Bain Capital Specialty Finance, Inc.

Stand by, your program is about to begin. If you need audio assistance during today's program, please press star zero. Good day, everyone, and welcome to today's Bain Capital Specialty Finance second quarter and the June 30th, 2024 earnings conference call. At this time, all participants are in a listen-only mode. Later, you will have the opportunity to ask a question during the question and answer session. You may register to ask a question anytime by pressing the star and one on your telephone keypad. You may withdraw yourself from the queue by pressing star and two. I will be standing by if you should need any assistance. It is now my pleasure to turn the conference over to Ms. Catherine Schneider. Please go ahead.

Thank you, Marjorie. Good morning and welcome everyone to the Bain Capital Specialty Finance second quarter ended June 30th, 2024 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 Finances 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. So with that, I'd like to turn the call over to our CEO, Michael Ewald.

Thanks, Catherine, and good morning, everyone, and thank you for joining us here on our earnings call. I'm joined today by Mike Boyle, our president, and our chief financial officer, Amit Joshi. In terms of the agenda for the call, I'll start with an overview of our second quarter, ended June 30, 2024 results, and then provide some thoughts on our performance, the overall market environment, and our positioning. Thereafter, Mike and Amit will discuss our investment portfolio and financial results in greater detail. As usual, we'll also leave some time for questions at the end. So starting with yesterday, after market closed, we delivered solid second quarter results. Q2 net investment income per share was 51 cents as we continued to benefit from high base rate interest rates across our portfolio. Our net investment income return represented an annualized yield of 11.6% on book value and covered our regular dividend by 121%. Q2 earnings per share were 45 cents or an annualized return on equity of 10.2%. as credit fundamentals remain healthy across our entire portfolio. As of June 30th, our net asset value per share was $17.70, unchanged from the prior quarter end. Subsequent to quarter end, our board declared a third quarter dividend equal to 42 cents per share, and payable to record date holders as of September 30th, 2024. The board also declared an additional dividend of three cents per share for shareholders of record as of June 30th, as we previously announced back in February. This brings total dividends for the third quarter to 45 cents per share, or a 10.2% annualized rate on ending book value as of June 30th, which we believe represents an attractive yield for our shareholders. Turning now to the market environment, we continue to see healthy transaction levels during the second quarter, driven by both refinancing and new LBO activity, although new deal activity still remains at lower levels relative to historical periods. In spite of this lower activity level for new M&A, we believe the private credit market remains well-positioned for future growth, given the large amount of private equity dry powder earmarked for new deal activity on the one hand and the mounting pressure for sponsors to return capital to investors through portfolio company sales on the other. Furthermore, market expectations for future rate cuts have increased in recent weeks on the back of softer economic data, which could continue to drive new activity levels into this year and into 2025 as well. Against this backdrop, Bain Capital's private credit group remained active in the middle market, sourcing new investment opportunities from our broad and deep set of relationships, while still remaining highly selective. Our gross originations during Q2 were $307 million, up 55% year-over-year, though down approximately 24% from Q1 levels of $403 million. During the quarter, we were active providing capital to new companies and add-on capital to existing portfolio companies to support their growth through our platform incumbency advantage. Our Q2 originations were split nearly half and half between new and existing borrowers. We continue to see attractive terms in the core middle market, which we define as companies with between $25 and $75 million of EBITDA, and where Bain Capital's platform has consistently invested over its 25-plus year history. Across our direct originations to new platforms during the second quarter, the median EBITDA of our borrowers was approximately $45 million. While we have seen some recent spread compression, terms and structure continue to be attractive with a weighted average yield of 11.6% and median leverage levels of 4.6 times on these new originations. We also remain focused on investing in debt structures that provide us with strong lender controls. 95% of our Q2 originations to new companies were structured with documentation containing financial covenants tied to management's forecasts, and we have majority control in nearly 80% of these debt tranches, allowing us to drive eventual outcomes at our discretion. These statistics are consistent with our broader portfolio, showing our continued focus on these core tenants. Moving on to credit quality, our portfolio companies continue to perform well in the current market environment. Investments on non-accrual status declined quarter over quarter and are below industry averages. Our non-accruals represented 1.2 and 1.0% at amortized cost and fair value respectively as of June 30th. Credit risk rating trends were also stable during the quarter with only a small percentage of our portfolio underperforming and on our watch list. We've been very pleased with the performance of our borrowers operating in a higher interest rate environment in recent years. and we believe this is a testament to Bain Capital's disciplined and highly selective underwriting process. Lastly, we also enhanced our capital position during the quarter by attracting new lenders to our platform. We increased the commitments under our secured revolving credit facility by nearly 30% and extended the maturity to mid-2029 from 2026. At the end of the second quarter, our gross and net leverage ratios were 1.03 times and 0.95 times, respectively. which are at the lower end of our target leverage ratio of 1.0 to 1.25 times, and position us well with ample dry powder to capitalize on new investment opportunities in the current market environment. 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 in the second quarter and then provide an update on trends in our portfolio. New investments made during the second quarter were $307 million into 77 portfolio companies, including $143 million into 11 new companies and $164 million in incremental funding to existing companies. Sales and repayment activity totaled approximately $474 million in the quarter, although $271 million of the sale activity was into our joint ventures. All of this activity resulted in a net harvesting of our investments of $167 million quarter over quarter. Our new fundings were split between new and existing portfolio companies as we leveraged our longstanding relationships with private equity sponsors who valued our industry expertise to help them grow and execute on their longer-term business plans. This quarter, we remain focused on investing in first lien senior secured loans with 86% of our new fundings into first lien structures. 9% of our investment activity was into investment vehicles, which included an additional contribution to the Senior Loan Program. Sales and repayment activity across the portfolio was elevated relative to prior periods as we continued to ramp our joint venture investment into the SLP, which has been producing attractive return on equities for our shareholders with an inception-to-date return of about 16%. Turning now to the investment portfolio, At the end of the second quarter, the size of our investment portfolio at fair value was approximately $2.2 billion across a highly diversified set of 154 portfolio companies operating across 32 industries. Our portfolio primarily consists of investments in first lien senior secured loans, given our focus on downside management and investing in the top of the capital structure. As of June 30th, 63% of the investment portfolio at fair value was in first lien debt. 5% in second lien or subordinated debt, and 9% in equity and other interests. The remaining 17% of the portfolio is invested in our joint ventures, including 11% in the international senior loan program and 6% in the senior loan program, both of which are primarily invested in first lien loans. As of June 30th, 2024, the weighted average yield on the investment portfolio amortized cost and fair value for 13.1% and 13.2% respectively, as compared to 12.9% and 13% respectively as of March 30th, 2024. 93% of our debt investments bear interest at a floating rate, positioning the company favorably in today's higher interest rate environment. Moving on to portfolio credit quality trends. our credit fundamentals remain very healthy. As Mike highlighted earlier, we saw stable trends within our internal risk rating scale quarter over quarter. Risk rating one and two investments, which indicate that a company is performing in line or better than expectations relative to our underwrite, totaled 97% of the portfolio as of June 30th, unchanged from the prior quarter. Risk rating three and four companies or underperforming investments comprised only 3% of our portfolio at fair value. Investments on non-accrual improved quarter over quarter to 1.2% and 1% of the total investment portfolio in amortized cost and fair value, respectively, down from 1.7% and 1.0%, respectively, in the prior quarter. This was primarily driven by the realization of one non-accrual in the quarter exited at the fair value from last quarter. As a reminder, Bain Capital's platform has deep restructuring of workout capabilities to utilize, if needed, to maximize value for our shareholders. We believe this deep bench of expertise positions us and our platform well throughout various market environments, especially today's higher interest rate environment. We would also mention that performance across our 100-plus companies within our underlying JVs continue to perform well, consistent with the trends in our broader portfolio. Amit will now provide a more detailed financial review.

Thank you, Mike, and good morning, everyone. I'll start the review of our second quarter 2024 results with our income statement. Total investment income was $72.3 million for the three months ended June 30, 2024, as compared to $74.5 million for the three months ended March 31, 2024. The decrease in investment income was primarily driven by the decrease in other income. Our investment income 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 96% of our total investment income in Q2. Total expenses before Texas for the second quarter were $38 million, as compared to $39.5 million in the first quarter. Net investment income for the quarter was 33.1 million or 51 cents per share as compared to 34 million or 53 cents per share for the prior quarter. During the three months ended June 30th, 2024, the company had a net realized and unrealized losses of 4 million. Net income for three months ended June 30, 2024 was 29.1 million or 45 cents per share. Moving over to our balance sheet, As of June 30th, our investment portfolio at fair value totaled $2.2 billion and total assets of $2.4 billion. Total net assets were $1.1 billion as of June 30th. NAS per share was $17.70, unchanged from $17.70 at the end of first quarter, as we demonstrated strong NII over-earning our dividends, coupled with stable credit quality across our portfolio. At the end of Q2, our debt-to-equity ratio was 1.03 times as compared to 1.19 times for the end of Q1. Our net leverage ratio, which represents principal debt outstanding, less cash, and unsettled trades, was 0.095 times at the end of Q2 as compared to 1.09 times at the end of Q1. As Mike highlighted earlier, we further strengthened our capital position through increasing the commitment under the Sumitomo Revolver Credit Facility to $855 million, up from $665 million, and extending the maturity date to May 2029 from December 2026. We were pleased with our ability to attract new lenders to the facility, and we were able to hold the terms on our existing facility constant. As of June 30th, approximately 49% of our outstanding debt was in floating rate debt and 51% was in fixed rate debt. Our debt funding continues to benefit from low fixed rate debt structure. For the three months ended June 30th, 2024, the weighted average interest rate on our debt outstanding was 5.1% as compared to 5.2% as of the prior quarter end. The weighted average maturity across our debt commitment was approximately 4.8 years as of June 30, 2024. Liquidity at quarter end totaled $712 million, including $617 million of undrawn capacity on our revolving credit facility, $98 million of cash and cash equivalents, including $67 million of restricted cash and negative $3 million of unsettled trade, net of receivables and payables of investments. Subsequent to quarter end, our board declared a third quarter 2024 dividend equal to $0.42 per share and a special dividend as previously announced of $0.03 per share, bringing total Q3 dividend to $0.45 per share. Both dividends are payable on October 31, 2024 to stockholders of record on September 30, 2024. As a reminder, our board declared a total of $0.12 per share additional dividend driven by our strong over earnings in 2023. We intend to pay these special dividend installments of $0.03 per share each quarter throughout the current year. We currently estimate that our spillover income totaled approximately $0.99 per share, representing over two times of our quarterly regular dividends. We will continue to monitor our undistributed earnings against prudent capital management considerations. With that, I turn the call back to Mike Ewald for closing remarks.

Thanks, Amit. And so in closing here, we are pleased to deliver another quarter of attractive earnings for our shareholders of NII well in excess of our dividend and stable NAV as our underlying borrowers continue to perform well. 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-plus years of experience investing in the core metal 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. Marjorie, please open the line for questions.

Thank you very much. At this time, if you'd like to ask a question... Please press the star 1 on your telephone keypads. You may remove yourself from the queue at any time by pressing star 2. Once again, that is star 1 to ask a question. We'll pause for a moment to allow questions to enter the queue. And again, ladies and gentlemen, if you would like to ask a question, that is star 1 We'll take our first question from Derek Hewitt from Bank of America.

Good morning, everyone. I'm not sure if you addressed this in your opening comments, but could you talk about the 20 basis point increase in the overall portfolio yield? It seems to be an outlier relative to what we were seeing this earnings season.

Sure. Thanks for the question, Derek. A key component of the increased yield is the fact that we sold a number of our investments down into the Senior Loan Program joint venture. As a reminder, that's a joint venture that's intended to hold many of the lower yielding assets off balance sheet rather than keeping them on our balance sheet and give us the flexibility to operate seamlessly in a market where spreads are tightening. And so really that optimization of assets between the balance sheet and the SLP is a key part of what drove that increase in the yields quarter over quarter. Because as a reminder, both the SLP and our balance sheet focus on those porcelain investments that are, we're in a market where there is some spread tightening, as we noted in our remarks, but we think we've set up a structure that works really well for this type of market environment.

Okay, and then...

In terms of the interest coverage, did you mention what interest coverage was for the second quarter?

We did not highlight that specifically across the portfolio, but it is still north of two times when we look at the median interest coverage across the portfolio. And we've run, as we've talked about in prior quarters, a number of stress tests really looking at prolonged interest rates floating right up at this level, as well as interest rate improvement from here or increase from here, excuse me. And that we feel like anything that has any meaningful interest coverage degradation is in our risk rating three and four basket. So I think the results of our interest rate sensitivities on the asset by asset basis are reflected in both the marks and the risk ratings of the portfolio.

Okay, thank you for that. And then my last question is just PIC income. It's about 8% of total investment revenue right now. It's only up about 1% quarter over quarter. But at what level would you start to get a little bit concerned about PIC? And then kind of how would you characterize it? Is it kind of structured into the – was it structured into the original investments? Or is the PIC mainly related to amendments and other credit deterioration issues?

Sure. So the vast majority of the PIC really comes from structures in the original investment thesis. And those come from opportunities where we were more junior in the capital stack. So on occasion, we are we are doing a more second lean or kind of pick junior capital investment. And so we do have a large portion of the pick comes from those original underwritten pick streams. There are some situations where we're doing amendments and adding pick to the portfolio as well in terms of getting increased yield on an underperforming company. But again, the majority really comes from the original underwritten investment that we're making.

Thank you.

Thank you. And again, ladies and gentlemen, that is star one for a question. We'll next move to Paul Johnson from KBW.

Yeah, good morning. Thanks for taking my question. I'm curious, for the loans that go into the JV, do any of those loans, given that the PIC is kind of an option, you know, it's the underwriting thesis, are any of those loans in the JVs, PIC loans, and are you able to kind of characterize how much of the income side of the JVs is currently?

Sure.

So the PIC level of the joint ventures is very low. Those are not structurally PIC loans that end up being traded down into those down into the ISLP or the SLP. So I would note that the interest income that's picked in both joint ventures is very, very low, particularly lower than compared to what's on the balance sheet.

That's helpful. And then just on the performance of the JVs, I was wondering if you can kind of maybe talk to high level how those are performing, non-accruals and such. I mean, they've been obviously performing very well. for you so far. But when I look at 18% trailing return on the SLP fund, that's obviously a very strong return for any kind of JV. So can you just kind of talk to that and what's really driven that strong performance?

Sure. So starting with the SLP, I would say non-accruals have been lower than what we've seen on our balance sheet. And so they are closer to kind of 1.5% to 2% versus the 3% of our risk rating threes and fours on balance sheet. So it is a very healthy portfolio in the SLP. And that, again, is driven by the fact that those assets are lower risk, lower spread, originated in North America. And so that has been a very healthy portfolio to date. In terms of the ISLP, where we are focused on international exposures, we've seen a slight uptick in non-accruals, but again, still in line with what we're seeing on balance sheet. We've seen that trailing return out of the ISLP has been about 12% since inception, reflecting the fact that there is solid underlying credit health there. We have seen a couple of new non-accruals or one in particular new non-accrual come up in the ISLP that is not yet defaulted or had a covenant breach, but we are keeping our eye on what the ultimate outcome will be for that investment. And so some of the decrease in the ISLP mark this quarter was actually from that one new non-accrual held primarily in the ISLP because it is a loan in the UK. But even in spite of that one name on non-accrual, we're still seeing that strong performance in the ISLP continuing.

Got it. That's a very helpful commentary. And then just kind of in terms of like the relative value, you know, currently and the spreads have obviously come in very meaningfully in the U.S. middle market. Do you have any kind of preference in terms of relative value between kind of the international market versus the United States?

Yeah, thanks, Paul. Look, I think at this point, they're still pretty equivalent. It certainly doesn't change really day-to-day or week-to-week. It's more kind of quarter-to-quarter. We obviously have seen some rate-cutting happen in Europe already, which we haven't seen in the U.S., so we're certainly mindful of that. But from an overall creditworthiness perspective, things like relative spreads when you account for currency hedging, when you think about leverage levels, when you think about competitive positioning of the underlying portfolio companies, I'd say today it's pretty equivalent between the U.S. and Europe. And Australia has always just been kind of a steady 5-ish percent plus or minus contributor.

Got it. Appreciate it. That's all the questions for me.

Thanks, Paul. Thank you, and I'd like to turn the call back over to our speakers for any additional or closing remarks.

Great. Thanks, Marjorie, and thanks, everyone, again, for your time today and your attention as we went through our second quarter results here. We'll look forward to speaking with you again once we've got our third quarter results ready to go. Thanks again, and have good days. Cheers.

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