Bain Capital Specialty Finance Inc (BCSF) 2020 Q4 法說會逐字稿

Good morning and welcome to the Bain Capital Specialty Finance Fourth Quarter and Fiscal Year Ended December 31, 2020 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

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

Thanks, Debbie. Good morning, everyone. Yesterday after market close, 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-K 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.

With that, I'll turn the call over to our Chief Executive Officer, Michael Ewald.

Thank you, Katherine, and good morning to all of you. Thanks for joining us today on our earnings call. Also with me are Mike Boyle, our President; and our Chief Financial Officer, Sally Dornaus.

I'll start with an overview of our fourth quarter and year ended December 31, 2020, results and provide some thoughts on our portfolio performance, the market environment as well as our recently announced strategic joint venture partnership. Thereafter, Mike and Sally will discuss our investment portfolio, credit quality and financial results in greater detail.

Yesterday, after market close, we reported solid fourth quarter results that were consistent with the preliminary figures that we provided back on February 11. Our results were a reflection of solid net investment income earned from our investment portfolio and strong earnings as we demonstrated our third consecutive quarter of producing net gains across our investment portfolio. Q4 net investment income per share was $0.34. Q4 earnings per share were $0.61. This brings net investment income per share to $1.46 for the full year 2020, representing an 8.6% NII return on average net assets. Our net investment income per share results for 2020 were above our distributions of $1.43 per share for the full year.

Earnings per share for 2020 were $0.14. Net asset value per share as of December 31 was $16.54, reflecting a 1.7% increase from our NAV as of September 30. While we have recaptured a large portion of the unrealized depreciation experienced across our portfolio in Q1 due to the significant market volatility following the initial outbreak of the pandemic, we expect a gradual recovery of the remaining unrealized depreciation over time, given our belief that the portfolio is largely comprised of high-quality companies with demonstrated value propositions.

Subsequent to quarter end, our Board declared a first quarter dividend equal to $0.34 per share and payable to record date holders as of March 31, 2021. This represents an 8.2% annualized yield on ending book value as of December 31.

Now while the events of 2020 created a challenging backdrop due to the global pandemic, we believe our solid performance was attributable to the core fundamental tenets of our investment strategy that we have honed over our 20-plus years of experience at Bain Capital, in particular, constructing well-diversified global portfolios, primarily investing in first lien loans and financial covenants, investing alongside high-quality private equity sponsors and maintaining a control position in our loans. All of these attributes helped to mitigate downside risk throughout the year.

For example, we successfully conducted amendments to a small portion of the borrowers in our portfolio. Maintaining strong documentation standards, including the presence of covenants, brought us early to the table to derisk certain investments and resulted in credit-enhancing outcomes, such as receiving additional economics, equity contributions and/or even tighter credit documentation. In fact, approximately $450 million of new capital was provided by our sponsors to support the portfolio of companies that require liquidity to preserve value, highlighting one of the benefits of partnering with well-funded top-tier sponsors.

We believe the strength of our credit quality is reflected in our low nonaccrual rates and the improving trends across our proprietary investment risk ratings. As of December 31, 2020, we had one portfolio company on nonaccrual status, representing 0.2% of the total investment portfolio at both cost and fair value. Furthermore, our peak nonaccrual rate throughout 2020 was only 1.8% of the portfolio at cost and 1.1% at fair value. And we are successful in coming to quick resolutions with impacted companies during the year. Likewise, our internal investment performance ratings demonstrated stable to improving trends across our borrowers.

Turning now to the market environment. We witnessed the debt and equity markets beginning to normalize during the second half of 2020. Fourth quarter origination levels across our platform were elevated given the backlog of deals from earlier in the year. We believe our platform is well positioned to capitalize on these opportunities, given our strong sponsor relationships and incumbency advantage across our large portfolio of over 100 existing borrowers.

During 2020, we remained active in providing capital to new platforms and existing borrowers that Mike Boyle will touch on shortly so we did remain on cautious footing throughout much of the year. Recall that there wasn't an approved vaccine in the U.S. until midway through the fourth quarter last year.

In addition to demonstrating strong credit performance and investment capabilities to our shareholders in 2020, we also focused on making significant improvements to our balance sheet and capitalization. First, we strengthened the company's balance sheet by further diversifying our liability structure to include unsecured debt given the increased flexibility that the structure provides.

And we're actually very pleased to report that this morning, the company also received an investment-grade rating of Baa3 with a stable outlook from Moody's. We believe this rating is a reflection of our demonstrated credit performance across our diversified and primarily first lien portfolio and the broader Bain Capital platform and risk management oversight that it provides to the company. This investment-grade rating from Moody's is a significant achievement for the company as it provides us with greater access to the institutional unsecured debt market. In recent months, we have observed this market to be increasingly attractive given the historically low interest rate environment.

Next, we demonstrated meaningful progress in deleveraging our balance sheet throughout 2020 while delivering stable net income -- net investment income to our shareholders. As of December 31, our net leverage ratio was 1.30x, down from a peak level of 1.78x as of Q1. Available liquidity, consisting of cash and undrawn capacity on our credit facilities, improved throughout the year, with approximately $430 million of availability against $190 million of undrawn investment commitments at year-end, representing coverage of 2.25x.

Lastly, we announced a strategic joint venture partnership with Pantheon earlier this month. And importantly, this transaction further deleverages our balance sheet to approximately 1.1x on a pro forma basis based on our portfolio at year-end as BCSF contributed approximately $320 million of loans from its balance sheet to the newly created joint venture structure on February 22. As a result of this deleveraging, we have significantly improved the company's balance sheet to take advantage of new attractive loan opportunities in the current market environment and provide for accretion to our net investment income.

Year-end 2021, we've revised the company's target net leverage range to be between 1.0 and 1.25x, down from our previous outer bound level of approximately 1.5x. We believe this change provides the company with greater asset cushion relative to our regulatory leverage limitation of 2.0x and demonstrates prudent liability management. However, we do not plan to change our investment strategy focus of lending to primarily first lien middle market borrowers as a result of this change.

Before turning the call over to Mike Boyle to walk through our investment portfolio in greater detail, I want to spend a few minutes discussing our recently announced strategic partnership with Pantheon. By way of background, Pantheon is a leading global alternative private markets manager, who we've known institutionally across our platform for a long time. In February 2021, we formed a joint venture with their private credit business, known as the International Senior Loan Program, or ISLP, to provide direct lending solutions to middle market borrowers, primarily across Europe and Australia. These are markets in which Bain Capital Credit has had a long-standing presence and track record of investing as we have a global footprint and local teams focused on providing financing solutions to middle market companies there. We have been an active investor across Europe since 2007 and have been investing in Australia's middle market for nearly a decade. This partnership with Pantheon will allow us to further expand BCSF's reach and capabilities into Europe and Australia, markets where we continue to see attractive investment opportunities.

And when forming this joint venture partnership, it was important for us to select a partner with whom we had an existing -- preexisting relationship and someone who brought the capabilities to diligence investments alongside us, given the structure of the joint venture, which requires 50-50 voting rights among both partners. Within Bain Capital broadly, Pantheon has been a [known limited] partner over time, and they have a dedicated private credit team, with offices in New York and London.

We believe the formation of the ISLP provides BCSF with 3 key benefits. First, the ISLP is expected to enhance BCSF's balance sheet flexibility to expand its global capabilities. Non-U.S. dollar investments, which count against the 30% nonqualifying asset bucket of BDCs, represented approximately 17% of BCSF's total investments as of year-end. Following the transfer of these assets from BCSF's balance sheet to ISLP, non-U.S. dollar-denominated investments represent less than 5% of the total year-end portfolio on a pro forma basis.

Second, BCSF's investment in ISLP is projected to result in higher portfolio yields to drive greater net investment income for our shareholders as we estimate BCSF's investment will produce a low double-digit yield. As a result, BCSF's investment portfolio yield is expected to increase by approximately 20 basis points on a pro forma basis based on the investment portfolio as of year-end. BCSF's investment in ISLP represents approximately 5% of our total portfolio with fair value based on the 12/31 pro forma portfolio. However, there is the potential for BCSF to increase its investment commitment over time as we identify attractive investment opportunities in Europe and Australia, which could lead to additional yield enhancement to our portfolio.

And third, given the deleveraging impact of the transfer of assets to ISLP, BCSF has greater capacity continue -- to continue investing in new senior secured loans to middle market companies to drive further accretion to net investment income. Our ability to form the ISLP is a demonstration of harnessing the relationships, resources and investment capabilities across Bain Capital in a manner that seeks to drive shareholder value. We look forward to providing further updates and transparency on our ISLP investment over time.

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

Thanks, Mike, and good morning. I'll kick it off with our investment activity for the fourth quarter and then provide an update on the credit quality of our portfolio. Q4 new investment fundings were $173 million in 26 portfolio companies, including $121 million in 6 new companies and $52 million in 20 existing companies. Sales and repayment activity totaled $188 million in the quarter.

During the fourth quarter, we were pleased to see investment activity levels revert back to healthy levels as a result of pent-up demand from the slower quarters experienced earlier in the year due to the market disruption. While our Q4 activity levels were skewed to lending to new platforms, we also remained active throughout the year in capitalizing on our incumbency advantage with existing borrowers. Our new investment funding activity was split approximately 60-40 between new and existing borrowers during the 6 months ended December 31.

Throughout 2020, we were able to invest with confidence in new platforms and to existing portfolio companies, given Bain Capital Credit's investing experience that has been honed over multiple market cycles. In addition, we aligned ourselves to invest alongside sponsors that we view to be high quality and whom we saw as highly supportive of their portfolio companies during the most recent period of market disruption.

Lastly, BCSF benefits from Bain Capital Credit's industry research team, providing us with even deeper sector expertise across many verticals. This allowed us to pivot to identify companies and sectors that are expected to be strong performers over the coming years.

As Mike Ewald discussed, our new joint venture through the International Senior Loan Program is noteworthy to emphasize our flexible and global capital base that enabled us to reach the unique financing needs that we saw from across a wide pipeline of our borrowers.

The majority of our new commitments during the fourth quarter were first lien loan opportunities. The weighted average yield on new investments was approximately 7.6%, almost 100 basis points greater than the weighted average yield across our sales and repayment activity. As a result, this drove our portfolio yields higher quarter-over-quarter by approximately 20 basis points.

At the end of the fourth quarter, the size of our investment portfolio at fair value was $2.5 billion across a highly diversified set of 105 portfolio companies operating across 28 different industries. Our investments consist largely of first lien loans to sponsor-backed middle market businesses.

As of December 31, 87% of the investment portfolio at fair value was invested in first lien debt, 7% in second lien debt and 6% in equity interest. The median EBITDA across our portfolio companies was $48 million as of December 31. We continue to favor middle market companies within the core of the middle market as these companies have diversified revenue streams and top line resiliency, both of which were demonstrated throughout 2020.

The industries that our portfolio companies operate within are largely comprised of defensive sectors that are less tied to consumer consumption. Our top industries include technology, aerospace and defense and health care. We continue to believe that we have limited exposure to industries experiencing the most severe impacts of the pandemic.

Credit quality trends within our portfolio improved quarter-over-quarter. Within our internal risk rating scale, 87% of our portfolio at fair value was comprised of rating 1 and 2 investments as of December 31, indicating that the underlying portfolio of companies are performing in line or better than our expectations. Throughout 2020, our portfolio has experienced a gradual markup on these investments following the mark-to-market volatility experienced in Q1. The weighted average fair value mark on these investments was 97.8 as of quarter end compared to an average mark of 99.4 at year-end 2019.

The remaining 13% of the portfolio was classified as a risk rating 3 or 4. These investments have experienced some impact from the pandemic, and we have been encouraged by the liquidity positions of these companies as we look ahead. Many of our borrowers within this category are performing better than originally expected at the outset of the pandemic due to cost-cutting measures and diversified revenue streams that have helped to offset pressures.

The vast majority of our risk rating 3 and 4 investments are comprised of first lien senior secured loans. This places us at the top of the capital structure and minimizes downside risk. As of December 31, our risk rating 3 and 4 investments had a weighted average fair value mark of 84% of par, which was relatively unchanged from the prior quarter. While it continues to be our expectation that we will recognize a par repayment for the majority of these investments, our robust valuation processes apply disciplined practices and techniques to assess the risk profile in the current environment given some of the existing macro conditions for these borrowers.

As Mike mentioned earlier during the call, no new investments were added to nonaccrual status during Q4, reflecting overall stable credit quality. As of December 31, one of our total 105 companies was on nonaccrual status, representing 0.2% of the investment portfolio at both cost and fair value.

Sally will now provide a more detailed financial review.

Thank you, Mike, and good morning, everyone. I'll start the review of our fourth quarter 2020 results with our income statement. Total investment income was $48.3 million for the 3 months ended December 31, 2020, as compared to $46.8 million for the 3 months ended September 30, 2020. The increase in investment income was primarily due to an increase in prepayment-related income and other income. For the year ended December 31, 2020, we had total investment income of $194.5 million. Our 2020 investment income was comprised primarily of contractual cash-paying interest income. PIK income, or payment-in-kind, represented only 3.2% of our total interest income for the year ended December 31. We believe the quality of our income is high given less reliance on the onetime fee income.

Total net expenses for the fourth quarter were $26.2 million as compared to $25.4 million in the third quarter. The increase was primarily driven by higher incentive fees, partially offset by voluntary base management fees and incentive fee waivers and lower interest and debt financing expenses. Our advisers' fee waivers demonstrates our alignment of interest with our shareholders in supporting the regular dividend level.

Net investment income for the quarter was $21.9 million or $0.34 per share as compared to $21.5 million or $0.33 per share for the prior quarter. As a result, net investment income per share for the full year 2020 was $1.46 per share.

During the 3 months ended December 31, 2020, the company had net realized and unrealized gains of $17.6 million, driven by the continued spread tightening and improving fundamental performance trends across our portfolio and investments. GAAP income per share for the 3 months ended December 31, 2020, was $0.61, bringing earnings per share for 2020 to $0.14.

Moving over to our balance sheet. As of December 31, our investment portfolio at fair value totaled $2.5 billion and total assets of $2.6 billion. The net assets were $1.68 billion as of December 31. NAV per share was $16.54 as compared to $16.27 at the end of the third quarter, representing a 1.7% increase quarter-over-quarter.

Following the significant market volatility and disruption during the first quarter, which caused an increase in the unrealized depreciation across our investments, we are pleased to see a gradual recovery throughout the following quarters in 2020. And while we have recovered a large portion of the related NAV recovery, there is still the potential to recapture further unrealized depreciation across our portfolio. The weighted average fair value mark on our investment portfolio was approximately 95.8 as of December 31, 2020, as compared to the amortized cost of 97.2.

At the end of Q4, our debt-to-equity ratio was 1.37x compared to 1.45x at the end of Q3. Our net leverage ratio, which represents principal debt outstanding less cash, was 1.3x at the end of Q4 as compared to 1.33x at the end of Q3. As Mike Ewald highlighted earlier during the call, our net leverage ratio further decreased to approximately 1.1x pro forma for the assets contributed by BCSF to the ISLP based on the December 31 static portfolio.

During 2020, we were active in conducting a number of credit enhancements across our liability structures to improve the company's balance sheet. This included reducing the rate and extending the maturity on one of our bilateral secured facilities and further diversifying our funding mix to include unsecured debt.

As Mike Ewald highlighted earlier during the call, the company recently received an investment-grade rating from Moody's as we announced this morning. We believe this is a noteworthy milestone for the company as it provides us with greater access to the institutional debt market.

For the 3 months ended December 31, 2020, the weighted average interest rate on our debt outstanding was 3.2% as compared to 3.3% for the 3 months ended September 30, 2020. As of December 31, 2020, the company had cash and cash equivalents of $55 million and $374 million of aggregate capacity under its credit facility. As of December 31, 2020, the company was in compliance with all terms under its secured credit facilities.

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

Thanks, Sally. And before concluding the call, we want to remind our shareholders that the company has a $50 million share repurchase program. This was authorized by our Board of Directors in May of 2019 and continues to be in place today. While we believe BCSF shares offered a very attractive value to shareholders throughout 2020, our primary focus was on deleveraging and preserving the liquidity of the company. We've been pleased to see the positive performance of our stock in recent months and believe BCSF shares continue to offer an attractive yield and value for shareholders.

Given the improved strength of our balance sheet in 2021, we will look to evaluate additional investment opportunities during the year while weighing a number of considerations, such as evaluating the company's liquidity position and leverage level, the portfolio's continued performance and credit quality and general market conditions, all while remaining disciplined in our credit selection approach.

Thank you for your continued support. Debbie, if you could please open the line for questions.

(Operator Instructions) The first question comes from Finian O'Shea with Wells Fargo Securities.

First question on a little bit of an interest rate pickup or spread pickup you experienced this quarter. Can you expand on, I guess, first, what happened there? Was this more low-yield exits? Or are you picking up more spread? And if so, if you're picking up more spread, is that sort of a 2020 phenomenon? Or do you anticipate continued spread pickup now that the market is more competitive? Any outlook there?

Sure. So on the exits that we did talk about, the weighted average yield on the exited positions in the portfolio was about 6.6%. And those reflect securities that we had underwritten 2 or 3 years ago. Companies had delevered, and their cost of capital was reduced as the risk profile was reduced and then ultimately paid us down. And so the fact that we're able to pick up about 20 basis points of weighted average yield while still staying in first lien-focused investments was really a product of exiting those deleveraged companies and underwriting new deals that are fresh M&A activity in the middle market.

And then your question about whether it's a 2020 phenomenon, I think what we're observing is that there was definitely a spike in returns in 2020. And it's come back down, but it's still higher today than it was pre-COVID. So we are certainly benefiting from that. Whether that's a new normal, we'll wait and see. But certainly, it's been a strong market from a lender perspective within that core middle market segment where we play.

Okay. Great. And just to follow, looking at your press release on the Moody's rating this morning. Congrats on that, by the way. I assume you want to -- that would entail about 1/3 of your debt stack will go unsecured and you'll be looking to do something soon, again, my assumption. Should we expect something like a $400 million or $500 million offering that would take out your current more expensive notes? Or something smaller that would begin to ladder it out and bring that outcome further down the line?

Yes. So Fin, what we've talked about, certainly over the course of the last year is wanting to increase the unsecured part of our liability structure. We did that a little bit, obviously, in the middle of last year. The IG rating is certainly the first step in that process, and we find the market conditions really attractive right now. So I think that we would expect something in line with that certainly.

The next question comes from Ryan Lynch with KBW.

Following up on Fin's last question regarding kind of the unsecured notes. Does this change the way you think about your 8.5% 2023 notes? I mean I believe that those are redeemable anytime. But can you remind us -- I don't remember if you recall what the pricing would be on those if they were redeemed. So can you remind us what their pricing would be if those -- if you did redeem those now? And any thoughts on kind of replacement of those high-cost notes?

Sure. So those notes are callable at par starting summer of 2022. So we are always looking at the opportunities to potentially refinance those out, recognizing that we are still in -- not in a call period there. So it is math we're always looking at and evaluating.

Okay. And then on your JV, one question about that. And you mentioned that the low double-digit yield -- is that a yield that you guys expect to achieve right on the gate on the formation of it? Or is that something that you will achieve over time as it fully ramps up? And if that's not going to be the yield kind of right out of the gate type of formation, what do you expect to generate kind of day 1 and then ramp that up to low double digits?

Sure. So Ryan, thanks for the question. We are very excited about the ISLP, and we think the double-digit yields are something that will be achieved over time. I'd say on day 1, probably closer to 10%, 11% yields, and that steps up to 12% or 13% yields as we continue to originate into international markets and generate incremental fee income and have repayments, et cetera. So we are in the double digits on day 1, but we do expect a continued ramp to the mid-double digits as we operate that program.

Okay. And then could you provide a little bit of background on what -- how does the lending opportunities compare in Europe and Australia? And then, of course, those could be different themselves. But how would those opportunities compare to opportunities today in the U.S. in terms of leverage, spreads, terms on those deals you're looking at?

Yes. Ryan, I would think about it in a few different ways. One is just from a company size perspective, again, we focused on that core middle market companies at $25 million to $75 million EBITDA. You can find yourself lending with about a $30 million, $40 million company in the U.S. that might dominate the tristate area around New York but not be particularly relevant to its overall industry. Or is that company might be the country champion in Norway, for example, right? So if you think about the size company we invest in, there are a lot of opportunities like that abroad, for sure.

The second point I would make is that the markets function differently internationally than they do here. Health care, for example, could be more regulated in the European country where capacity and the constraint, pricing is much more stable for different services like radiology, for example. And so we might be more inclined to invest in a company like that in Germany than we would be in the U.S. where pricing has competed down at the actual company level. So I think there's those 2 just generic, what does the company look like, questions.

And then the third point, which is what you were really asking about in terms of conditions, that can certainly change over time. Doesn't change week-to-week, but it changes quarter-to-quarter and certainly year-to-year. I'd say, currently, Europe is probably, from a yield perspective, marginally lower than the U.S., although marginally higher from an OID perspective. Australia is probably marginally higher from a spread perspective and about the same from an OID perspective.

So that -- again, that's a snapshot today. That can certainly change over time. But we certainly hedge everything back to U.S. dollars. And the nice thing is we actually have a multicurrency revolver set up for that JV to help mitigate some of those FX issues there as well.

Okay. That's helpful color and backdrop on those different markets. And congrats on the nice quarter end and especially the investment-grade rating. That should be, I think, really helpful for your guys' business.

Thanks, Ryan. Appreciate that.

(Operator Instructions)

Great. Well, it sounds like there's no more questions. We certainly thank everybody for their time and attention this morning. If any questions, reach out. Certainly, feel free -- or any questions come up, certainly feel free to reach out. You know where to find us, certainly on baincapitalbdc.com as well. So thanks again for the time, and we look forward to speaking with you again soon. Cheers.

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