we thank you for the privilege of managing our shareholders' capital. Emma, please open the line for questions.

Thanks.

Speaker 0

We will now take our first question from Paul Johnson from Keefe, Bioton Woods. Please go ahead. Your line is open.

Speaker 5

Yes. Good morning, Thanks for taking my questions. Just a couple, but I was curious on the repurchase of the 8.5 percent bonds during the quarter. It was a good opportunity to be able to buy those back at a discount, as you said. Is that more of a one off opportunity type of thing that you took advantage of?

Or is that something you think you would like to look at potentially doing again in future quarters prior to that non call period?

Speaker 3

Yeah. Thanks for the question. So we are always looking to opportunistically, buy back that more expensive debt in our capital structure. So we do you know, we will try to be opportunistic going forward, but, you know, it's hard to say exactly what we'll be able to do between now and and when the non call is up in the summer of twenty twenty two.

Speaker 5

Okay. And then, just on the kind of a broad question, but on the sponsor activity, obviously across the space, we're seeing heightened repayments and just a very robust activity. Have you seen that carry over into the fourth quarter as well? And do you think that's something you would expect to kind of just continue to play out as it is right now over the next couple of quarters?

Speaker 2

Yes. Look, I certainly think that the fourth quarter is shaping up to be fairly busier as well, not just because of the economic recovery, but also concerns around whether taxes are increasing and some sellers trying to potentially get ahead of that by year end. So I think the fourth quarter will be fairly busy as well.

Speaker 5

Got you. And obviously, the international deal sourcing that you have has obviously helped you quite a bit and be able to produce a lot of opportunities for you at a time when competition is at its highest here in The U. S. But I'm curious as time goes on and that remains an attractive place for you to invest there. Do you expect to see or maybe are you possibly already seeing competition

Speaker 3

pick up

Speaker 5

in those markets as well and potentially make it harder to find opportunities in Europe? Do you still see that as maybe a less traveled space versus its U. S. Counterparts?

Speaker 2

Yes. Look, it's a good question. I think what I'd point you to is Europe certainly isn't just one monolithic market obviously, right? So I would say there's different pockets where the competition has picked up. We've had an office open there focused on middle market direct lending since 02/2007.

And so we've got a long standing presence there. I'd tell you The UK market, for example, is probably the the easiest in which to compete, especially for, let's say, American players looking to move over there, same language, in legal regimes fairly easy to understand. It's an easy trip, etcetera. So I'd say that market, sure. I think we're definitely seeing some more signs of increased competition there.

But there's a whole lot of other regions, Benelux, Nordics, etcetera, that are certainly less traveled today. And we think it's going be a little harder to potentially break into those markets also just because they're smaller. So I think it really depends on which particular country or region you're looking at within Europe.

Speaker 5

Sure. Got it. Appreciate it. Thank you for taking my questions. That's all for me today.

Speaker 3

Okay. Thanks.

Speaker 0

We will now take our next question from Finan O'Shea from Wells Fargo Securities. Can

Speaker 6

you go over again the international versus US breakdown of this quarter and and and how much you dropped into the ISLP?

Speaker 3

Sure. So so we highlighted about 65% of our net new origin our new originations were, were out of Europe. And so we ended up dropping some assets down into the ISLP. So the ISLP position size went from 5.7% up to 6.1%. But the overall European exposure is sitting at about 19% of the portfolio, between the combination of loans sitting in the ISLP as well as loans sitting directly on our balance sheet made outside of The US.

So we are in a position where we have ample room to grow both within the ISLP as well as, as well as on our balance sheet relative to the 30% basket that, that can constrain, assets outside of The US.

Speaker 6

So this but you were you decide did you make some decisions to not fully grow the ISLP with all of that non US origination, keep some of it on the core balance sheet more than normal it seems or is is

Speaker 3

Sure. So every quarter we go through and and look at at loans sitting on the balance sheet versus the ISLP vis a vis that 30% basket and yield optimization in the portfolio. And so we have chosen to stay at that 19% level between the ISLP and and on balance sheet loan, but I would anticipate that we would continue to move loans into that ISLP program as we seek to manage, the 30% test and the opportunities that we see across Europe.

Speaker 6

Okay. And then it looks like the ISLP return went up from what correct me if I'm wrong. Looks like a pretty similar portfolio size. Did the did the earnings go up in some way for the ISLP, or were you, just retaining earnings earlier?

Speaker 3

Sure. So the earnings have gone up because leverage there is targeted to run between one and one and a quarter, similar to the leverage level, at BCSF overall. And when we originally structured the ISLP, we were at the lower end of that leverage range. And as we drop some assets in, we actually increased the leverage, which which drove the the yield up in across the ISLP complex.

Speaker 6

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

Speaker 2

Great. Thank you, Fin.

Speaker 0

Thank you. There are currently no questions in the queue. I will turn the call back to your host.

Speaker 2

Great. Well, again, thanks, everyone, for joining us today. As I said, we're very pleased with the performance this past quarter, and we look forward to bringing you more news next quarter. Thanks very much. Have good days.

Speaker 0

Ladies and gentlemen, that will conclude today's conference. You may now all disconnect.