Q3 2020 Bain Capital Specialty Finance Inc Earnings Call
Got a quality and financial results in greater detail.
We are pleased of delivered strong financial results to our shareholders in the third quarter net investment income was 33 cents per share driven by solid net investment income earned by our investment portfolio.
Earnings per share were 80 cents driven by net appreciation in our investment portfolio due to the reversal of a portion of the unrealized losses recognized in the first quarter.
Net asset value per share as of September thirtyth was $16.27.
I think a 2.9% increase from our NAV as of June Thirtyth.
During the third quarter the portfolio benefited from the spread tightening that we witnessed across credit markets.
We are pleased to see a meaningful recapture of the NAV decline at the portfolio experienced in Q1 as a result of Cove at 19.
Given the high quality nature of our portfolio. We believe there is still significant embedded upside potential in our portfolio to recapture a greater portion of the remaining unrealized losses as spreads and company performance remained stable and our loans are repaid at par.
As of September Thirtyth, our total investment portfolio had a weighted average fair value Mark as a percentage of par of 95.7% as compared to the weighted average fair market value of 98.5% at year end.
In addition, we continued to demonstrate meaningful progress in de leveraging our balance sheet, while delivering stable net investment income to our shareholders.
As of September Thirtyth, our net leverage ratio was 1.33 times down from 1.42 times as of the end of Q2 and significantly down from the end of Q1, where it was 1.78 times.
The decline in our leverage ratio this quarter was attributed to par principal repayments and sales activity together with the increase in our net assets during the quarter.
As a result of this deleveraging we have significantly improved the strength of the company's balance sheet.
First we have greater asset cushion to withstand any potential volatile periods ahead, and second we had better position the company to take advantage of new yield accretive investment opportunities to grow earnings.
Based on the current portfolio, our target leverage range remains one to one and a half times and we're now just about in the middle of that range.
We are comfortable operating there and given the high foresee an exposure within our portfolio, but also maintaining significant asset coverage should market conditions change.
During the third quarter credit quality, and importantly credit clarity continued to improve as exhibited by the following trends in the portfolio.
Weve observed improving revenue cash flow and liquidity trends at or about borrowers as a result of more normalized economic activity and cost cutting measurements action earlier this year.
The average loan to value of our investments is approximately 46% and we believe these valuations continue to hold true in the current environment.
For example, within our portfolio, we have observed sponsors being able to attract new minority equity investments at valuations similar to levels that existed pre ecova 19.
We believe our active portfolio management and ability to come to amenable solutions with our portfolio companies and sponsors is a reflection of the significant resources of our advisor.
These improvements are reflected in our overall risk rating trends and non accrual rates.
As of September Thirtyth, 13% of the total investment portfolio at fair value was in a higher risk rating bucket of either a three or four down from 16% as of the end of Q2.
Non accruals declined quarter over quarter to just 0.2% of the total portfolio at both cost and fair value as a result of no new investments being added to non accrual status and the successful resolution of one of our prior nonaccruals.
Following a period of low new deal activity in Q2 middle market transaction volumes rebounded in Q3 on the backs of sponsor and lender receptivity to new investments and a rebound in economic activity.
In the near term however, we remain cautious given the continued risks in the economy, such as lingering systemic unemployment, especially in the service industries and slow and uneven corporate recovery.
In such an environment, we have been focused on capitalizing our incumbency advantage with existing borrowers as sponsors seek to take advantage of tuck in acquisition strategies.
This allows us to benefit from underwriting an existing portfolio company with a demonstrated history of performance and clean EBITDA, while further benefiting from improved documentation lower leverage and increased economics in order to compensate us for higher risk premiums today.
During the third quarter all of our new investment funding activity was to existing borrowers.
We're also beginning to see opportunities for new platform transactions in the fourth quarter and beyond and we'll continue favoring companies and defensive industries that are less tied to consumer consumption.
We believe the company is well positioned to take advantage of such opportunities expand the core earnings of the company.
Subsequent to quarter end, our board declared a fourth quarter dividend equal to 34 cents per share and payable to record date holders as of December 30, Onest 2020. This.
This represents an annualized 8.4% yield on ending book value as of September Thirtyth.
Based on the current attributes of the investment portfolio. We believe this dividend level is sustainable in this current market environment.
Sally will discuss further it is important to note that our net investment income is largely comprised of high quality contractual cash interest income.
Pik income or payment in kind income represents less than 5% of our total interest income.
As deal flow normalizes in M&A activity begins to pick back up to more normalized levels sales and repayment activity levels should increase as well, providing the company with incremental income through prepayment related fees, including the acceleration of original issue discount rely D. Providing further support to our current dividend strategy.
I will now turn the call over to Mike Boyle, Our Vice President Treasurer to walk through our investment portfolio in greater detail.
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Thanks, Mike Good morning, everyone.
I'll take it off with our investment activity this quarter and then provide an update on the credit quality of our portfolio.
New investment fundings were $29 million, just 16 company.
All of our new fundings in the quarter were two existing portfolio companies.
Sales and repayment activity totaled $90 million driven by pay downs across our portfolio.
During the quarter, we continued to see net repayments of revolvers and delayed draw facility.
Our revolving utilization across these credit facilities is closer to normalized levels at approximately 28% as of September thirtyth.
We believe this is a reflection of the health and strong liquidity profiles of our companies given the sequential improvement demonstrated over the past two quarters.
At the end of the third quarter. The company had significant liquidity consisting of cash and undrawn capacity on our secured facility of approximately $363 million against our $153 million of Undrawn investment.
Representing coverage of 2.4 times.
We believe our portfolio is well positioned in the current environment.
At the end of the third quarter the size of our investment portfolio at fair value was $2.5 billion across a highly diversified set of 107 portfolio companies operating across defensive industries.
Our average investment size is less than 1% of the total portfolio at fair value, resulting in significant diversification.
The weighted average portfolio yield at amortized cost was 6.9% up from 6.6% as of Q2 due to the increased spread following recent amendment.
Our investments consist largely of first lien loan the sponsor backed middle market businesses with a median EBITDA of $44 million.
As of September Thirtyth, 87% the investment portfolio at fair value was invested in first lien debt, including 1% in first lien last out debt.
The remaining portfolio was comprised of 6% second lien debt less than 1% subordinated debt and 6% in equity interest.
We continue to favour middle market companies within the core of the middle market. These companies have diversified revenue streams and topline resiliency.
Furthermore, we were able to benefit from strong documentation within our loan structures, which places us in a strong position to manage downside risk. This is evidenced in our portfolio as we have over 90% of our debt investments with both financial maintenance covenants and effective control right.
The industry is that our portfolio companies operate within are largely comprised of defensive sectors that are less tied to consumer consumption.
Our topline industries are top industries, including technology, Aerospace and defense and healthcare.
We continue to believe that we have limited exposure to industries experiencing the most severe impacts at the pandemic.
Within our internal risk rating scale, 87% of our portfolio at fair value was comprised of ratings one and two.
Indicating that the underlying portfolio companies are performing in line or better than expectations.
The weighted average fair value Mark on these investments was 97% of par as of quarter end compared to an average marked at 99.5% of par at year end 2019.
The remaining 13% of the portfolio was classified as a risk rating three or four these investments have experienced some impact from the pandemic within our risk rating three investments our portfolio companies had well understood value proposition and we have an informed view of their path to recovery over time.
90% of our debt investments classified as a risk rating three or four our first lien senior secured debt.
This places us at the top of the capital structure and minimizes our downside risk.
As of September Thirtyth, our risk rating three and four investments had a weighted average fair value mark of 84% of par and it is our expectation that we'll recognize the par repayment on the majority of these investments over time.
As Mike mentioned earlier during the call no new investments were added to non accrual status during Q3, reflecting overall stable credit quality.
As of September Thirtyth, one of our total 107 investments was on nonaccrual status, representing 0.2% the investment portfolio of both cost and fair value.
Sally will now provide a more detailed financial review.
Thank you Mike.
Hi, good morning, everyone.
Sorry, the review of our third quarter 2020 results in our income statement.
Total investment income was $1.8 million for the three months ended September Thirtyth 2020.
Compared to 47.9 million in the three months ended June Thirtyth 2020.
The decrease in investment income, primarily driven by a reduction in the size of the investment portfolio due to sales and repayment activity.
Our investment income is comprised primarily of high quality.
The majority of our interest income kids contractual cash paying income.
He conservative accounting approach to recognizing commitment fees are structuring fees on new investment by amortizing that over the life of all line as opposed to taking fees upfront.
Pick income or payment in kind represented less than 5% of our total interest income and the three months ended September Thirtyth. We believe the quality of our income is best in class given these attributes.
Total expenses for the quarter were $25.4 million in the third quarter as compared to $27.9 million in the second quarter. The decrease was driven by lower interest and debt financing expenses.
Our average borrowing levels and linerboard.
Net investment income for the quarter was 21, and a half million dollars or 33 cents per share as compared to $20 million or 37 cents per share for the prior quarter.
This quarter, the weighted average fair value Mark on our investment portfolio increased quarter over quarter to approximately 96% as of September Thirtyth 2020. This was largely attributed to broadly spread tightening across our investment portfolio and partially offset by decreased financial performance due to covance.
For certain portfolio company.
As we've discussed on prior earnings call the employee Aruba valuation framework in which nearly all of our liquid investments are being reviewed by an independent third party provider each quarter. We believe these additional layers to review provide for best in class valuation processing.
Finally during periods of increased market volatility.
During the three months ended September Thirtyth 2020, the company had net realized and unrealized gain of $30 million GAAP income per share for the three months ended September Thirtyth 2020, with 80 cents per share.
Now onto our balance sheet as of September Thirtyth, our investment portfolio at fair value totaled two and a half billion dollars total assets of $2.6 billion.
Total net assets were 1.050 billion as of September Thirtyth.
NAV per share with $16 to 27 cents as compared to 15 81 at the end of the second quarter, representing a 2.9% increase quarter over quarter.
The end of Q3, our debt to equity ratio was 1.45 times compared to 1.52 times at the end of Q2.
Our net leverage ratio, which represent principal debt outstanding less cash with 1.33 times at the end of Q3 as compared to 1.42 times at the end of Q2. We believe these are significant improvements to enhancing the strength of our balance sheet quarter over quarter.
In August we favorably amended our vcs that revolving credit facility to reduce the spread payable to 300 that gap and 325.
We also reduced the size of its ability to improve our overall borrowing costs given the large unused portion outstanding and Maui, and while still retaining a meaningful amount of available liquidity.
Over half of our total principal debt outstanding that's comprised of CLL securitization structure and unsecured debt as of September Thirtyth East.
These structures.
In addition, the company with a stronger balance sheet as these facilities provide for greater durability periods of volatility.
Over time, we would like to see unsecured debt become a larger portion of our capital structure given the benefit that these structures provide.
For the three months ended September Thirtyth 2020, the weighted average interest rate on our debt outstanding was 3.3% as compared to 3.7% for the three months ended June Thirtyth a.
The decline was attributed to LIBOR resets that occurred during the quarter.
As of September Thirtyth 2020, the company had cash and cash equivalents of $45 million and $318 million of aggregate capacity under its credit facility.
As of September Thirtyth 2020, the company was in compliance with all term under a secured credit facility.
With that I will turn the call back over to Mike for closing remarks.
Thanks, Sally in closing we are pleased to have delivered strong earnings to our shareholders. This quarter, notwithstanding the still challenging market backdrop.
Our team continues to work hard and monitoring our existing investments to protect shareholder value. While also focusing on identifying attractive new investment opportunities in the current environment.
We believe the company is well positioned to take advantage of these new opportunities given the improved strength of its balance sheet.
We appreciate the support from our shareholders and entrusting us to manage your capital to produce attractive risk adjusted returns.
With that I'd like the operator, please open the line for questions.
Thank you.
We will now begin the question and opposition.
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At this time, we will listen to D. Two standalone roster.
Our first question is from Finian O'shea of Wells Fargo Securities.
[laughter].
Hi, good morning, Thanks for taking my question.
Mike Okay, you talked about topline yields in this environment.
Do you.
You know ER.
Are you willing and able.
Engage in higher yielding strategies or is the market backed out any kind of opportunity.
You identify there for for the BDC and you know and what the style what would drive that.
Any context on on growing the top line yields today.
Sure. Thanks for the question Clinton.
Good night.
So we have seen a number of opportunities to increase yield in the on the top line I'm some of which has already been seen by the 30 basis point increase in our yield of our portfolio quarter over quarter.
We do think there is there has been some spread widening in the market that we can still continue to capture going forward in both first lien and Unitranche security. So we will primarily focus on on that strategy.
Which we think we can increase yields still.
Second lien and subordinated debt is always a small portion of what we do but we do believe that there will be opportunities to increase yield some second lien debt going forward as well.
Sure.
It was sort of you know is as the pipeline reemerges.
Newer origination youre looking at now I assume is mostly first lien.
Hmm, what kind of spread.
A ballpark are you are you looking at.
Or spread and an all in yield that as well.
Sure. So I'd say spreads have widened between kind of 50 basis points to 50, and 75 basis points all in from before the pandemic and so.
We do think there is continued opportunity to ramp in the past, 8% total total return context in first lien senior tranche that's still.
Okay. That's helpful. And then just a follow on to the comments on from sell even more.
Unsecured.
That being as a goal for the BDC <unk> would that does that indicate that you would.
<unk> like replace or reduce the COO.
Component or would it kind of be likes threed, even legs to the stool.
Yes, the way we go through that there's a lot to just figure out what we think that the most efficient way is to to use those facilities and so.
I think then.
The.
Plan would be to have a balanced approach between all of our facilities, but certainly to increase.
That unsecured.
Okay, very well, let's hope on but that's all for me. Thank you everybody.
Our next question is from Ryan Lynch KBW.
Hey, good morning, Thanks for taking my questions.
First would.
The market activity over over the spring and summer months and has been obviously extremely slow given the downturn, which which worked out.
Okay for you guys or you were looking to de leverage your balance sheet.
At this point you guys have done a good job of getting your leverage kind of right in the middle of your your targeted leverage range and now market activity is starting to pick back up.
At this point you know given the place of your balance sheet is in do you guys. See are you guys looking to to grow and deploy capital into new investments and potentially grow leverage or is the thought is to take time to keep leverage here or even a continued.
To push alone, whereas you guys have in the past.
Yeah. Thanks, Ryan its a good question you know Lucky I as I mentioned in the remarks. Your range is still one to one and a half as you point out you know where we're at we're at 133 now. So so we're kind of in the middle there from a from a net perspective, there's certainly isn't any borrowing of doing new deals I think we found the right deal we'd be happy to do it and.
Clearly activities picked up you know we are certainly seeing a lot of deals were also actively bidding on deals so.
It's not a matter of not seeing them or or preferably not being open for business because we very much are.
Yeah, I'd say, there's certainly some deals that have gone away from us there's.
Yeah, I think a lot of people have been pent up for a while and so there's a fair amount of aggressive action around some of the better quality companies out there and we just haven't been willing.
But to add to meet some of those requests out in the marketplace or a yeah. As I mentioned I think we're still a little bit concerned about the state of the economy, what's going on with the virus coming into the winter here et cetera, and so we have been fairly cautious a if we find the right deal I think we'd be happy to or to to lead that her to participate in that.
Yeah. The other point I would make two is the flip side of that coin is we haven't seen as much.
Repayment activity because there hasnt been that much general market activity right. So we would expect that to pick up here in the fourth quarter and going into next year as well. So yeah. What do you think about that further would reduce our leverage giving us further room within our range. If you will to to make new investments as well. So so it's a it's a bit of a moving target I'd say from that perspective.
Okay that makes sense.
Hmm, yes.
Yes, certainly.
That's helpful. Can you just talk about black brush energy that that was a an investment.
Previously on non accrual or can you just talk about what we will do the outcome for that with that we've got restructure was that did that just come back on accrual status is what happened that investment.
Sure. So we did restructure that investment over the quarter.
Where we originally were a first lien lender to that business, we reinstated incremental debt on the business. So less less leverage. So there is a new first lien that we own. We also now owns the equity of the business.
We do think that that positioning will drive us to a place where we'll recover our original investment as well as some incremental return from there so with the help of our restructuring and distressed team up in capital, we focused on that amendment or a quarter and we were pleased to move it off non accrual over the course of the third quarter.
[music].
Okay, and then just one last one on the dividend.
I think you said you guys feel that you're you're comfortable you know with the current level of the dividend. A you gave some commentary on [noise] on aftermarket activity picks up you guys expect to have greater repayments, which increases well I'd income, which will be helpful also higher.
Spreads are currently in the marketplace, which which which helps yields as well in your portfolio.
Obviously, we're also you know in the mid to the pandemic and there's you know you know some investments on your portfolio that have some pretty sizable Mark downs, which which you know for us are higher risk.
Credit issues in the future potential non accruals. So when you made that comment about being comfortable with the current level of the dividend are you guys factoring in some uptake or some increase level of of non accruals or credit issues in the future.
Yeah, the I wouldn't say, there's actually an uptick there I mean, there were looking holistically across the portfolio and I think you know some companies continue get healthier a as we've seen you know I don't think anything that's really got worse over the quarter. So I think that things have stabilized amongst some of the coming to one.
Performing as well and as you remember we did a number of amendments.
In our portfolio at the end of the second quarter, which we think are positioned those companies are fine for the time being so yeah. There's nothing there that that overly concerns us about a any potential increases going forward any of the other point to make there too is Sally point out I point out as well the vast vast vast majority of.
Of our income is actually cash income and not pick income expenses that also speaks to the health of the portfolio right.
Okay understood or those are all my questions I appreciate the time this morning.
Thanks Ryan.
Our next question is from Derek Hewett of Bank of America.
Hi, Good morning, everyone. Most of my questions were already addressed but maybe for Sally what was driving a 30 basis point improvement in the portfolio yield and I'm looking at it on a cost basis. What was did that have to do with that that nonaccrual resolution or were there other factors involved.
Yeah, there is an era oh.
A combination of things certainly that that we.
We had some.
ER positive momentum with with our <unk>.
Portfolio during the quarter.
As well as.
We saw some of that in the in the second quarter were lied bar floors, where were beneficial to us. So it whether it was yes the combination thing.
Okay, and what percentage of the portfolio had much worse and what is the average floor.
HM.
Yeah, I read like you I'm not.
Sure.
So about 75% of the portfolio had LIBOR floors on those floors are at 1%.
Okay.
Great. Thank.
Thank you.
Thank you Doug.
Our next question is from center predicted.
[noise] Hi, good morning, guys. I think there was a question already asked about Floyd growth, but just wanted to ask it a little differently. We've had two quarters of net investment declines I mean, which is obviously due to your defensive stance and kind of your prudence during the.
Time of uncertainty, but I guess in the event that you guys have to be conservative longer and you see those net investment declines through 2021, or how would you feel about your portfolio. I know you mentioned that their own level of repayments, what helped your dry powder and lowering the leverage but.
What are some of the other factors, we need to watch out for.
Yeah look I think in terms of being conservative I think we're conservative as we're concerned about Oh gosh, yeah. The Ami broadly in the market environment I think what we're actually in a very good place from a balance sheet perspective, So I'm I don't feel like we're being.
A force to be conservative because we're actually concerned about our leverage level, we think its well within our target levels. So we are definitely looking at the idea that the other point I would make in terms of southern repayments that Youve seen is some has actually been revolver repayments right. So we saw a huge drawdown of those revolvers. The end of the first quarter and doesn't pay.
Back over the second quarter over the third quarter as well, so I wouldn't read too much necessarily into some of the repayments are from that perspective, <unk> again, what we haven't seen as a as a full scale repayment change of control type transactions here that just hasn't flown through the through the the portfolio yet.
We expect to see more of that in the fourth quarter for sure where entire positions will be taken out, which I think again frees up for their capital to potentially invest in some some higher yielding investments and then what we have now today as well Oh, we just quite frankly anything it's that compelling from a risk reward perspective out there today, but certainly if we did.
We'd be happy to make that investment.
Got it Thats it from me. Thank you so.
Ladies and gentlemen, just a final reminder, if anyone else would like to ask a question you're welcome space Star then one.
Great well hearing I hearing no further questions we want to thank everyone again for their time today. So I appreciate the questions anything else anything else comes up in the meantime, please do feel free to reach out otherwise, we'll look forward to speaking you see.
With you again, a another three months or so thanks a lot.
Ladies and gentlemen.
The conference has now concluded. Thank you. Good evening today's presentation you may now disconnect.