Q2 2023 Bain Capital Specialty Finance Inc Earnings Call
Good morning, ladies and gentlemen, and welcome to the Bain capital Specialty Finance second quarter ended June 30th. Thank you 23 earnings conference call. At this time all lines are in 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.
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This call is being recorded on Wednesday August 19, 2023, I would now like to turn the conference over to Katherine Schneider Director of Investor Relations. Please go ahead.
Thanks, Andrew Good morning, and welcome everyone to our bank capital Specialty Finance second quarter ended June 30 of 2023 earnings Conference call.
Yesterday after market closed we issued our earnings press release and Investor presentation of our quarterly results a copy of which is available on Bain capital specialty finance at Investor Relations Web site.
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.
That I would like to turn the call over to our CEO Michael <unk>.
Thanks, Kathryn and good morning to all of you and thanks for joining us here on our earnings call today.
I'm also joined by Mike Boyle, our President and our Chief Financial Officer, Sally Darn us.
I will start with an overview of our second quarter ended June 32023 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.
Yesterday after market closed we delivered strong earnings results Q2, net investment income per share was <unk> 60, an increase of 20% quarter over quarter, driven by the continued benefit of higher interest rates across our portfolio.
Our net investment income return represented an annualized yield of 13, 9% on book value and was well in excess of our Q2 dividend demonstrating 158% NII and dividend coverage.
Q2 earnings per share were <unk> 45, driven by stable credit quality across our portfolio investments during the quarter.
Our net income produced an annualized return on book value of 10, 4%.
These are also results in turn led to modest NAV growth during the quarter net asset value per share as of June 30 was $17 44.
Reflecting a 40 basis point increase from our $17 37, NAV as of March 31.
And with all that we're very pleased to announce our board increased our regular quarterly dividend by <unk> <unk> per share up 10, 5% to <unk> 42 per share to shareholders of record as of September 29, 2023.
This represents an annualized yield of nine 6% on ending book value as of June 30th and an 11% annualized yield at BCS apps current trading levels importantly.
This increase is in the regular dividend rate represents a third increase for our shareholders in the past 12 months.
Our dividend framework seeks to provide our shareholders with an attractive rate of return while also seeking an appropriate level of cushion for future NAV stability and growth.
As we have been evaluating our dividend policy with our board throughout the past year.
Light of higher earnings we believe it is important to provide our shareholders. The benefit of the higher income that the company is generating while remaining prudent in setting the regular dividend level to a rate that the company can earn under various interest rate and economic scenarios.
In the current environment, we believe the company remains well positioned to generate net investment income in excess of our newly announced dividend rate, while staying consistent with our objective of achieving NAV stability and growth over time.
Our spillover income is estimated to be approximately <unk> 66 per share, which we believe is a healthy amount and provides for increased dividend stability.
We expect to evaluate the potential for any additional distributions as we near the end of the year.
Turning out of the market environment, and new middle market loan volumes picked up a bit during the second quarter from first quarter levels and our volumes remained low overall as compared to recent years, given muted LBO activity as buyers and sellers continue their struggle to find enterprise value equilibrium in the current market environment.
As the private credit markets have continued to grow in recent years, both on the supply and demand side of the equation the value of a well established direct lending platform have longstanding relationships and expertise is increasingly important to not only source attractive investments, but also have deep resources to diligence and work through complex situations.
New companies on which our private credit group platform invested during the second quarter, we leverage our in house industry expertise within niche verticals, such as aerospace and defense and continuing to partner with top tier sponsors who value our prior relationship working with them on past investments.
We believe the lending environment for middle market lenders continues to be attractive given favorable terms and structures that are more lender friendly.
While we have begun to see a small amount of spread compression relative to peak levels. In recent quarters, we are still seeing market spread pricing for new first lien term loans between 625 and 700 basis points.
In fact, the weighted average spread on our new portfolio company first lien debt investments in the second quarter was approximately 670 basis points.
Which produced a weighted average yield of 12, 2% when factoring in current base rates and amortization of original issue discounts.
And the weighted average net to EBITDA leverage on these new loans was four five times, reflecting conservative capital structures.
In addition to the new first lien loans in which we invested during the second quarter. We also made an initial equity investment into legacy corporate lending Holdco LLC.
Our newly formed portfolio company created you invest in middle market ABL loans.
<unk> background with this new investment Bain capital credit recently announced they had formed a partnership with legacy corporate lending and independent asset based lending company focused on serving the needs of North American middle market borrowers.
We believe the ABL space as compelling as the asset class benefits from growing deal volumes and increased non bank penetration and provides for attractive risk adjusted returns with differentiated return profiles.
Over the past few years, we have evaluated various acquisition opportunities and whether it's a buy or build an ABL platform and were fortunate to partner with a talented and experienced leadership team who brings years of ABL and commercial lending experience to build the business organically.
Our initial investment in the company is modest we believe it could be an attractive growth investment for Bcf overtime and provides us with differentiated deal flow in a market, which is tangential and complementary to our existing core middle market corporate focus.
Our portfolio of companies continue to perform well in light of a more complex operating environment as demonstrated by stable credit quality metrics across our portfolio with no investments added to non accrual status during the quarter.
Almost 40% of our investments were originated after January one 2022.
Period, one rising rates and higher expectations of an economic slowdown, we're very much central to the investment decision.
Overall, we feel good about the health and quality of our portfolio as our underlying borrowers have largely proven to be defensible, thus far this year.
I will now turn the call over to Mike Boyle, our president to walk through our investment portfolio in greater detail Mike.
Thank you, Mike and good morning, everyone I'll start with our investment activity for the second quarter, and then provide an update on our portfolio.
New investing investment fundings during the second quarter were $198 million across 46 portfolio companies.
<unk> $120 million into six new companies.
Sales and repayment activity totaled approximately $228 million.
<unk> and our net funded portfolio, a decline of $30 million quarter over quarter.
This quarter, we remain focused on investing in first lien senior secured loans with 81% of our new funding within first lien structures, and 15% and investment vehicles, which comprised an additional $30 million contribution to our senior loan program the.
The remaining 4% was comprised of equity investments driven primarily by our new investment so legacy corporate lending that Mike you all just highlighted.
With new originations, we continued to leverage our longstanding relationships with private equity sponsors who value our ability to minimize execution risk when financing their deal.
Paired with our deep industry expertise across many niche verticals.
Turning to the investment portfolio at the end of the second quarter the size of our portfolio at fair value was approximately $2 4 billion.
Across our highly diversified set of 142 companies operating across 30 different industries.
Continued to grow our diversification by portfolio company.
The highest number of borrowers within our portfolio since inception growing 16% year over year.
Our portfolio primarily consists of investments in first lien loans, given our focus on downside management and investing in the top of capital structures.
As of June 30, 64% the investment portfolio at fair value was invested in first lien debt, 4% in second lien debt, 2% in subordinated debt, 4% in preferred equity and <unk>.
11%.
In equity and other interests and 15% in our joint ventures.
As we have highlighted to our shareholders in prior earnings calls the decline in our stated first lien exposure has come down given the growth of our investment vehicles, but notably 95% of the underlying investments held in these vehicles consists of first lien loans.
<unk> at a look through first lien exposure of approximately 82% across the entire portfolio.
We remain focused on investing in structures that provide us with strong lender controls 94% of our investments are structured with documentation containing financial covenants tied to management forecast and we have majority control positions and nearly 80% of our debt tranches, allowing us to drive eventual outcomes at our disc.
Question.
As of June 32023, the weighted average yield of the portfolio at amortized cost and fair value for 12, 8% and 13%, respectively as compared to 12, 3% and 12, 5% respectively. As of March 31, 2023. This.
This increase was primarily driven by higher reference rates across the portfolio.
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.
During the quarter, we continued to execute on our investment strategies within our joint ventures, our JV investments represented 15% of our overall portfolio at fair value include.
Including 10% in the international senior loan program or <unk> and.
And 5% in the senior loan program the SLP.
<unk> investment portfolio as of June 30 was approximately $687 million comprised.
Comprised of investments in 39 companies, 98% of the portfolio was invested in senior secured floating rate loans.
As of June 30th SLP is investment portfolio was approximately $830 million comprised of investments in 60 different portfolio companies, 100% of that investment portfolio was invested in senior secured loans.
Moving on to portfolio trends credit quality was stable quarter over quarter.
Within our internal risk rating scale, 91% of our portfolio as of June 30 was comprised of prescribing one into investments, indicating that the company was performing in line or better than expectations relative to our initial underwriting.
Risk rating three investments comprised 9% of our portfolio at fair value. These investments reflect the companies that have been impacted by inflationary impacts and rising interest rates, we remain focused on watching these companies closely.
Risk ratings for investments comprise zero percent of our portfolio at fair value and included two portfolio companies on nonaccrual.
No new investments were added to nonaccrual during the quarter.
Yes.
Overall, we believe our credit fundamentals remains solid across our portfolio. Our median leverage is five one times as of June 30, as compared to four nine times as of March 31, and our immediate EBITDA of the portfolio was $58 million.
I'll turn it over now to Sally who will provide a more detailed financial review.
Thank you, Mike and good morning, everyone I'll start the review of our second quarter 2023 results with our income statement.
<unk> investment income was $75 $7 million for the three months ended June 32023, as compared to $74 7 million for the three months ended March 31 2023.
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, partially offset by lower other income.
ACSF continues to benefit from high quality sources of investment income largely driven by contractual cash income across its investment.
Interest income and dividend income represented 97% of our total investment income in Q2 with prepayment related income representing less than 1%.
Other income comprised only 3% of our total investment income.
Total expenses for the second quarter were $35 7 million as compared to $42 million in the first quarter a decrease in expenses was driven by lower incentive fees.
Net investment income for the quarter was $38 9 million or <unk> 60 per share as compared to $32 2 million or <unk> 50 per share for the prior quarter.
During the three months ended June 32023, the company had net realized and unrealized losses of $9 7 million.
Net income for the three months ended June 32023, with $29 2 million or <unk> 45 per share.
Moving over to our balance sheet as of June 30.
Our investment portfolio at fair value totaled $2 4 billion and total assets of $2 7 billion.
Total net assets were $1 1 billion as of June 30.
NAV per share was $17 44 up from $17 37 at the end of the first quarter, representing a <unk>, 4% increase quarter over quarter.
The increase in our NAV was driven by the hour.
Earning of our dividend coupled with the relative stability in the value of our investments during the quarter.
At the end of Q2, our debt to equity ratio was 133 times as compared to $1. Two six times from the end of Q1, our net leverage ratio, which represents principal debt outstanding less cash and unsettled trades was one three times at the end of Q2 as compared to one six times at the end of Q1, we are comes.
<unk> operating in the middle of our net.
Target leverage ratio between one and one and a quarter times.
As of June 30 at approximately 60% of our outstanding debt was in floating rate debt and 40% are fixed rate.
The company does not have any debt maturities until 2026, and the weighted average maturity across our total debt commitments with four eight years at June 30, yet.
Our debt funding continues to benefit from low fixed rate debt structures as we accessed the unsecured markets during a period of low interest rates.
A weighted average interest rate on our unsecured notes is 275%.
For the three months ended June 32023, the weighted average interest rate.
On our debt outstanding was five 2% as compared to 5% as of the prior quarter and the increase was driven by higher sell through rates on our floating rate debt structures.
Quiddity at quarter end totaled $329 million, including $104 million of Undrawn capacity on our revolving credit facility.
$29 million of cash and cash equivalents, including $36 million of restricted cash and $96 million of unsettled trades net of receivables and payables of investments.
That I will turn the call back over to Mike for closing remarks.
Thanks Ali.
So in closing we are pleased to deliver another quarter of strong earnings for our shareholders with NII well in excess of our dividend and NAV growth is our underlying borrowers continue to perform well.
We're also delighted to deliver another regular dividend increase reflecting the companys continued earnings growth and stability.
Bain capital credit remains well positioned to execute on its direct lending strategy, given our platform's expertise resources and relationships that have been built on 25 years of experience investing in this middle market.
We remain committed to delivering value for our shareholders through producing attractive ROA and.
And thank you for the privilege of managing our shareholders' capital.
Cynthia Please open the line for questions.
Thank you ladies and gentlemen, we will now begin the question answer session should you have a question. Please press star followed by the one on your Touchtone you will hear my free time from knowledge in your question. If you would like to withdraw your question. Please press the star followed by the team once again to register for a question. Please press star followed by the one on you touched on.
There will be a brief pause for questions have been digested.
Thank you. Our first question comes from Ryan Lynch from <unk>. Please go ahead. Your line is open.
Hey, good morning, Thanks for taking my questions and really nice quarter.
First one I had was just on the legacy corporate.
Lending investment.
The investments that are made and that vehicle will those all.
Show up as investments in that portfolio company or will you be making any investments from that team will any of those investments go directly on your balance sheet.
Hi, Good morning, Ryan. Thanks for the question. So all of the investments will end up in that in that entity. So they won't be directly on our balance sheet.
Okay.
And then.
So what is kind of the expectation I know, there's some new investment kind of a new formation of our strategy.
That's your company I mean.
What would be what is sort of the goal for kind of growth.
That business over the next year or two.
Sure. So we've modeled a number of different scenarios, depending on how the market evolves over the next year or two I think in our base case, we could see that growing to be a 5% position in the portfolio.
But there is potential upside from there if we think the market opportunity continues to be could be compelling to be slightly larger than 5% over time.
Okay and Ed.
On that I guess.
I guess it depends on what sort of specific investment that we're making because it sounds like that.
That team can do a lot of things I would have assumed a accounts receivable financing is probably going to have a different.
Return than than like a machine or equipment financing, but I guess what are sort of the overall.
Returns that are expected on those investments.
Is there going to be are those investments are going to be financed with I'm, assuming a combination of capital from from Bain as well as leverage in that entity and then ultimately when this entity get sort of full scale.
Our scaled which I'm not sure of the timeframe of that but it sounds like.
There'll be a period of time before does that what sort of returns what is the return expectation.
You hope to generate from this investment.
Sure. So baseline returns that we're looking at for the investment on the equity or about 15, 16%.
We do think there'll be slightly lower than that as we ramp and build diversification.
But we do have an expectation that over the next six months to 12 months that portfolio should be operating at that mid teen level of return and given the highly cash generative nature of those investments.
It will be producing some nice net investment income for the CSS overtime.
How would it be how will they be financially behind us with leverage also in the fund as well.
It's a combination so there will be some leverage.
Yes.
The company, but then we'll also be contributing equity every time, we make a new level.
What sort of leverage roughly would you expect to run that operate that entity.
Yes, so probably between.
Two and three times to three times leverage.
Okay.
Alright, I appreciate all the comments on that the other question I had was you mentioned which is.
Mike You mentioned.
But you're starting to see a little bit of tightening in spreads still still very attractive spreads in the marketplace that are starting to kind of see a little bit of tightening which is not uncommon and not not something.
And is something we've heard from from other.
Platforms out there today.
I'm just curious.
Outside of the little bit of spread tightening are there any other.
Sort of changes in the quality of deals whether are you starting to see any sort of pressure on any other terms or structures. Besides just the spreads.
For the new deals out there, while still keeping in mind that that debt.
Overall deals are are still a really good environment for deploying capital.
Yes, Ryan not really I think it was a short answer we're definitely seeing some pressure on that spread like we said call. It $25 50 basis points, but as you point out.
On 11% 12.
Percent returns at the asset level, that's not really that big a move necessarily.
On the leverage front, that's another pinch point in times, but as you saw our average for last quarter was about four five times. So that's still a pretty conservative and Thats really driven by the math, given how high rates base rates or how much that can accompany afford and cutting 25 basis points out of the spreads really not going to alter that much. So we haven't seen pressure there.
The third pressure point, then would be just general documentation.
Things like covenants as you know.
R.
Our philosophy is very much focused on getting financial covenants and over 90% of our deal. So that's the only at least a term that we would not give an and.
Other documentation terms like EBITDA definitions and things like that are still in our estimation pretty tightened pretty lender friendly. So it really has just been a little bit on the spread side, where we've seen the competition.
Okay understood.
That's all from me nice quarter and I appreciate the time today.
Thanks, Brian .
Thank you. Our next question comes from Derek Hewett from Bank of America. Please go ahead. Your line is now open.
Good morning, everyone and congrats on the good quarter. My first question is about the incentive fee. It was a little bit lower than expected. So what's the calculation was that impacted by the realized losses during the quarter and should we expect that to the <unk>.
Scientists each normalize.
Beginning in the third quarter.
Yes, so it doesn't it doesn't have to do this.
Our look back.
The Covid era.
Causing a bit of noise.
Do you do that calculation on a cumulative basis in U K.
<unk> taken per dollar.
You would have noticed last quarter and the quarter before we're sort of out of alleghany rate that's going to cause this quarter in the next quarter to be slightly lower and then it will start to normalize again.
Okay. Thank you Paul.
Okay that makes sense and then the yield on the international Jv's.
In aggregate remained really attractive so how should we think about the growth in that international JV portfolio going forward do you want to kind of keep it where it's at a roughly <unk> <unk>.
15% of the overlap of the <unk>.
Overall portfolio or do you think there is a little bit more room for growth.
Yes.
Sure.
There is some room for growth, Eric, but I don't think it will be it.
It'll be a couple of percentage points not.
Not a step function in terms of growth, we are continuing to see interesting opportunities, particularly internationally, but I would note. There has been some churn in that portfolio as well, where we're able to replace assets that are harvesting with new assets. So limited growth there, but we have been very pleased with the yield profile coming out of both joint ventures.
Okay, Great and then my last question is just around the overall funding strategy.
You have some time, because youre bonds aren't due for another few years or so but.
All of the bonds are due in 2026 and just given what we've seen.
Some other bdcs do within the funding Mark unsecured funding markets.
Recently.
What are you what is the strategy in terms of kind of staggering.
And maturities.
We are focused on.
Looking at ladder maturities and recognize that the unsecured market.
Is open today.
We are managing the fact that we do have plenty of runway to the existing security so.
So we're always managing when the market is open vis vis the needs of the existing liability stack.
Okay.
Thank you.
Thank you. Our next question comes from Aaron <unk> from Citi. Please go ahead. Your line is now open.
Thanks.
Your commentary you mentioned kind of a muted LBO activity with buyers and sellers.
Having a hard time, reaching equilibrium what do you think we will we will get them too.
Move on and.
If you have any idea of timeframe on when that could open back up.
Yes, Andrew it's a good question, Yeah, I think theres a little bit of.
I've, probably pent up right that's happening in the sponsored market that there's obviously plenty of dry powder. There. So while we took a pause.
Going to be increasing pressure to actually invest but I think theres also.
A matter of once we start getting some economic stability and understanding what.
Whether there's a recession, if theres going to be recession, what the recovery looks like so you can get a little more confidence about.
Different growth vectors I think at that point sponsors certainly going to be willing to essentially pay more for assets.
Forward looking basis than they might be right now so I think that's all part and parcel with it.
And talking to.
Visors in this space either kind of the tip of the spear there seems to be an increase or an uptick in pitch volume there.
And.
Then translates into an actual transaction several weeks or a couple of months later, so from a timing perspective. It does seem like there could be a rush post labor day to get some fresh fresh deals out into the market. So we're hopeful that the second half of the year ends up picking up a little better than I guess, the fourth quarter of the year starts picking up.
Little bit more.
Thank you.
Thank you as a reminder, if you do wish to register for a question. Please press star followed by the one on your telephone keypad.
Okay.
Sure.
Thank you there appear to be no further questions I'll return the conference back to Michael Ewald for closing remarks.
Great, Thanks, Andrew and and.
Thanks, again for everyone's time and attention today, we're very pleased to share the results of the second quarter here with you and we look forward to talking with you again soon thanks very much.
Thank you. This does conclude today's conference call. Thank you all for attending you may now disconnect your lines.