Q4 2022 Bain Capital Specialty Finance Inc Earnings Call
Speaker 1: We I ation.
Speaker 2: Greetings and welcome to the Bain Capital Specialty Finance Fourth Quarter and Fiscal Year Earnings Conference Call. At this time all participants are in a listen only mode.
Speaker 2: A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Catherine Schneider, Investor Relations. Please go ahead, ma'am.
Speaker 3: Thanks, Reina. Good morning, everyone, and welcome to Bain Capital Specialties Finance fourth quarter and year-ended December 31, 2022 conference call. Yesterday at the market close, we issued our earnings press release and investor presentation of our quarterly and year-end results, a copy of which are available on Bain Capital Specialties 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 made available on our website. This call and the webcast are property of Bain Capital Specialties 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.
Speaker 2: St. Capital Specialty Finance assumes no obligation to update any forward-looking statements at this time unless required to do so by law. Lastly, past performance does not guarantee future results. So with that, I'd like to turn the call over to our Chief Executive Officer, Michael Ewald. Thank you, Katherine. Good morning, everyone, and thank you for joining us on our earnings call today. I'm here with Mike Boyle, our President, and our Chief Financial Officer, Sally Dornis. I'll start with an overview of our fourth quarter and year-ended December 31, 2022 results, and then provide some thoughts on our performance, the overall market environment, and our positioning. Thereafter, Mike and Sally will discuss our investment portfolio and financial results in greater detail. Starting with our results.
Speaker 2: Q4 net investment income per share was $0.37, equating to an annualized yield on average book value of 8.7%. Our net investment income covered our dividend by 103% during the fourth quarter. Q4 earnings per share, or $0.67, equating to an annualized return on average book value of 15.7%. For the full year 2022, net investment income per share was $1.59, equal to a 9.3% return on equity. This was up over 100 basis points from our 2021 NII return on equity. Our NII covered our dividend by 115% during the year. Earnings per share for 2022 were $1.63, representing a total return on equity of 9.8% for the full year of 2022. Consistent with our 2021 earnings, our annual net earnings exceeded our dividend payout for a second consecutive year.
Speaker 2: We believe this is an important metric for measuring not only attractive levels in that investment income generated across our portfolio, but also overall credit performance of our portfolio, and is a testament to being capital credit experience investing in the middle market. Our returns are driven by high quality interest income earned from our middle market borrowers, and strong credit performance, as demonstrated by overall net realising and unrealising gains across our portfolio during both the fourth quarter and full year.
Speaker 2: Our net asset value ended the year at $17.29 per share, up from $16.98 from the previous quarter, and up from $17.04 as of Q4 2021, reflecting the portfolio strength. We are especially pleased with the strong performance in 2022 during a period of greater market volatility that occurred throughout the second half of the year. At year end, we estimate that our spillover income per share is approximately $0.32. We believe this is a healthy amount of distributed income and beneficial to the stability of our dividend. For the second consecutive quarter, our board increased our regularly quarterly dividend by
Speaker 2: the BDC sector. Our investment portfolio is largely comprised of a highly diversified portfolio of first-learn senior secured floating rate notes. The strong credit quality health of our portfolio is reflected by low non-acrual rates as of over 98% of our debt investment and fair value are performing loans that are paying interest currently pursuant to their contractual terms. Furthermore, we are in a solid capital structure position with over 40% of our outstanding liabilities comprised of low cost fixed rate debt, maturing in 2026. We ended the fourth quarter with a net leverage ratio of 1.14 times.
Speaker 2: right in the middle of our target range between 1.0 and 1.25 times, providing us with additional dry powder to capitalize on new investments in the current environment. As compared to prior loan ventages in recent years, we are seeing higher market spreads, tighter documentation, and more favorable overall structures. While we see compelling returns within the middle market opportunity set, we are also mindful of high inflation, high interest rates, and a slow growth economic backdrop for middle market companies. We believe having a disciplined investment approach and prior experience investing through several cycles will be increasingly important to navigate potential risks ahead.
Speaker 2: Being capital credit has 25 years of experience investing in the middle market and our senior leadership has remained consistent over that longstanding history. Given the current market backdrop, we have heightened our focus on our portfolio company that debt service coverage and free cash flow metrics. For companies that are on our watch list, we are looking ahead in focusing on our alignment with private equity sponsors on near-term value preservation and liquidity management. This is especially important to get ahead of any potential issues that may arise so we can identify problems early and preserve value to maximize our outcome in any downside scenario. 93% of our debt investments are structured with documentation containing financial covenants tied directly to management's forecasts and we have majority control positions in 80% of our debt tranches allowing us to drive eventual outcomes in our direction. Being capital credit's industry research team continues to provide us with even deeper sector expertise across many verticals and allows us to uncover companies and niche industries that are expected to be strong performers over the coming years. Recently we have been digging in further to uncover industries that may have less susceptibility to inflationary pressures.
Speaker 4: resulting in net funded portfolio growth of $59 million quarter over quarter. For the full year, investment fundings were $1.5 billion. Total sales and repayment activity for the year were $1.4 billion. We were pleased with our ability to modestly grow our investment portfolio size while staying within our net leverage target range. Our new investing activity for the fourth quarter and full year are comprised of a mix of new fundings.
Speaker 4: to new portfolio companies and existing portfolio companies. During the year, our new investment fundings, excluding investments in our joint ventures, were comprised of approximately 65% to new companies and 35% to existing companies. Our incumbency advantage across our large portfolio of middle market borrowers provides us with the ability to provide add-on capital to existing borrowers with whom we have an existing relationship. In 2022, we benefited from higher market spreads on new originations. On our first lien investments that we originated to new companies during the fourth quarter, the weighted average spread was approximately 695 basis points, which was 150 basis points higher as compared to our new first lien originations one year ago in Q4 2021. Not only are we able to underwrite new first lien loans at higher spreads and yields, but we have also seen leverage levels on new loans decrease as lenders are focused on maintaining leverage-free cash flow and fixed charge coverage ratios. We remain focused on structuring tight documentation, particularly around leverage covenant levels.
Speaker 4: and EBITDA definitions to limit add-backs. Turning to the investment portfolio, at the end of the fourth quarter, the size of our investment portfolio at fair value was $2.4 billion across a highly diversified set of 132 portfolio companies operating across 31 different industries. We continue to maintain our focus on first-lien senior secured structures. As of December 31st, 68% of the investment portfolio at fair value was invested in first-lien debt, 13% in joint ventures, 6% in second-lien or subordinated debt, and 13% in preferred or common equity. It is worth highlighting that while the overall percentage of first-lien investments have come down over the past year, this is largely attributed to our investment vehicles or joint ventures, which comprise of over 96% first-lien senior secured funds. As of December 31st, 2022, the weighted average yield on the investment portfolio at amortized cost at fair value.
Speaker 4: was 11.4% and 11.6% respectively, as compared to 10.2% and 10.6% respectively as of September 30, 2022. This increase was primarily driven by higher reference rates on our loan. These yields are also meaningfully higher on a year-over-year basis and up approximately 380 basis points. 95% of our debt investments bear interest at a floating rate, positioning the company favorably as interest rates have continued to rise beyond the reference rate floors across our loans. During the quarter and throughout 2022, we continue to execute on our investment strategies within our joint ventures of investing in senior secured middle market loans. We continue to see the benefit of higher interest rates flowing through our JVs as almost all of our investments are floating rate loans.
Speaker 4: At year end, our JV investments represented 13% of our overall portfolio share value and generated strong performance in line with our target expectations. ISLP generated an annualized income return on equity of 11.5% in Q4 and 10.4% over the course of 2022. ISLP generated an annualized income return on equity of 21.5% in Q4 and 19.5% in 2022. ISLP's investment portfolio at fair value as of December 31st was approximately $700 and $8 million. Comprises of investments in 38 portfolio companies operating across 17 different industries. 98.5% of the investment portfolio was invested in senior secured, listening rate loans, including 96% in first lane, 3% second lane, and 1% in equity interest.
Speaker 4: As a reminder, our ISLP is our joint venture focused on investing across Europe and Australia, both markets in which they earn capital credit, has a longstanding presence and experience investing within. While Europe has experienced greater market volatility throughout 2022 than the U.S., we feel good about the underlying health of our portfolio companies across our diversified portfolio. Our largest sector exposures include business services, high-tech industries, and healthcare and pharmaceutical companies, which have been resilient sectors versus more industrial-focused companies in Europe . As of December 31, SLP's investment portfolio at fair value was approximately $547 million, comprised of investments in 48 portfolio companies across 21 different industries. 100 percent of the investment portfolio within senior secured loans is a total of $547 million.
Speaker 4: including 96% in first lane and 4% in second lane. Moving on to support other credit quality trends, they were stable in quarter to quarter. Within our internal risk rating scale, 91% of our portfolio at fair value as of December 31st was comprised of risk rating 1 and 2 investments, indicating that the company was performing in line or better than expectations relative to our initial underwrite. Discrating 3 investments comprised 8% of our portfolio at fair value. These investments reflect companies that have been impacted by inflationary pressures, resulting from supply change disruption, higher freight costs and wage pressures, as well as rising interest rates. We remain focused on watching these companies closely, however we do not currently anticipate near-term restructuring or default. Risk rating 4 investments comprised less than 2% of our portfolio at fair value and in close to it included 3 portfolio companies on non-accrual. Overall, we believe our credit fundamentals remain solid across the portfolio. Our median portfolio leverage is 5.1 times as of December 31st, down from 5.6 times as of September 30th. The net asset value of BCSS benefited from these stable credit trends.
Speaker 3: as well as the strength of our travel and aviation portfolios where we have observed continued strong, fundamental performance. Sally will now provide a more detailed financial review. Thank you, Mike, and good morning, everyone. I'll start the review of our fourth quarter 2022 results with our income statement. Total investment income was $62.4 million for the three months ended, December 31, 2022, as compared to $58.8 million for the three months ended, September 30, 2022. The increase in investment income was primarily driven by the benefit of rising interest rates across our large portfolio of senior secured floating rate loans. Total expenses for the fourth quarter were $37.3 million as compared to $28.7 million in the third quarter. The increase in expenses was driven by greater incentives due to a higher cumulative net return earned by the company. As a reminder, we net our capital losses, whether realized or unrealized, against pre-incentive net investment income for the purposes of calculating incentive fees and measure our cumulative net return against our hurdle rate over a trailing three-year period.
Speaker 3: While this can create periods of volatility within our incentive feedstream, we believe this provides us with the proper alignment with our shareholders, especially during periods of elevated market volatility. Net investment income for the quarter was $24.2 million, or $0.37 per share, as compared to $30.1 million, or $0.47 per share for the prior quarter. Our net investment income was lower during the quarter due to higher incentive fees earned from prior quarters given our three-year total return lookback feature. Excluding the impact of the lookback, Q4 NII would have been approximately $0.43 per share. Net investment income per share for the full year 2022 was $1.59 per share. During the three months ended December 31, 2022, the company had net realized and unrealized gains of $19.3 million. Gap income per share for the three months ended December 31, 2022, was $0.67 per share, bringing earnings per share for 2022 to $1.63.
Speaker 3: Moving over to our balance sheet, as of December 31, our investment portfolio at fair value totaled $2.4 billion and total assets of $2.6 billion. Total net assets were $1.1 billion as of December 31. NAV per share was $17.29 up from $16.98 at the end of the third quarter, representing a 1.8% increase quarter over quarter. Our NAV increase during the fourth quarter was primarily driven by net gains related to travel-related investments that generated strong performance. At the end of Q4, our debt-to-equity ratio was 1.25 times unchanged from the end of Q3. Our net leverage ratio, which represents principal debt outstanding less cash, was 1.14 times at the end of Q4 as compared to 1.2 times at the end of Q3.
Speaker 3: During the quarter, we continue to improve our liability structure. We increase the size of our Sumitomo Credit Facility to $665 million, up from $635 million, and over the course of 2022, this facility more than doubled in size for reflecting our continued efforts to further strengthen the company's balance sheet and funding profile. That's the Quintet Quarter-On. We announced Crowell Bond Rating Agency or KBRA, assigned the company an investment-grade rating of triple B and stable outlook. We are pleased to now have three investment-grade ratings from well-known and regarded rating agencies. Our capital structure is durable with a large portion of our outstanding debt and fixed rate on secured debt allegations. These structures provide the company with greater financial flexibility to withstand greater periods of volatility ahead. As of December 31st, approximately 57% of our outstanding debt was exploding rate debt at 43% and fixed rate.
Speaker 3: The company is well positioned to benefit from higher interest income across our portfolio given its large portfolio of floating read loans. As of December 31, holding all else constant, we calculate that a 100 basis point increase in rates could increase our quarterly earnings by approximately 4 cents per share. Our Form 10-K provides further detail on our sensitivity to various changes in interest rates. Available liquidity consisting of cash and undrawn capacity on our credit facilities is approximately $317 million. This compares to $304 million of undrawn investment commitments. For the three months ended December 31, 2022, the weighted average interest rate on our debt outstanding was 4.3% as compared to 3.7% as of the prior quarter end. The increase is driven by higher SOFR rates on our floating rate debt structures. With that, I will turn the call back over to Mike for closing remarks.
Speaker 2: Thanks, Sally. In closing, we were pleased with the execution of our investment strategy on behalf of our shareholders during the fourth quarter and the entirety of 2022. We demonstrated high and attractive levels of investment income earned across our portfolio and strong credit performance across our middle market borrowers while mitigating risk wherever possible. As we look forward into 2023, we believe our portfolio is on strong footing to navigate greater periods of volatility ahead and that we are well positioned to capitalize on attractive growth opportunities. We remain committed to delivering value to our shareholders by producing attractive returns on equity and thank you for the privilege of managing our shareholders' capital. Operator, please open the line for questions. Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Please hold while we poll for questions.
Speaker 2: So companies overall have been performing quite well, although it has been a much more challenged environment. Hey, Aaron, I'd also add that from an inflationary perspective, we've been, I guess, pleased and surprised to the extent to which our portfolio companies have been able to increase prices themselves in order to hold their gross margins, if not necessarily constant, but it's certainly up there. Of course, the negative consequence of that is that just kind of keeps the inflationary spiral going, right? But overall, they've actually performed pretty well from a profitability perspective as well.
Speaker 2: Thanks, and maybe just about the origination environment, obviously it seems much more lender-friendly today, but also I would imagine the activities probably lower what your outlook in terms of, you know, originations going forward. Yeah, I think the activity is definitely lower. I think we continue to see muted sales and churn in the portfolio. Having said that, we continue to see some strength on the add-on front where if private responses are holding their investments longer, they're trying to bolt on some acquisitions in the meantime. So, you know, you'll see the stats in our remarks and in our filing that we are active both on the new deal front, but also especially so.
Speaker 2: Aaron's question a little bit. Have you guys conducted any sort of test, I guess, with your portfolio in terms of just stressing portfolio companies with something like the forward curve or perhaps something even more extreme with that and gotten a sense, I guess, where where your portfolio falls?
Speaker 4: So for rates 5% plus, if they went there immediately and for a prolonged period of time to understand the interest rate coverage decay that would happen. And that's an important factor when we're actually doing our risk ratings 1 through 4. And names that have more rapid decay in interest rate coverage are what fall into our risk rating 3, which are still a fairly small percentage of our portfolio overall. So that is to say, yes, we run stress tests, but we do feel quite good about the health of the portfolio. As I said, we are about two times interest coverage based on today's and LTM perspective of interest rate coverage in the portfolio.
Speaker 4: We do see that coming down if we run some of these stress tests, but we still feel like we're adequately covered across the portfolio. I appreciate that. Thanks for the color on that. Another question I just had, you guys have a fairly large percentage of your portfolio in the aerospace and defense industry, around 15% or so. I know that's generally been a big sector for you guys. That industry has obviously undergone some massive changes over the last year or so. I'm just wondering your thoughts on that sector and whether you find things to be more attractive there, how you feel about your current portfolio, any sort of color you can provide there.
Speaker 2: We think we're on the right platforms from a commercial aerospace perspective, the growing ones. We've seen that demand pick up pretty considerably again. And so we actually think it's a pretty interesting place to be today. Yeah, thanks. That's interesting. So I'll ask question, smaller ones. I'm just wondering if you're able to give any sort of sense of the incentive for next quarter or if you expected to be anywhere in line with, I guess, what we had this quarter 9.2 million or anything.
Speaker 2: Appreciate it. Thanks, that's all for me. Great. Well, it looks like there's no more questions. I really appreciate everyone's time today. Certainly, if you have any other questions, please do reach out. And we'll look forward to updating you in the normal course here. Thanks very much.
Speaker 2: This concludes today's Teleconference. You may disconnect your lines at this time. Thank you for participating.
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