Bain Capital Specialty Finance, Inc. (BCSF) Q1 2023 Earnings Call Transcript


Good morning, ladies and gentlemen, and welcome to the Bain Capital Specialty Finance First Quarter ended March 31st, 2023 Earnings Conference Call. At this time, all lines are in listen-only mode. Following the presentation, we will conduct a question-and-answer session [Operator Instructions] This call is being recorded on Wednesday, May 10th, 2023.

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

Katherine Schneider

Thanks, Colin. Good morning, everyone, and welcome to the Bain Capital Specialty Finance First Quarter ended March 31st, 2023 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’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.

Michael Ewald

Thanks, Katherine. Good morning, and thanks to all of you for joining us today on our earnings call. I’m also joined here today by Mike Boyle, our President; and our Chief Financial Officer, Sally Dornaus.

I’ll start with an overview of our first quarter ended March 31st, 2023 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 close, we delivered strong first quarter results. Q1 net investment income per share was $0.50, driven by high levels of investment income earned from our portfolio during the quarter. Our net investment income return represented an annualized yield of 11.5% on book value and covered our dividend by 132%.

Net investment income per share was up 35% quarter-over-quarter and 47% year-over-year. The significant growth in our NII was driven by the continued benefits of higher interest rates, greater dividend income earned from our joint ventures as these investments have grown over time and higher other income.

Q1 earnings per share were $0.45 driven by stable credit quality across our portfolio investments during the quarter. Our net income produced an annualized return on book value of 10.5%.

Net asset value per share as of March 31st was $17.37, reflecting a 0.5% increase from our $17.29 NAV as of December 31st. Subsequent to quarter end, our Board declared a second quarter dividend equal to $0.38 per share and payable to record date holders as of June 30th, 2023. This represents an 8.8% annualized yield on ending book value as of March 31st.

We believe the company is well positioned to continue to generate net investment income in excess of our regular dividend rate as demonstrated by our strong out earnings during Q1. Our spillover income per share is approximately $0.44, which we believe is a healthy amount of undistributed income and provides for increased dividend stability.

Our management team, alongside our Board, continues to evaluate potential increases to the dividend rate versus retaining excess earnings while taking a thoughtful approach under various future interest rate and macroeconomic scenarios.

Turning now to the market environment. We observed lower levels of new activity in the middle market, driven by lower LBO and M&A volumes and increased market volatility stemming from the commercial bank challenges during the quarter.

Following these events, banks in general are likely to be more risk averse and pull back from lending activities, which can create a greater opportunity set for private lenders like us as borrowers value certainty of capital, especially during periods of increased market volatility.

Against this backdrop, we continue to execute on our long-standing strategy of sourcing and underwriting middle market investment opportunities. The majority of our new investment fundings were to existing portfolio companies versus new companies, benefiting from the incumbency advantage we enjoy across our portfolio.

We continue to observe favorable terms and structures for newly originated loans as compared to prior loan vintages. The weighted average spread on our new portfolio of company first lien debt investments was 677 basis points, which produced a weighted average yield of 11.7% when factoring in current base rates and amortization of original issue discounts.

Our Private Credit Group platform takes a global approach to source new middle-market investments. Our long-standing global presence provides us with a large pipeline of investment opportunities and we remain selective regarding the ones that we choose to pursue based on the relative attractiveness of each new investment.

In recent years, our investment activities have ebbed and flowed in and out of Europe. In 2021, we view the market in Europe to be increasingly attractive given the increased competitiveness in the US markets.

While conversely, we slowed our investing activities in Europe last year given increased volatility and broader recessionary concerns that took hold in that region earlier than elsewhere. Today, our view of relative value between Europe and the US is back on parity.

During the first quarter, our new investments to companies were comprised of approximately two-thirds to North American borrowers and one-third to European borrowers. Having that global footprint enhances and further diversifies our deal flow of opportunities to identify attractive risk-adjusted returns for our shareholders.

Our portfolio of companies continue to perform well and have proven to be defensive thus far in light of the macro headwinds related to inflationary pressures and the high interest rate environment.

This has been demonstrated by the stable credit quality metrics across our portfolio, including a decline on our nonaccrual investments with no new investments added to nonaccrual status during the quarter, and watch list investments remaining relatively stable quarter-over-quarter.

At quarter-end, we only had two companies on nonaccrual status, representing 0.6% of the portfolio at fair value, which we believe is one of the lowest levels in the entire B2C sector.

I will now turn the call over to Mike Boyle, our President, to walk through our investment portfolio in greater detail.

Michael Boyle

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

New fundings during the first quarter were $308 million across 52 portfolio of companies including $116 million in six new companies, $157 million in 45 existing companies and $35 million in the senior loan partnership.

Sales and repayment activity totaled approximately $285 million, resulting in net funded portfolio growth of $23 million quarter-over-quarter. As a result of these activities, the size of our investment portfolio was relatively stable.

Our new investing activity for the first quarter was comprised of fundings to new portfolio of companies and existing companies with the vast majorities of our new investments in first lien structures. Our new fundings, excluding our investments in joint ventures, were comprised of approximately 43% to new businesses and 57% to existing businesses.

As Mike highlighted earlier in the call, we were active with existing portfolio of companies this quarter given the slowdown of new LBO and M&A activities in the broader middle market.

Turning to the investment portfolio. At the end of the first quarter, the size of our portfolio at fair value was $2.4 billion across the highly diversified set of 138 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 capital structures.

As of March 31st, 66% of the investment portfolio at fair value was invested in first lien debt, 4% in second lien debt, 2% in subordinated debt, 3% in preferred equity, 11% in equity and other interest and 14% across our joint ventures, including 10% in the ISLP and 4% in SLP.

As we have highlighted to our shareholders in previous quarters, the decline in our stated first lien exposure has come down given the growth of our investment vehicles. Importantly, 95% of the underlying investments held in these investment vehicles consist of first lien loans resulting in a look through first lien exposure of 82% of the portfolio.

We remain focused on investing in debt structures that provide us with strong lender control. 93% of our debt investments are structured with documentation containing financial covenants tied to management forecast, and we have majority control positions in 80% of our debt tranches, allowing us to drive eventual outcomes at our discretion.

As of March 31st, 2023, the weighted average yields of the portfolio, amortized cost and fair value were 12.3% and 12.5%, respectively as compared to 11.4% and 11.6%, respectively, as of December 31st, 2022.

The increase was primarily driven by higher reference rates on our loans. Our portfolio of yields are also meaningfully higher on a year-over-year basis and up approximately 440 basis points year-over-year.

While the primary increase to our yields over this period has been from reference rates, we have seen modest spread widening across our portfolio as we have been originating new loans in recent quarters at higher spreads. The weighted average spread on our total debt investments is approximately 670 basis points, up approximately 20 basis points from one year ago.

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 across our loans.

During the quarter, we continued to execute on our investment strategies within our joint ventures of investing in senior secured middle-market loans. We continue to see the benefits of higher interest rates flowing through the JVs as nearly all of our investments are floating rate loans.

Our JV investments represented 14% of our overall portfolio at fair value, including 10% in the ISLP and 4% in SLP. During the quarter, our investment in the SLP increased from a 2% position size to nearly 4%. We demonstrated strong performance on our JVs in line with our target expectations.

Over the trailing 12 quarters, ISLP generated an annualized income return on equity of 11% and the SLP generated an annualized income return on equity of 20%. Our investment in the SLP can grow over time as we identify attractive investment opportunities, driving the potential for incremental earnings growth for the company.

ISLP’s investment portfolio at fair value as of March 31st was approximately $672 million, comprised of investments in 39 portfolio of companies operating across 18 different industries. 96% of the investment portfolio was in senior secured floating rate loans [Technical Difficulty] and 3% in equity interest.

As of March 31st, SLP’s investment portfolio at fair value was approximately $685 million, comprised of investments in 53 portfolio of companies operating across 23 different industries. 100% of the investment portfolio was invested in senior secured loans, including 97% in first lien and 3% in second lien.

Moving on to portfolio of credit quality trends. They were stable quarter-over-quarter. Within our internal risk rating scale, 91% of our portfolio at fair value as of March 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 underwriting.

Risk rating three investments comprised 8% of our portfolio at fair value. These investments reflect companies that have been impacted by inflationary impacts and rising interest rates. We remain focused on watching these companies closely.

Risk rating for investments, comprised less than 1% of our portfolio at fair value and include two portfolio of companies on nonaccrual. No new investments were added to nonaccrual during the quarter.

Overall, we believe our credit fundamentals remain solid. Our median leverage attachment point is 4.9% as of March 31st, down from 5.1% as of December 31st.

Sally will now provide a more detailed financial review.

Sally Dornaus

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

Total investment income was $74.7 million for the three months ended March 31st, 2023, as compared to $62.4 million for the three months ended December 31st, 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.

BCSF has high-quality sources of investment income, largely driven by contractual cash income across its investments. Interest income and dividend income represented 93% of our total investment income in Q1, with prepayment-related income representing less than 1%. Other income comprised 7% of our total investment income and was driven by certain onetime fees on new originations. Payment-in-kind or PIK income remains low at 6% of our total investment income.

Total expenses for the first quarter were $42 million as compared to $37.3 million in the fourth quarter. The increase in expenses was driven by higher interest and debt financing expenses due to higher base rates on our floating rate debt structures and greater incentive fees. Net investment income for the quarter was $32.2 million or $0.50 per share as compared to $24.2 million or $0.37 per share for the prior quarter.

During the three months ended March 31st, 2023, the company had net realized and unrealized losses of $2.9 million. Net income for the three months ended March 31st, 2023, was $29.3 million or $0.45 per share.

Moving over to our balance sheet. As of March 31st, 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 March 31st.

NAV per share was $17.37, up from $17.29 at the end of the fourth quarter, representing a 50 basis point increase quarter-over-quarter. The increase in our NAV was driven by the out earning of our dividend, coupled with the relative stability in the value of our investments during the quarter.

At the end of Q1, our debt-to-equity ratio was 1.26 times relatively unchanged from the end of Q4. Our net leverage ratio, which represents principal debt outstanding less cash was 1.19 times at the end of Q1 as compared to 1.14 times at the end of Q4. We’re comfortable operating in the middle of our net target leverage ratio between 1 times and 1.25 times.

We remain focused on the continued execution of our financing strategy for the company, which focuses on durable and long-term capital structures. As of March 31st, approximately 58% of our outstanding debt was in floating rate debt and 42% in fixed rate debt.

During the first quarter, our adviser loan matured at the end of March. This was a three-year loan that Bain Capital Credit provided to BCSF during a significant elevated period of volatility in 2020.

Looking ahead, the company does not have any debt maturities until 2026 and the weighted average maturity across our total debt commitments was five years at March 31st, 2023.

Liquidity at quarter-end included $185 million of undrawn capacity on our revolving credit facility, $81 million of cash and cash equivalents, including $51 million of restricted cash and $36 million of unsettled trades net of receivables and payables and investments.

For the three months ended March 31st, 2023, the weighted average interest rate on our debt outstanding was 5% as compared to 4.3% as of the prior quarter end. The increase was 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.

Michael Ewald

Thanks a lot, Sally. Before we close, we wanted to highlight that we believe BCSF stock price offers a very compelling value to shareholders, and we believe a higher valuation should be warranted in the market.

Based on our current dividend yield, BCSF stock is yielding 13% on a portfolio of largely first lien senior secured floating rate loans. Bain Capital Credit brings 25 years of experience investing in the middle market and has demonstrated solid credit quality with low losses and nonaccrual rates since our inception.

As we mentioned earlier during our prepared remarks, we believe the company is well positioned to generate strong levels of net investment income in excess of our dividend as we demonstrated this quarter with our earnings well exceeding consensus expectations. We remain confident and committed to delivering value for our shareholders through producing attractive ROEs and thank you for the privilege of managing our shareholders’ capital.

Colin, please open the line for questions.

Question-and-Answer Session


Thank you. Ladies and gentlemen, we will now conduct a question-and-answer session. [Operator Instructions] And your first question comes from Finian O’Shea from Wells Fargo. Please go ahead.

Finian O’Shea

Hey, everyone. Good morning. The first question on the joint venture returns. Does that improvement sort of reflect a run rate or was there any one-off type item or change in distro policy, for example, that elevated the returns this quarter?

Michael Boyle

So there is a slight increase driven by new origination activity for those joint ventures. So there is origination fees that do flow through and help improve the economics. As we look at the SLP return, for example, at 20%, I’d say the run rate is in the high teens, and there was a couple of hundred basis points of improvement driven by those origination fees. But we do continue to think going forward that we’ll be able to generate those teens level of returns from the joint ventures.

Finian O’Shea

I think that’s helpful. And can you remind us the –is the origination function independent from BCSF or is a material amount of it drop downs? And if so, what percent of your number amount of your exits this quarter were dropdowns to JVs?

Michael Ewald

Sure. That’s a good question. So the majority of the originations are drop-downs from the BCSF’s balance sheet. So if you look at our sales and repayment number for this quarter, about 60% of that activity was dropping assets down into the joint ventures.

Finian O’Shea

And is that newer stuff or older stuff or a mix?

Michael Ewald

It’s primarily newer assets that are originated.

Finian O’Shea

Okay. Thanks. And can you touch on the idea for the SLP addition to the sub notes. It didn’t look like that portfolio grew too much, at least in the context of how much more money was put in. So what was the idea there?

Michael Boyle

Sure. So the investment that BCSF makes in the SLP is a combination of sub notes and common equity. And so when we’re contributing incremental assets and increasing the exposure, it will be a pro rata strip of both the sub notes and the equity, and that helps to drive current income through both interest income on the subordinated notes, but then dividends that are routinely paid out through the equity.

Finian O’Shea

Okay. But so capital structure was constant and leverage is, I guess, is coming down a little bit effectively given that sort of equity in practice. Do I have that right?

Michael Boyle

Yes, that’s the right way to think about it.

Finian O’Shea

Okay. And I guess just a final question for me. I know I’ve asked a few. As to the sort of closing remarks on the stock not trading close enough to book for the industry. Can you give us an update on your thought on share repurchases?

Michael Ewald

Sure, Fin. It’s really something that we evaluate on a constant basis, and we kind of look at how much value is there in terms of NAV accretion or otherwise in terms of buying shares below NAV versus how much can we generate from investing in today’s market environment. And as you’ll know, to date, we have not made any share repurchases, but it is something we continue to evaluate with our Board.

Finian O’Shea

Great. Thanks so much.

Michael Ewald

Thanks, Finian.


[Operator Instructions] Okay. And there are no further questions at this time. I’ll turn it back — actually one just popped in. Okay. We have a question from Derek Hewett from Bank of America. Derek, please go ahead.

Derek Hewett

Good morning, everyone. I hopped on a little late, but could you talk about the incentive fee and when it will begin to normalize given the look-back deferrals?

Sally Dornaus

Sure. I would expect that would normalize and protect — couple of quarters.

Derek Hewett

Okay. Great. Thank you.


Okay. There are no further questions at this time. I’ll turn it back to Michael.

Michael Ewald

Great. Thanks, Colin, and again, thanks, everyone, for joining the call today. We appreciate taking the time out of your busy mornings here to listen to us. And certainly, to the extent there’s any more questions, please do reach out, and we look forward to bringing you more news on our efforts in the future. Thanks very much. Bye-bye.


Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.