Bain Capital Specialty Finance, Inc.

Greetings. Welcome to the Bain Capital Specialty Finance Third Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. Should anyone require operator assistance during the conference, please press star zero on your telephone keypad. Please note this conference is being recorded. I will now turn the conference over to your host, Sloan Bolin, Investor Relations. You may begin.

Good morning. Last night, we issued our third quarter 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 we make 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 annual report in 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. And with that, I'd like to turn the call over to our President and Chief Executive Officer, Michael Ewald.

Good morning, and thank you for joining us for our third quarter 2019 earnings call. As Sloan mentioned, my name is Michael Ewald, and I'm joined today by our Vice President and Treasurer, Mike Boyle, and our Chief Financial Officer, Sally Dornis. I'm going to start with a brief snapshot of the portfolio and we'll provide some higher level comments on our strategy in the market. Then both Mike and Sally will give some additional detail on the investment book and our results. At the end of the third quarter, the BCSF portfolio represented $2.5 billion invested across 30 different industries and 126 portfolio companies, with a current weighted average yield of 7.7%. In the quarter, we originated $275 million of new investments, and had sales or repayments of $184 million. Excluding the impact of the ABCS balance sheet consolidation in the second quarter, our new originations year-to-date total $953 million against sales or repayments of $755 million. As for the makeup of the portfolio, it's relatively unchanged by loan type and industry exposure. At quarter end, approximately 88% of our portfolio is invested in first-dollar risk, is made up of traditional first lien loans and unit tranches. Credit in the portfolio is still very strong and there remain zero non-accruals. We are again pleased to announce that our board declared a fourth quarter dividend of 41 cents per share. The quarterly dividend will be payable on January 30th, 2020 to stockholders of record on December 31st, 2019. Overall, we remain cautious with regard to credit and believe the portfolio is well positioned for a weakening economy if that eventually occurs. Our portfolio remains overweight in resilient sectors like technology and healthcare. Before I discuss what we're seeing in the markets, let me take a moment to speak to our capital structure. As you can see, we ended the quarter with leverage of 1.6 times gross debt to equity, but it is 1.5 times net of cash. As we continue to operate at the high end of our stated one to one and a half times range, we continue to be focused on expanding the core earnings of the company through thoughtful portfolio construction. In short, we continue to believe that the natural rotation of the portfolio into higher spread assets, further expansion of Unitranche loans under the ABCS program, and access to strategic partnerships and verticals such as our aviation efforts will drive continued earnings growth over the near term. Mike Boyle will expand on this in a bit. From a market perspective, since the beginning of the year, while we have seen periods of fits and starts, the market has generally remained more subdued versus recent years as evidenced by lower new issue volumes published by various providers. This is particularly evident in the broadly syndicated markets where we have seen an increase in flex pricing, spread widening, and general terms and documentation pushback. This is most obvious at the lower end of the credit quality spectrum where there continues to be further bifurcation on who can access the market and at what terms. Such an environment is well-suited for an experienced middle market lender such as ourselves. The ability to remain selective, dictate terms and pricing, and work alongside trusted private equity partners who we have seen execute in the past, all the while overlaying our senior secured focus, creates the opportunity to originate high-quality loans. So without painting an overly rosy picture, this is our way of saying that we continue to find compelling investment opportunities and expect we will be able to continue to execute on our direct lending strategy. Sally will now provide a more detailed financial review.

Thank you, Mike, and good morning, everyone. I'll start the review of our third quarter 2019 results with our income statement. Net investment income for the quarter was $21.2 million, or $0.41 per share, which was consistent with the second quarter of 2019. GAAP earnings per share for the three months ended September 30, 2019, was $0.35 per share, compared to 37 cents per share for the three months ended June 30th, 2019. The quarter over quarter decrease was due to net unrealized depreciation of $3.5 million offset by net realized gains of $500,000. Total expenses for the quarter net of waivers increased sequentially by 2.1 million to approximately $31.5 million in the third quarter compared to 29.4 million in the second quarter. Our expenses increased primarily due to a first full quarter of interest and fee expense associated with our JP Morgan credit facility. For the three months ended September 30th, 2019, our management and incentive fees net of waivers was $6.3 million and $3.6 million, respectively, compared to a management fee and incentive fee net of waivers of $6.4 million and $4.5 million for the three months ended June 30th, 2019. Similar to last quarter, our advisor voluntarily waived its right to receive a base management fee and the incremental assets associated with the ABCS transaction. For the third quarter, the impact of that voluntary waiver was $1.5 million. In addition, our advisor also voluntarily waived an additional $1.1 million related to management fee. As we have stated in the past and continue to demonstrate, we and our advisor believe the fee waiver aligns with the interests of our shareholders and our commitment to a stable dividend. Now moving to our balance sheet. As of September 30th, our investment portfolio at fair value totaled $2.5 billion. The increase was driven by investments of $275 million offset by sales and paydowns of $184 million in the quarter. The weighted average portfolio yield was 7.7% compared to 8% in the second quarter. Portfolio yields declined due to the decrease in LIBOR during the quarter. However, overall weighted average portfolio spread increased eight basis points quarter over quarter. Moving to the right side of the balance sheet, the total net assets were $1 billion as of the end of the third quarter. NAV per share was $19.71 compared to $19.77 in the second quarter due to the net activity losses of $3 million. As of September 30th, we had total principal debt outstanding of $1.7 billion, comprised of our Goldman Sachs and J.P. Morgan credit facilities, along with our 2018-1 and 2019-1 notes. In August, we closed our second middle market CLO for a total amount of $398.8 million. We priced the AAAs at LIBOR 170, and the total liability stack has a weighted average cost of LIBOR plus 230, maturing in October of 2031. As we've talked about before in relation to our first middle market CLO, this structure works very well through a cycle given the protection it provides around market volatility. In conjunction with the 2019-1 issuance, we terminated our $192 million balance drawn on the Citibank facility. This was expected to reset at LIBOR plus 260 in February 2020. Our debt to equity ratio was 1.63 times in Q3 compared to 1.48 times in Q2. Our net leverage ratio, which represents principal debt outstanding less cash, was 1.48 times in Q3 compared to 1.35 times in Q2. Finally, we are pleased to announce that our board declared a fourth quarter dividend of 41 cents per share. The fourth quarter dividend is payable on January 30th, 2020 to stockholders of record on December 31, 2019. Thank you, as always. I will now turn the call over to Mike Boyle, our Vice President and Treasurer, to walk through our investment portfolio and some recent investments in more detail.

Thanks, Sally, and good morning. I'll kick it off with an update on the credit quality of our portfolio and also provide more detail on our originations this quarter. As of September 30th, the fair value of our investment portfolio is $2.5 billion, diversified across 126 companies operating in 30 industries. 99% of the fair value of these investments performing in line or ahead of our underwriting case split between our performance ratings of 1 and 2. We are pleased to report that we have had no non-accruals since the inception of BCSF in 2016 and have no non-accruals in the portfolio at the end of the third quarter of 2019. Our investments are primarily comprised of first lien senior secured loans, which represent 87% of the portfolio. The weighted average yield of investments is 7.7%, median EBITDA is $54 million, with an average leverage level of 5.0 times. 87% of our investments contain financial maintenance covenants. Recently, we have been favoring sectors that should not cycle alongside the macroeconomy, including high-tech, healthcare, and aerospace and defense. We believe that the sum product of these variables creates a portfolio that is well-positioned to withstand any potential market volatility. The defensive nature of our investments is a key consideration in choosing to operate at the high end of our leverage range, which Mike Ewell discussed earlier at 1 to 1.5 times. Shifting to third quarter originations, we invested $275 million in 10 new portfolio companies over the course of the quarter. The weighted average spread of new investments was LIBOR plus 6% versus exits over the quarter at LIBOR 4.9%. Approximately 20% of our new originations were Unitronch loans. One specific example is a Unitronch we extended to support the LBO of Ventive Technologies. a provider of risk management software to enterprises and government agencies with a specialization in insurable risks. With strong retention statistics and a clear value proposition, we view this investment as one that will demonstrate resilient performance in a variety of macroeconomic environments. The loan represents a 1% position in the portfolio and is one component of our largest industry exposure, high-tech. Another investment made in Q3 was a first lien loan to Kellstrom, a U.S.-based provider of replacement parts to the airline industry. The company has many of the positive attributes we look for in distributors, operating with a many-to-many model, which includes long-term relationships across multiple stakeholders. On the demand side, they have good forward visibility driven by the size and diversification of the global aircraft fleet. Given our deep understanding of the aviation industry, we were able to lead the financing and provide a valued solution. As Mike mentioned earlier, while the direct lending market is competitive, we continue to believe it is investable and requires a manager with long-term expertise and a proven track record. Looking forward, our pipeline for the fourth quarter has continued to be full and is in line with our demonstrated investment pace that we've shown over the course of 2019. With that, I'll turn the call back over to Mike for closing remarks.

Thanks, Mike. Before I conclude, I would like to reflect on our first year as a publicly traded business development company as we approach the anniversary of our IPO last November. We have continued to execute on the core middle market investment strategy we have honed at Bain Capital Credit for over 20 years. On the asset side, we are proud of the portfolio of 126 companies we have built with no non-accruals inception to date. We are maintaining our cautious view of macroeconomic considerations and are focusing on the senior most exposure in defensible industries. In addition to our comprehensive diligence work aided by the greater Bain Capital platform, we spend significant time ensuring we have tight documentation in our transactions and are relevant to driving outcomes by controlling the majority of our tranches. We continue to look for relevant investment opportunities globally with local teams on the ground. On the liability side, We are looking to match our debt to our assets as best as we can, especially while maintaining competitive pricing and flexibility and ensuring longevity and certainty through moves like issuing middle market CLOs. Put together, we look to provide an appropriate risk-adjusted return to our shareholders, including ourselves. As always, I would like to thank our investors for their continued support and all of you for your time today. Operator, please open the line for questions.

Thank you. At this time, we will be conducting a question and answer session. Please limit your question to one question and one follow-up. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. The first question is from Finn O'Shea of Wells Fargo Securities. Please go ahead.

Hi, guys. Good morning. Thanks for taking my question. I have a first one on your top-line yields. You outlined both Mike and Mike that they're – and this has been, you know, the plan for some time. You have some lower-yielding assets and plans for expansion into Unitronch. specialty or asset-backed finance, can you talk about sort of in the context of today with LIBOR down, late cycle concerns, what you think is reasonable or what you intend to push toward near to intermediate term on a top line spread perspective?

Sure, and thanks for the question, Finn. So in the third quarter, our originations averaged LIBOR plus 6%, as we were thinking about just from a coupon perspective. And I think that's a fair characterization of where we're seeing attractive risk return. I think that LIBOR 6% is something that has been in line with our Q4 pipeline, and we are assuming that that's kind of an average pace for originations going forward when we think about first lien and unit tranche loans.

And Finn, I would just add, you know, you're absolutely right in terms of our thinking about where we are in the economic cycle. So we don't think this is a time to take on unnecessary risk. So while we improved our spread, I think it was eight basis points, quarter over quarter, I would expect to see a huge jump there. And certainly libel coming down obviously helps from a liability perspective as well.

Okay, thanks, and on the theme you also touched on of pushback in the liquid markets, more demand for documentation, is this impacting, you know, I'd imagine in a positive way, but on any specific front of your strategy, would we, as things are now, Is it fair to say you're looking at larger deals or are you in the camp where those are wobbly for a reason and you're still going to stick to the core middle market?

Our average EBITDA hasn't really changed much. We're at about $54 million for average EBITDA amongst our portfolio companies. That's pretty consistent. That's certainly the segment we like. We've certainly seen some other folks who Even though numbers increase, and that's certainly a different strategy, but this is a segment that we've been in for 20 plus years, and it's the segment we like. So I certainly don't see us changing from that perspective. You're absolutely right, though. We're able to push back a little bit more on things like terms and documentation. So if anything else, we're not as much of an outlier as we have been. by demanding covenants and those sorts of things in the vast majority of our deals. So that certainly helps by not having us stick out as much.

Got it. Thank you. That's all from me. I'll hop back in the queue. Thanks, Sam.

The next question is from Ryan Lynch of KBW. Please go ahead.

Good morning. Thanks for taking my questions. Just wanted to comment or get your guys' comment on your, you mentioned a nice pipeline building. You guys had strong portfolio growth in this quarter. You guys are at your leverage target. So can you just talk about how you guys manage that pipeline and growth being at your leverage target in addition to one of the reasons I know that you consolidated the JV onto the balance sheet was that you guys were bumping up against your 30% bucket and wanted to continue investing in that fund and having the BDC invest and grow the assets with that relationship. Given that you guys are up against your leverage target, how do you manage that?

Sure. Maybe I'll start and Mike will jump in. I'm trying to think of a couple different questions and answers and wrap it up in there. Certainly from a Leverage range perspective, we're definitely at the high end of that range. And as we mentioned, it does include some cash. We had expected some paydowns at the end of the quarter, which ended up leaking into Q4. So it was somewhat artificially high from that perspective. As we've said before, we certainly think that the nature of the portfolio, being such a senior-focused portfolio, does lend itself to, on average, a higher level of leverage than you might see out there. But on the other hand, if you think about our leverage, at this point, all of our leverage is actually on the balance sheet. So from a look through perspective, the number we reported at 1.6 is the number that we have on balance sheet, not balance sheet. So we think overall that that number is fine. In terms of the collapsing of the JV, you're absolutely right. we're bumping up against that 30% limit bucket. If you recall, one of the things that we do there, we have a pretty active international business as well. And with ABCS, as big as it was, it was about roughly 20% of that 30% bucket, and international, therefore, is limited to 10%. But we've seen some pretty interesting opportunities internationally from our teams on the ground in Europe and Australia. And so if you think about our Q3 originations, About 17% of those were international deals. That would not have been possible if we'd still been limited in the 30% market, for example. We think it's a nice way to diversify the risk. And so if we find better opportunities globally, we can still utilize this fund structure to take advantage of those.

Okay. And then you guys waived about $3.3 million in fees this quarter. About $1.5 million was related to your guys' kind of the continual waiver from collapsing the JV, but the remainder was just on top of that, I would assume, to support the dividend. You guys have done this in the past. Is your guys' goal and intention to continue waiving fees to the extent necessary in the future in order to support the dividend?

Yeah, hard to comment on what we do in the future, but clearly we have a pretty proven track record of having done that now. Certainly in the last four quarters or so that we've been public. So I think it's probably reasonable to assume that that will be the case going forward as well.

Okay, thank you. I will hop back in the queue.

Thanks, Ryan. As a reminder, it is star one to ask a question. The next question is from Sam Coey of Credit Suisse. Please go ahead.

Hi, guys. I'm on for Doug today. One on credit quality. I know you guys don't have any non-accrual statuses in the portfolio, but, I mean, I'm just looking at your investment portfolio rating, and the rating three bucket had a company enter it, so... I'm just wondering if there's any common thread you're seeing with those companies or if the concerns are pretty idiosyncratic.

Sure. Thanks for the question. The risk rating threes and where we're seeing underperformance has been very idiosyncratic, ranging from a company that overspent on OpEx to another business that was a carve-out that had some some customer losses that were unanticipated on the back of the carve out. So as we think about the overall quality of the portfolio, it is still quite strong and any situations that have been that performance rating three have been an idiosyncratic environment at the individual business. I did highlight the average leverage across the portfolio is 5.0 times. So we're still feeling quite good about average leverage and EBITDA trends across the portfolio.

Great. And then another one on investment activity. How has that trended in the month of October? If you can comment on that.

Sure. I did comment in my statements that it has been fairly in line with the strong investment activity we've seen over the course of 2019. I won't give kind of specific guidance there, but it has been a very busy Q4. You'll note our Q4 of 2018 was our largest origination quarter since IPO. So we certainly have continued to see a strong pipeline and note that Q4 tends to be a busy quarter in direct lending as there's many transactions looking to get done before the end of the year.

Okay, super helpful. Thank you so much.

We have reached the end of the question and answer session. I will now turn the call back over to Michael Ewald, President and CEO, for closing remarks.

Great. Thanks a lot. And thanks, everyone, for your time and attention today. We're happy with the performance of the quarter. And again, we're happy to have been public for the past year and look forward to continuing to deliver our news to you in future quarters. Thanks very much.

This concludes today's conference and you may disconnect your lines at this time. Thank you for your participation.