Bain Capital Specialty Finance Inc (BCSF) 2021 Q1 法說會逐字稿

Good morning, and welcome to the Bain Capital Specialty Finance First Quarter ending in March 31, 2021 Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Katherine Schneider, Director of Investor Relations. Please go ahead.

Thanks, Emily. Good morning, everyone, and welcome to the Bain Capital Specialty Finance First Quarter ended March 31, 2021 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'll turn the call over to our Chief Executive Officer, Michael Ewald.

Thanks, Katherine, and good morning, all, and thank you for joining us on our earnings call. I'm joined 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 31, 2021 results, and then provide some thoughts on our investment performance, the overall market environment as well as our positioning. Thereafter, Mike and Sally will discuss our investment portfolio, credit quality and financial results in greater detail.

As Katherine mentioned, 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 investments. Our net investment income covered our dividend by 100%. Q1 earnings per share were $0.49 driven by net gains across our investment portfolio, largely driven by the continued improvement in the performance of our borrowers and broad-based spread tightening.

Net asset value per share as of March 31 was $16.69, representing a 0.9% increase from our NAV as of December 31. As we've observed improving credit metrics across our portfolio, we've been pleased to deliver a continued gradual recovery in our NAV per share to our shareholders. We also demonstrated improving credit metrics throughout our -- through our low nonaccrual rates. In fact, as of March 31, the company had no investments on nonaccrual status, reflecting solid credit quality across our diversified loan portfolio.

Subsequent to first 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, 2021. This represents an 8.1% annualized yield on ending book value as of March 31.

On February 25, we closed our joint venture partnership with Pantheon through the International Senior Loan Program, or ISLP. This program, as you may recall, is focused on investing in middle-market direct lending opportunities across Europe and Australia. These are 2 markets in which Bain Capital Credit and its Private Credit Group, in particular, has a long-standing presence and strong track record of investing as we have a global footprint with local teams focused on providing financing solutions to middle market companies.

As we discussed with our shareholders at length during last quarter's earnings call, the ISLP provides BCSF with 3 key benefits: first, enhanced balance sheet flexibility to expand our global capabilities as non-U.S. dollar investments count against the 30% nonqualifying asset bucket; second, higher portfolio yields to drive greater net investment income for our shareholders as we estimate BCSF's investment in ISLP will produce a low double-digit yield; and finally, greater capacity to continue to invest in new senior secured loan opportunities to drive net investment income accretion as BCSF contributed existing investments from its balance sheet to ISLP.

While we are still early in our formation of the ISLP, we are very pleased to demonstrate progress in achieving higher portfolio yields to our shareholders as our overall yield increased by approximately 30 basis points quarter-over-quarter to 7.6% at amortized cost. Our goal is to achieve at least an 8% portfolio yield as we've been focused on driving higher net investment income for our shareholders.

Over time, we believe this can be attained in a number of ways, such as: rotating out of lower-yielding investments into higher-yielding investments as some of those loans repay; growing our interest in the ISLP if we continue to find attractive investment opportunities outside of North America; and identifying new middle market loan opportunities at attractive spread levels. Importantly, we seek to accomplish this by retaining a focus on first lien loans and remaining disciplined in our credit selection.

Turning now to the market environment. During the first quarter, our private credit platform, including BCSF, was very active in terms of new investment activity. We witnessed the M&A market open back up in 2021 driven by a more constructive economic backdrop for private equity sponsors as they sought to accomplish add-on acquisitions for growth activities as well as find new platform investments. Our market tends to be reliant on M&A activity, given our focus on sponsor-backed lending. We believe our long-standing presence in this market, which has led to a large number of incumbency positions, is a significant competitive advantage for us as we continue to invest with existing companies which we know well. Furthermore, our flexible capital base allows us to offer a full suite of solutions for borrowers. This often results in us investing with companies longer through different ownership and segments of the capital structure, depending on where we identify the best risk-adjusted return. We also saw a significant amount of new investment activity out of Europe this quarter as half of our new portfolio companies were sourced from our offices in London and Dublin.

On the liability side, the institutional unsecured debt markets were also robust during the first quarter driven by strong investor demand levels. In February, the company received an investment-grade rating of Baa3 from Moody's, which enabled us to take advantage of issuing unsecured debt in a historically low interest rate environment. So in March, the company issued $300 million of 2.95% unsecured notes maturing in March 2026.

We are very pleased with our execution level as a debut issuer in this market. We believe this was a reflection of our demonstrated credit performance across our diversified portfolio, largely consisting of first lien loans as well as the broader Bain Capital platform, including the breadth of our resources, capabilities and expertise which benefit the company. We believe this notes issuance fortifies our balance sheet, and we look forward to being an ongoing issuer in this market in the future.

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

Thanks, Mike. Good morning, everyone. I'll kick it off with our investment activity for the first quarter and then provide an update on our portfolio. Q1 new investment fundings were $384 million in 26 portfolio company including $143 million in 5 new companies, $132 million to ISLP and $108 million in 20 existing companies.

Sales and repayment activity totaled $549 million driven by $320 million of investments that were contributed to the ISLP. The remaining $229 million were comprised of broad-based repayment and sale activities across our investments.

As Mike mentioned earlier during the call, new investment levels were high during the first quarter amid a backdrop of strong M&A activity. We were active lending to new platforms through our strong sponsor relationships as well as lending to existing borrowers through our incumbency advantage. The majority of our new commitments were comprised of first lien loan opportunities. The weighted average yield on new investments was approximately 8.2% as compared to the weighted average yield of 7.2% across our sales and repayments. As a result, the quarter -- as a result, the yield at amortized cost on our total investment portfolio increased by approximately 30 bps quarter-over-quarter.

We were also active investing with European borrowers as our flexible and global capital base enables us to reach the unique financing needs across our wide pipeline of borrowers. Our largest new investment in the first quarter was sourced through our London office to a market-leading software and hardware developer headquartered in Germany. Our preexisting relationship with the sponsor and track record of investing in prior European investments alongside them gave us the experience and direct access required to lead this deal.

We structured a first lien unitranche investment in an attractive spread and discount alongside of sponsors we believe to be high quality. Leading this transaction enabled us to earn syndication income as we brought in another partner.

Turning to the investment portfolio. At the end of the first quarter, the size of our investment portfolio at fair value was $2.3 billion across a highly diversified set of 101 portfolio of companies operating across 29 different industries. We continue to favor companies within the core of the middle market for borrowers with between $25 million and $75 million of EBITDA. This is demonstrated by the portfolio's median EBITDA of $43 million. This is a segment of the market that we continue to find attractive investment opportunities and tends to be less competitive than the upper middle market, which competes with broadly syndicated loans, given greater borrower size.

Our investments consist largely of first lien loans to sponsor-backed middle market businesses. As of March 31, 82% of the investment portfolio at fair value was invested in first lien debt, 5% in second lien debt, 7% in equity interest and 6% in the ISLP. The ISLP's investment portfolio at fair value was $320 million comprised of investments in 18 portfolio of companies operating across 10 different industries. 100% of the investment portfolio was invested in senior secured floating rate loans, including 87% in first lien and 13% in second lien loans.

Moving on to portfolio credit quality trends. Credit metrics at our borrowers were stable quarter-over-quarter. The median leverage through our investment was 5.2x, a modest improvement from 5.3x as of December 31. Within our internal risk rating scale, we witnessed stable to improving trends. 87% of our portfolio at fair value was comprised of risk rating 1 and 2 investments. While this was in line with the prior quarter, the portfolio experienced an upgrade in the percentage of investments at fair value, moving from a risk rating 2 to 1, with a risk rating 1 being the highest rating in terms of positive credit performance.

Risk rating 3 investments comprised 13% of our portfolio at fair value, and there were no classified as a risk rating 4 as of March 31. The number of investments rated 3 or 4 was reduced from 15 to 12 quarter-over-quarter. Our risk rating 1 and 2 investments have a weighted average fair value mark of 98.5%, reflecting a continued gradual improvement of approximately 1% from the prior quarter.

Our risk rating 3 investments have a weighted average fair value mark of 84% at par, which was flat from the prior quarter. These investments largely comprise first lien loans with borrowers operating in industries that have been more impacted by the pandemic. While we have observed improving financial trends and sufficient liquidity runway across the vast majority of these companies, we currently expect a back half of '21 or '22 recovery as the broader economic environment resumes more normalized activity.

Based on our current fair valuations, we believe our portfolio still has the potential for NAV appreciation. Our portfolio, in our view, is comprised of high-quality companies with demonstrated value propositions, and it is still our current expectations to recognize a par repayment for the majority of these investments.

Nonaccrual investments declined quarter-over-quarter. As of March 31, we had no investments on nonaccrual status as we exited the 1 de minimis position that was previously on nonaccrual.

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 2021 results with our income statement. Total investment income was $49.8 million for the 3 months ended March 31, 2021 as compared to $48.3 million for the 3 months ended December 31, 2020. The increase in investment income was primarily due to an increase in prepayment-related income and other income.

Total net expenses for the first quarter were $27.7 million as compared to $26.4 million in the fourth quarter. The increase was primarily driven by higher incentive fees partially offset by lower interest and debt financing expenses. Our adviser waived a portion of its base management fee, demonstrating our continued alignment of interest with our shareholders and supporting the regular dividend level. We believe the company is well positioned to drive higher net investment income over time for our shareholders without the need for fee waivers.

Net investment income for the quarter was $22.2 million or $0.34 per share as compared to $21.9 million or $0.34 per share for the prior quarter. During the 3 months ended March 31, 2021, the company had net realized and unrealized gains of $9.6 million. GAAP income per share for the 3 months ended March 31, 2021 was $0.49 per share.

Moving over to our balance sheet. As of March 31, our investment portfolio at fair value totaled $2.3 billion and total assets of $2.5 billion. Total net assets were $1,078,000,000 as of March 31. NAV per share was $16.69 as compared to $16.54 at the end of the fourth quarter, representing a 0.9% increase quarter-over-quarter. Our gains were attributed to net realized and unrealized gains across the portfolio. While we have recovered a large portion of the net unrealized losses on our investments over the course of the past 4 quarters, we believe there is still the potential for a further gradual recovery based on the current fair valuations across our investments.

At the end of Q1, our debt-to-equity ratio was 1.26x compared to 1.37x at the end of Q4. Our net leverage ratio, which represents principal debt outstanding less cash, was 1.15x at the end of Q1 as compared to 1.3x at the end of Q4. Our net leverage ratio was in line with our stated target range of between 1x and 1.25x.

As Mike mentioned earlier during the call, the ISLP closed during the first quarter. The company contributed $317 million of investments at fair value in exchange for a 70.5% ownership stake in the JV. As of March 31, BCSF's investment in ISLP was $129 million, representing approximately 6% of BCSF's total portfolio.

Turning to our capitalization and liquidity. During the quarter, we issued $300 million of 2.95% unsecured notes maturing in March of 2026, increasing the percentage of unsecured debt and our capital structure to 33%, up from 10% as of year-end. We believe this is a significant improvement to strengthening the company's financial flexibility and capital structure. The proceeds of our notes offering were primarily used to repay our revolving credit facilities.

In March, we repaid a full outstanding -- we repaid in full outstanding commitments under the company's revolving credit facility with Goldman Sachs and terminated this facility, which was scheduled to mature in April of 2022. This secured facility had a spread of 300 basis points as compared to the March 2026 unsecured notes issuance, which we were able to obtain a spread of 240 basis points, given the historically low interest rate environment. We continue to have access to our JPMorgan revolving credit facility and our adviser loan.

Available liquidity, consisting of cash and undrawn capacity on our credit facilities was $398 million against our $217 million of undrawn investment commitments. This represents coverage of 1.84x as of March 31. For the 3 months ended March 31, 2021, the weighted average interest rate on our debt outstanding was 3.2%, consistent with the rate during the prior quarter. As of March 31, 2021, the company was in compliance with all terms under its secured credit facilities.

With that, I will turn the call back over to Mike for closing remarks.

Thanks, Sally. In closing, we are very pleased to deliver another solid quarter of earnings to our shareholders. We believe the company is off to a strong start here at the beginning of the year, and that we're well positioned to capitalize on new investment opportunities to drive higher earnings to our shareholders. We appreciate our shareholders' support managing your capital, and we look forward to continuing to work hard throughout the remainder of the year.

Emily, if you could please open the line up for questions? Thanks.

(Operator Instructions)

Our first question comes from Finian O'Shea from Wells Fargo Securities.

A couple of questions on the ISLP. It looks like that got off to a quick start but is still underlevered, I think, and it was a partial quarter. Can you remind us of the leverage target? And what's the sort of run rate ROE as of 3/31?

Sure. So the leverage target for the ISLP is similar to the leverage target that we stated for BCSF overall, so between 1 and 1.25x net leverage is what we're targeting over time. The ROE for the program, when levered at that level, should be in the 12% to 13% range. But because we are operating slightly underlevered, as you noted, when we set up the ISLP, we're running closer to 9% or 10% ROEs as of March 31.

Okay. And should we expect -- I think it looks like there was some interest income. Should we expect an uptick in dividend income starting this quarter?

Yes, that's right. And we talked a little bit about the strength of our European pipeline in the prepared remarks. But I would continue to reiterate that our boots on the ground across the globe are driving really interesting deal flow. And I would expect the deals coming in through that channel to really tick up here in the coming quarters to drive that increase in dividend income out of the ISLP over time.

Okay. And then for the assets, what was the breakdown of incumbent portfolio drop-ins versus sell-downs from your new origination this quarter for the ISLP portfolio?

Sure. So the ISLP portfolio for what we did in Q1 were all incumbent drop-down position. Starting in Q2 and going forward, there will be new originations that will get allocated to that program. But given the program was just set up in February, Q1 was all incumbent sales into that structure.

(Operator Instructions) And our next question comes from Ryan Lynch at KBW.

The first one I had was just on your -- you kind of talked about your opportunities in the international markets being much stronger than here domestically. I think you said half of your deals were international this quarter. Can you maybe just compare and contrast how the international margin, obviously depends on which country we're talking about, but just from a high level, how did those markets compare from a competitive standpoint compared to U.S. markets just because it feels like the U.S. markets have come back, basically, give or take, to where pre-COVID levels were. How has that been from an international standpoint?

Sure. Just high level, what I would say is probably the most comparable market, especially from a competitive standpoint in Europe versus the U.S. would be the U.K. It's probably one where a lot of folks that might even be U.S.-based might occasionally try to do deals, and it's probably the longest-standing market in terms of looking like the U.S. from a sponsor-backed M&A perspective.

As a result, what you'll see is we tend to -- while we have an active business there, and we're obviously based in London, we tend to do some deals in the Nordics. We like the Benelux countries. The company that Mike highlighted in his remarks was actually a German company. So we're trying to -- [not as we] stay away from the U.K., but certainly, what we're finding better risk-adjusted return because of potentially less competition, because of maybe less sophistication in some of the more peripheral markets of Europe rather than in the U.K.

It's not to say Germany is obviously a peripheral market because it's a huge economy. But again, having a local presence there and having native language speakers of all different countries in our offices actually really helps there as well. So again, I'd say U.K. probably looks most like the U.S. and then each of the other countries is definitely very distinct and different.

Okay. Understood. That's helpful. And then as far as balance sheet capital management, at this point, with the formation of the JV, it looks like you guys delevered your balance sheet as you guys wanted to. At this point, at this leverage level, is this where we should kind of think about you guys operating going forward?

Yes, that's right. So we've highlighted that we're focused on a net leverage range between 1 and 1.25x. I think where we ended the quarter at 1.15x was kind of hitting the nail on the head in terms of what we're looking for in terms of operations in the future. We did highlight in prepared remarks that our goal is to get our asset yields from the mid-7s up into 8% or 8%-plus range. And I think that's a critical part of increasing the income potential of BCSF.

Okay. And on that last point you just mentioned with increasing the yields in your portfolio, I know you've mentioned growing the JV, rotating some assets on your balance sheet as well. As far as the U.S. middle market lending's going, how would you say that yields in your kind of core target markets are coming in today versus your current portfolio yield?

Yes. So in the U.S., I'd say the yields have been fairly consistent, to your point, where we are almost back to pre-COVID levels. So a key part of really increasing the yield in the portfolio is, as you noted, JVs and continued allocations into markets outside of the U.S. We do view the U.S. as an important core earner for BCSF, and we think new investment opportunities should be able to drive yields in that 7.5% to 8% range. But the real way that we're able to pick up spread here is through international markets and things like joint ventures.

This concludes the question-and-answer session. I would now like to turn the conference back over to Michael Ewald for closing remarks.

Thanks, Emily. Again, we're very happy and pleased with the performance of the company here in the first quarter. We do think it sets us up very well for the remainder of the year, and we look forward to speaking with you after the end of the second quarter. Thanks very much.

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