Bain Capital Specialty Finance - Q4 2023

Transcript

Operator (participant)

Good morning, ladies and gentlemen, and welcome to the Bain Capital Specialty Finance Fourth Quarter and Fiscal Year Ended December 31, 2023 earnings conference call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. If at any time during this call you require immediate assistance, please press star zero for the operator. I would now like to turn the conference over to Katherine Schneider, Director at Investor Relations. Please go ahead.

Katherine Schneider (Director of Investor Relations)

Thank you, Jenny. Good morning, everyone, and welcome to the Bain Capital Specialty Finance Fourth Quarter and Year Ended December 31, 2023 conference call. Yesterday, after market close, we issued our earnings press release and investor presentation of our quarterly and year-ended 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 Factor section of our Form 10-K, 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 the call over to our CEO, Michael Ewald.

Michael Ewald (CEO)

Thanks, Katherine, and good morning to everyone, and thank you for joining us on our earnings call. I'm joined here today by Mike Boyle, our President, and our Chief Financial Officer, Amit Joshi. Before we begin, I would like to welcome Amit. For those who may not have seen our announcement, Amit has been appointed as our new Chief Financial Officer, effective January 1, 2024. He brings a wealth of accounting knowledge, specifically within the private credit and BDC landscapes, and has over two decades of finance and accounting experience. We're excited to have Amit join our management team. I would be remiss if I didn't thank our predecessor, CFO, Sally Dornaus, for her many contributions to the company over the last eight years. Sally remains in place as a senior leader across the greater Bain Capital platform. Thank you, Sally.

In terms of the agenda for the call, I'll start with an overview of our fourth quarter and 2023 full year results, and then provide some thoughts on our performance, the overall market environment, and our positioning. Thereafter, Mike and Amit will discuss our investment portfolio and financial results in greater detail. So first, yesterday, after market close, we delivered strong fourth quarter and full year 2023 results. Q4 net investment income per share was $0.54, representing an annualized yield on book value of 12.3%. Our net investment income covered our dividend by 129% during the quarter. Q4 earnings per share were $0.48, reflecting an annualized return on book value of 10.9%.

For the full year 2023, net investment income per share was $2.19, equal to a 12.6% return on equity. This was up $0.60 per share or 38% year-over-year. Our NII covered our dividend by 137% during the year. 2023 earnings per share were $1.91, representing a total return on equity of 11.4%. Our annual net earnings continued to exceed our dividend payout for a third consecutive year, demonstrating our consistently strong credit performance. Our results were driven by high-quality interest income earned from our middle-market borrowers and stable credit performance across our portfolio during the fourth quarter and throughout the year.

Our net asset value ended the year at $17.60 per share, up from $17.54 from the previous quarter, and up from $17.29 as of Q4 2022, reflecting the underlying portfolio's strength. In addition, total dividends to our shareholders were $1.60 per share for 2023, reflecting a 16% increase from 2022 dividends. Subsequent to quarter end, our board declared a first quarter dividend equal to $0.42 per share and payable to record date holders as of March 28, 2024. As we have highlighted to our shareholders in prior calls, our management team, alongside our board, has been continuously evaluating paying out any additional dividends as we neared year-end.

In recognition of the strength of our 2023 earnings, as demonstrated by the company's strong net investment income and continued growth in our excess undistributed earnings, our board has declared additional dividends to shareholders totaling $0.12 per share for 2024. We intend to pay these special dividends in installments of $0.03 per share each quarter throughout the year. Together with our declared, regular, and special dividend, our total dividend payout for the first quarter represents an attractive yield of 10.2% annualized on ending book value. At BCSF's current trading levels, our total Q1 dividend represents an 11.6% annualized yield, and we believe this is a compelling level for investors on both an absolute and relative value basis across the BDC sector.

Over the course of 2023, our middle-market borrowers across our diversified portfolio demonstrated resiliency against a macroeconomic backdrop of moderate inflation and stunted economic growth. Corporate fundamentals remained solid, with net debt to EBITDA across our borrowers declining to a median net leverage across our portfolio of 4.8 times at year-end. The strong credit quality health of our portfolio is reflected both by the low non-accrual rate of 1% of the portfolio at fair value and the small number of portfolio companies on our watch list, as only 5% of our portfolio at fair value merited a risk rating 3 or 4, our lowest ratings.

We ended the fourth quarter at a net leverage ratio of 1.02 times, at the lower end of our target net leverage ratio between 1-1.25 times, providing us with ample dry powder to capitalize on new investments in the current environment. While middle market transaction volumes were lower throughout 2023, we believe future transaction growth from new LBO and M&A processes are expected to be higher in 2024, with a clearer macroeconomic outlook and increased clarity on the rate environment.

Importantly, while much has been made in the press lately of the return of the broadly syndicated loan market and how it may portend a decline in private credit opportunities going forward, the public markets have never been a player in our core middle market segment of companies with $25 million-$75 million of EBITDA, and we don't see that dynamic changing in the future. Bain Capital's global and longstanding presence in the middle market positions us well to source new investment opportunities from our broad and deep set of relationships while remaining highly selective. Furthermore, our platform incumbency advantage provides us with a sourcing, underwriting, and execution edge.

As new deal flow volume has slowed over the past year, supporting existing portfolio companies has been an increased source of new investment activity across our platform, as we've been providing add-on capital to existing portfolio companies to allow them to grow and execute their business plans. I will now turn the call over to Mike Boyle, our president, to walk through our investment portfolio in greater detail. Mike?

Michael Boyle (President)

Thank you, Mike, and good morning, everyone. I'll start by discussing our investment activity in the fourth quarter and then provide an update and more detail on our portfolio. New fundings during the fourth quarter were $206 million across 43 portfolio companies, including $56 million to two new companies, $145 million to 40 existing companies, and $5 million to the ISLP. Sales and repayment activity totaled approximately $308 million, resulting in net funded portfolio decline of $102 million quarter-over-quarter. For the full year, fundings were $821 million. Total sales and repayment activity for the year were $924 million. As a result of this activity, the size of our total portfolio modestly declined 4% year-over-year.

But that leaves us well positioned with ample dry powder for investment opportunities over the course of 2024. Our new investing activities for the fourth quarter and full year were comprised of a mix of fundings to new portfolio companies and existing portfolio companies. During the fourth quarter, fundings to new portfolio companies represented 27% of total, versus 73% to existing companies. For the full year, 52% of our investment activity was lending to new portfolio companies, with the remaining 48% to existing companies, highlighting the importance of incumbencies in a market with muted LBO volumes. The cornerstone of our investment philosophy is focused on rigorous fundamental due diligence at the industry and company level. During the quarter, we continued to leverage Bain Capital's in-house industry knowledge across our new investments.

Our two largest investments this quarter were to companies within industries that are less trafficked: capital equipment and aerospace and defense. In Q4, we provided a first lien senior secured loan at SOFR + 6.75, and a preferred equity co-investment to AXH Air-Coolers, a supplier of air-cooled heat exchangers, which are manufactured products that are used to cool gases and liquids. We sourced this investment from a high-quality sponsor who also knows the niche and market well and has partnered with us on prior investments within the sector. We also provided add-on capital to Forward Slope, a provider of mission-critical software and surveillance solutions to the defense industry. Aerospace and defense is our largest sector exposure and one that we continue to favor in the current environment, given the non-cyclical nature of the demand drivers in this industry.

Our add-on investment was structured at the same interest rate as our existing first lien loan at SOFR plus 675 basis points. Turning to the investment portfolio, at the end of the fourth quarter, the size of our investment portfolio at fair value was approximately $2.3 billion across a highly diversified set of 137 portfolio companies operating across 31 different industries. Our portfolio primarily consists of investments in first lien senior secured loans, given our focus on downside management and investing at the top of capital structures. As of December 31, 64% of the investment portfolio at fair value was invested in first lien debt, 3% in second lien debt, 2% in subordinated debt, 5% in preferred equity, 10% in equity and other interests, and 16% across our joint ventures.

As we've highlighted to our shareholders on prior earnings call, 96% of the underlying investments held in our joint ventures consist of first lien loans, resulting in a look-through first lien exposure of approximately 82% of the overall portfolio. As of December 31, 2023, the weighted average yield on the investment portfolio at amortized cost and fair value were 13.0% and 13.1%, respectively, as compared to 12.9% and 13.1% as of September 30, 2023. 94% of our debt investments bear interest at a floating rate, positioning the company favorably as interest rates have continued to rise beyond reference rate floors across our loan portfolio. Moving on to portfolio credit quality trends, fundamentals remained healthy, and we have observed positive credit migration across our portfolio.

As Mike highlighted earlier, the median leverage detachment point declined to 4.8x as of December 31st, as compared to 5.0x as of September 30th. Over the course of a year, we were pleased to see declining leverage across older vintage companies that have come back in line with our budgets. During the quarter, we realized a net gain by exiting our investment in BlackBrush Oil and Gas. This was a 2018 vintage investment that was restructured back in 2020, and we are pleased to demonstrate our ability to drive a positive outcome for our shareholders by taking ownership of that business. The gross IRR and multiple of money for our investment in BlackBrush Oil and Gas were 14% and 1.6x, respectively, at year-end.

We have a small residual value that we currently expect a near-term distribution at or near our mark. Within our internal risk rating scale, we saw a modest improvement within our risk rating one and two investments, which indicates that the company is performing in line or better than expectations relative to our original underwrite. As of December 31, these investments comprised 95% of our portfolio at fair value, relatively unchanged from the prior quarter end. Risk rating three and four investments comprise 5% of our portfolio at fair value, consistent with prior quarter end. Investments on non-accrual remain low across our portfolio and represented 1.9% and 1.2% of the total investment portfolio at amortized cost and fair value as of December 31, as compared to 1.5% and 1.0%, respectively, as of September 30. Amit will now provide a more detailed financial review.

Amit Joshi (CFO)

Thank you, Mike, and good morning, everyone. I'll start the review of our fourth quarter 2023 results with our income statement. Total investment income was $74.9 million for the three months ended December 31, 2023, as compared to $72.4 million for the three months ended September 30, 2023. The increase in investment income was primarily driven by increase in dividend and other income. BCSF continues to benefit from high-quality sources of investment income, largely driven by contractual cash income across its investments. Interest income and dividend income represented 97% of our total investment income in Q4. Total expenses for the fourth quarter were $39 million, as compared to $36.1 million for the third quarter.

Net investment income for the fourth quarter was $34.9 million, or $0.54 per share, as compared to $35.6 million, or $0.55 per share for the prior quarter. Net investment income per share for the full year 2023 was $2.19. During the three months ended December 31, 2023, the company had a net realized and unrealized losses of $3.8 million. Notably, the company had $19 million of net realized gain during the fourth quarter, primarily driven by an exit of our investment in BlackBrush Oil and Gas, as Mike highlighted earlier. Net income for the three months ended December 31, 2023, was $31.1 million or $0.48 per share. Moving over to our balance sheet.

As of December 31, our investment portfolio at fair value totaled $2.3 billion and total assets of $2.5 billion. Total net assets were $1.1 billion as of December 31, 2023. NAV per share was $17.60, up from $17.54 at the end of third quarter, representing a 0.3% increase quarter-over-quarter. The increase in our NAV was primarily driven by overearning of our dividend. At the end of Q4, our debt-to-equity ratio was 1.11 times, as compared to 1.22 times for the end of Q3. Our net leverage ratio, which represents principal debt outstanding, less cash and unsettled trades, was 1.02 times at the end of Q4, as compared to 1.12 times at the end of Q3.

As of December 31, approximately 53% of outstanding debt was in floating rate debt and 47% in fixed rate debt. The company does not have any debt maturities until 2026, and that the weighted average maturity across our total debt commitment was 4.3 years on December 31, 2023. Our debt funding continues to benefit from low fixed rate debt structures as we access the unsecured market during the period of low interest rate. For the three months ended December 31, 2023, the weighted average interest rate on our debt outstanding was 5.3%, as compared to 5.4% as of the prior quarter end.

Liquidity at quarter end totaled $448 million, including $343 million of undrawn capacity on our revolving credit facility, $112 million of cash and cash equivalents, including $63 million of restricted cash, and liquidity was netted with $7 million of unsettled trade payables, net of receivables and payables of investments. As Mike highlighted earlier, our board declared our first quarter 2024 dividend equal to $0.42 per share, payable on April 30, 2024 to stockholders of record on March 28, 2024. Given our strong earnings throughout the year, we outearned the dividend paid in 2023, resulting in an increase in our undistributed taxable income or spillover income. We currently estimate that our spillover income totaled approximately $0.87 per share at year-end, reflecting an increase of $0.51 per share from 2022 level.

And currently represent over two times of our quarterly regular dividend. As a result of the company's spillover income expansion throughout the year, our board declared additional dividend totaling $0.12 per share during 2024, which will be paid in four equal quarterly installments of $0.03 per share, alongside our regular dividend. The first additional dividend of $0.03 per share is payable on April 30, 2024, to stockholders of record on March 28, 2024. Including our $0.42 per share regular quarterly dividend, this brings our total Q1 distribution to $0.45 per share, which equates to an annualized dividend yield of 10.2% based on our ending fourth quarter NAV. We will continue to monitor our undistributed earnings against prudent capital management considerations.

Overall, we believe having a strong and meaningful amount of undistributed income is beneficial to the stability of our dividend through varying market conditions. With that, I'll turn the call back over to Mike Ewald for closing remarks.

Michael Ewald (CEO)

Great. Thanks, Amit. In closing, we are pleased with the execution of our investment strategy on behalf of our shareholders during the fourth quarter and throughout 2023. We demonstrated attractive levels of investment income earned across our portfolio and strong credit performance across our middle market borrowers. As we look forward into 2024, we believe we are well positioned to capitalize on attractive growth opportunities. We remain committed to delivering value for our shareholders by producing attractive returns on equity, including through our newly announced additional special dividends. Thank you for the privilege of managing our shareholders' capital. Jenny, please open the line for questions.

Operator (participant)

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. If you have a question, please press the star followed by the one on your touchtone phone. You will hear a three-tone prompt acknowledging your request. Questions will be taken in the order received. Should you wish to cancel your request, please press the star followed by the two. If you're using a speakerphone, please lift the handset before pressing any keys. Your first question is from Paul Johnson from KBW. Please ask your question.

Paul Johnson (VP, Equity Research)

Yes, thank you. Thanks for taking my questions this morning. I just kind of wondered, just kind of give some maybe higher level commentary on credit. Obviously, looks like, you know, there's fewer three and four rated names in the portfolio this quarter. I don't think that BlackBrush would have been one of those names, but maybe talk about the movements there as well as just the new non-accrual this quarter.

Michael Boyle (President)

Sure. Thanks for the question. So as we've highlighted, the number has stayed quite low, particularly our non-accrual number, representing about 1% of the portfolio. I'd say the non-accruals we've had have been highly idiosyncratic and across varied industries. Right now, we have three different names on non-accrual, really spanning from consumer industries to more industrial industries. And I think we have marked all of those positions appropriately, probably close to where we think ultimate recoveries are across the portfolio. I think some of the positive migration has been names that were COVID-era issues that we've seen companies start to perform better. One of the specific companies was actually in an educational travel space that was dealing with a reduction in travel during COVID.

But as we've seen the world reopen and, and the company get back on firm footing, we were able to take that name off of non-accrual and move that up back to a risk rating three. So it really has been highly idiosyncratic, and I think I'd highlight the fact that 95% of the portfolio is at or above budget, really focusing in on the fact that credit, credit has been stable in spite of some of these idiosyncratic issues.

Paul Johnson (VP, Equity Research)

Thanks for that, Michael. That's very helpful. And then I guess, you know, just kind of looking at, you know, the opportunity set globally, you know, where do you kind of weigh, I guess, the best set of opportunities today? I mean, is it Europe, you know, is it the United States, you know, or somewhere else internationally? You know, what do you-- how are you kind of looking at the world today?

Michael Ewald (CEO)

Thanks, Paul. You know, look, I would say today, the relative value across the different geographies is fairly equivalent. As we've talked about in the past, for example, in 2021, the U.S. was a little bit overheated, so we focused a little more on Europe. 2022, we were a little bit more focused on the U.S., given some of the geopolitical concerns in Europe. But as we sit here today, I'd say that they're probably relatively equivalent. The one caveat I would say is that, as Mike highlighted, most of our deal flow or a big chunk of our deal flow in 2023 has been with existing portfolio companies, so there's just been a dearth of new volume across geographies.

So, we're happy to take a look at anything in either geography, certainly Australia and New Zealand as well. But it's just been a little bit more focused on existing portfolio companies, the past year or so.

Paul Johnson (VP, Equity Research)

Great. Thanks for the commentary. That's all for me.

Michael Ewald (CEO)

Sure. Thanks, Paul.

Operator (participant)

Thank you. Once again, should you have a question, please press star one. There are no further questions at this time. I will now hand the call back to Mike Ewald for the closing remarks.

Michael Ewald (CEO)

Great. Thanks, Jenny. And again, thanks, everyone, on the phone, not just for your time today, but for your support of BCSF over the years. We look forward to bringing you more news in the upcoming quarters. Thanks very much.

Operator (participant)

Thank you. Ladies and gentlemen, the conference has now ended. Thank you all for joining. You may all disconnect.