Bain Capital Specialty Finance, Inc.

Good morning, ladies and gentlemen, and welcome to the Bain Capital Specialty Finance second quarter and the June 30th, 2023 earnings conference call. At this time, all lines are in listen-only mode. Following the presentation, we will conduct a question and answer session. If at any time during this call you require immediate assistance, please press star zero for operator. This call is being recorded on Wednesday, August 9th, 2023. I would now like to turn the conference over to Catherine Schneider, Director of Investor Relations. Please go ahead.

Thanks, Enso. Good morning and welcome everyone to our Bain Capital Specialty Finance second quarter ended June 30th, 2023 earnings 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 includes 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. So with that, I'd like to turn the call over to our CEO, Michael Ewald.

Thanks, Catherine, and good morning to all of you, and thanks for joining us here on our earnings call today. I'm also joined by Mike Boyle, our president, and our chief financial officer, Sally Dornis. I'll start with an overview of our second quarter and the June 30, 2023 results, and then provide some thoughts on our performance, the overall market environment, and our positioning. Thereafter, Mike and Sally will discuss our investment portfolio and financial results in greater detail. Yesterday after market closed, we delivered strong earnings results. Q2 net investment income per share was 60 cents, an increase of 20% quarter over quarter, driven by the continued benefit of higher interest rates across our portfolio. Our net investment income return represented an annualized yield of 13.9% on book value and was well in excess of our Q2 dividend, demonstrating 158% NII dividend coverage. Q2 earnings per share were 45 cents, driven by stable credit quality across our portfolio investments during the quarter. Our net income produced an annualized return on book value of 10.4%. These results in turn led to modest NAV growth during the quarter. Net asset value per share as of June 30th was $17.44, reflecting a 40 basis point increase from our $17.37 NAV as of March 31st. And with all that, we're very pleased to announce that our board increased our regular quarterly dividend by 4 cents per share, up 10.5% to 42 cents per share, to shareholders of record as of September 29th, 2023. This represents an annualized yield of 9.6% on ending book value as of June 30th and an 11% annualized yield at BCSF's current trading levels. Importantly, this increase in the regular dividend rate represents the third increase for our shareholders in the past 12 months. Our dividend framework seeks to provide our shareholders with an attractive rate of return while also seeking an appropriate level of cushion for future NAV stability and growth. As we have been evaluating our dividend policy with our board throughout the past year, In light of higher earnings, we believe it is important to provide our shareholders the benefit of the higher income that the company is generating, while remaining prudent in setting the regular dividend level to a rate that the company can earn under various interest rates and economic scenarios. In the current environment, we believe the company remains well positioned to generate net investment income in excess of our newly announced dividend rate, while staying consistent with our objective of achieving NAV stability and growth over time. Our spillover income is estimated to be approximately $0.66 per share. which we believe is a healthy amount and provides for increased dividend stability. We expect to evaluate the potential for any additional distributions as we near the end of the year. Turning out of the market environment, new middle market loan volumes picked up a bit during the second quarter from first quarter levels. Our volumes remain low overall as compared to recent years, given muted LBO activity, as buyers and sellers continue their struggle to find enterprise value equilibrium in the current market environment. As the private credit markets have continued to grow in recent years, both on the supply and demand side of the equation, the value of a well-established direct lending platform with longstanding relationships and expertise is increasingly important to not only source attractive investments, but also have deep resources to diligence and work through complex situations. For the new companies in which our private credit group platform invested during the second quarter, we leverage our in-house industry expertise within niche verticals such as aerospace and defense, and continue to partner with top-tier sponsors who value our prior relationship, working with them on past investments. We believe the lending environment for middle market lenders continues to be attractive given favorable terms and structures that are more lender-friendly. While we have begun to see a small amount of spread compression relative to peak levels in recent quarters, we are still seeing market spread pricing for new first lien term loans between 625 and 700 basis points. In fact, the weighted average spread on our new portfolio company, First Lean Debt Investments, in the second quarter was approximately 670 basis points, which produced a weighted average yield of 12.2% when factoring in current base rates and amortization of original issue discounts. And the weighted average net to EBITDA leverage on these new loans was 4.5 times, reflecting conservative capital structures. In addition to the new First Lean loans in which we invested during the second quarter, We also made an initial equity investment into Legacy Corporate Lending Holdco, LLC, a newly formed portfolio company created to invest in middle market ABL loans. By way of background to this new investment, Bain Capital Credit recently announced that it formed a partnership with Legacy Corporate Lending, an independent asset-based lending company focused on serving the needs of North American middle market borrowers. We believe the ABL space is compelling as the asset class benefits from growing deal volumes and increased non-bank penetration and provides for attractive risk-adjusted returns with differentiated return profiles. Over the past few years, we have evaluated various acquisition opportunities and whether to buy or build an ABL platform. And we're fortunate to partner with a talented and experienced leadership team who brings years of ABL and commercial lending experience to build the business organically. While our initial investment in the company is modest, We believe it could be an attractive growth investment for BCSF over time and provide us with differentiated deal flow in a market which is tangential and complementary to our existing core middle market corporate focus. Our portfolio companies continue to perform well in light of a more complex operating environment as demonstrated by stable credit quality metrics across our portfolio, with no investments added to non-accrual status during the quarter. Almost 40% of our investments were originated after January 1, 2022. a period when rising rates and higher expectations of an economic slowdown were very much central to the investment decision. Overall, we feel good about the health and quality of our portfolio as our underlying borrowers have largely proven to be defensible thus far this year. I will now turn the call over to Mike Boyle, our president, to walk through our investment portfolio in greater detail.

Mike? Thank you, Mike, and good morning, everyone. I'll start with our investment activity for the second quarter and then provide an update on our portfolio. New investment fundings during the second quarter were $198 million across 46 portfolio companies, including $120 million into six new companies. Sales and repayment activity totaled approximately $228 million, resulting in a net funded portfolio decline of $30 million quarter over quarter. This quarter, we remained focused on investing in first lien senior secured loans with 81% of our new funding within first lien structures and 15% in investment vehicles, which comprised an additional $30 million contribution to our senior loan program. The remaining 4% was comprised of equity investments, driven primarily by our new investment to legacy corporate lending that Mike Ewald just highlighted. With new originations, we continue to leverage our longstanding relationships with private equity sponsors who value our ability to minimize execution risk when financing their deals, paired with our deep industry expertise across many niche verticals. Turning to the investment portfolio, at the end of the second quarter, the size of our portfolio share value was approximately $2.4 billion across a highly diversified set of 142 companies operating across 30 different industries. We have continued to grow our diversification by portfolio company with the highest number of borrowers within our portfolio since inception, growing 16% year over year. Our portfolio primarily consists of investments in first lien loans, given our focus on downside management and investing in the top of capital structures. As of June 30th, 64% of the investment portfolio at fair value was invested in first lien debt, 4% in second lien debt, 2% in subordinated debt, 4% in preferred equity, and 11% in equity and other interests, and 15% in our joint ventures. As we have highlighted to our shareholders in prior earnings calls, the decline in our stated first lien exposure has come down given the growth of our investment vehicles, but notably, 95% of the underlying investments held in these vehicles consist of first lien loans, resulting in a look-through first lien exposure of approximately 82% across the entire portfolio. We remain focused on investing in structures that provide us with strong lender controls. 94% of our investments are structured with documentation containing financial covenants tied to management forecasts, and we have majority control positions in nearly 80% of our debt tranches, allowing us to drive eventual outcomes at our discretion. As of June 30th, 2023, the weighted average yield of the portfolio at amortized cost and fair value for 12.8% and 13% respectively, as compared to 12.3% and 12.5% respectively as of March 31, 2023. This increase was primarily driven by higher reference rates across the portfolio. Ninety-four percent of our debt investments bear interest at a floating rate, positioning the company favorably as interest rates have continued to rise beyond reference rate floors. During the quarter, We continue to execute on our investment strategies within our joint ventures. Our JV investments represented 15% of our overall portfolio at fair value, including 10% in the International Senior Loan Program, or ISLP, and 5% in the Senior Loan Program, the SLP. ISLP's investment portfolio as of June 30th was approximately $687 million, comprised of investments in 39 companies. 98% of the portfolio was invested in senior secured floating rate loans. As of June 30th, SLP's investment portfolio was approximately 830 million, comprised of investments in 60 different portfolio companies. 100% of that investment portfolio was invested in senior secured loans. Moving on to portfolio trends, credit quality was stable quarter over quarter. Within our internal risk rating scale, 91% of our portfolio as of June 30th, was comprised of risk-rating one and two investments, indicating that the company was performing in line or better than expectations relative to our initial underwrite. Risk-rating three investments comprised 9% of our portfolio at fair value. These investments reflect companies that have been impacted by inflationary impacts and rising interest rates. We remain focused on watching these companies closely. Risk rating four investments comprised 0% of our portfolio at fair value and included two portfolio companies on non-accrual. No new investments were added to non-accrual during the quarter. Overall, we believe our credit fundamentals remain solid across our portfolio. Our median leverage is 5.1 times as of June 30th as compared to 4.9 times as of March 31st. And our median EBITDA of the portfolio was $58 million. I'll turn it over now to Sally, who will provide a more detailed financial review.

Thank you, Mike, and good morning, everyone. I'll start the review of our second quarter 2023 results with our income statement. Total investment income was $75.7 million for the three months ended June 30th, 2023, as compared to $74.7 million for the three months ended March 31st, 2023. The increase in investment income was primarily driven by the benefit of rising interest rates across our large portfolio of senior secured floating rate loans, partially offset by lower other income. BCSF continues to benefit from high quality sources of investment income, largely driven by contractual cash income across its investments. Interest income and dividend income represented 97% of our total investment income in Q2. with prepayment-related income representing less than 1 percent. Other income comprised only 3 percent of our total investment income. Total expenses for the second quarter were $35.7 million as compared to $42 million in the first quarter. The decrease in expenses was driven by lower incentive fees. Net investment income for the quarter was $38.9 million, or 60 cents per share, as compared to $32.2 million, or 50 cents per share, for the prior quarter. During the three months ended June 30th, 2023, the company had net realized and unrealized losses of $9.7 million. Net income for the three months ended June 30th, 2023 was $29.2 million or 45 cents per share. Moving over to our balance sheet, as of June 30th, our investment portfolio at fair value totaled $2.4 billion and total assets of $2.7 billion. Total net assets were $1.1 billion as of June 30th. NAV per share was $17.44, up from $17.37 at the end of the first quarter, representing a 0.4% increase quarter over quarter. The increase in our NAV was driven by the out-earning of our dividend, coupled with the relative stability in the value of our investments during the quarter. At the end of Q2, our debt-to-equity ratio was 1.33 times as compared to 1.26 times from the end of Q1. Our net leverage ratio, which represents principal debt outstanding less cash and unsettled trades, was 1.13 times at the end of Q2 as compared to 1.16 times at the end of Q1. We are comfortable operating in the middle of our net target leverage ratio between one and one and a quarter times. As of June 30th, approximately 60% of our outstanding debt was in floating rate debt and 40% in fixed rate. The company does not have any debt maturities until 2026. And the weighted average maturity across our total debt commitments was 4.8 years at June 30th. Our debt funding continues to benefit from low fixed rate debt structures as we access the unsecured markets during a period of low interest rates. The weighted average interest rate on our unsecured notes is 2.75%. For the three-month end of June 30th, 2023, the weighted average interest rate on our debt outstanding was 5.2% as compared to 5% as of the prior quarter end. The increase was driven by higher SOFR rates on our floating rate debt structures. Liquidity at quarter end totaled $329 million, including $104 million of undrawn capacity on our revolving credit facility, $129 million of cash and cash equivalents, including $36 million of restricted cash, and $96 million of unsettled trades, net of receivables, and payables of investments. With that, I will turn the call back over to Mike for closing remarks.

Thanks, Allie. So in closing, we are pleased to deliver another quarter of strong earnings for our shareholders, with NII well in excess of our dividend and NAV growth as our underlying borrowers continue to perform well. We're also delighted to deliver another regular dividend increase, reflecting the company's continued earnings growth and stability. Bain Capital Credit remains well positioned to execute on its direct lending strategy, given our platform's expertise, resources, and relationships that have been built on 25 years of experience investing in this middle market. We remain committed to delivering value for our shareholders through producing attractive ROEs, and thank you for the privilege of managing our shareholders' capital. Sindhu, please open the line for questions.

Thank you. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press the star followed by the one on your touchtone phone. You will hear a three-tone prompt acknowledging your request. If you would like to withdraw your request, please press the star followed by the two. Once again, to register for a question, please press star followed by the one on your touch-tone phone. There will be a brief pause whilst questions are being registered. Thank you. Our first question comes from Ryan Lynch from KBW. Please go ahead. Your line is open.

Hey, good morning. Thanks for taking my questions and really nice quarter. First, what I had was just on the legacy corporate lending investment. The investments that are made in that vehicle, will those all show up as investments in that portfolio company or will you be making any investments from that team? Will any of those investments go directly on your balance sheet?

Hi, good morning, Ryan.

Thanks for the question. So all of the investments will end up in that entity, so they won't be directly on our balance sheet.

So what is kind of the expectation? I know it's a new investment, kind of a new formation of a strategy and a team at your company. I mean, what is sort of the goal for kind of growth of that business over the next year or two?

Sure.

So we modeled a number of different scenarios depending on how the market evolves over the next year or two. I think in our base case, we could see that growing to be a 5% position on the portfolio. But there is potential upside from there if we think the market opportunity continues to be compelling, to be slightly larger than 5% over time.

Okay. And then on that, I guess... I guess it depends on what sort of specific investment they're making because it sounds like that team can do a lot of things. I would assume accounts receivable financing is probably going to have a different return than like a machine or equipment financing. But I guess what are sort of the overall returns that are expected on those investments? Are those investments going to be financed with, I'm assuming, a combination of capital from from bain as well as as leverage uh in that entity and then ultimately when this entity gets sort of full scale or scaled which i'm not sure the time frame of that but it sounds like uh you know there'll be a period of time before it does that what sort of return is the what is the return expectation uh that you hope to generate from this investment

Sure.

So baseline returns that we're looking at for the investment on the equity are about 15%, 16%. We do think they'll be slightly lower than that as we ramp and build diversification. But we do have an expectation that over the next 6 to 12 months, that portfolio should be operating at that mid-teens level of return. And given the highly cash-generative nature of those investments, we think it will be producing some nice net investment income for BCSS over time.

How will they be financed? Will they be financed with leverage also in the fund as well?

It's a combination. So there will be some leverage at the company, but then we'll also be contributing equity every time we make a new loan.

What sort of leverage roughly would you expect to run that, operate that entity at?

Yeah, so probably between two and three times leverage.

All right, I appreciate all the comments on that. The other question I had was you mentioned, which is, Mike, you mentioned that you're starting to see a little bit of tightening and spreads, still very attractive spreads in the marketplace, but starting to kind of see a little bit of tightening, which is not uncommon and is something we've heard from other platforms out there today. I'm just curious, outside of the little bit of spread tightening, are there any other sort of changes in the quality of deals? Are you starting to see any sort of pressure on any other terms or structures besides just the spreads for the new deals out there, while still keeping in mind that the overall deals are still a really good environment for deploying capital?

Yeah, Ryan, not really. I think it's a short answer. We're definitely seeing some pressure on that spread. Like we said, call it 25, 50 basis points. But as you point out, on 11, 12 kind of percent returns at the asset level, that's not really that big a move necessarily. On the leverage front, that's another pinch point at times. But as you saw, our average for last quarter was about four and a half times. So that's still pretty conservative. That's really driven by the math. Given how high base rates are, how much tech can a company afford? And cutting 25 basis points out to spread is really not going to alter that much. So we haven't seen pressure there. The third pressure point then would be just general documentation. Things like covenants, as you know, are – Our philosophy is very much focused on getting financial covenants in over 90% of our deals, so that's really at least a term that we would not give on. And other documentation terms like EBITDA definitions and things like that are still, in our estimation, pretty tight and pretty lender-friendly. So it really has just been a little bit on the spread side where we've seen the competition.

Okay, understood. That's all from me. Nice quarter, and I appreciate the time today. Thanks, Ryan.

Thank you. Our next question comes from Derek Hewitt from Bank of America. Please go ahead. Your line is open.

Good morning, everyone, and congrats on the good quarter. My first question is about the incentive fee. It was a little bit lower than expected. So was the calculation, was that impacted by the realized losses during the quarter, and should we expect the fee to, the incentive fee to normalize beginning in the third quarter?

Yeah, so it doesn't have to do with this quarter. It's because of our look back and the COVID quarter causing a bit of noise. When you do the calculation on a cumulative basis and you take what you've taken prior, you would have noticed last quarter and the quarter before were sort of at an elevated rate. So it's going to cause this quarter and the next quarter to be slightly lower, and then it'll start to normalize again.

Okay.

Thank you. The math kind of shakes out. Yeah.

Okay. That makes sense. And then the yield on the international JVs in aggregate remained really attractive. So how should we think about the growth in that international JV portfolio going forward? Do you want to kind of keep it where it's at, at roughly like 15% of the overall portfolio, or do you think there's a little bit more room for growth?

There is some room for growth, Derek, but I don't think it'll be a couple percentage points, not a step function in terms of growth. We are continuing to see interesting opportunities, particularly internationally. But I would note there has been some churn in that portfolio as well, where we're able to replace assets that are harvesting with new assets. So limited growth there, but we have been very pleased with the yield profile coming out of both joint ventures.

Okay, great. And then my last question is just around the overall funding strategy. I mean, you have some time because your bonds aren't due for another few years or so, but all of the bonds are due in 2026. And just given what we've seen some other BDCs do within the funding markets recently, what is the strategy in terms of kind of staggering the bond maturities?

We are focused on looking at laddering maturities and recognize that the unsecured market is open today. We are managing the fact that we do have plenty of runway to the existing security. So we're always managing when the market is open vis-a-vis the needs of the existing liability stack.

Okay. Thank you.

Thank you. Our next question comes from Aaron Siganovich from Citi. Please go ahead. Your line is now open.

Thanks. In your commentary, you mentioned kind of a muted LBO activity with buyers and sellers kind of having a hard time reaching equilibrium. What do you think will get them to move on and have any idea of time frame when that could open back up?

Yeah, Aaron, look, it's a good question. I think there's a little bit of probably pent-upness, right, that's happening in the sponsored market, that there's obviously plenty of dry powder there. So while I took a pause, there's going to be increasing pressure to actually invest. But I think there's also a matter of once we start getting some economic stability and understanding whether there's a recession, if there's going to be a recession, what the recovery looks like, So you can get a little more confidence about different growth factors. I think at that point, sponsors are certainly going to be willing to potentially pay more for assets on a forward-looking basis than they might be right now. So I think that's all part and parcel with it. In talking to advisors in the space, they're kind of the tip of the spear. There seems to be an increase or an uptick in pitch volume there. And that then translates into... an actual transaction several weeks or a couple of months later. So from a timing perspective, it does seem like there could be a rush post-Labor Day to get some fresh deals out into the market. So we're hopeful that the second half of the year ends up picking up a little better than, I guess, the fourth quarter of the year starts picking up a little bit more.

Thank you.

Thank you. As a reminder, if you do wish to register for a question, please press star followed by the one on your telephone keypad. One moment. Thank you. There appear to be no further questions. I'll return the conference back to Michael Ewald for closing remarks.

Great. Thanks, Cynthia. And thanks again for everyone's time and attention today. We're very pleased to share the results of the second quarter here with you, and we look forward to talking with you again soon. Thanks very much.

Thank you. This does conclude today's conference call. Thank you all for attending. You may now disconnect your lines.