PennantPark Floating Rate Capital Q3 2024 Earnings Report

PennantPark Floating Rate Capital EPS Results

• Actual EPS: $0.31
• Consensus EPS: N/A
• Beat/Miss: N/A
• One Year Ago EPS: N/A

PennantPark Floating Rate Capital Revenue Results

• Actual Revenue: $27.92 million
• Expected Revenue: N/A
• Beat/Miss: N/A
• YoY Revenue Growth: N/A

PennantPark Floating Rate Capital Announcement Details

• Quarter: Q3 2024
• Date: 8/7/2024
• Time: Before Market Opens
• Conference Call Date: Wednesday, August 7, 2024
• Conference Call Time: 3:00AM ET

PennantPark Floating Rate Capital (NYSE:PFLT) is a business development company. It seeks to make secondary direct, debt, equity, and loan investments. The fund seeks to invest through floating rate loans in private or thinly traded or small market-cap, public middle market companies. It primarily invests in the United States and to a limited extent non-U.S. companies. The fund typically invests between $2 million and $20 million. The fund also invests in equity securities, such as preferred stock, common stock, warrants or options received in connection with debt investments or through direct investments. It primarily invests between $10 million and $50 million in investments in senior secured loans and mezzanine debt. It seeks to invest in companies not rated by national rating agencies. The companies if rated would be between BB and CCC under the Standard & Poor's system. The fund invests 30% is invested in non-qualifying assets like investments in public companies whose securities are not thinly traded or do not have a market capitalization of less than $250 million, securities of middle-market companies located outside of the United States, high-yield bonds, distressed debt, private equity, securities of public companies that are not thinly traded, and investment companies as defined in the 1940 Act. Under normal conditions, the fund expects atleast 80 percent of its net assets plus any borrowings for investment purposes to be invested in Floating Rate Loans and investments with similar economic characteristics, including cash equivalents invested in money market funds. It expects to represent 65 percent of its portfolio through senior secured loans. In case of floating rate loans, it holds investments for a period of three to ten years.

PennantPark Floating Rate Capital Q3 2024 Earnings Call Transcript

Key Takeaways

• Positive Sentiment: Portfolio grew to $1.7 billion (up 12% QoQ) after investing $321 million in the quarter at a weighted average yield of 11.5%, with an additional >$115 million deployed post-quarter at 11.2%, signaling robust deal flow and attractive yields.
• Positive Sentiment: Funding costs and liquidity improved after closing a $351 million securitization at a 1.89% weighted spread (down ~50 bps) and upsizing/extending the Truist revolver to $636 million at SOFR+2.25, which should lower financing expense and support growth.
• Positive Sentiment: Leverage remains conservative at 1.1x debt-to-equity (target 1.5x), giving the company capacity to deploy capital and potentially lift net investment income per share as it increases leverage.
• Negative Sentiment: GAAP and adjusted NAV fell 0.5% to $11.34 per share due primarily to valuation markdowns, and two new non-accruals were added (non-accruals are still small at 1.5% of cost), which could pressure near-term book value.
• Positive Sentiment: Credit quality remains solid with 87% first-lien exposure, portfolio weighted average debt/EBITDA of 4.1x and interest coverage of 2.2x, and the JV portfolio is approaching $1 billion with expected mid‑teens returns that could enhance future earnings.

Presentation

[Operator]

Good morning, and welcome to the PennantPark Floating Rate Capital's third fiscal quarter 2024 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 speaker's remarks. If you would like to ask a question at that time, simply press star one on your telephone keypad. If you would like to withdraw your question, please press star two on your telephone keypad. It is now my pleasure to turn the call over to Mr. Art Penn, Chairman and Chief Executive Officer of PennantPark Floating Rate Capital. Mr. Penn, you may now begin your conference.

[Art Penn, Chairman and CEO at PennantPark Floating Rate Capital]

Thank you, and good morning, everyone. I'd like to welcome you to PennantPark Floating Rate Capital's third fiscal quarter 2024 earnings conference call. I'm joined today by Rick Allorto, our Chief Financial Officer. Rick, please start off by disclosing some general conference call information and include a discussion about forward-looking statements.

[Rick Allorto, CFO at PennantPark Floating Rate Capital]

Thank you, Art. I'd like 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. An audio replay of the call will be available 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. We do not undertake to update our forward-looking statements unless required by law.

[Rick Allorto, CFO at PennantPark Floating Rate Capital]

To obtain copies of our latest SEC filings, please visit our website at pennantpark.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.

[Art Penn, Chairman and CEO at PennantPark Floating Rate Capital]

Thanks, Rick. We're going to spend a few minutes discussing the current market environment for private middle-market lending, how we fared in the quarter ended June thirtieth, how the portfolio is positioned for the upcoming quarters, a detailed review of the financials, and then open it up for Q&A. For the quarter ended June thirtieth, GAAP and core net investment income was $0.31 per share. As of June thirtieth, our portfolio grew to $1.7 billion, or 12% from the prior quarter. During the quarter, we continued to originate attractive investment opportunities and invested $321 million in 11 new and 47 existing portfolio companies at a weighted average yield of 11.5%. We continue to see an attractive vintage in the core middle market.

[Art Penn, Chairman and CEO at PennantPark Floating Rate Capital]

For investments in new portfolio companies, the weighted average debt to EBITDA was 3.8x, the weighted average interest coverage was 2.2x, and the weighted average loan to value was 47%. Subsequent to quarter end, we remained active and invested over $115 million at a weighted average yield of 11.2%. Investment volume is increasing, and we have a robust pipeline and expect the second half of 2024 to be active. During 2024, the market yield on first lien loans has tightened 50-75 basis points. As the credit statistics just highlighted indicate, we continue to believe that the current vintage of core middle market loans is excellent. In the core middle market, leverage is lower, spreads are higher, and covenants are tighter than in the upper middle market.

[Art Penn, Chairman and CEO at PennantPark Floating Rate Capital]

Despite covenant erosion in the upper middle market and the core middle market, we are still getting meaningful covenant protections. As of June 30th, our debt-to-equity ratio was 1.1 times to 1. With a target ratio of 1.5 times to 1, we believe that we are well-positioned to drive additional growth in net investment income going forward. Securitization financing continues to be a good match for our lower-risk first lien assets. Subsequent to quarter end, PFLT closed on the refinancing and upsize of a $351 million term loan, term debt securitization transaction with a weighted average spread of 1.89%, a 4-year reinvestment period, and a 12-year final maturity. The weighted average spread of 1.89% is a meaningful decrease of 50 basis points from the prior level of 2.39%.

[Art Penn, Chairman and CEO at PennantPark Floating Rate Capital]

The main contributor to this decrease was a favorable market environment in which the AAA portion of the structure priced at an attractive weighted average spread of 1.75%. The ratio of external debt to PFLT's junior capital was 3.1 times to one, which creates plenty of liquidity for the company. During the quarter, we added two new lenders to the Truist Revolving Credit Facility and upsized total commitments to $611 million from $436 million. In addition, this week, we expect to close on an amendment, an extension of the Truist Revolving Credit Facility.

[Art Penn, Chairman and CEO at PennantPark Floating Rate Capital]

The highlights of the amendment are an increase in total commitments to $636 million, a reduction in rate to SOFR + 2.25, which is down from SOFR + 2.36, and an extension in the revolving period to 2027. We expect continued stability in NII, in part due to our investment in the joint venture. As of June 30, the JV portfolio totaled $904 million, and together with our JV partner, we continue to execute on the plan to grow the JV portfolio to approximately $1 billion of assets. During the quarter, the JV invested $85 million in five new and 11 existing portfolio companies at a weighted average yield of 11.6%, including $69 million of assets purchased from PFLT.

[Art Penn, Chairman and CEO at PennantPark Floating Rate Capital]

We believe that the increase in scale of the JV's balance sheet will continue to drive attractive mid-teens returns on invested capital and enhance PFLT's earnings momentum. GAAP and adjusted NAV decreased 0.5% to $11.34 per share from $11.40 per share. The decrease in NAV for the quarter was due primarily to valuation adjustments on both debt and equity investments. Credit quality of the portfolio has remained strong. We added two new investments to the non-accrual status. Non-accruals represent only 1.5% of the portfolio cost and 1.1% at market value. As of June thirtieth, the portfolio's weighted average leverage ratio to our debt security was 4.1x, and the portfolio's weighted average interest coverage ratio was 2.2x.

[Art Penn, Chairman and CEO at PennantPark Floating Rate Capital]

We believe that this is one of the most conservatively structured portfolios in the direct lending industry and is a testament to our focus on the core middle market. We like being positioned for capital preservation as a senior secured first lien lender focused on the United States. We continue to believe that our focus on the core middle market provides the company with attractive investment opportunities, where we provide important strategic capital to our borrowers. We have a long-term track record of generating value by successfully financing growing middle market companies in five key sectors. These are sectors where we have substantial domain expertise, know the right questions to ask, and have an excellent track record. They are business services, consumer, government services and defense, healthcare, and software technology. These sectors have also been resilient and tend to generate strong free cash flow.

[Art Penn, Chairman and CEO at PennantPark Floating Rate Capital]

The core middle market, companies with 10-50 million of EBITDA, is below the threshold and does not compete with the broadly syndicated loan or high-yield markets, unlike our peers in the upper middle market. In the core middle market, because we are an important strategic lending partner, the process and package of terms we receive is attractive. We have many weeks to do our diligence with care. We thoughtfully structure transactions with sensible credit statistics, meaningful covenants, substantial equity cushions to protect our capital, attractive spreads, and equity co-investment. Additionally, from a monitoring perspective, we receive monthly financial statements to help us stay on top of the companies. With regard to covenants, unlike the erosion in the upper middle market, virtually all of our originated first lien loans have meaningful covenants, which help protect our capital.

[Art Penn, Chairman and CEO at PennantPark Floating Rate Capital]

This is a significant reason why we believe we are well positioned in this environment. Many of our peers who focus on the upper middle market state that those bigger companies are less risky. That may make some intuitive sense, but the reality is different. According to S&P, loans to companies with less than $50 million of EBITDA have a lower default rate and higher recovery rate than loans to companies with higher EBITDA. We believe that the meaningful covenant protections of core middle market loans, more careful diligence, and tighter monitoring have been an important part of this differentiated performance. Our credit quality since inception over 13 years ago has been excellent. PFLT has invested $6.3 billion in over 500 companies, and we have experienced only 20 nonaccruals. Since inception, PFLT's loss ratio on invested capital is only 10 basis points annually.

[Art Penn, Chairman and CEO at PennantPark Floating Rate Capital]

As a provider of strategic capital, we fuel the growth of our portfolio companies. In many cases, we participate in the upside of the company by making an equity co-investment. Our returns on these equity co-investments have been excellent over time. Overall, for our platform from inception through June 30th, we've invested over $511 million in equity co-investments and have generated an IRR of 26% on a multiple on invested capital of 2x. Our experienced and talented team and our wide origination funnel is producing active deal flow. Our continued focus remains on capital preservation and being patient investors. Our mission and goal are a steady, stable, and protected dividend stream, coupled with the preservation of capital. Everything we do is aligned to that goal. We seek to find investment opportunities in growing middle market companies that have high free cash flow conversion.

[Art Penn, Chairman and CEO at PennantPark Floating Rate Capital]

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. Let me now turn the call over to Rick, our CFO, to take us through the financial results in more detail.

[Rick Allorto, CFO at PennantPark Floating Rate Capital]

Thank you, Art. For the quarter ended June 30th, GAAP and core net investment income was $0.31 per share. Operating expenses for the quarter were as follows: interest and expenses on debt were $16.4 million, base management and performance-based incentive fees were $9.2 million, general and administrative expenses were $1.5 million, and provision for taxes were $0.2 million. For the quarter ended June 30th, net realized and unrealized change on investments, including provision for taxes, was a loss of $4.3 million. As of June 30th, our GAAP NAV was $11.34 per share, which is down 0.5% from $11.40 per share last quarter. Adjusted NAV, excluding the mark-to-market of our liabilities, was $11.34 per share, down 0.5% from $11.40 per share last quarter.

[Rick Allorto, CFO at PennantPark Floating Rate Capital]

As of June 30th, our debt-to-equity ratio was 1.1 times, and our capital structure is diversified across multiple funding sources, including both secured and unsecured debt.

[Rick Allorto, CFO at PennantPark Floating Rate Capital]

As of June 30th, our key portfolio statistics were as follows: Our portfolio remains highly diversified, with 151 companies across 45 different industries. The weighted average yield on our debt investments was 12.1%, and approximately 100% of the debt portfolio is floating rate. PIK income equaled only 1.4% of total interest income for the quarter. We had three non-accruals, which represented 1.5% of the portfolio at cost and 1.1% at market value. The portfolio is comprised of 87% first lien senior secured debt, less than 1% in second lien and subordinated debt, 4% in equity of PSSL, and 9% in other equity. The debt to EBITDA on the portfolio is 4.1x, and interest coverage was 2.2x.

[Rick Allorto, CFO at PennantPark Floating Rate Capital]

Now, let me turn the call back to Art.

[Art Penn, Chairman and CEO at PennantPark Floating Rate Capital]

Thanks, Rick. In closing, I'd like to thank our dedicated and talented team of professionals for their continued commitment to PFLT and its shareholders. 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. If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press star one to ask a question. We'll take our first question from Brian McKenna from Citizens JMP.

[Brian McKenna, Director at Citizens JMP]

Thanks. Good morning, everyone. You know, it was another strong quarter of growth for the investment portfolio, and that's actually now increased 55% year to date. So what's the expectation around growth for the portfolio over the next couple of quarters? You still have capacity on the leverage side, and then cash also remains somewhat elevated. So I'm just trying to think through the trajectory of the portfolio from here, and ultimately, if you're actually in a position to grow earnings into next year, even with what's likely going to be lower base rates.

[Art Penn, Chairman and CEO at PennantPark Floating Rate Capital]

Yeah, thank you. It's the right question, and I gotta say, we're busy. We're busy. We've been busy, obviously, over the last quarter or two, maybe somewhat differentiated than some of our peers who are in the upper middle market, where it's been either slower or they have, you know, severe competition going against the broadly syndicated loan market. Here in the core middle market, you know, we're active, we're seeing a lot of deal flow. We're kind of doing our prototypical start with a platform that's a little smaller, but with add-on acquisitions, delayed draw term loans, substantial equity from the sponsor and grow it over time. So that's a lot of what we're doing. Hard to put a pin in it for you, Brian, in terms of actual capital deployed.

[Art Penn, Chairman and CEO at PennantPark Floating Rate Capital]

We've built a very nice war chest between the upsized Truist facility, $200 million upsize, the upsized securitization, and the ATM program. So, really, really well positioned from a liquidity and capital side to take advantage of the opportunity. And should the markets become choppier, and that's certainly a possibility, having capital to be able to take advantage of that, should that happen. So feel like we're in a really good position, liquidity-wise and capital-wise, to grow. Certainly, in terms of NII per share as we lever up, that should fall to the bottom line. So we're trying to find the balance of keeping a lot of powder dry to take advantage of the vintage, to take advantage of the opportunity, and also to leverage up and drive NII per share up.

[Brian McKenna, Director at Citizens JMP]

Okay, super helpful. Thanks. And then just to follow up on leverage specifically, you know, so you've clearly leaned into the ATM, the last several quarters, and, you know, that's been a big driver of kind of leverage being quite a bit below that target range. So, you know, given where the stock's trading today, I'm assuming you'll shy away from raising equity capital, then leverage will start to move higher. But is there just a way to think about kind of the timeline around getting back to that 1.5x leverage target?

[Art Penn, Chairman and CEO at PennantPark Floating Rate Capital]

Yeah, it's a good question. Look, with the stock where it is today relative to NAV, we're not gonna be... You know, that would be, that would be dilutive. We would not issue shares. We would not do that. We're very pleased that we did the last round of ATM. We raised it, you know, around $11.40, so feel good about that. Today, it's a time to deploy that capital and the capital we've built on the credit facility side, on the CLO side. So I think right now, we kind of timed it propitiously or whatever, and now's the time to kind of deploy and use the capital to take advantage of the opportunity.

[Brian McKenna, Director at Citizens JMP]

Okay, great. And then, Art, just, you know, one more bigger picture question for you. You've clearly operated the business through a number of different cycles and operating environments, and the macro today remains very fluid, and there's quite a bit of uncertainty just around kind of the broader economic outlook into 2025. So, you know, I'm curious, you know, what are your broader thoughts on where we are in the cycle, what this evolving macro means for your business, and then, are you leaning in on, you know, any of your past experiences, to make sure that PFLT remains well positioned to deliver strong results for all stakeholders?

[Art Penn, Chairman and CEO at PennantPark Floating Rate Capital]

Yeah, thank you. Yeah, look, we have been in business. We're going into our eighteenth year, so we've lived through the global financial crisis, an industrial downturn in the middle of last decade, the pandemic. And, you know, most of it still comes down to the micro versus the macro. The micro being select excellent companies, keep the leverage low and sensible, structure good packages, including meaningful covenants. And if you do that, while maintaining liquidity at the vehicle level, making sure you have dry powder to defend and to play offense, the rest of it usually takes care of itself. So that's kind of lessons from many years in the business. Hard to say whether we're going into a recession or not. Any good credit underwriter always underwrites deals with a recession case in the underwriting package.

[Art Penn, Chairman and CEO at PennantPark Floating Rate Capital]

Let's assume there's a recession. What happens? What are the levers the company has to pull? How much costs are variable? How much are fixed? Can CapEx be managed? Working capital be managed? So, you know, PFLT has about 150 names. If you go back to the credit memos and all of them, we had downside cases, we had recession cases, in all of them. And so, you know, of course, you always can get surprised, but generally, generally, you know, we have pretty solid packages, and you're seeing it in the portfolio. You know, non-accruals are very low. When we do have non-accruals, they're usually idiosyncratic, and even our consumer names, and we have some consumer in the portfolio, are generally performing just fine right now.

[Brian McKenna, Director at Citizens JMP]

All right, I'll leave it there. Thanks for taking my questions.

[Art Penn, Chairman and CEO at PennantPark Floating Rate Capital]

Thank you.

[Operator]

We will take our next question from Doug Harter from UBS. Please go ahead.

[Doug Harter, Equity Research Analyst at UBS]

Thanks. Can you talk a little bit about the competition you're seeing on new loans, both in terms of spreads and covenant packages?

[Art Penn, Chairman and CEO at PennantPark Floating Rate Capital]

Sure, Doug, thank you. So spreads, as we said in the prepared remarks, are down over the course of the year, over the course of 2024. We're now in August, 50-75 basis points. That's driven by some of our peers. That's driven by what's been a stable, sanguine environment that's been driven by high base rates. You know, when you're still getting 11+% on a first lien on an absolute basis, that's still attractive for investors, even though the spread obviously is tighter than it was nine months ago. So, we have seen spread tightening. That said, as we, as we kind of reviewed the statistics in the prepared remarks, we are getting really nice packages, so we still think it's an attractive vintage.

[Art Penn, Chairman and CEO at PennantPark Floating Rate Capital]

Average debt to EBITDA on the new loans was 3.8x. Average interest coverage, 2.2x, even in these elevated rates, and the weighted average loan-to-value, 47%. We are getting meaningful covenant protections. That's one thing you get in the core middle market that you, that you may not get in the upper middle market is, is covenants that, that are meaningful, that are quarterly maintenance tests, that the companies have to meet. And if they don't meet them, you know, there's a conversation. Additionally, the overall structures are much stronger structures. There's been a lot of press on some of the names in the upper middle market and some of the, I'll call it, shenanigans, that went on with moving intellectual property around and getting assets away from the lenders, et cetera.

[Art Penn, Chairman and CEO at PennantPark Floating Rate Capital]

None of that happens in the core middle market. It's just not allowed, you know, because the upper middle market went covenant light and had to compete with the broadly syndicated space. That was just a market they had to absorb. In our market, these are very strong structures. So we feel very good about the vintage to date. Even though the spreads are down, we feel very good about the credits and the yields. And non-accruals continue to be light, and the portfolio is generally performing very well.

[Doug Harter, Equity Research Analyst at UBS]

Great. Thank you.

[Operator]

We will now move to Maxwell Fritscher from Truist Securities. Please go ahead.

[Maxwell Fritscher, Equity Research Associate at Truist Securities]

Hi, good morning. I'm on for Mark Hughes. Kind of going off the competition question, you know, you mentioned all the benefits of operating in the core middle market. Are you seeing any of those competitors from the upper middle market or the middle market come downstream a little bit to tap these better loan values and better covenants?

[Art Penn, Chairman and CEO at PennantPark Floating Rate Capital]

It's a great question. We have not seen a lot of evidence of the big players moving down into the core. Now, it depends how you define core. We define core as 10-50 of EBITDA. Occasionally, you'll see some of the big guys come down to a 40 or 50 EBITDA company, because they can deploy a couple hundred million in one check, but that's occasional. And many of our deals, you know, our prototypical situation is it's a company that's doing 10-20, and it's a fragmented industry. There's a game plan, there's identified acquisitions for growth, and the goal is to take that 10-20 million EBITDA company and grow it to 30, 40, 50 and above. So we'll be that we'll be that lender that's strategic to the borrower.

[Art Penn, Chairman and CEO at PennantPark Floating Rate Capital]

We will provide the late-draw term loan and a pathway to get that company, you know, larger. And so if we're doing that, it's less about the last few basis points. It's much more about, are we aligned in terms of the game plan for growing the company? And certainly, in some of those companies, since we're growing those companies, the equity story is actually very attractive, which is why we like, in many cases, doing the equity co-investment, and putting some of our capital side by side with the sponsor so that we can participate in some of the upside that we're helping to generate on the debt side. And those, those equity co-invest over 17 years, you know, over $500 million deployed in our various vehicles, have had a 2x multiple on invested capital and a 26% IRR.

[Art Penn, Chairman and CEO at PennantPark Floating Rate Capital]

That's a nice, you know, bonus of our model.

[Maxwell Fritscher, Equity Research Associate at Truist Securities]

Yeah. Thank you. And then with a little bit more visibility and clarity into the future rate trajectory and Fed actions, have you seen any portfolio companies kind of resume normalized CapEx spending, add-on acquisitions, assuming that they had previously paused these investments?

[Art Penn, Chairman and CEO at PennantPark Floating Rate Capital]

You know, it's case by case. I don't know that I can give you a, you know, one that kind of sticks out, where someone's proactively leaning in ahead. You know, we just don't. I think most of our companies just have long-term game plans and kind of stick to them and have pulled back if needed. I can. There's unfortunately nothing that comes to my mind that kind of sticks out as someone who's proactively leaning into a situation where they're kind of running ahead of it.

[Maxwell Fritscher, Equity Research Associate at Truist Securities]

Okay. Got it. Thank you.

[Art Penn, Chairman and CEO at PennantPark Floating Rate Capital]

Thanks, Maxwell.

[Operator]

I will now turn the call back to Art Penn for any additional or closing remarks.

[Art Penn, Chairman and CEO at PennantPark Floating Rate Capital]

I wanna thank everybody for being on the call today. On behalf of Rick Allorto, our Chief Financial Officer, and our entire team, thank you for your interest. Looking forward to speaking to you in mid-November. Reminder that the 9/30 quarter is our 10-K, so our earnings release and call will be out a little bit later than our typical quarterly quarterly timing, but we look forward to speaking to you then. Thank you for your interest, and have a great rest of the summer.

[Operator]

This concludes today's call. Thank you for your participation. You may now disconnect.

Participants

Executives

• Art Penn, Chairman and CEO
• Rick Allorto, CFO

Analysts

• Brian McKenna, Director at Citizens JMP
• Doug Harter, Equity Research Analyst at UBS
• Maxwell Fritscher, Equity Research Associate at Truist Securities