2023-11-22 18:26:42 ET
Summary
- Bain Capital Specialty Finance is paying shareholders an 11% dividend yield that's 131% covered by net investment income.
- NAV per share continues to increase with spillover income enough to cover the current base dividend 1.9x.
- Underwriting quality remains strong with loans rated grade 2 rising 330 basis points sequentially.
Bain Capital Specialty Finance, Inc. ( BCSF ) saw its net asset value come in at $1.13 billion, $17.54 per share , at the end of its fiscal 2023 third quarter. This was a per share growth of 10 cents sequentially and was up roughly 3.32% over its year-ago comp of $16.98 per share. The BDC is currently trading for $15.14 per share, a roughly 14% discount to its NAV despite the upward pull of its NAV year-to-date and a credit portfolio set to continue to generate investment income in excess of the quarterly dividend. BCSF most recently declared a $0.42 per share quarterly distribution, in line sequentially for an 11% dividend yield annualized. BCSF forms one of my investment positions as it increases its propensity to be labeled as a sleep well at night ticker. I last covered the ticker prior to its third-quarter earnings.
Whilst BCSF can now be bought for 86 cents on the dollar, it's important to flag that 2024 will pose a dramatically more difficult macroeconomic backdrop for middle market credit. A potential inversion of the current 'Goldilocks' environment of high interest rates and strong economic growth could see a deterioration of BDC portfolios. The CME's 30-Day Fed Funds futures pricing data has essentially written off any further rate hikes, with the rate hike back in July 2023 retrospectively set to be the final of a hiking cycle in place since early 2022. I believe the Fed is done. Hence, growth from the upward pull of yield from floating rate loans will be more stunted. Against this backdrop strong underwriting quality for the minimization of loans on non-accrual combined with continued credit activity to facilitate growth against a macroeconomic context next year where the Fed is more privy to rate cuts is important.
CME FedWatch Tool
Growth, Underwriting Quality, Net Funding
BCSF Fiscal 2023 Third Quarter Presentation
BCSF has seen its weighted average portfolio yield at cost get progressively pulled up on the back of the Fed's fight with inflation. This was at 12.9% at the end of the third quarter, up 10 basis points sequentially. BCSF's portfolio was valued at $2.39 billion across 143 portfolio companies at the end of the third quarter. This was 94.2% floating rate loans to underscore why a flat Fed fund rate next year will form a more difficult backdrop for investment income growth. To be clear, BCSF will have to lend to more companies whilst maintaining underwriting quality to maintain growth against falling yields. BCSF recorded a total investment income of $72.39 million during the third quarter, up 23% over its year-ago comp.
BCSF Fiscal 2023 Third Quarter Presentation
The BDC also realized new investment funding of $109.5 million in 40 portfolio companies during the third quarter with $52.1 million of this in 2 new companies and the remainder in existing investments. This exceeded sales and repayments of $102.8 million and meant net investment fundings of $6.7 million. Critically, credit underwriting has remained strong with investments on non-accrual at 1.5% and 1.0% of BCSF's total investment portfolio at amortized cost and fair value. 94.7% of portfolio companies came with a grade 2 risk rating, up by 330 basis points sequentially. This grading describes a company performing as expected with no concerns about its ability to meet covenant requirements, interest payments, or principal amortization.
BCSF Fiscal 2023 Third Quarter Presentation
Leverage, Spillover Income, And Dividend Coverage
BCSF Fiscal 2023 Third Quarter Presentation
Further, median EBITDA across the portfolio is rising whilst net leverage is dipping. The latter was 5x during the third quarter, down from 5.6x in the year-ago period. BCSF's debt to equity is also falling. It was 1.2x at the end of the third quarter, trending down sequentially from 1.32x. A reduction of the debt-to-equity ratio reduces the risk of a dividend reduction in the bearish scenario that the US will fall into a recession next year. A lower ratio provides more financial flexibility in the face of credit volatility.
The BDC's spillover income continues to build up and at $0.79 per share at the end of the third quarter was 1.9x BCSF's base dividend. BCSF also recorded third-quarter net investment income of $35.6 million, around $0.55 per share. This meant the base dividend is currently 131% covered, around a 76% payout ratio. Hence, the BDC is likely to pay a strong year-end special dividend with spillover set to exceed $1 per share. BCSF will likely err on the side of caution regarding increasing the base dividend. This would be to maintain flexibility and NAV growth through 2024. The ticker still forms a buy on the back of healthy dividend coverage and a 14% discount to NAV per share that is on the up.
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Bain Capital Specialty Finance: 11% Dividend Yield, 14% Discount To NAV