Bain Capital Specialty Finance Inc

NYSE:BCSF

Earnings Call Analysis

Bain Capital Specialty Finance's Q3 2024: Strong Earnings and Growing Deal Flow

In Q3 2024, Bain Capital Specialty Finance reported robust growth, with net investment income per share at $0.53, reflecting an annualized yield of 11.9%. The company's earnings per share reached $0.51, alongside a steady net asset value of $17.76 per share. The Board declared a fourth-quarter dividend of $0.45 per share, yielding 10.1%. With gross originations of $413 million—up 278% year-over-year—activity in M&A and leveraged buyouts remain strong. The company anticipates continued transaction momentum into 2025, supported by private equity capital pressure and a potentially lower interest rate environment.

Strong Quarter Performance

Bain Capital Specialty Finance reported a commendable third quarter for 2024, showcasing a net investment income (NII) of $0.53 per share. This substantial performance was buoyed by the continuing high interest rates within their portfolio, yielding an impressive annualized return of 11.9% on book value. This NII successfully covered their regular dividend by 126%, demonstrating robust financial health. Furthermore, their earnings per share stood at $0.51, reflecting an annual return on equity of 11.5%, indicating a well-managed investment approach.

Asset Growth and Dividends

As of September 30, 2024, the company's net asset value (NAV) per share edged up to $17.76, marking a modest increase of 0.3% from the previous quarter. The Board of Bain Capital Specialty Finance announced a fourth quarter dividend of $0.42 per share, along with an additional special dividend of $0.03 per share. This brings total dividends for the fourth quarter to $0.45 per share, which translates to a notable annualized yield of 10.1% based on ending book value.

Market Environment and Deal Flow

The market dynamics remained favorable during the third quarter, as the company observed active deal flow, driven by mergers and acquisitions (M&A) and new leveraged buyout (LBO) transactions. The management anticipates these trends to persist into 2025, supported by substantial private equity liquidity and potential easing of interest rates. With gross originations reaching $413 million in Q3, a stark increase of 278% year-over-year and up 35% from Q2, Bain Capital's Private Credit Group is poised to take advantage of these opportunities, especially amid shifts in lending patterns.

Focus on Middle Market

Bain Capital Specialty Finance is strategically focused on the middle market, which offers good insulation from larger market volatility. The median EBITDA of their new borrowers remained consistent at around $33 million, fitting within their targeted range of $25 million to $75 million. Their commitment to being selective in investments proved beneficial, as 96% of new investments were secured by strong documentation with financial covenants, showcasing their strong underwriting and management expertise.

Credit Quality and Risk Management

Across their portfolio, credit quality remains stable, with a median leverage of 4.8x and an interest coverage ratio of approximately 1.7x, reflecting solid underlying performance. Nonaccrual investments accounted for a mere 1.1% of the total portfolio, indicating effective risk management practices. Although there was a slight increase in companies rated as underperforming (credit risk rating 3 and 4) from 8 to 11, the overall risk remains dilutive to the portfolio's health.

Leverage Position and Financial Planning

Bain Capital's gross and net leverage ratios were reported at 1.14x and 1.09x, respectively, falling well within their target range. The company is closely monitoring its liquidity position, which totals $562 million with $501.3 million of untapped capacity on their revolving credit facility. These prudent financial practices enhance their ability to navigate upcoming obligations, including a looming $300 million bond maturity due in early 2026. The management indicated plans to access the market in 2025 to manage that liability effectively.

Outlook: Steady Growth Ahead

Overall, Bain Capital Specialty Finance continues to maintain a solid outlook, poised to benefit from ongoing activities within the middle-market sector while remaining cautiously optimistic about future performance. With a focus on earnings growth and a flexible capital structure, coupled with a steady stream of potential deal opportunities, the company stands ready to capitalize on emerging market trends, which positions it favorably for investors looking for consistent returns and sustainable growth.

Earnings Call Transcript 2024-Q3

[Operator]

Good day, everyone, and welcome to today's Bain Capital Specialty Finance Third Quarter ended September 30, 2024, Earnings Conference Call. [Operator Instructions] Please note, this call is being recorded. [Operator Instructions] It is now my pleasure to turn today's program over to Katherine Schneider with Investor Relations.

[Katherine Schneider, executive]

Thank you, Britney, and good morning, everyone, and welcome to the Bain Capital Specialty Finance Third Quarter ended September 30, 2024, Conference Call. Yesterday after market close, we issued our earnings press release and investor presentation of our quarterly results, a copy of which is available on Bain Capital Specialty Finance's Investor Relations website.

Following our remarks today, we will hold a question-and-answer session for analysts and investors. This call is being webcast, and a replay will be available on our website. This call and webcast are property of Bain Capital Specialty Finance and any authorized broadcast in any form is strictly prohibited.

Any forward-looking statements made today do not guarantee future performance, and actual results may differ materially. These statements are based on current management expectations, which include risks and uncertainties, which are identified in the Risk Factors section of our Form 10-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.

[Michael Ewald, executive]

Thanks, Katherine, and good morning, and thanks to all of you for joining us here today 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 third quarter ended September 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. And as usual, we'll also leave some time for questions at the end.

So yesterday after market closed, we delivered strong third quarter results. Q3 net investment income per share was $0.53 as we continue to benefit from high base interest rates across our portfolio.

Our net investment income return represented an annualized yield of 11.9% on book value and covered our regular dividend by 126%.

Q3 earnings per share were $0.51, or an annualized return on equity of 11.5% as credit fundamentals remained healthy across our portfolio.

As of September 30, our net asset value per share was $17.76, an increase of 0.3% from the prior quarter end. Subsequent to quarter end, our Board declared a fourth quarter dividend equal to $0.42 per share and payable to record date holders as of December 31, 2024. The Board also declared an additional dividend of $0.03 per share for shareholders of record as of December 31, as we had previously announced back in February. This brings total dividends for the fourth quarter to $0.45 per share or a 10.1% annualized rate on ending book value as of September 30, which we believe represents an attractive yield for our shareholders.

Turning now to the market environment. During the third quarter, we continued to see active deal flow with increased transaction levels, driven by both M&A and new LBO activity as volumes returned to levels comparable to historical periods. Based on current market conditions, we would expect these trends to continue into 2025, supported by the large amount of private equity dry powder, pressures for private equity sponsors to return capital back to their investors and a likely lower interest rate environment from the higher levels seen in recent years.

Our Private Credit Group's long-standing presence in the middle market, combined with our strong focus and expertise across myriad industries, enables us to generate an attractive deal pipeline while remaining highly selective in our investments.

Gross originations during Q3 were $413 million, up 278% year-over-year and approximately 35% from Q2 levels of $307 million. This quarter, our platform was particularly active providing capital to new platforms that we sourced from our sponsor relationships who value the specialized industry expertise that Bain Capital Credit brings as a source of differentiation versus other lenders.

While the private credit market continues to experience significant growth as many private lenders have moved upmarket, we continue to see attractive opportunities to source and underwrite investment opportunities in the core middle market and serve as a value-added capital provider and business partner to growing businesses. We value this segment of the market given its stable size premium and insulation to large market volatility.

Across our direct originations to new platforms during the third quarter, the median EBITDA of our borrowers was approximately $33 million, consistent with our core borrower EBITDA focus of between $25 million and $75 million.

Relative value remains attractive on new investments within this segment of the market. While we have seen some recent spread compression across the broader market this year, terms and structure continue to be attractive. The weighted average yield on Q3 investments to new companies was 10.7%, with a median leverage levels of 4.5x on these new these originations.

We continue to place a heavy emphasis on investing in structures, which benefit from strong lender controls through credit agreement documentation containing financial covenants and having control positions among lender groups. 96% of our Q3 originations to new companies were structured with documentation containing financial covenants tied specifically to management's forecasts, and we have majority control positions in nearly 87% 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 tenets of our investing strategy.

Moving on to credit quality. Our portfolio companies continue to exhibit strong fundamental performance in the current market environment. Leverage statistics across our borrowers remain healthy at 4.8x overall based on our portfolio company median levels. Interest coverage also remain solid across our portfolio at approximately 1.7x at quarter end despite continued elevated base rates.

Investments on nonaccrual remain low across the portfolio, which is 1.1% of the total portfolio at fair value.

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 believe our strong record, track record of solid company performance is a testament to Bain Capital's disciplined and highly selective underwriting process.

Lastly, at the end of the third quarter, our gross and net leverage ratios for BCSF were 1.14x and 1.09x, respectively, which falls in the middle of our target leverage ratio of 1.0 to 1.5x, and position us well with ample dry powder to capitalize on new investment opportunities in the current environment.

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

[Michael Boyle, executive]

Thanks, Michael, and good morning, everyone. I'll start with our investment activity for the third quarter and then provide an update on our current portfolio. New fundings during the third quarter were $413 million into 83 portfolio companies, including $331 million into 16 new companies and $82 million into 67 existing companies.

Sales and repayment activity totaled approximately $248 million, resulting in net investment fundings of $165 million in the quarter. This quarter, we remained focused on investing in first lien senior secured loans with 97% of our new investment fundings in first lien structures and 3% in preferred or common equity.

As Michael highlighted earlier in the call, new investments made in the quarter were 80% to new portfolio companies and 20% to existing or incumbent companies. We added 16 new companies this quarter, which led to an improvement in our single name company diversification to 159 different companies in the current portfolio.

In making new investments, we leverage Bain Capital's deep industry expertise across a wide range of sectors, including industries such as hotel, gaming and leisure, aerospace and defense and business services. Our sponsor relationships often value Bain Capital's knowledge base across a wide spectrum of industries, including specialized industries, which enable us to be a value-added partner to private equity sponsors through multiple cycles.

Turning now to our current investment portfolio. At the end of the third quarter, the size of our portfolio at fair value was approximately $2.4 billion across a diversified set of 159 companies operating across 31 industries. Our portfolio primarily consists of first lien senior secured loans given our focus on downside management and investing in the top of the capital structure. As of September 30, 63% of the portfolio at fair value was invested in first lien debt, 3% in second lien debt, 2% in subordinated debt, 7% in preferred equity, 9% in equity and other interests, and 16% across our joint ventures, including 10% in the ISLP and 6% in the SLP. The vast majority of our underlying investments within both of these joint ventures are first lien loans.

As of September 30, the weighted average yield of the investment portfolio at amortized cost was 12.1% as compared to 13.1% as of June 30. This decline in yields was partially driven by the decrease in base rates, which contributed about 38 basis points to this yield decline, but it was primarily driven by the decrease in dividends from our aviation portfolio and our joint ventures.

It's worth noting that the spread on our debt investments remain relatively constant quarter-over-quarter from 663 basis points over SOFR in Q2 to 653 basis points over SOFR in Q3. 91% of our debt investments bear interest at a floating rate, which positions the company favorably in today's higher interest rate environment.

Moving now to portfolio credit quality trends. Our fundamentals remain healthy. As highlighted earlier, portfolio company fundamentals exhibited solid trends, with a median net leverage across our portfolio of 4.8x at quarter end versus 4.7x in the prior quarter. Credit quality trends within our internal risk rating scales were also stable quarter-over-quarter. Risk rating 1 and 2 investments, which indicate that the company was performing in line or better than expectations, totaled 96% of our portfolio as of September 30 as compared to 97% in the prior quarter. Risk rating 3 and 4 are underperforming investments comprise just 4% of our portfolio at fair value.

Investments on nonaccrual represented 1.9% and 1.1% of the total investment portfolio at amortized cost and fair value, respectively, as of September 30. This is compared to 1.2% and 1.0%, respectively, as of June 30.

Lastly, we would highlight the performance across our aggregate 120-plus companies within our underlying joint ventures continue to perform well and consistent with our broader portfolio. I'll now turn the call over to Amit who will provide a more detailed financial review.

[Amit Joshi, executive]

Thank you, Mike, and good morning, everyone. I'll start the review of our third quarter 2024 results with our income statement. Total investment income was $72.5 million for 3 months ended September 30, 2024, as compared to $72.3 million for the 3 months ended June 30, 2024. The increase in investment income was primarily driven by an increase in other income. Our investment income continues to benefit from high-quality source of investment income, largely driven by contractual cash income across its investments.

Interest income and dividend income represented 92% of our total investment income in Q3.

Total expenses before taxes for the third quarter were $37.5 million as compared to $38 million in the second quarter.

Net investment income for the quarter was $34 million or $0.53 per share as compared to $33.1 million or $0.51 per share for the prior quarter.

During the 3 months ended September 30, 2024, the company had net realized and unrealized losses of $900,000.

Net income for 3 months ended September 30, 2024, was $33.1 million or $0.51 per share.

Moving over to our balance sheet. As of September 30, our investment portfolio at fair value totaled $2.4 billion and total assets of $2.5 billion. Total net assets were $1.1 billion as of September 30, 2024.

NAV per share was $17.76, an increase of $0.06 per share or a 0.3% increase from $17.70 at the end of second quarter as we demonstrated strong NII overearning of our dividend, coupled with stable credit quality across our portfolio.

At the end of Q3, our debt-to-equity ratio was 1.14x as compared to 1.03x for the end of Q2. Our net leverage ratio, which represents principal debt outstanding less cash and unsettled trade, was 1.09x at the end of Q3 as compared to 0.95x at the end of Q2.

As of September 30, approximately 54% of our outstanding debt was in floating rate debt and 46% in our fixed rate debt.

Our debt funding continues to benefit from low fixed rate debt structures. For the 3 months ended September 30, 2024, the weighted average interest rate on our debt outstanding was 5.1% as compared to 5.1% as of the prior quarter end.

The weighted average maturity across our total debt commitment was approximately 4.5 years at September 30, 2024.

Liquidity at quarter totaled $562 million, including $501.3 million of undrawn capacity on our revolving credit facility, $59.8 million of cash and cash equivalents, including $29.3 million of restricted cash and around $600,000 of unsettled trade net of receivables and payable of investment.

Subsequent to quarter end, our Board declared a fourth quarter 2024 dividend equal to $0.42 per share and a special dividend, as previously announced, of $0.03 per share, bringing total Q4 dividend to $0.45 per share. Both dividends are payable on January 31, 2025, to stockholders of record date on December 31, 2024.

As a reminder, our Board declared a total of $0.12 per share additional dividend, driven by our strong overearning in 2023. These special dividends have been paid out in installments of $0.03 per share per quarter throughout the year.

We currently estimate that our spillover income totaled approximately $1.13 per share, representing over 2x of our quarterly regular dividend. We will continue to monitor our undistributed earning against prudent capital management considerations.

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

[Michael Ewald, executive]

Thanks, Amit. In closing, we are pleased to deliver another strong quarter of attractive earnings for our shareholders with NII well in excess of our dividend and steady NAV growth as our underlying borrowers continue to perform well. We believe the company remains well positioned to source new middle-market lending opportunities given our own dry powder, global footprint and deep industry expertise, while remaining disciplined in our credit selection.

As always, we thank you for the privilege of managing our shareholders' capital. Britney, please open the line for questions.

[Operator]

[Operator Instructions] We will take our first question from Paul Johnson with KBW.

[Paul Johnson, analyst]

I just like to kind of maybe get a sense of just within the portfolio yield declined this quarter 100 basis points or so quarter-over-quarter. What was kind of the interplay of the decline in yield sort of due to some sort of lower reset on the base rates versus spread compression? It sounded like in your comments that spreads were actually fairly stable quarter-over-quarter. So just kind of like to get a sense of what's driving the yield decline this quarter?

[Michael Boyle, executive]

Sure. Thanks for the question, Paul. So as we noted, about 38 basis points of that yield decline was driven by lower base rate. There was another about 10 basis points that was driven by the decrease on spreads on the credit assets in the portfolio. So fairly stable, as you noted and as we spoke about in our prepared remarks. The biggest step down in yield was really driven by the dividend income that was earned in BCSF quarter-over-quarter. So about $6.1 million was earned in Q3 versus about $8.2 million earned in the prior quarter. And that also was really driven by both our aviation investment called Gale, where we did not distribute all of the earnings. There we decided to invest some into the fleet of planes. And so that drove some of the step down as well as a slight step down in some of the dividends earned from our joint ventures. So it was primarily just driven by those dividends, not actual degradation in the spreads of the assets that we're originating.

[Paul Johnson, analyst]

Got it. I appreciate that. That's really helpful. And then how do you guys think about -- I mean, your pipeline, I mean, in terms of spreads and where that's shaping up to kind of the average spread in the portfolio at this point? It seems like M&A, from what you're seeing at least, is picking up. Do you expect there to be some more spread compression in the portfolio as the portfolio churns into next year?

[Michael Ewald, executive]

Thanks, Paul. Look, I think a lot of the spread compression has kind of played out during the course of this year. I think what we're seeing now is a lot more bifurcation in spreads based on the quality of the credit, which is certainly helpful to see. So I think the well bank sponsor with an A+ credit you might still see some spread compression there, but the sort of more average deal or the sponsor that hasn't gotten as much coverage or maybe lenders having left our core middle market and gone upmarket leaves a little bit more room for us to operate. I think there, we'll still see spreads hang in pretty similar to the numbers that we saw this quarter.

[Paul Johnson, analyst]

And then, I mean, in terms of the private credit premium, yield premium to the syndicated markets, I mean, how do you guys think about the international private credit market? I mean do you see that market as potentially a little bit more insulated with the premium that private credit gets over the bank syndicated market just due to more competition in the middle market here in the U.S.? Or I'm just curious if there's any kind of relation between the two?

[Michael Ewald, executive]

Yes. I'd say a couple of things. One is, we're still seeing 150-, 200-basis-point spread, at least in the U.S. between our assets and the more typical probably syndicated loan market. That same relationship doesn't necessarily exist in Europe just because neither of the markets, quite frankly, neither the syndicated market nor the private credit market is as developed over there. So it's harder to kind of benchmark one versus the other.

What I would say, though, is in today's environment, from a relative value perspective, spreads are fairly similar right now between U.S. and Europe. The caveat I would give you is that, in the U.S., you're seeing some of this pressure on some PIK optional interest, especially in the larger cap market, we're not seeing as much in our core middle market. You are seeing that pressure in Europe in the core middle market. And so if you're thinking like-for-like, the spreads are the same, but there's a demand for PIK optionality in Europe that makes Europe marginally less attractive for those particular deals. So at this point, it's less about pricing relative value and more about structure relative value when we weigh U.S. versus Europe.

[Paul Johnson, analyst]

That's an interesting dynamic there. And then just on the credit quality, there was a little bit of deterioration, I mean just within your credit ranking, your credit scoring of investments. I mean there's 11 companies rated 3 and 4 this quarter versus 8 last quarter. There was a small increase in nonaccruals. So what was the driver of I guess the number of companies rated 3 and 4? Is that just the companies going on nonaccrual? Or is there is there any more there?

[Michael Boyle, executive]

Yes. It's still quite idiosyncratic. So there are some companies that are -- it's not necessarily going on nonaccrual. It's just companies that are going on our watch list for performance under the original underwrite. But I noted there's -- it's not concentrated in any industry or really any theme that's been pulling through. It has still been quite idiosyncratic in the -- that small percentage of our portfolio that's risk rating 3 and 4.

[Paul Johnson, analyst]

Got it. And then just last one for me real quick. The $2.8 million small realized net gain, or realized gain in the portfolio this quarter, was there anything in particular that drove that? Was there an exit of any investments?

[Michael Boyle, executive]

Yes. So it was the exit of an investment called BlackBrush, which was in the restructuring that happened during COVID that we finally completed the sale and exit well above our par value, and we took the keys there. So it was that legacy exit from that company called BlackBrush.

[Operator]

[Operator Instructions] And we will take our next question from Derek Hewett of Bank of America.

[Derek Hewett, analyst]

Congrats on the good quarter. Could you talk about your plans to address the $300 million of bonds that mature in early 2026? Are your -- are you going to use your credit facility to take care of that maturity? Are you interested in tapping the unsecured market again later on next year?

[Amit Joshi, executive]

Yes. I mean, we are prudently talking to all our banking partners. We are in continuous dialogue with them. And I would say our intend would be to access the market in 2025. As you highlighted, we have 2 unsecured, which will mature in 2026. So we definitely will access the market. But at the same time, as you saw, we did increase our revolving facility, so between those 2 we'll prudently manage our liability.

[Operator]

[Operator Instructions] It appears we have no further questions in the queue. I'll turn the program back over to Michael Ewald for any additional or closing remarks.

[Michael Ewald, executive]

Thanks, Britney, and thanks again to all of you for joining us on our call today. Again, we're very pleased with the results of the third quarter, and we look forward to bringing you more news at the end of next quarter. Hope everyone has a good day.

[Operator]

Thank you. This does conclude today's program. Thank you for your participation. You may disconnect at any time, and have a wonderful day.