BCSF - NYSE

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 would like to turn the conference over to Ms. Katherine Schneider, Investor Relations. Please go ahead.

Thanks, 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'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 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. Bain 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 CEO, Michael Ewald.

Thanks Katherine. 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 Officer, Sally Dornaus. I'll start with an overview of our financial results in a greater detail. So yesterday after market close we delivered strong first quarter results to our shareholders. Q1 net investment income per share was $0.34, driven by solid net investment income earned by our portfolio investments. $0.22, reflecting a 1.1% 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 closed, we delivered strong first quarter results to our shareholders. Q1 net investment income per share was $0.34, driven by solid net investment income earned by our portfolio investment. Our net investment income covered our dividend by 100%. Q1 earnings per share were $0.52 driven by net realized and unrealized gains across our investment portfolio. Net at the value per share as in March 31 was $17.22, reflecting a 1.1% 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 our Board declared a second quarter dividend equal to $0.34 per share and payable to record date holders as of June 30, 2022. This represents a 7.9% annualized yield on ending book value as of March 31. During the first quarter we witnessed lower activity levels overall in the middle market against the backdrop of a slow growth economy with rising interest rates, increasing inflation and growing geopolitical tension. While our platform has been actively investing in Europe, particularly over the course of 2021, given the increase attractiveness 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. Importantly, we have no direct or significant exposure to companies located in Russia, Ukraine or Eastern Europe across the portfolio. Overall, credit fundamentals remain healthy across our portfolio as credit quality continue to improve during the quarter as reflected in our net portfolio gains and a decrease in our watch list or risk rating through investments. As of quarter end, no investments were on non-accrual status for another consecutive quarter. Notwithstanding the strength and health of our portfolio, we've remained watchful of inflationary impacts across our portfolio as the COVID-19 pandemic has created supply and demand imbalances across a number of industries. In particular, we have observed an acute impact in the transportation industry and companies which rely heavily on trade and transportation. The transportation sector has seen 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 demands. This current market environment underscores our longstanding approach to investing in defensive sectors, such as technology, healthcare and business services, while avoiding cyclical, commodity or noncritical 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, while a large portion of our debt capital consists of six rate debt. We also remain focused on the impact of rising interest rates to our 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. Furthermore, this has proven to be manageable for our portfolio 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 Capital senior loan program or SLP. This program is focused on senior secured loans to U.S. middle market borrowers. As we discussed with our shareholders briefly during last quarters’ earnings conference call, the SLP provides us with increased capacity and balance sheet flexibility to invest in senior middle market loans, 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 lean senior secure loans that were contributed by BCSF. The SLP benefited from the Seed portfolio and the current financing in place on the investment through our existing 2018-1 CLO facility, allowing our investment to produce an attractive return to BCSF. BCSF’s investment in SLP represented 2% of the total portfolio as of March 31. Based on the initial capital commitments to the SLP BCSF’s investment size in the SLP can grow to almost 10% of the portfolio as we find attractive new investment opportunities. The target return on our SLP 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 dividend and interest income to BCSF as we grow this investment over time. While our platform has an active quarter of new originations that we'll discuss in greater detail, the contribution of assets from BCSF’s balance sheet to SLP resulted in our balance sheet declining quarter-over-quarter. As of March 31, our debt to equity leverage ratio was 0.99 times on a gross basis and 0.89 times net of cash. This was down from a net debt to equity ratio of 1.12 times as of the fourth quarter. Looking forward, we believe the company is well positioned with capital and liquidity as we continue to execute on our longstanding strategy of directly originating loans to middle market companies. We remain focused on operating within our dated target leverage range of 1.0 to 1.25 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 lean loans and access to the broader Bain Capital platform, including 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 and coming off of a very busy end to last year. Q1 new investment fundings were $371 million across 42 portfolio companies, including $247 million in 11 new companies, $72 million in 29 existing companies, $11 million in the ISLP, and $41 million in SLP. Sales and repayment activity totaled approximately $170 million, resulting in net investment fundings of $201 million. In addition, the company contributed $351 million of investments to 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 over 20 industries. In the current market environment, we remain focused on investing in defensive industries, such as: Business Services, Aerospace & 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 investments – say new companies were comprised 72% of North American borrowers, 17% in Europe and 11% in Australia. The Bain Capital Credit platform remains well positioned in this market to source attractive new investment opportunities on behalf of our shareholders. Our longstanding global presence provides us with a large pipeline of investment opportunities to source from and we remain selective within the 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 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 this evidenced with our median EBITDA of $43 million in our portfolio. Serving as a lender to these middle market businesses provides us the ability to control the trance and set appropriate financial covenants at a reasonable level of budgeted plans as compared to covenant light structures that are prevalent in the upper middle market and broadly syndicated loan markets. 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 remained focused on investing in first lien senior secured loans to sponsor back to middle market businesses. As of March 31st, 70% of the investment portfolio at fair value was invested in first lien debt, 5% in second lien debt, 2% into coordinated debt, 3% in preferred equity, 9% in common equity interest and 10% across our joint ventures split between 8% in the ISLP and 2% in the SLP. As of March 31, 2022 the weighted average yield on the investment portfolio at amortized cost and fair value were 7.9% and 8.1% respectively, as compared to 7.6% and 7.8% respectively as of December 31, 2021. 96% of our debt investments bear interest at a floating rate positioning the company favorably as we recently witnessed interest rates rising beyond the reference rate floors across our loans. ISLP's investment portfolio at fair value as of March 31st was approximately $520 million comprised of investments in 27 portfolio companies operating across 11 different industries. 100% in the investment portfolio was invested in senior secured floating rate loan, including 97% in first lien and 3% in second lien. As of March 31st SLPs investment, pardon me, SLPs investment portfolio at fair value was approximately $372 million comprised 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% in second lien. Moving on to portfolio credit quality trends within our internal risk rating scale, credit quality trends improved quarter-over-quarter. As of March 31st, 91.5% of our portfolio at fair value was comprised of risk rating one and two investments. With a risk rating one being the highest risk rating in terms of positive credit performance. Risk rating three investments comprised of 8.5% of our portfolio at fair value, down from 10% as of December 31st. There continued to be no investments classified as a risk rating four our lowest risk rating in terms of credit quality. The continued improvement in our risk rating three investments contributed to our positive NAV growth this quarter. In particular, we saw positive improvements from selective investments within the Aerospace & Defense and Travel sectors. While recovery in air travel was slower than expected in 2021 due to headwinds from various COVID-19 variants, air traffic volumes have continued to increase as a result of the gradual increase in business and international travel. As of March 31st our risk rating one and two investments had a weighted average fair value mark of approximately 99% at par. Our risk rating three investments have a weighted average fair value mark of approximately 83% of par. We continue to believe our remaining risk rating three investments have the potentials to contribute to future NAV appreciation as we expect our original invest thesis to remain impact. No investments were on non-accrual as of March 31st. 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 the three-month ended March 31, 2022 as compared to $51.5 million for the three-month ended December 31, 2021. The decrease in investment income was 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 principle debt outstanding and an improvement in our overall cost-to-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 $0.34 per share as compared to $21.9 million or $0.34 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 advisor. During the three months ended March 31, 2022 the company had net realized and unrealized gains of $12 million. GAAP income per share for the three months ended March 31st was $0.52 per share. Moving to our balance sheet, as of March 31st our investment portfolio at fair value totaled $2.2 billion and total assets of $2.3 billion. The net – total net assets were $1.1 billion as of March 31st. NAV per share was $17.22 up from $17.04 at the end of the fourth quarter, representing a 1.1% increase quarter-over-quarter. At the end of Q1 our debt-to-equity ratio was 0.99 times, down from 1.3 times at the end of Q4. Our net leverage ratio which represents principle debt outstanding less cash with 0.89 times at the end of Q1, as compared to 1.12 times at the end of Q4. As Mike mentioned earlier during the call, we formed a senior loan program during the first quarter with BCSF contributing approximately $350 million of investments at fair value. This was 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 $35 million of undrawn investment commitments. This represents coverage of 1.7 times as of March 31st. For the three months ended March 31, 2022 the weighted average interest rate on our debt outstanding was 2.9% and unchanged as of the prior quarter end. Looking across our debt maturities, we have $112.5 million remaining principle 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 position and 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 months live we're 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 31st, 65% of our outstanding debt was in fixed rate and 35% in floating rate debt. Unlike the majority of our assets, our floating rate liabilities typically had zero percent floors. As of March 31st holding all out constant we calculate that 100 basis point increases in rates could increase our quarterly earnings by approximately $0.04 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, Sally, and thanks to 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. We thank you for the privilege of managing our shareholders capital. And Jennifer, please open the line for questions.

Thank you. We'll go first to Finian O'Shea with Wells Fargo.

Sorry, I was on mute. Hi everyone. Good morning. Mike, to your closing remarks on the NAV improvement, can you add some color to what drove that across the portfolio? And if there were any puts and takes there given we've seen most BDCs take NAV down a bit this quarter due to –due to 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 & Defense and Travel investments. Those had been marked in the mid-80s 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% NAV improvement across our standard first lien investment. They were about flat quarter-over-quarter, so at round $0.99 mark, both last quarter as well as – as well as March 31st. So we ended up holding those yields flat from a NAV perspective.

So that's helpful. Thanks. And just a follow-on on leverage with the dropdown being complete, can you remind us what your target leverage will be given the joint venture setups are complete and does that change with today's funding market, obviously unsecured is presumably much more expensive today and the bank lines will be more immediately impacted by LIBOR. So just any updated thoughts on how you're thinking about leverage with current market conditions?

Sure. We're still targeting leverage between one and one-and-a-quarter at the balance sheet level. We are just south of 1 times at March 31st, so there's plenty of room for us to grow and take advantage of the current opportunity that are looking forward. If right now we're quite pleased that we have the fixed rate liabilities in the bond market that that are funding the majority 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-and-a-quarter. So as we look ahead at the new investment environment we'll decide where to – how much to invest and where to end up in that one to one-and-a-quarter target range.

Great. That's all for me. Thanks so much.

We go next to Ryan Lynch with KBW.

Good morning. First question I had was; it was kind of interesting when I was looking at your investment funding for the quarter. It was up pretty meaningfully versus the third and fourth quarter of 2021. Even when you back out your cash to the FLT in the quarter, that was very different than the trends. I think we saw broader in the BC space where fundings were down in Q1 after a very robust third and fourth quarter of 2021. So can you speak to what cost kind of the ramp up in Q1 versus Q4 when I think overall market activity was down?

Yes. Ryan thanks for the question. I think it's a little bit idiosyncratic. I think it's a great answer there, but when you think about it the – we did have a number of deals that we committed to in the fourth quarter that that leaked into the first quarter a little bit for us and that just happened to be with the deals that were in our pipeline. I think the other point there is that there are a number of other BCs that I would argue 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 in that market were just a little bit slower than they were in that core middle market where we tend to participate.

Okay. Got it. Maybe a similar response, but you talked about sort of seen a slow down on opportunities across Europe. And again, maybe this is just because it kind of happened later in the quarter, but you guys actually grew the portfolio in the ISLP in the quarter. So I was also a little bit surprised to see that given what's going on over there, that there was actually growth and your commentary of the slowdown that it was growth. So I'm not sure can you reconcile that with that kind of, was that growth more first half before all the issues started or what was the driver behind that?

Yes, I think that's, again, a bit timing. If you recall that the U.S. had a bit of 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 accident in Europe at the time. And so the 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. There's not a lot of new deals that have come out here in February, March, April, for example, since the war in Ukraine began.

And then you mentioned in your prepared comments you talked a bit about Russia, Ukraine, or even Eastern Europe. But you do have exposure in that area. Obviously you're still trying to work through, what are going to be the ramifications of everything which we probably won't know for months on all the trickle down effects, even if you don't have direct exposure in those countries, it feels like Europe is going to have some meaningful impact to other countries from the geopolitical issues going on over there. I guess, how much have you had, or in your evaluation of your company, how confident do you feel that those companies are set up to continue to perform fine through this? And what's your confidence level yet knowing that we're so early in sort of the discovery process and there's still really just so many uncertainties out there of how all this plays out and the alternate ramifications.

Yes, look, I think you're certainly right there, Ryan, there is 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're talking about. 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 have increase as obviously Russia's 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 to Europe specifically. So that's something we've been dealing with even prior to the war, but obviously that war has exacerbated that. And in terms of other knock on effects, I mean, as 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's actually smaller than the state of Texas, the entire Russian economy is. So I think that's really helped mitigate some immediate effects around sanctions and things like that. They are very important in terms of certain metals that are mine there 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 on a handful of companies in our European book who had sales offices in either Ukraine or Russia where they might have one, two or three sales representatives there, but the overall sales contribution from Russia or Ukraine, or even Belarus, quite frankly was generally in the, like 1% to 2% or 3% range. So we know the direct effects aren't going to be that big. We do have one company that's most impacted in that they have a sub-assembly for one of their components happening in a factory in Western Ukraine. Amazingly, and my hat goes off to the folks back in Ukraine, amazingly that factory is actually still up and running, workers are showing up and the components are being made. How they can manage that in the midst of a war is just mind blowing to me personally. But that is still actually happening. In that instance, the company has actually identified two alternative sites within Poland to make that sub-assembly work in case that plant does end up getting shut down, bombed whatever the case may be. So I think we've got a pretty good handle on the median impacts.

Okay, thanks. That's really helpful color and details on that, knowing that a lot of it is still kind of the ramifications are to be determined, but it sounds like the direct impacts are pretty limited. That's all for me. I appreciate the time this morning.

Thanks Ryan.

And at this time there are no further questions.

Well thanks, Jennifer. And thanks everyone for listening in today. I appreciate the questions as well. We are obviously in the midst of working hard during the second quarter and look forward to delivering those results to you in due course. Thanks everyone.