PennantPark Floating Rate Capital Q4 2021 Earnings Call Transcript

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Provided by Quartr
November 18, 2021

Key Takeaways

  • Positive Sentiment: Core net investment income rose to $0.28 per share, driven by growth initiatives but excluding a one-time $2.9 M credit facility amendment expense.
  • Positive Sentiment: PFLT’s portfolio increased to $1.08 B and PSSL’s to $565 M this quarter, backed by $248 M and $77 M in new originations respectively.
  • Positive Sentiment: Credit metrics remain strong with an average debt/EBITDA of 4.3×, interest coverage of 3.2×, and only two non-accruals representing 2.7% of cost.
  • Negative Sentiment: The underperformance of DBI Holding drove a $0.29 per share NAV decline, with potential zero recovery risking an additional $0.28 per share hit and $0.30 drag on quarterly NII.
  • Neutral Sentiment: The company targets a leverage ratio of up to 1.5× debt-to-equity and has diversified funding, including recent unsecured notes at a 3.875% yield for further investment capacity.
AI Generated. May Contain Errors.
Earnings Conference Call
PennantPark Floating Rate Capital Q4 2021
00:00 / 00:00

There are 6 speakers on the call.

Operator

Good morning, and welcome to the PennantPark Floating Rate Capital's Fourth Fiscal Quarter twenty twenty one Earnings Conference Call. Today's conference is being recorded. At this time, all participants have been placed in a listen only mode. The call will be open for a question and answer session following the speakers' remarks. It is now my pleasure to turn the call over to Mr.

Operator

Art Penn, Chairman and Chief Executive Officer of PennantPark Floating Capital Rate Capital. Mr. Penn, you may begin your conference.

Speaker 1

Thank you, and good morning, everyone. I'd like to welcome you to PennantPark Floating Rate Capital's fourth fiscal quarter twenty twenty one earnings conference call. I'm joined today by Richard Chung, our Chief Financial Officer. Richard, please start off by disclosing some general conference call information and include a discussion about forward looking statements. Thank you, Rod.

Speaker 1

I'd like

Speaker 2

to remind everyone that today's call is being recorded. Please note that this call is the property of PennantPark Floating Rate Capital and that any unauthorized broadcast of this call in any form is strictly prohibited. Audio replay of the call will be available by using telephone numbers and PIN provided in our earnings press release as well as on our website. I'd also like to call your attention to the customary Safe Harbor disclosure in our press release regarding forward looking information. Today's conference call may also include forward looking statements and projections, and we ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these projections.

Speaker 2

We do not undertake to update our forward looking statements unless required by law. To obtain copies of our latest SEC filings, please visit our website at pennantparks.com or call us at (212) 905-1000. At this time, I'd like to turn the call back to our Chairman and Chief Executive Officer, Art Penn.

Speaker 1

Thanks, Richard. I'm going to spend a few minutes discussing how we fared in the quarter ended September 30, how the portfolio is positioned for the upcoming quarters, our capital structure and liquidity, the financials and then open it up for Q and A. Our core net investment income grew to $0.28 per share, which excludes a onetime expense of $2,900,000 in connection with the amendment of our credit facility. Our credit quality generally remains solid. We are poised to significantly grow NII through a three pronged strategy, which includes: one, growing assets on the balance sheet at PFLT as we move towards our target leverage ratio of 1.5 times debt to equity from 1.3 times number two, growing our PSSL JV with Kemper to about $730,000,000 of assets from approximately $550,000,000 and three, rotating the equity value in the portfolio that has come from our strong equity co investment program into the cash paying debt instruments.

Speaker 1

With regard to the PSSL JV, with the CLO financing we completed earlier this year as well as additional capital contributions from PFLT and Kemper, the JV will grow over time. The capital contributions from PFLT are targeted to generate a 10% to 12% return. We intend to invest another $42,000,000 over time in order to bring PFLT's investment into PSSL to approximately $243,000,000 As part of our business model, alongside the debt investments we make, we selectively choose to co invest in the equity side by side with the financial sponsor. Our returns on these equity co investments have been excellent over time. Overall for our platform, from inception through September 30, our $246,000,000 of equity co investments have generated an IRR of 28% and a multiple on invested capital of three times.

Speaker 1

In a world where investors may want to understand differentiation among middle market lenders, our long term returns on our equity co investment program are a clear differentiator. We are well on our way to implementing the NII growth strategy. During the September, PFLT had new originations of $248,000,000 and PSSL had new originations of $77,000,000 far outpacing the repayment activity. As a result, the investment portfolio of PFLT increased by approximately $46,000,000 to $1,080,000,000 from $1,040,000,000 PSSL's investment portfolio also grew this quarter from $565,000,000 to $565,000,000 from $530,000,000 an increase of $35,000,000 We continue to be busy. Since September 30, PFLT has had new funded investments, net of sales and repayments of $82,000,000 PSSL has had new funded investments, net of sales and repayments of $23,000,000 We are focused on the core middle market, which we generally define as companies with between 10,000,000 and $50,000,000 of EBITDA.

Speaker 1

We like the core middle market because it is below the threshold and does not compete with the broadly syndicated loan or high yield markets. As such, we do not compete with markets where leverage is higher, equity cushion lower, covenants are light, wide or nonexistent, information rights are fewer, EBITDA adjustments are higher and less diligent and the timeframe for making an investment decision is compressed. On the other hand, where we focus in the core middle market, generally our capital is more important to the borrower. As such, leverage is lower, equity cushion is higher. We have real quarterly maintenance covenants.

Speaker 1

We receive monthly financial statements to be on top of the company's. EBITDA adjustments are more diligent than achievable, and we typically have six eight weeks to make thoughtful and careful investment decisions. According to S and P, loans to companies with less than $50,000,000 of EBITDA have a lower default rate and a higher recovery rate than those loans to companies with higher EBITDA. Portfolio performance remains strong. As of June 30, the average debt to EBITDA on the portfolio was 4.3 times and the average interest coverage ratio, the amount by which cash income exceeds cash interest expense was 3.2 times.

Speaker 1

This provides significant cushion to support stable investment income. These statistics are among the most conservative in the direct lending industry. As of September 30, we had only two non accruals out of 115 different names in PFLT and PSSL. This represents only 2.7% of the portfolio at cost and 2.6% at market value. For the quarter ended September 30, the decline in the value of DBI Holding was the largest driver of the decline in NAV and represented a negative impact of zero two nine dollars per share.

Speaker 1

This was somewhat offset by increases in the valuations of Lash OpCo, marketplace events and SFP Holding. Since quarter end, DBI has continued to underperform and the company has decided to pursue a partial sale and liquidation of the business. It is unclear at this point how this will play out. In the worst case scenario, if PFLT and PSSL have no recovery, NAV would be negatively impacted by $0.28 per share. From an NII perspective, the impact of DBI to NII is expected to be $0.3 per share per quarter.

Speaker 1

The portfolio is highly diversified with 110 companies and 45 different industries. Our credit quality since inception over ten years ago has been excellent. Out of four eighteen companies in which we have invested since inception, we have experienced only 14 non accruals. Since inception, PFLT has invested over $4,400,000,000 at an average yield of 8%. This compares to a loss ratio of only eight basis points annually.

Speaker 1

We are one of the few middle market direct lenders who was in business prior to the global financial crisis and have a strong underwriting track record during that time. Although PSLT was not in existence back then, PennantPark as an organization was investing at that time. During that recession, the weighted average EBITDA of our underlying portfolio companies declined by 7.2% at the bottom of that recession. This compares to the average EBITDA decline of the Bloomberg North American High Yield Index of 42%. Based on the tracking of EBITDA of our underlying portfolio companies through COVID, our EBITDA decline was substantially less than it was during the global financial crisis.

Speaker 1

Our median EBITDA decline at the bottom of COVID in June 2020 was 1.4%. This compares favorably to the 7% decline in EBITDA during COVID of the Credit Suisse high yield index. Many of our portfolio companies are in industries such as government services, healthcare, technology and software, business services and select consumer companies where we have a meaningful domain expertise. The outlook for new loans is attractive. We are as busy as we've ever been in fourteen years in business, reviewing and doing new deals.

Speaker 1

With our experienced and talented and growing team, our wide funnel is producing active deal flow that we can then carefully and thoughtfully analyze so that we can be selected as to what ends up in our portfolio. Let me now turn the call over to Richard, our CFO, to take us through the financial results in more detail.

Speaker 2

Thank you, Rod. For the quarter ended September 30, core net investment income was 28¢ per share, which excludes a onetime expense of $2,900,000 in connection with amendment to the credit facility. Looking at some of the expense categories, management fees and performance based incentive fee totaled about $3,300,000. Taxes, general and administrative expenses totaled about $450,000, and interest expense totaled about 8,500,000.0, which includes the credit facility amendment expense. During the quarter ended September 30, net change in unrealized appreciation on investments was a loss of $7,500,000 or $0.19 per share.

Speaker 2

Net realized gains were about $2,500,000 or $06 per share and changes in the value of our credit facility and notes decreased NAV by $01 per share. GAAP investment income was lower than the dividend by $05 per share. Consequently, GAAP NAV went from $12.81 to $12.62 per share. Adjusted NAV, excluding the mark to market of our liabilities, was $12.43 per share, down from $12.62 per share. Our entire portfolio, our credit facility and notes are mark to market by our Board of Directors each quarter using the exit price provided by an independent valuation firm exchanges on independent broker dealer quotations when active markets are available on the ASC eight twenty and eight twenty five.

Speaker 2

In cases where broker dealer quotes are inactive, we use independent valuation firms to value the investments. With ample liquidity and appropriately levered, our GAAP debt to equity ratio was 1.3 times, while GAAP net debt to equity after subtracting cash was 1.2 times. Regulatory debt to equity ratio was 1.4 times and our regulatory net debt to equity ratio after subtracting cash was 1.3 times. With regard to leverage, we have been targeting a debt to equity ratio of up to 1.5 times. We have a strong capital structure with diversified funding sources and no near term maturities.

Speaker 2

We have a $300,000,000 revolving credit facility maturing in 2026 with $219,000,000 drawn as of September 30, a $118,000,000 of unsecured senior notes maturing in 2023, dollars $228,000,000 of asset backed debt associated with PennantPark sale one due 2,031 and $100,000,000 of unsecured senior notes maturing in 2026. Subsequent to September 30, TFLT issued an additional $85,000,000 of the four point two five percent twenty twenty six unsecured senior notes, bringing the total principal to $185,000,000 The add on notes were issued at a premium resulting in a yield of 3.875%. The proceeds from this note issuance provide additional capital for investments. Our portfolio remains highly diversified with 110 companies across 45 different industries. 86% is invested in first lien senior secured debt, including 13% in PSSL, 1% in second lien debt and 13% in equity, including 4% in PSFL.

Speaker 2

Our overall debt portfolio has a weighted average yield of 7.4%. 99% of the portfolio is falling rate and 81% of the portfolio at the LIBOR floor. The average LIBOR floor is 1%. Now let me turn the call back to Art. Thanks, Richard.

Speaker 1

To conclude, we want to reiterate our mission. Our goal is a steady, stable and protected dividend stream coupled with the preservation of capital. Everything we do is aligned to that goal. We try to find less risky middle market companies that have high free cash flow conversion. We capture that free cash flow primarily in first lien senior secured instruments, and we pay out those contractual cash flows in the form of dividends to our shareholders.

Speaker 1

In closing, I'd like to thank our extremely talented team of professionals for their commitment and dedication. Thank you all for your time today and for your investment and confidence in us. That concludes our remarks. At this time, I would like to open up the call to questions.

Operator

Thank you. And our first question today comes from Paul Johnson of KBW. I'm sorry.

Speaker 3

Morning, guys. Thanks for taking my questions. Sounds like the pipeline is pretty strong. You've seen some pretty strong growth activity here quarter to date. This is the calendar fourth quarter.

Speaker 3

I'm just wondering, given the investment opportunities that you guys are looking at, I mean, are you you're getting up close to the leverage range? Are you compelled to be given what you're looking at, do you have any idea in mind where you would like to be operating at in terms of your leverage range on the low end versus the high end?

Speaker 4

Thanks, Paul. Yes, I think we're targeting kind

Speaker 1

of 1.5 the zone

Speaker 4

of 1.5x for PFLT. That's kind of where we're targeting. Of course, PSSL is a joint venture kind of side by side. And that vehicle we hope and think can over time grow to over $750,000,000 vehicle, which we got a boost from the CLO financing we did there a little while back. And we'll continue to grow that platform.

Speaker 4

And yes, you're right, we're at 1,300,000,000.0 I think at $1.5 zone, kind of topped out PFLT.

Speaker 3

Great. Appreciate that. And then one thing, just on the sort of, I guess, the change quarter over quarter in your equity investments. I was wondering if there was anything particular going on there or if there's any sort of restructuring or new equity investments. It looks like, at least on a cost basis, they went up pretty quite a bit quarter over quarter, but I'm wondering what's going on there.

Speaker 1

Yes. I mean I think part of that

Speaker 4

is probably PSSL and the growth of PSSL. That's probably the main driver of that. Other than that, no, there's no and look, we do continue to on these deals where we think there's a very good opportunity to participate in the upside. We are gradually and thoughtfully doing these equity co invests which have worked out well for us over fourteen years. We don't say yes to all of them.

Speaker 4

We decline many of them. But we do say yes to the ones that we think are very attractive. And so I'd imagine the biggest change is the PSSL investment that we keep making in growing that vehicle.

Speaker 3

Got it. Thanks for that. And my last question that you touched on a little bit during the call, but any sort of color you can give on the your investment in DBI, maybe just exactly what that business is and just if at all. I'm also curious if there was any overlap with that in the well.

Speaker 4

Yes. So there's DBI is in both PFLT and the JV. And when we, you know, on the transcripts kind of talked about what it would mean, you know, on a consolidated basis between both PFLT and PSSL. The company is a labor services company that does work for municipalities and states. Think about managing vegetation, cutting lawns, managing laboratories, you know, things of that nature.

Speaker 4

And the issue there and you read about newspapers and inevitably when you have a portfolio of over 100 names you're going to get, you know, one of them, at least one of them may have some challenges. Most of their employees are unskilled labor. So it's been hard to get unskilled labor. And when you get unskilled labor it's more expensive on one hand. On the other hand they enter into fixed price contracts with the states and cities.

Speaker 4

So unfortunately this company got mismatched between the fixed price contracts they have with the states and the cities and the unskilled labor market where they need to hire. So that's basically the key reason it's underperformed. As we said, they're looking at a partial sale and a partial liquidation. Don't yet know how that is going to play out. We gave the statistics on the transcript as to in the worst case scenario if it's a zero what that would look like.

Speaker 4

It may or may not be the worst case scenario, A. And B, obviously, we have a wide range of equity con vests throughout the portfolio which have had some lift. So if you look at this last quarter, the quarter ended September 30, DBI had a negative impact of $0.29 a share, but that was offset to some extent by some of the other co invests like LASH, Marketplace Events and SFP. So we have a diversified book of these co invests. Some performed well.

Speaker 4

Over time they performed really well. Some underperformed. DBI is an example of an underperformer. And this is an

Speaker 1

example of some of the things that are going on

Speaker 4

in the economy. We think this is not endemic of our portfolio. This is a one off. The vast, vast, vast majority of our names have 25%, 30% EBITDA margins where they are able to increase their pricing to their customers to hopefully more than cover their costs.

Speaker 3

Got it. Appreciate it. Thanks for the color. Very helpful detail. Those were all my questions.

Operator

Thanks. Our next question comes from Mickey Schleien of Ladenburg.

Speaker 5

Good morning, everyone. Art, in your prepared remarks, you mentioned a lot of the advantages of investing in the lower middle market, and I certainly agree. My question is, given how intense the competition is higher up in the middle market with so much private debt and private equity capital available, are you seeing any signs of that trickling down into the middle market and the lower middle market? And are you seeing competitors perhaps idiosyncratic behaving erratically or unrationally?

Speaker 4

Yes, it's a good question. And thankfully, we don't see much of the what we'll call seeping down into the core middle market. Some of these folks have raised so much money and they are aggressively deploying it and they're bringing kind of covenant light and low yield and shorter diligence processes into the market. We kind of say core middle market is $50,000,000 and below. Occasionally, you'll see a $40,000,000 EBITDA company kind of fall sway to that.

Speaker 4

One of the big guys will swoop down and pick that one off and will kind of say, God bless. But kind of below 40, we're not seeing it. And that could change and we're vigilant about it, but below 40% we're not seeing it. We really like where our added value has been. And if you look at our track record, and we'll go into it in the PNNT call, over the

Speaker 1

last six years, it's where we

Speaker 4

can start out with these companies that are doing 10% to 20 of EBITDA. The sponsor has injected a lot of equity, a lot of equity cushion, so we feel very safe about our capital preservation. And there's a real growth plan to take that 10,000,000 or $20,000,000 EBITDA company up to 30,000,040 million 50,000,000 and higher where our debt capital can grow with the company. We can deploy really attractive capital. We have the front row seat.

Speaker 4

Obviously, we're the incumbent and there's less competition by definition on the debt. And then of course we'll co invest in the equity occasionally and participate in the upside that our debt is helping to drive. So those deals are kind of where we can add the most value to today, where our capital is not commoditized, where we can get a front row seat for the long term and then when we can get some upside. That's kind of the prototypical deal for us across our platform. Some of those companies do grow at a $40,000,000 50,000,000 $100,000,000 of EBITDA, and that's terrific.

Speaker 4

And sometimes they leave us on the debt side and we hold the equity. And sometimes that equity is worth a lot of money. So that's kind of where we see our highest value add today.

Speaker 5

Thanks for that, Art. And to follow-up, given the size of those private funds, do you think there's effectively a barrier of entry into the lower middle market where the average deal size just doesn't move the needle for them? And even though the terms may be interesting, it's just not something that they're to put a lot of time in. And does that benefit you?

Speaker 4

Yes. I think that's fair. When you're in the AUM growth business and it's about AUM growth and you're looking at the amount of labor intensity you need to put against the deal versus how much capital you can deploy. I would agree with you. And a long

Speaker 1

time ago I was a big firm.

Speaker 4

I know how sometimes they think below a certain bite size it just doesn't make sense for the model.

Speaker 5

I understand. My last question, Art, is just a little more philosophical thinking about next year relative to what we've had the last couple of years. This year, in particular, there's been a lot of tailwinds in the sector, apart maybe from high levels of of repayments and prepayments. But next year, you know, economic growth might decelerate. The Fed might start raising rates.

Speaker 5

Certainly, defaults probably can't go any lower. They've been historically very low, and we have an election. So it it could be messy. When you think of those issues, how are you considering the right hand side of your balance sheet, both at I guess, at both of your funds or all of your funds in terms of, you want to take some money off the table and keep leverage perhaps below your long term targets next year and see how things work out?

Speaker 4

Yes. You're right. Obviously, in 2022, we've got supply chain, labor, inflation, any number of different potential challenges as an economy. So how do you think about leverage in light of that? Well, first, we have to underwrite companies that can deal with that, that have enough cushion in them so that they can, for instance, raise prices relatively easily as their costs go up.

Speaker 4

So we have to underwrite very carefully in this environment. We think we're well positioned. EBITDA to interest is kind of roughly three times or 3.2 times in this portfolio. So plenty of cushion in the portfolio generally to deal with rising interest rates. But it is something that we think about.

Speaker 4

In terms of leverage of the vehicles, I mean for PFLT in particular, you know, we're kind saying targets 1.5 times. We know and you know that you can take these same assets and walk them over to another department at S and P called the CLO Department. And you could safely get three or four times debt to equity in a box that's very robust and safe and has weathered pandemics and weathered global financial crises, etcetera. So for the assets that we put in PFLT, which we think are among the lowest risk assets in the BDC space, we're very comfortable kind of at that 1.5 times knowing that. Another option is we could take move these assets right over and get more leverage if we wanted to and still feel safe about those capital structures.

Speaker 4

And then we could talk about P and N T later, but again, you have to

Speaker 1

look at the underlying assets.

Speaker 4

We have a lower target ratio there because the underlying assets are different kind of assets. So it's something that we you've seen us do bonds. We've done unsecured bonds recently. That will continue to be an interesting and important tool for us to manage risk and always have diversified financing sources.

Speaker 5

Thank you for that, Ork. That's very helpful, and I look

Speaker 1

forward to talking to you later today. Thanks.

Speaker 2

Thanks.

Operator

The next question comes from Devin Ryan of JMP Securities.

Speaker 2

Hi, good morning. This is Kevin Fultz on for Devin. First question, over the past few quarters, you've talked about the strong growth to continue growing operating earnings, and clearly, you've made progress this year in growing NII. This quarter, core NII was just shy of covering the dividend. Could you talk about when you expect net investment income to cover

Speaker 3

the dividend going forward? Yes.

Speaker 1

Look,

Speaker 4

we believe that as we continue to execute on this plan that we outlined in the very near future, it's hard for me, Kevin, to kind of say on February 3, so it's kind of it's dependent on the deal flow. It's dependent on repayments. It's dependent on rotation of equity. It's dependent on how quickly we can ramp PSSL. We would hope that sometime in 2022 we could safely cover this dividend.

Speaker 2

Okay. Makes sense. And then could you provide an update on the current amount of spillover income?

Speaker 1

Yes. Richard, do you want to handle that one?

Speaker 2

Sure. The current spillover is $0.22 per share, and we should be able to cover that over the assuming the distribution remains the same, we should be able cover that over the next, three quarters. Okay. And that's as of 09/30/2021?

Speaker 3

Yes. Correct. Yes.

Speaker 2

Great. Thank you. That's it for me. Thanks for taking my questions.

Speaker 4

Yes, but thank you. We appreciate it.

Operator

As there are no further questions, would like to hand the call back to Art for any additional or closing remarks.

Speaker 4

Thanks everybody for listening in and giving us your time and attention. Our next quarterly call will be in early February. In the meantime, wishing everybody a terrific Thanksgiving, a terrific holiday season and a season filled of health. Speak to you soon.

Operator

Ladies and gentlemen, that concludes today's conference call. We thank you for your participation.

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