Bain Capital Specialty Finance, Inc.

Greetings. Welcome to the Bain Capital Specialty Finance first quarter 2020 earnings conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should 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, Catherine Snyder. You may begin.

Thanks, Jamalia. Good morning, everyone, and welcome to the Bain Capital Specialty Finance Conference Call for the first quarter of 2020. On Monday after market closed this week, we issued our earnings press release and investor presentation of our quarterly results, a copy of which is available on Bain Capital Specialty Finance 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 factor 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. And with that, I'll turn the call over to our President and CEO, Michael Ewald.

Thanks, Katherine, and good morning, everyone, and thanks for joining us for our first quarter 2020 earnings call. As Catherine mentioned, my name is Michael Ewald, and I'm also joined today by our Vice President and Treasurer, Mike Boyle, and our Chief Financial Officer, Sally Dornis. First, we hope everyone, along with their loved ones, is doing well and has remained safe and healthy during this unprecedented time. In terms of the format for this call, I'll start with a brief overview of our first quarter results, share some thoughts on the market, and then provide an update on the steps we are prudently taking to position the company to navigate uncertain and volatile periods ahead. Mike and Sally will give some additional detail on the investment book and our financial results. Our net investment income for the quarter was $0.44 per share as compared to our regular stated dividend of $0.41 per share. This resulted in NII dividend coverage of 107%. Net asset value per share was down approximately 12% quarter over quarter, primarily due to broad-based credit spread widening across our investment portfolio as a result of the increased volatility and uncertainty and the financial markets in light of the COVID-19 global pandemic. While we certainly did not predict that a global pandemic would elevate the likelihood of a potential recession, we have been positioning our investment portfolio with a late cycle mentality in recent years and believe that it is well insulated to withstand the current market environment. Reflecting this investment strategy, we have focused on first lien senior secured loan structures with strong documentation and have constructed a diversified portfolio of middle market companies and defensible industries such as technology, aerospace and defense, and healthcare and pharmaceuticals. We have largely avoided cyclical industries, including those currently experiencing significant distress, such as energy, hospitality, and airlines. In light of COVID-19, our investment team has been efficiently operating at full capacity, even with our global team working remotely. We have also taken additional steps in actively overseeing and managing BCSF's portfolio. These measures include Communicating frequently with our portfolio company management teams and related private equity sponsors to understand the expected financial impact of this crisis. Re-underwriting and remodeling each of our 108 portfolio company investments to understand the impact on each company's performance if the current economic environment persists for a longer period of time. And establishing an internal working group focused on understanding the potential financial needs of our portfolio companies and engaging with these companies and their private equity sponsors as needed. Our working group is comprised of investment professionals across the firm who contribute deep expertise in multiple market environments and diverse viewpoints. And the group has been focused specifically on covenants and liquidity. During the quarter, our new investments were primarily driven by the fundings of undrawn investment commitments that we provided to existing portfolio companies alongside term loans in the form of revolving credit and delayed draw facilities. We received unprecedented amounts of draw requests from these portfolio companies as many of them sought to preserve excess cash as a defensive measure in light of an uncertain market environment. We met all of these borrow requests in a timely fashion and amended our credit facilities to allow for the inclusion of revolvers as collateral. Furthermore, out of an abundance of caution, our advisor provided additional support to the company through the establishment of a $50 million unsecured revolving credit facility maturing in 2023. We believe this is evidence of Bain Capital's commitment to our success and provides a tangible example of the resources that it can bring to the company. At the end of the first quarter, we had sufficient liquidity consisting of cash and undrawn credit facility capacity of approximately $211 million against our remaining $91 million of undrawn investment commitments, representing coverage of well over two times. We seek to capitalize the company's balance sheet in a prudent manner, consisting of appropriate equity and debt capital based on the underlying risk profile of our assets within the portfolio. As the proportion of first lien risk within that portfolio increased in recent quarters, we have been operating at the outer band of our target leverage range. However, our new investment fundings, together with the decrease in NAV during the quarter, caused the company's ending debt-to-equity ratio to be higher than our target leverage range for the company at between 1 and 1.5 times. Specifically, we ended the first quarter at 1.86 times gross and 1.78 times net of cash, respectively. As many of our shareholders know, our investment philosophy is rooted in Bain Capital's heritage of a disciplined and thoughtful approach to investing. Consistent with this approach, we are focused on safeguarding the stockholder capital entrusted to us. While we believe our investment portfolio is defensively positioned, the current economic environment remains uncertain, including the duration of the economic shutdown and its full impact on the economy. After careful consideration with BCSF's Board of Directors, we announced a rights offering to our stockholders. We believe strengthening BCSF's balance sheet is a prudent and necessary course of action in the uncertain market environment in which we are operating, as it will allow us to maximize long-term stockholder value. The capital raised in the rights offering will allow BCSF to strengthen its balance sheet as the new equity capital will initially be used to deleverage our structure in order to continue to maintain an appropriate debt-to-equity ratio in a challenging environment. While the company is currently in compliance with its debt requirements under its existing facilities and regulatory debt requirements, the additional capital will provide for greater cushion and increased flexibility. Furthermore, we believe the company will have a stronger balance sheet to be able to support existing portfolio companies and take advantage of new opportunistic investments resulting from this period of extreme market volatility and dislocation. We strive to structure the rights offering to be shareholder-friendly as possible. It has been structured as a one-for-four offering, that is, one share of common stock for every four rights held. Thus, the size of this offering minimizes the dilution impact for stockholders, while it provides sufficient liquidity for the company to navigate these uncertain times. We have also structured the rights to be transferable, thus providing some value to shareholders who are unable or unwilling to participate in the offering. Total gross proceeds are estimated to be approximately $120 million, based on current subscription price assumptions. Our advisor is also providing support for this offering, as Bain Capital and its affiliates have indicated that they intend to oversubscribe and to invest up to $50 million pursuant to the oversubscription privilege. While choosing to sell shares below NAV is a difficult decision, we take our responsibility as shareholders by exercising this option with the utmost care and responsibility. We believe this is a prudent course of action for the company to take in light of its leverage profile and is a means to properly equip the company to navigate uncertain volatile periods ahead. Subsequent to quarter end, our Board declared a second quarter dividend distribution equal to 41 cents per share, based on the current number of shares outstanding, for record-date shareholders as of June 30, 2020. If all rights are exercised and approximately 12.9 million shares of our common stock are issued pursuant to this offering, this will be adjusted to 34 cents per share. This is intended to maintain our historical distribution rate of approximately 8% annualized on book value. I will now turn the call over to Mike Boyle, our Vice President and Treasurer, to walk through our investment portfolio in greater detail.

Thanks, Mike. Good morning, everyone. I'll kick it off with more detail on our investment activity this quarter and then provide an update on our investments and credit quality across our portfolio. New fundings were $276 million in 52 portfolio companies operating across 23 different industries. As Mike highlighted earlier on the call, the majority of our new investment fundings were driven by undrawn commitment to existing portfolio companies. The other portion included commitments to four new companies that were funded during the first half of the first quarter. Sale and repayment activity totaled $181 million driven by full repayment from three portfolio companies. As of March 31st, the fair value of our investment portfolio was $2.5 billion. The weighted average portfolio yield and amortized costs was 7.3% as compared to 7.8% in the prior quarter. The decrease was primarily driven by the decline in LIBOR that occurred. As we have discussed with our shareholders during prior calls, we have been positioning our portfolio with a late cycle mentality. We believe the attributes of the investment portfolio that we put into place over the past several years provides the company with solid footing to withstand the potential market volatility ahead. First, we have focused on first dollar risk within our investment portfolio, as this puts us at the top of the capital structure to maximize recovery value in the event of any potential default. 88% of the investment portfolio is invested in this first lien debt, including 1% in the first lien last out debt. We have not been investing in highly leveraged structures as demonstrated by the median leverage of 5.2 times across the portfolio's last dollar attachment points. Our portfolio is comprised of a highly diversified set of companies operating in defensive industries. As of March 31st, the company has 108 portfolio companies with the top 10 investments representing 24% of the total portfolio. As a result, no single investment should have a significant impact on the company overall. Our largest industries are comprised of durable sectors, such as technology, aerospace and defense, and healthcare and pharmaceutical. In particular, within aerospace and defense, we have focused on two main verticals, government defense contractors and businesses in the aviation maintenance and supply chain. For example, one portfolio investment is a first lien loan to an engine repairing business. While plane travel has certainly come down in recent months, we anticipate the continued focus on servicing existing fleets will provide stability to this company's overall operating model. Across the portfolio, we believe we have low exposure to cyclical industries currently most impacted by COVID-19, such as energy, consumer transportation, hotel, gaming, and leisure, and retail. The largest of each of these single industry exposures within our portfolio is less than 3%. Next, we have focused on investing in debt structures with strong loan documentation and voting controls, so we can be in a stronger position to drive favorable outcomes during periods of distress. In particular, we have focused on ensuring our loan agreements have maintenance and financial covenant protection, which help us identify issues early on and allows the team to take action when necessary. 92% of our debt investments have financial covenants, and 92% of our debt investments we have effective voting control. Lastly, we have favored private equity sponsor-backed companies within the core of the middle market segment, as these are a more established set of companies with diversified revenue streams and multiple growth levers available. We have largely avoided smaller businesses as they tend to be less resilient during economic downturns. The median EBITDA of our portfolio companies is $51 million. Our focus on sponsor-backed companies has been driven by the professional management, resources, oversight, and alignment necessary to guide them through various macroeconomic periods. Turning to underlying company performance, while we believe our overall investment portfolio is on solid footing, there are certain companies within our portfolio that have a segment of their end market being more significantly impacted than others as a result of COVID-19. In order to provide transparency to our investors regarding these increased risk factors, we employed an internal risk rating system across our portfolio investments. This framework takes into consideration individual portfolio company performance, business and industry trends, and various factors such as compliance with debt covenants and status of loan payments due. As of March 31st, 2020, 86.3% of the investment portfolio fair value had an internal risk rating of two or lower. This represents an indication that the investment is performing as expected or above expectations relative to the time of our underwriting. 12.6% of the investment portfolio was categorized as a risk rating 3, indicating that the investment is performing below our underwriting expectations, and there may be concerns about the portfolio company's performance or trends in the industry. At this point, the vast majority of this is not driven by underlying fundamental performance portfolio company results, but rather our ongoing proactive analysis of the impact of COVID-19 on each of our portfolio companies. 1.1% of the total investment portfolio is categorized as a risk rating four, in which the investment is performing materially below our underwriting expectations. Sally will speak to our fair evaluation process in greater detail during this call. but we believe our failed value marketing approach reflects the increased risk within our investment portfolio based on the information we have to date. The weighted average fair value price on portfolios in risk rating one and two was 96% of par as compared to 82 on our risk rating three and four investments. As of March 31st, 2020, two portfolio companies were on non-accrual status, representing 1.1% of the total investment portfolio fair value. All other portfolio companies made their scheduled interest and principal payments as expected for the period ended March 31st, 2020. 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 2020 results with our income statement. Total investment income was $51.5 million for the three months ended March 31st, 2020. as compared to $54.8 million for the three months ended December 31, 2019. The decrease in investment income was primarily driven by a decrease in interest income due mainly to a decrease in LIBOR over the quarter. Total expenses for the quarter were $29 million in the first quarter as compared to $33.5 million in the fourth quarter. The decrease was due to no incentive fee expense this quarter because of the incentive fee cap. We met our capital losses, whether realized or unrealized, against pre-incentive net investment income for the purposes of calculating incentive fees. We believe this provides us with the proper alignment with our shareholders. Net investment income for the quarter was $22.5 million, or $0.44 per share, as compared to $21.3 million, or $0.41 per share, for the prior quarter. Given the large movement and focus on valuations this quarter, we wanted to spend a few minutes to highlight our valuation approach. First, our valuation framework consists of a multi-layer valuation process, including internal and external review by our advisor, independent valuation firms, and ultimately our board of directors. For investments for which market quotations are readily available, these investments are generally valued at such market quotations. However, Given our investment strategy is primarily focused on directly originating loans to private middle market companies, the majority of our investments consist of illiquid investments for which market quotations are not available. Our approach to determining the fair value of our illiquid investments utilizes various valuation techniques, such as a discounted cash flow analysis and parallel company multiples and a collateral analysis. 100% of our liquid investments are reviewed by an independent valuation firm each quarter. This quarter, the fair value mark as a percentage of notional on our investment portfolio declined from 99 as of December 31, 2019 to 94.6 as of March 31, 2020. This was largely attributed to spread widening across our investment portfolio given the increase in risk premiums. while also factoring in elevated risk factors around certain portfolio companies that may be more impacted than others as a result of COVID-19. During the three months ended March 31st, 2020, the company had net realized and unrealized losses of $126.9 million, driven by unrealized depreciation across the fair value of the company's investments. Gap loss per share for the three months ended March 31st, 2020 was $2.02 per share. Now moving over to our balance sheet. As of March 31st, our investment portfolio at fair value totaled $2.5 billion and total assets of $2.6 billion. Total net assets were $900 million as of March 31st. NAV per share was $17.29 as compared to $19.72 at the end of the fourth quarter, representing a 12% decline quarter over quarter. Before going into our outstanding debt commitments at quarter end, I would like to spend a few minutes on our financing strategy. First, as Mike Ewald mentioned earlier, our risk management framework dictates the appropriate levels of debt capital that the portfolio can withstand. Within our debt capital structures, we are focused on having diversified sources of funding. We take into consideration a number of factors, including the financial flexibility within each structure, the term of the debt, and the fixed versus floating nature of various structures. Our liability structure has a matched funding profile as we have floating rate liabilities matched with floating rate assets and tiered long-dated maturities to mitigate refinancing risk. The maturities on our existing facilities range from October 2022 to 2031. The company currently utilizes two main structures of debt capital. First, Approximately 46% of our principal debt outstanding as of March 31st was funded with CLO securitization structures. These were purposeful structures that were put into place because of the durable nature of these facilities in periods of volatility. These are non-mark-to-market facilities as the marking mechanism is driven by private ratings based upon fundamental company performance. Our other main source of debt capital is through secured bilateral facilities sourced from Bain Capital's long-standing relationships with various financial institutions. We chose to put in place bilateral agreements as we were able to directly negotiate with our lender as opposed to having to go through a broader syndicate. The marketing mechanism on these facilities are subject to valuation adjustment events and we are required to maintain a certain level of loan-to-value. As of March 31st, 2020, the company was in compliance with all terms under its secured credit facility. During the quarter, we made several amendments to both of our secured facilities. First, in January, we amended our BCSF revolving credit facility to alleviate various covenants, allowing us to better maximize that facility. In addition, we amended our JP Morgan credit facility to improve pricing and extend the maturity date to January 2025. As Mike Ewald highlighted earlier, we amended our secured facilities in March to, among other things, provide for enhanced flexibility to borrow against revolvers and delayed draw facilities given the increased amount of activity on these facilities during the quarter. During the month of March, we entered into a $50 million unsecured revolving credit facility maturing in March 2023 with our advisor. The revolving advisor loan accrues interest at the applicable federal rate As of March 31st, this rate was 1.59%. As of March 31st, we had total principal debt outstanding of $1.7 billion, comprised of the three types of facilities just discussed. For the three months ended March 31st, 2020, the weighted average interest rate on debt outstanding was 4.1%, as compared to 4.5% for the three months ended December 31st, 2019. Our debt-to-equity ratio was 1.86 times at the end of Q1 compared to 1.55 times at the end of Q4. Our net leverage ratio, which represents principal debt outstanding less cash, was 1.78 times at the end of Q1 as compared to 1.48 times at the end of Q4. As of March 31, 2020, the company had cash and cash equivalents and foreign cash of $55.8 million. and $155.1 million of aggregate capacity under its credit facilities. With that, I will turn the call back over to Mike for closing remarks.

Thanks, Sally. In summary, we are living in an unprecedented time. While a number of positive signs have emerged recently in different geographies around the world, we as an advisor and as a management team have invested together through a number of cycles and remain vigilant about protecting shareholder capital in BCSF. We believe we have curated a durable portfolio that will withstand current pressures well, and we are taking necessary steps, such as the previously announced rights offering, to ensure the fund structure is not only able to withstand further unexpected turbulence, but properly situated to capitalize on new investment opportunities still to come. We thank you for your support in this endeavor.

Operator, please open the line for questions.

At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two 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. Our first question is from Chris York from JMP Securities. please proceed with your question.

Good morning, guys, and thanks for taking my questions. So, Mike, just a question on the rights offering. Notice the filings were submitted this week and that you changed the term of the offering from a non-transferable to a transferable offering. So, in light of that change, can you let us know the reasons for that? And then... given that you had the option of coming out to the market with a transferable offering in March?

Sure. So, when we first filed back in March, there was a lot of uncertainty in the world generally. We didn't know really what was going on. I don't think any of us did. Things have certainly settled down a little bit here in terms of markets, in terms of doing the work on our portfolio and ensuring we fully understand where it stands, where the valuations come out, etc. So, When we first filed, we didn't have a shelf in place, so we needed to just get something to the SEC. So we effectively went with a worst-case scenario where we filed, and it was bracketed, you know, the one to two, which some folks like you picked up on. But it was really just a placeholder to see, you know, to sort of see some more cards turned over and try to figure out what amount we felt like we needed to raise. As things have settled down here in the second quarter, we realized that a one to four would actually provide us with sufficient liquidity and deleveraging to achieve that goal while minimizing shareholder dilution. As it turns out, if you have anything that is bigger than a one for three, you actually cannot offer transferable rights. So in the one to two framework, we actually couldn't do it. Now that we're doing one to four, you're actually allowed to. It's a regulatory issue. you're allowed to issue transferable rights as well. And so we figured that would also make it a little bit more shareholder-friendly as well.

Okay. That color helps. A follow-up question on capital planning is, you know, why did you decide to issue the transferable rights in lieu of straight common equity? Because you are one of the few PDCs to receive shareholder approval to issue stock below NAV. And then historical rights offerings for the industry have tended to be a little bit more expensive, even including fees since 2009.

Yeah. So, you know, the theory with the rights offering was since we're going to be issuing below NAV here, we thought it'd be best to actually allow existing shareholders to participate in that. So if we just issued shares, you know, in a private placement or just had a bank place them somewhere, you wouldn't have been able to offer that opportunity to existing shareholders automatically, plus give them the actual transferable right, which may have some value if they choose to sell that instead. So, again, it was more of a matter of, you know, we understand it can be dilutive, even though we could do it another way. You know, let's go ahead and do it through a rights offering specifically.

Does that make sense?

It does.

Last question from me. Many investors know you have some aircraft leasing investments in the portfolio. Market is heavily impacted by COVID here today. Alternatively, though, there seems to be a lot of airlines in need of liquidity. So would you want to increase your investment exposure to that industry? And then if that is the case, are sale leaseback transactions for airlines an area where you'd want to be more active?

Sure.

So about 2% of the portfolio currently is in aircraft leasing. We do think it's an interesting investment opportunity and will continue to be, particularly as we see the world move on from the COVID crisis. We've been comfortable with our existing investments and the capital profiles of those investments remains intact. I think we'll wait to see exactly how the economy turns around and how travel turns around out the back of this crisis before making incremental investments there. But we are pleased that our positioning at about 2% is a meaningful underweight today. And I think we'll be able to take that positioning up to the extent we see interesting opportunities in aviation leasing going forward.

Great, that's it for me. I hope you guys are well. Thanks, Chris.

And our next question is from Aaron Siganovich from Citi. Please proceed with your question. Thanks. Somebody you talked a little bit about, you mentioned many of your industries being kind of a bit defensive, yet there's still some that stand out to be, seem to be a little bit more cyclical. The aerospace and defense is, I think, 12% of the portfolio. Maybe you could talk a little bit about how that's performing and how that's more non-cyclical. You have construction and building, which is, I think, 4% of the portfolio. So you have a few of these, and I think I've asked you this in the past, but I just trying to understand how these are defensive industries and how you think they're going to perform through this tough time. Sure.

Thanks for the question, Aaron. So I guess I'd start by saying, highlighting that we have an average EBITDA of about $50 million in our portfolio. And that means that any company that's in these industries has a diversified set of revenue streams. and also has multiple levers to pull from a cost-cutting perspective. And so at a high level, I think our focus on this upper segment of the middle market is one way that we've seen diversification benefits really flow through our investments. Aerospace and defense specifically, I highlighted in my earlier remarks that we really focus in two different buckets, one of which is government-contracted work, which we've continued to see stability in, the second of which is manufacturers and suppliers in the aviation channel. And I highlighted one investment there, an engine investment. engine repair shops effectively for planes and we've seen that actually hold in quite nicely during this period as although plane travel has has been reduced there is a continued focus on servicing existing cleats as we go through the whole portfolio we see many of the businesses that are potentially most impacted by this slowdown actually on quite firm footing from a capitalization standpoint so one aviation manufacturer was able to raise $100 million incremental debt facility during this time, which should shore up its liquidity for the year ahead. So as we really look through, it's not just an industry by industry view that we're taking. It's also a company by company view. And that's what resulted in about 12% of our portfolio being put as a risk rating three. Those are whether it's a construction business, whether it's an aviation business, those are all of the companies in our portfolio that we do think has increased risk. We don't think there's capital impairment in that bucket, but we do have our teams on high alert as we're working through this period of volatility.

Okay, that's helpful. And what about the international piece of your portfolio, too? How are those performing relative to the U.S.? ? Sure.

So they continue to perform reasonably well. I would say that the fact that Europe is opening a little bit sooner than the U.S. has actually driven some stronger trends here in the very short term. We actually have none of those investments on our risk rating three or four currently. So we are still feeling good about the opportunities abroad and that they do provide solid diversification.

Okay. Thank you.

And we have reached the end of the question and answer session, and I will now turn the call back over to Mike Ewald for closing remarks.

Thanks, and thanks to everyone for joining us on our call today. Certainly, if there's any other questions, do please reach out, and we look forward to continuing to work with you in the future. Hope everyone has a good day. Thanks a lot.

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

Thank you for your participation.