Q3 2023 Bain Capital Specialty Finance Inc Earnings Call

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Good day and welcome to the Bain capital Specialty Finance third quarter ended September 30th.

Finally, twenty-three earnings conference call.

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Please note this event is being recorded.

I would now like to turn the conference over to Katherine Schneider.

Please go ahead.

Thank you Joe Good morning, everyone and welcome to the Bain capital Specialty Finance third quarter ended September 32023 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 finances Investor Relations website.

Following our remarks today, we will have 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 future results.

So with that I'd like to turn the call over to our Chief Executive Officer, Michael Ewald.

Thanks, Kathryn and good morning, and thank you everyone for joining us today on our on their earnings call I'm joined by Mike Boyle, President and our Chief Financial Officer Sally Dornish.

I'll start with an overview of our third quarter ended September 30th 2023 results and then provide some thoughts on our performance the overall market environment and our positioning.

After Mike and Sally will discuss our investment portfolio and financial results in greater detail.

Yesterday after market close we delivered strong third quarter results Q3, net investment income per share was <unk> 55, driven by the continued benefits of higher interest rates across our portfolio.

Net investment income return represented an annualized yield of 12, 6% on book value and covered our dividend by 131%.

Q3 earnings per share were 52, driven by stable credit quality across our portfolio investments during the quarter.

Our net income produced an annualized return on book value of 12.0%.

These results led to another consecutive quarter of growth in our net asset value to $17.54, reflecting a 60 basis point increase from our $17 44 sat NAV as of June 30th.

Subsequent to quarter end, our board declared a fourth quarter dividend equal to 42 cents per share and payable to record date holders as of December 29 2023.

We believe our regular dividend amount represents an attractive yield for our shareholders at a nine 6% annualized yield on ending book value as of September 30th.

Our spillover income per share was approximately 79 cents or 1.9 times, our quarterly regularly regular dividend. We believe this is a healthy amount of undistributed income and provides for increased dividend and NAV stability.

Our management team alongside our board continues to evaluate the potential for any additional distributions as we near the end of the year.

Turning to the market environment, new loan volumes in the private credit markets saw a modest increase during the third quarter from Q2 levels, but volumes remain low overall draw.

Driving the higher activity levels in this quarter was the return of large unit tranche loans as private credit continues to take share away from broadly syndicated loan markets, particularly during periods, where new CLO creation remains challenged as the BSL market is largely dependent on this.

While we observe these trends taking place in the private credit market, we continue to favor middle market sized companies versus large corporate borrowers as many of the core tenants that we value for our direct lenders.

For direct lenders provides greater value within this segment of the market in our view.

Particularly we prefer investing in debt structures that benefit from strong lender controls through loan credit documentation containing financial covenants and having control positions among our small lender group.

Our focus on these structures allows us to drive eventual outcomes at our discretion and minimize as lender consensus risk.

Within our investment portfolio, 93% of our debt investments are structured with documentation containing financial covenants and we have majority control positions in 75% of our debt tranches.

For the new companies in which our private credit group platform invested during the third quarter, we were the lead investor driving terms and structure as we leveraged our in house industry expertise and partner with high quality sponsors.

The investing environment for middle market lenders continues to be attractive as demonstrated by favorable terms and structures that are more lender friendly.

For example, the weighted average spread on our new portfolio company first lien debt investments was approximately 650 basis points this quarter, which produced a weighted average yield of 12% when factoring in current base rates and amortization of original discounts and the weighted average net debt to EBITDA leverage on these new loans was 4.0 times.

Reflecting conservative capital structures in the current market environment.

Our portfolio of companies continue to perform well and have proven to be durable thus far in the light of the higher interest rate environment as demonstrated by stable credit quality trends across our portfolio.

Our non accrual rates continue to be low with just 1% of the portfolio at fair value and we had an overall improvement in our watch list investments within our risk ratings.

Notwithstanding the solid portfolio metrics, our team remains vigilant monitoring our portfolio of companies closely, particularly given the expectation for a more sustained higher interest rate environment and any potential for an economic slowdown.

I'll now turn the call over to Mike Boyle, our president to walk through our investment portfolio in greater detail.

Yeah.

Thanks, Mike Good morning, everyone I'll start with our investment activity for the third quarter, and then provide an update on our portfolio.

New investment fundings during the third quarter were approximately $110 million across 40 portfolio company <unk>.

<unk> $52 million in two new companies and $57 million.

Add ons to existing investment.

Sales and repayment activity totaled approximately $103 million, resulting in a net funded portfolio growth of $7 million quarter over quarter.

This quarter, we remain focused on investing in first lien senior secured loans with 93% of our new investment fundings within first lien structures and 7% in equity investments.

Our new investment fundings were comprised of a mix between new and existing companies, representing 48% and 52% respectively.

Across our new portfolio companies this quarter, we leverage bank capitals in house industry knowledge and expertise.

Our largest new investment with a first lien senior secured loan to forward slope a provider of mission critical software and surveillance solutions to the defense industry.

We source this investment from a sponsor who has a value oriented approach with strong experience in aerospace and defense and.

And who valued our prior experience working with them in this sector.

Aerospace and defense is our largest sector exposure and one that we continue to favor in the current environment given it does not generally cycle with the macro economy.

Another notable new investment this quarter was the first lien senior secured loan and equity co investment to help drive a provider of a comprehensive suite of onsite medical services to patients in skilled nursing facilities.

While we have shied away from many of the health care physician practice management roll ups in recent years.

Now focused on finding attractive spots in the health care sector.

Our investment thesis for helped drive centered on the solid fundamental industry dynamics, which are underpinned by non discretionary services. The company has attractive financial profile, demonstrating high retention rates and partnering with a well capitalized health care focused sponsor.

Turning now to the investment portfolio at the end of the third quarter the size of our investment portfolio at fair value was approximately $2 4 billion.

Cross a highly diversified set of 143 portfolio companies operating across 30 different industries.

Our portfolio primarily consists of investments in first lien senior secured loans, given our focus on downside management and investing in the top of the capital structure.

As of September 30th 64% of 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.

11% in equity and other interests and 15% across our joint ventures.

As we have highlighted to our shareholders in prior earnings calls the decline in our stated first lien exposure is driven by the growth in our joint ventures.

Notably 94% of the underlying investments held in these investment vehicles, because that's the first lien loans, resulting in a look through first lien exposure of approximately 82% of the portfolio.

As of September 30th 2023, the weighted average yield on the investment portfolio at amortized cost and fair value were 12, 9% and 13, 1%, respectively as compared to 12, 8% and 13% as of June 32023, the increase was primarily drove.

And by higher reference rate on our loan.

And as a reminder, 94% of our debt investments bear interest at a floating rate.

Moving on to portfolio credit quality trends, they were stable quarter over quarter.

Within our internal risk rating scale, we saw an improvement within our risk rating, one and two investments.

Which indicate that the company was performing in line or better than expectations relative to our initial underwriting.

As of September 30th he was investments comprise 95% of our portfolio at fair value.

Up from 91% as of the prior quarter end.

Risk rating three and four investments comprised 5% of our portfolio at fair value down from eight 5% as of Q2.

Investments on nonaccrual or one, 5% and 1.8% of the total investment portfolio at amortized cost and fair value, respectively, as compared to two 1% and zero percent as of June 30, we believe our non accrual rates are among the lowest level across the BDC sector.

Credit fundamentals remain solid in our portfolio, but the median leverage of 5.0 turn as of September 30th.

To five one turns as of June 30th.

Sally will now provide a more detailed financial review.

Thank you, Mike and good morning, everyone I'll start the review of our third quarter 2023 results with our income statement.

Total investment income was $72.4 million for the three months ended September 30th 2023, as compared to $75 $7 million for the three months ended June 30th 2023.

The decrease in investment income was primarily driven by a decrease in interest income as a result of lower interest income and other income.

D. C. S. F continues to benefit from high quality sources of investment income largely driven by contractual cash income across its investments interest income and dividend income represent 99% of our total investment income in Q3 with no prepayment relate.

Related income this quarter other income comprised only 1% of our total investment income.

Total expenses for the third quarter were $36 $1 million as compared to $35 $7 million in the second quarter.

Net investment income for the quarter was $35 $6 million or 55 cents per share as compared to $38 $9 million of 60 cents per share for the prior quarter.

During the three months ended September 32023, the company had net realized and unrealized losses of $1.8 million.

Net income for the three months ended September 32023 was $33 $9 million or <unk> 52 cents per share.

Moving over to our balance sheet as of September 30th 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 September 30th.

NAV per share was $17.54 up from 17 44 at the end of the second quarter, representing a 0.6% increase quarter over quarter.

The increase in our NAV was driven by the over earnings of our dividend coupled with the relative stability in the value of our investments during the quarter.

At the end of Q3, our debt to equity ratio was one point to two times as compared to 1.33 times at the end of Q2.

Our net leverage ratio, which represents principal debt outstanding less cash and unsettled trades with 1.12 times at the end of Q3 as compared to 1.13 times at the end of Q2.

We remain comfortable operating in the middle of our target leverage ratio of between one and 1.25 times.

As of September 30th approximately 56% of our outstanding debt was in floating rate debt and 44% in fixed rate debt.

The company does not have any debt maturities until 2026, and the weighted average maturity across our total debt commitments with four and a half years at September 30th.

Our debt funding continues to benefit from low fixed rate debt structures as we access the unsecured markets during a period of low interest rates.

The weighted average interest rate on our unsecured notes is $2 75 per cent for the three months ended September 30th twenty-three the weighted average interest rate on our debt outstanding was five 4% as compared to five 2% as of the prior quarter end.

The increase was driven by higher sulfur rates on our floating rate debt structures.

Liquidity at quarter end totaled $329 million, including $224 million of Undrawn capacity on our revolving credit facility of $105 million of cash and cash equivalents, including 26 million of restricted cash and less than a million dollars of unsettled trades that have receivables and payables have investments.

That I will turn the call back over to Mike for closing remarks.

Thanks Alley in closing were pleased to deliver another quarter of strong earnings for our shareholders demonstrated by high levels of net investment income that are well in excess of our dividend and modest NAV growth is our underlying borrowers continue to perform well being.

Being 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 the core middle market, we remain committed to delivering value for our shareholders and thank you for the privilege of managing our shareholders' capital.

CECO. Please open the line for questions.

Okay.

Thank you.

Now begin the question and answer session.

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At this time, we will pause momentarily to assemble our roster.

You.

The first question comes from.

I wouldn't signal, which.

With Citi. Please go ahead.

Thanks.

Talk a little bit about.

The investing environment, you mentioned attractive characteristics today, youre seeing wider spreads and lower leverage.

Or are you seeing any kind of pickup in activity from sponsors and what does your pipeline look like these days for new investments.

Yeah. Thanks, Erin look I think it kind of varies a little bit maybe.

Maybe not week to week or maybe month to month.

We do continue to have a busy months not so busy months.

Sponsors are definitely showing us things that there might be a little bit of going through the motions and just trying to see whether.

They can maybe pick up some some value plays but we're not necessarily seeing a wholesale change from the current I'd say stable level, that's still a little bit depressed from.

Pre COVID-19 and certainly 2021, but it's I qualified as fine great from a deal flow perspective.

Okay, and how does it look from from an international perspective versus the U S.

You know, it's it's still pretty balanced right now I definitely say last year. We were in 2022, we were.

More U S heavy more Europe heavy in 2021, but I'd say this year, we're probably a little more balanced.

With Australia, New Zealand being a smaller piece and that just kind of being steady so.

I don't think there's any notable differences between the two markets right now.

Okay. Thank you.

Yeah.

Thank you.

Our next question comes from Paul Johnson.

With Gabe VW. Please go ahead.

Yeah. Good morning, Thanks for taking my questions.

I was just wondering if you can kind of comment on I guess, the EBIT growth trends that you're seeing in your portfolio I guess both.

Domestically as well as internationally I know, it's kind of hard to generalize, maybe all of international but just in general kind of Europe.

You know versus U S.

What's been the performance like are in the portfolio.

Sure. So performance has been quite strong across both markets.

Referring to U S and Europe broadly I do think top lines have held in particular in the industries, we selected to invest in.

And so as we as we noted 95% of our portfolio was in line with our original underwrite and most of those original underwrites include some sort of EBITDA growth in the.

15% to 20% sort of CAGR.

On the EBITDA line. So we've seen much of the portfolio performed in line with that sort of 15% to 20% year over year EBITDA growth, but that's largely driven by again the sectors. We've chosen to invest in and we've really been able to shy away from any more more cyclical sectors that might not district.

So the same amount of growth in this type of market environment.

Thanks for that and.

Just kind of generally I guess, what are your thoughts on where the portfolio or where the BDC is today from a leverage standpoint, I believe we're around one two times kind of gross levels as of the third quarter.

Within obviously the target range that you guys run with but just kind of given the uncertainty running into next year potentially you know the higher for longer scenario do you guys have any thoughts.

Around where you'd like leverage to be in the BDC.

Sure. So so I do look at the net.

The net level.

More specifically when I think about where we're where we're running our leverage which is at $1. One two times, which is really right in that center of the range I do think given the market environment. The fact that interest rates are likely to be higher for longer operating at the lower end of our leverage range, while we wait for for new deal activity to pick up and it would be well commented.

Earlier, the pipeline to get a little bit better than good and go back to great. I think we think about bringing the leverage back up but in the in the near term I do think we'd probably trend towards the lower end of our range. So that we have dry powder to take advantage of future market opportunity.

Thanks for that that's helpful and last one from me.

Was there anything specific driving I guess the credit the internal credit rating sort of increased during the quarter. This big jump in the rated two category from 91% to 95% was that due to any sort of markups or markdowns or any sort of activity in the portfolio that drove that.

It was really driven by two companies that we had previously had on our watch list. They were companies that had been impacted by Covid and we're really recovering took a few years to recover back to pre COVID-19 earnings levels and so it was really two companies that are.

That performed better that were taken off the watch list that drove that change.

Okay.

Thanks, that's all for me.

Thank you Paul.

Thank you.

The next question is from.

Derek Hewett pit.

Bank of America. Please go ahead.

Good morning, everyone could you talk a little bit about the mechanics of the incentive fee since it declined on a quarter over quarter basis, and should we expect it to normalize.

Like prospectively. Thank you.

Yeah. Thanks for the question I think you talked about that.

Last couple of quarters.

Ill take Hudson, the lower levels of incentive fees.

Prior we had our COVID-19 quarter that dropped off.

And the mechanics of the C caused this kind of lower incentive level, but should go back to normal and then next one or two quarters and so I would expect that run rate to be a bit higher than that.

Okay. Thank you for that and then in regards to the dividend.

Significantly over earning it if you adjust.

For the the lower incentive you're still materially over earning the dividend what are your thoughts on additional increase in the core dividend.

Ah versus.

Or potentially implementing kind of a cut above supplemental.

Formulate type of special dividend.

Yeah and.

That's something that we talk about often and we've talked about with our management team and our board obviously.

The spillover it gives us some good NAV stability, but we do have you know disability to either.

You know do a possibly an additional dividend or or increase the dividend both of those things are are.

Are being considered.

Okay. Okay. Thank you that's all for me.

Okay.

Thank you.

If you have a question.

This concludes our question and answer session I would like to turn the conference back over to Mike for legal for closing remarks.

Great. Thanks, Heiko I just wanted to thank everyone again for your time today and we certainly appreciate your continued support and look forward to bringing you more news around executing our middle market investing strategy through <unk> in the future I'm, probably gonna have a good day. Thanks again.

Thank you.

The conference has now concluded. Thank you for attending today's presentation you may now disconnect.

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