Q1 2022 Bain Capital Specialty Finance Inc Earnings Call

Please standby regards to begin.

Good day and welcome to the Bain capital Specialty Finance first quarter ended March 31, 2022 earnings conference call.

Today's conference is being recorded at this time I'd like to turn the conference over to MS. Katherine Schneider Investor Relations. Please go ahead.

Thank you Jennifer good morning, and welcome to the Bain capital Specialty Finance first quarter March 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 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.

Being 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 of future results.

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

Thanks, Kathryn 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 officers, how are we doing this.

Let's start with an overview.

Sure.

Okay.

Financial results detail.

So yesterday after market close we delivered strong first quarter results for shareholders Q1, net investment income per share was <unk> 34, driven by solid net investment income earned by a portfolio of investments.

Yes.

Okay.

And 22 cents, reflecting a 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.

Yesterday after market close.

We delivered strong first quarter results to our shareholders Q1, net investment income per share was <unk> 34.

Even by solid net investment income earned by our portfolio.

Our net investment income covered our dividend by 100%.

Q1 earnings per share were <unk> 52.

Driven by net realized and unrealized gains across our investment portfolio.

Net asset value per share as of March 31st what $17.22, reflecting a one 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.

Board declared a second quarter dividend equal to <unk> 34 per share payable to our record date holders as of June 32022.

This represents a seven 9% annualized yield on ending book value as of March 31.

During the first quarter, we wouldn't hurt we witnessed lower activity levels overall in the middle market against the backdrop of a slow growth economy with rising interest rates.

Leasing inflation and growing geopolitical tension.

While our platform has been actively investing in Europe , particularly over the course of 2021, given the increase the craft units of this market, we saw relative to the U S.

We have seen a slowdown in new activity levels from our European offices as a result of the volatility stemming from the war in Ukraine.

Accordingly, we have no direct or significant exposure to companies located in Russia, Ukraine Eastern Europe across the portfolio.

Overall credit 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.

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-19 pandemic has created supply and demand imbalances across a number of industry.

In particular, we have observed acute impact in the transportation industry and companies, which rely heavily on trade and transportation.

Transportation sector has been 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 disruptions. 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 longstanding approach to investing in defensive sectors, such as technology healthcare and business services, while avoiding cyclical.

<unk> or non critical 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.

Large portion of our debt capital consists of fixed rate debt.

We also remain focused on the impact of rising interest rates term 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.

More this has proven to be manageable for our portfolio of 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 loan to U S middle market borrowers as.

As we discussed with our shareholders briefly during last quarter's earnings conference call.

<unk> provides us with increased capacity and balance sheet flexibility to invest in senior middle market loans, which.

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 DCSS.

The SLP benefited from the seed portfolio and the current financing in place on the investments through our existing 2018 dash one CLO facility.

Allowing our investments to produce an attractive return to BCS.

<unk> investment in SLP represented 2% of the total portfolio as of March 31.

Based on the initial capital commitments to the SLP Bcf Thats investment size and the MLP can grow to almost 10% of the portfolio as we find attractive new investment opportunities.

The target return on our MLP 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 <unk>.

Dividend and interest income to be UCSF as we grow this investment over time.

While our platform had an active quarter of new originations will discuss in greater detail the contribution of assets from <unk> balance sheet to SLP resulted in our balance sheet.

Decline in quarter over quarter as of March 31, our debt to equity leverage ratio.

099 times on a gross basis and 0.89 times net of cash.

This was down from a net debt to equity ratio of 112 times as of the fourth quarter.

Looking forward, we believe the company is well positioned with capital and liquidity as we continued to execute on our long standing strategy of directly originating loans to middle market companies.

We remain focused on operating within our target leverage range of one point out to one five 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.

<unk>, 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.

Coming off of a very busy end to last year.

Q1, new investment fundings were 300 $371 million across 42 portfolio companies.

Including $247 million in 11, new companies.

$92 million in 2009 existing companies $11 million in the <unk> and $41 million in SLP.

Sales and repayment activity totaled approximately $170 million, resulting in net investment fundings of $201 million in.

In addition, the company contributed $351 million of investments the SLP, resulting in our net funded portfolio declining by $150 million quarter over quarter.

Our new originations were comprised of a diversified set of middle market borrowers across a broad range of upper 20 industry.

And 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 investment new companies were comprised 72% of North American borrowers, 17% in Europe and 11% in Australia.

The bank 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 rock and we remain selective with any 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 U S. In recent years.

We continue to favor middle market companies within the core of the middle market, which we define as companies with $25 million to $75 million of EBITDA and as evidenced with our median EBITDA up $43 million 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 up budgeted plans as compared to covenant light structures that are prevalent in the upper middle market and broadly syndicated loan market.

Turning now to the investment portfolio at the end of the first quarter the size of our investment portfolio at fair value was $2 $2 billion 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% common equity interest and 10 first half across our joint ventures split between 8% and the <unk> and 2% in the MLP.

As of March 31, 2022, the weighted average yield on the investment portfolio at amortized cost and fair value were seven 9% and eight 1%, respectively as compared to seven 6% and seven 8% respectively. As of December 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.

<unk> investment portfolio at fair value as of March 31 was approximately $520 million 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 <unk>.

Leanne and 3% and secondly.

As of March 31.

<unk> investment.

Pardon me SLP is the investment portfolio at fair value was approximately $372 million comprised of 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 3% secondly.

Moving on to portfolio of credit quality trends.

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 into investments.

With a risk rating one being the highest risk rating in terms of positive credit performance.

Risk rating three investments comprised eight 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 for our lowest risk rating in terms of credit quality.

The continued improvement in our risk rating three investments contributed to our positive nap growth this quarter.

In particular, we saw positive improvement 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-19 variant 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 into investments had a weighted average fair value mark of approximately 99% with PARP.

Our risk rating three investments have a weighted average fair value mark of approximately 83% of par we.

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 impact.

No investments were on nonaccrual as of March 31.

Sally will now provide a more detailed financial review.

Thank you, Mike and good morning, everyone.

I'll start the review of our first quarter 2022 results with our income statement.

Total investment income was $46 million for three months ended March 31, 2022, as compared to $51 $5 million to the three months ended December 31st 2021.

The decrease in investment income is primarily due to lower prepayment related income and dividend income.

Total expenses for the first quarter were $24 $3 million as compared to $29 $6 million 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 7 million or 30, <unk> per share as compared to $21 9 million or <unk> 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 adviser.

During the three months ended March 31, 2022, the company had net realized and unrealized gains of $12 million gap.

GAAP income per share for the three months ended March 31 was <unk> 52 per share.

Moving to our balance sheet as of March 31, our investment portfolio at fair value totaled $2 2 billion and total assets of $2 3 billion the.

Total net assets were $1 1 billion as of March 31st.

<unk> per share was $17 22 up from $17 <unk> at the end of the fourth quarter, representing a one 1% increase quarter over quarter.

At the end of Q1, our debt to equity ratio was <unk> 99 times down from one three times at the end of Q4.

Net leverage ratio, which represents principal debt outstanding less cash was the airplane eight nine times at the end of Q1 as compared to 112 times at the end of Q4.

As Mike mentioned earlier during the call we formed the senior loan program during the first quarter with DCF, that's contributing approximately $350 million of investments at fair value.

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 million against our $235 million of Undrawn investment commitments.

Represents coverage at one seven times as of March 31.

For the three months ended March 31.

2022, the weighted average interest rate on our debt outstanding was two 9% and unchanged at the prior quarter end.

Looking across our debt maturities.

$112 $5 million 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 month LIBOR now above 1%, we 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 within fixed rate and 35% in floating rate debt. Unlike the majority of our assets are floating rate liabilities typically have zero percent, Florida.

As of March 31, holding all else constant we calculate that 100 basis point increase in rates could increase to our quarterly earnings by approximately <unk> <unk> 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.

Thanks Ali.

And thanks, Mike Boyle for covering for some technical 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.

Thank you for the privilege of managing our shareholders' capital.

Jennifer Please open the line for questions.

Yes.

Thank you if you'd like to ask a question. Please signal by pressing star one on your telephone keypad. If you are you may speaker phone. Please make sure. Your mute function is turned off to allow your signal to reach our equipment 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 will go first to Finian O'shea with Wells Fargo.

Oh, sorry, I was on mute hi, everyone. Good morning.

Might be to your closing remarks on the NAV improvements 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.

Now down a bit this quarter due to do too.

Higher.

Discount yields based on higher market spreads LIBOR expectations and so forth.

Sure. So the primary driver of the NAV increase was improvement in our aerospace and defense and travel.

Those had been marked in the mid eighties and as we've seen.

The market for those companies pick up meaningfully those marks moved up quarter over quarter contributing to that north of 1% Nab improvement across our standard first lien investments they were about flat quarter over quarter. So at a brown the 99 cent mark both last quarter as well as as well as March 31.

So.

So we ended up holding those.

Yields flat.

From a from an asset perspective.

Sure that's helpful. Thanks.

Just to follow on on leverage.

With the dropdown.

<unk> completes can you remind us.

What your what your target leverage will be.

Given the joint venture set ups are complete and.

In.

Does that change with today's.

Funding market obviously.

Unsecured is.

Presumably much more expensive.

Today.

The bank lines will be.

More immediately impacted by quite LIBOR, So just any updated.

Thoughts on how you are thinking.

About leverage with current market conditions.

Sure. So we're still targeting leverage between one and one in a quarter.

At the balance sheet level.

We are just.

South of one times.

March 31, so there is plenty of room for us to grow and take advantage of the current opportunities looking forward.

Right now we're quite pleased that we have the fixed rate liabilities and the and the bond market.

That are funding the majority of our of our balance sheet and so we do but we do have revolver capacity to grow to the top end of that leverage range up to that one in a quarter. So as we look ahead at the new investment in box environment.

We'll decide where to.

How much to invest and where that.

Where to end up in that one to one and a quarter target range.

Great. That's all for me thanks, so much.

We'll go next to Ryan Lynch with K B W.

Good morning.

First question I had was kind of interesting when I was looking at your investment fundings for the quarter.

Pretty meaningfully versus.

Third and fourth quarter of 2021, even when you back out your contribution to.

Yes.

Quarter that was very different than the trends I think we saw broader in the BDC space, where fundings were down Q1 Acura.

Very robust third and fourth quarter.

2021 so.

Can you just speak.

What kind of a ramp up in Q1 versus Q4, and I think overall market activity was down.

Yes, Ryan Thanks for the question I think it's a little bit idiosyncratic.

It was a great answer there.

When you think about it we did have a number of deals that we've committed to in the fourth quarter that leaked into the first quarter, a little bit for us and that just happened to be with the with the deals that were in our pipeline I think the other point there is that.

There are a number of other bdcs that I would argue to 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 of that market or just a little bit slower than they were in that core middle market, where we tend to participate.

Okay.

Got it.

Our response, but.

You talked about sort of.

<unk> seen a slowdown in opportunities across Europe and again, maybe this is just because it kind of happened later in the quarter, but.

Do you guys actually grew the portfolio and the <unk> in the quarter. So I was also a little bit.

Prior to that given what's going on over there that there was actually growth in your commentary it slowdown that that there was growth so I'm not sure.

Reconcile that with that kind of is that growth more first half before she started or what was the driver behind that.

Yes, I think thats again of the timing if you will.

Recall that in the U S.

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 Q1 in the U S.

That same stress or pressure wasn't.

The accident in Europe at the time and so.

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 is not a lot of new deals that have come out here in February March April for example, since.

Since the war in Ukraine began.

And then.

You mentioned.

In your prepared comments about Russia, Ukraine.

Eastern Europe .

But you do have exposure in that area.

Obviously, we're still trying to work through what are going to be the ramifications of everything.

Which we probably won't know for four months.

And all of the trickle down effect, even if you don't have direct exposure in those.

Those countries.

Hi.

Europe is going to have some some meaningful impact.

Other countries from the geopolitical issues going on over there.

Yes.

Have you how much have you had there.

In your evaluation of your Companys, how confident do you feel that those companies.

Companies are set up.

Sure.

Continued to perform fine through there and what's your confidence level, yet knowing that we're still early in the discovery process.

There is still really just so many uncertainties out there of how all this plays out and the ultimate ramifications.

Yes.

I think youre certainly right there Ryan there's a lot a lot to come there, but the 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 are talking about it and one of the obvious knock on effects is.

The increase that we've seen across the board and energy prices oil and gas prices increases, obviously, Russia has a fairly large exporter.

Of.

Those sorts of assets. So I think that is going to be a global effect that impacts everybody as opposed to one that's really.

Targeted two to Europe , specifically, so that's something we've been dealing with even prior to the war, but obviously that the award is exacerbated that.

In terms of other knock on effects I mean is 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.

The global marketplace. I mean, you think about it is actually smaller than the state of Texas the entire Russian economy. So I think thats really helped mitigate some immediate.

Thanks.

Around sanctions and things like that they are very important in terms of certain metals that are minor that are hard to find elsewhere.

So we're certainly keeping an eye on that.

And then in terms of immediate effects I think 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 all of the handful of companies in our European book, who had.

<unk> has offices in either Ukraine, or Russia, where they might have one two or three sales representatives there.

<unk> sales contribution from Russia, or Ukraine, and Belarus, My frankly.

It was generally in the like 1% to 2% to 3% range. So we know the direct effects arent going to be that big.

We do have one company that's most impacted.

In that they have a sub assembly for one other components happening.

And a factory in Western Ukraine.

Amazingly in my head my hat goes off to the folks back in Ukraine Amazingly that factory is actually still up and running workers are showing up in our components are being made how they can manage that in the midst of award is just mind boggling to me personally, but that is still actually happening and in that instance, the companies actually identified.

To alternative sites within Poland.

Make that sub assembly work and case.

It does end up getting shut down bonds or whatever the case might be so I think we've got a pretty good handle on the immediate impacts.

Okay.

That's really helpful color and details.

On that knowing that a lot of it is still kind of.

The <unk> to be determined but it sounds like the trends.

We're pretty limited.

That's all from me I appreciate the time this morning.

Thanks, Brian .

And as a reminder, that is star one for questions.

And at this time there are no further questions.

Great well, thanks, Jennifer and thanks, everyone for listening in today I appreciate the questions as well.

We are obviously in the midst of.

Working harder in the second quarter and look forward to delivering those results to you in due course, thanks, everyone.

Yeah.

This does concludes today's conference we thank you for your participation.

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Yeah.

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