Q2 2021 PennantPark Floating Rate Capital Ltd Earnings Call
Yeah.
Good morning, and welcome to the pennant Park floating rate capital second fiscal quarter 2021 earnings Conference call. Today's conference is being recorded at this time all participants have been placed in a listen only mode. The goal will be open for question and answer session. Following the Speakers' remarks, if he would like to ask a question at that time so depressed.
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It is on my pleasure to turn the call over to Mr. Art, Penn Chairman and Chief Executive Officer that depend on park floating rate capital. Mr. Penn You May begin your conference.
Thank you Hey, good morning, everyone I'd like to welcome you to <unk> floating rate Capital's second fiscal quarter 2021 earnings conference call.
Im joined today by Vivat fried, our Chief Financial Officer.
As in our portfolio continue to improve.
We have several portfolio companies on which our equity call investments have materially appreciated in value as they are benefiting from the economic recovery.
This is solidifying and bolstering our niv.
Over time rotation of that equity into debt instruments should help growth <unk> income.
We will highlight those companies in a few minutes.
As part of our business model alongside the dead investments, we make we selectively choose to co invest in the equity side by side with the financial sponsor.
Ah returns on these equity call investments have been excellent overtime overall for our platform from inception through March 31 on.
Or $226 million of equity converse have generated on IRR of 28% and a multiple on invested capital of cute nine times.
In a world where investors may want to understand differentiation among middle market lenders are long term returns on our equity call investment program are clear differentiator.
As a result of the completion of the CLO financing PSL last quarter, we can efficiently grow the joint venture, which would generate additional income from <unk>.
<unk> sales assets grew by $103 million during the quarter ended March 31 in his capacity for an additional approximately $100 million of assets overtime. This growth can be substantial driver of NII.
The combination of potential income growth from equity rotation, a larger more efficiently finance PSL and a growing more often optimized <unk> balance sheet should help grow the company's net investment income relative to the dividend overtime.
Those factors combined with strong portfolio performance through COVID-19 and or twenty-two spillover as of September 30th have led us to conclude that we will be keeping our dividend steady at this point.
We are also pleased that we diversified our financing sources this past quarter with the issuance of $100 million or 4% to 5% five year senior notes to institutional investors in late March.
With our decline will be substantially less than it was during the global financial crisis.
Many of our portfolio companies are in industries, such as government services Defense Health care technology software business services on select consumer companies that are less impacted by COVID-19.
And where we have meaningful domain expertise.
We believe that we are experiencing economic recovery with some companies and industries being beneficiaries of the environment.
We are pleased that we have significant equity investments in three of these companies, which can substantially move the needle and both abbvie and overtime net investment income.
To highlight those three companies they are kanno Walker Edison and by late <unk>.
<unk> health is a national leader on primary health care, who is leading the way in transforming healthcare to provide high quality care at a reasonable cost to a large population.
Our equity position as a cost and fair market value on March 31 of $431009 1 million respectively.
We believe there is a massive market opportunity for <unk> to grow in the years ahead with the Medicare advantage program.
The merger with <unk> acquisition is currently scheduled to close in June.
At that time, we will receive another $800000 of cash and one 825274 shares of Cano health and a limited partnership controlled by a financial sponsor where the sponsor will earn 20% of the exit proceeds.
The shares will be locked up for six months.
From a valuation perspective due to the lockup the independent valuation firm value position with a 6% illiquidity discount to the traded value on March 31.
Walker Edison is leading e-commerce platform focused on selling furniture exclusively online through top e-commerce companies as.
As of March 31, our equity position at a cost of one 4 million and a fair market value of $12 1 million.
Shortly after quarter end the company executed a refinancing and dividend recap, which resulted in shareholders receiving approximately two times their cost.
Maintaining the same ownership percentage in the company.
This resulted in <unk>, receiving a $2 $8 million cash payment on its equity position.
<unk> is a leading software hardware and engineering solutions company focused on national security challenges across modeling and simulation cyber and global defense networks, our position as a cost of $2 2 million and a fair market value of $11 8 million as of March 31.
All three of these companies are gaining financial momentum in this environment and our ltvs should be solidified and bolstered from the substantial equity investments is there momentum continues.
Over time, we would expect to exit these positions and rotate those proceeds and the debt instruments to increase income at <unk>.
The outlook for new loans is attractive.
We are focused on the core middle market, which we generally define as companies with between $10 million and $50 million of EBITDA.
We like the core middle market because it is below the threshold and does not compete with a broadly syndicated loan or high yield markets.
As such we do not compete with markets, where leverages higher equity cushion lower covenants are light wide or non existent.
Information rights or fewer EBITDA adjustments are higher and less diligence and the timeframe from making an investment decision is compressed.
On the other hand, where we focus on the core middle market, because we are not competing with a broadly syndicated loan or high yield markets.
Generally our capital is more important to the borrower as such Leverages lower equity cushion higher we have quarterly maintenance covenants, which are real we received monthly financial statements to be on top of the companies.
If there are EBITDA adjustments, there are more diligence and achievable and we typically have six to eight weeks to make thoughtful and careful investment decisions.
According to S&P loans to companies with less than $50 million EBITDA have a lower default rate and higher recovery rate than those loans to companies with higher EBITDA.
We also believe that middle market lending as a vintage business. This upcoming vintage of loans is likely to be the most attractive we've seen since the 2009 to 2012 time period.
Which was the time period after the global financial crisis. This vintage is characterized by leverage levels that are lower equity Cushing higher yields are higher and the package of protections, including covenants are tighter.
After enduring about five years of a late cycle market from middle market lending. It is refreshing to have an attractive risk reward available to us.
Let me now turn the call over to <unk>, our CFO to take us through the financial results in more detail.
Thank you art.
For the quarter ended March 31, net investment income was 26 cents per share low.
Tom on the expense categories management fees totaled about $3 9 million taxes general and administrative expenses totaled about $800000 and interest expense total about $4 8 million.
During the quarter ended March 31, net unrealized depreciation on investment was about $12 million or 29 cents per share net.
Net realized gains were about $500000 or <unk> <unk> per share.
Net unrealized depreciation on our credit facility on notes was 2007.
Sure.
Our regulatory net debt to equity ratio after subtracting cash was one two times.
With regard to leverage we have been targeting a debt to equity range of up to one five times.
We have ample liquidity to fund revolver draws and we're in compliance with all of our facilities at March 31.
We have readily available borrowing capacity and cash liquidity to support our commitments.
We have a strong capital structure with diversified fund funding source and no near term maturities.
We have 400 million revolving credit facility maturing in 2023 with a syndicate of 11 banks.
With $147 million drawn as of March 31.
$118 million on the unsecured senior notes maturing in 2023.
$228 million of asset backed debt associated with Penn and park CLO, one due 2031.
And our newly issued $100 million of unsecured senior notes maturing in 2026.
Our portfolio remains highly diversified with 100 companies across 41 different industries.
86% is invested in first lien senior secured debt, including 12% in <unk>.
3% in second lien debt and.
And 11% in equity, including 4% NPS on sale.
Our overall net portfolio has a weighted average yield of seven 6%.
98 per cent of the portfolio is floating rate and 84% of the portfolio has a LIBOR floor. The average LIBOR floor is 1% now let me turn the call back to art.
Thanks, Steve to.
To conclude we want to reiterate our mission.
<unk> 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 flow is in the form of dividends to our shareholders.
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'd like to open up the call to questions.
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 speaker phone. Please make sure. Your mute function is turned off to allow your signal to reach of equipment again. This press star one to ask a question.
Our first question comes from.
Shelley explained.
Ladenburg. Please go ahead, Sir your line is open.
Good morning, Art and Aviv hope you're well.
You mentioned the advantages of structures in the middle market versus the broader loan market.
Hi.
We agree.
Obviously, the broader loan market is very probably at the moment.
Are you seeing that frothiness, starting to trickle down into the middle market and how is that affecting your ability to close deals.
It's a great question Mickey look it's the market has been remarkable in terms of how it's bounced back certainly we've seen it.
In the broadly syndicated loan and high yield market and how it's related to the upper middle market, which we call the upper middle market about 50 of EBITDA.
We're not quite back to where we werent pre COVID-19 yet in the below 50 EBITDA zone.
Certainly if the economy.
Continues to recover at some point in the not too distant future.
We will be back to where it was pre COVID-19.
Which.
So look we think number one the vintage right now is good we should be capturing the vintage.
Best we can.
With high quality companies could structures.
And taking advantage of 2021.
The extent the market continues to rebound.
Some extended back to the future we need to continue to be very diligent.
Diligent and careful about what we invest in as you know with <unk>, we've always had a very defensive mindset.
GAAP leverage levels, low and reasonable been willing to prioritize capital preservation over yield which has been a good thing for <unk> shareholders over time, and where <unk> is positioned as kind of we want to be among the lowest risk bdcs willing to accept a lower reward, but having us and our investors feel very.
On strongly about the capital preservation attributes one of the nice things we get in the below 50 of EBITDA space as we get these equity co invest to the extent we want them to.
Those are separate investment decisions, but there's equity co invest have been very helpful over time.
In terms of creating some additional return helping filling the gaps for losses et cetera. So.
We only have an eight basis point annualized loss ratio part of that is due to the power of these equity co invests so.
So we're not we're not back to where we were yet if things continue inevitably we may be let's capture the opportunity today.
While we have the opportunity and and then lets continue to have.
Execute on what has been a good track record.
Now nearly 10 years, we're coming up.
On our 10 year anniversary here so.
So I don't know if I answered your question Mickey but please keep going so that's fun and congrats on the 10 year anniversary.
How would you characterize then given what you just said.
Prepayment risk in the portfolio.
Just again, considering that the broader market frothiness and how much call protection do you typically get on your deals.
So look the market is active and Thats good news and bad news right. The bad news is when the market is active.
High quality credits get taken out.
Sometimes companies are sold sometimes they can access the broadly syndicated low market at a at a lower yield.
That's the bad news. The good news is we are getting paid when would you get paid off we say thank you and deal flow is heavy so we can we can replace that and over time grow the portfolio. Because there is so much activity and thats certainly the game plan here.
<unk> to the tune of about another $100 million gross <unk> on balance sheet.
Over time up to the one five times.
Debt to equity and then of course rotate those equity investments. So we've never had a tenant had a difficult time ramping and still finding high quality deals that fit our box it's because.
We have such good relationships on calls had been around so long relative to <unk>.
Call us were medium sized relative to our capital the origination flow relative to our capital is usually very robust. So we've never had a.
A challenge ramping over time.
These deals do take longer these are fully diligence.
Fully negotiated six to eight week processes, where we negotiate covenants. So its not like we can turnaround on flip on the switch and ramp overnight, but we arent, we arent, we arent very active.
And do you see an opportunity to grow the portfolio in terms of call protection as you know typically we're buying these loans at 98% 99 cents on the dollar original issue discount, which we do not account for as upfront fee.
Amortize the net original issue discount.
Over the life of loan typically we will get a one or two or 101 in the first couple of years.
The best part of the best call Protection, we can add for really really good deals is those little equity co invest which continue to generate value even when the debt is called out so that's and we've seen that with some of these some of these wins like Kanno, Canada, we're not on the debt anymore of the company refinanced this out of the debt in the broadly syndicated.
<unk> low market, but we have a very valuable equity co invest.
Walker Edison with valuable co invest buy like we have a valuable co invest so that's that's the way we have a tail on this the way we continue to have upside on these on these deals.
Okay I understand just last sort of housekeeping question for you or.
Could you just highlight what were the main drivers of the.
Unrealized depreciation on investments.
Go ahead please.
Yes, certainly.
Some of the large mover is if you look at.
Quarter over quarter.
DVI holding.
Improved about <unk> <unk> per share quarter over quarter.
The <unk> JV, it's mark to market.
It's a robust first lien portfolio and there is about seven or so.
And on the negative side of this country, Chris It's mark to market went down about nine.
Quarter on quarter. So net net that you see the large motors.
Thank you for that.
Rate your time those are all my questions.
Thanks Mickey.
Yes.
We will now take our next question from Paul Johnson with <unk>. Please go ahead.
Yes.
Good morning, guys. Thanks for taking my questions.
Kind of.
On the lines long Mickey's question.
With competition in the middle market I am curious on you.
<unk> talked to this a little bit, but just I mean.
Have you guys seen.
On.
Any pressure on covenants or LIBOR floors.
Compared to I guess sort of the pre COVID-19 vintage.
From any sort of competition as the market recovers.
Yes, so on the covenant side we've.
We're getting tighter covenants that we did pre COVID-19.
So thats good for now.
And again, we get these quarterly maintenance test and we get the monthly financial statements, which.
On a differentiator in our kind of below $50 million of EBITDA world.
What was the second part of your question Paul governance in the LIBOR floors.
Yeah. So.
When there is a little bit of pressure in certain cases, you get pressure to push it down to 75 basis points from 100 basis points.
So that all depends that could be good news or bad news it depends on your going in yield on your spread I guess the good news about the lower floor is that if and when LIBOR goes up inevitably it will.
We'll start capturing more upside sooner than if the LIBOR floor stays at 100 in certain cases, we've had LIBOR floors higher we had a recent deal where loans as a LIBOR floor was $1 50. So.
So its deal by deal, it's kind of a dynamic you negotiate.
And it just depends on on on.
On that particular deal on what the what the situation is so we've seen it go both directions. The LIBOR floor and 90 plus percent of cases is still 1%.
Okay. Thanks, that's good color.
And then I guess kind of along similar lines.
Do you guys see any difference from those same reasons just competition growing maybe not so strong yet in your sort of core middle market below 50 million EBITDA.
But do you see any.
The pressure at all that.
Would make you view the difference I guess an opportunity set.
Queen.
Loans on the balance sheet vs.
Investments in the J D.
No I mean, it's still the same group of competitors.
Like in our World There is no like new new people new money that's.
Has has cash burning a hole in their pocket and it's just kind of changing the risk reward spectrum. It's the same characters same people we compete with.
One day, we're competing with them the next day, where on a club with them. So it's a it's the I'll call. It the usual suspects.
So generally those usual suspects are.
Our relatively rational in how they're behaving.
So we're not seeing any exogenous kind of kind of kind of movement.
Okay. Thanks for that.
The last question.
It was just around the equity co investments.
Kind of curious I mean, obviously.
Again, the markets getting more competitive have you seen any change in terms of your ability to.
Receive equity co investments.
From from any of your.
Our portfolio companies has this changed at all as sponsors I guess less willing to give equity at all or is it just really no change in kind of a case by case basis, It's more case by case.
And with US it's case by case too we don't automatically always say, we want the equity when we're doing that for us. It's a separate investment decisions. So some cases will like the debt and.
We will graciously decline in co invest even if it is offered in other cases, we may fight hard.
To do more co invest so for us the equity co investment is a separate investment decision needs to stand on its own two feet as an investment decision.
And there is no.
Difference in behavior. It's again, it's case by case idiosyncratic based on the sponsor based on the deal.
The deal dynamics and.
It's something that as we look over the last 14 years of our business that by and large has worked out really well as we're looking at at.
That the opportunity set over 14 years now through the global financial crisis through COVID-19 now too.
Two nine times multiple on invested capital says in general it's something that we think should be part of most of these portfolios. Obviously you could do some bad day had been equity call invests on you can do some really good equity combat so but by and large the good ones have a way outperformed the bad ones you get to the.
Canada was or the buyer lights of the Walker Edison.
Some of these youre those can be very powerful.
Add ons to the portfolio and by the way you don't get those for the folks who are doing direct lending from with companies above 50 of EBITDA.
Hundreds of EBITDA or whatever there that's generally not part of the mix. So that is a benefit you get in the kind of below 50 of EBITDA world that we traffic in.
Yeah, Okay. Thanks for that and congratulations on the 10 year public anniversary.
Thanks, Paul.
We will take now our next question from Devin Ryan from <unk>.
<unk> Securities. Please go ahead.
Hey, great good morning, everyone.
Yes.
So first one I guess just to follow up on the last conversation. These are just a couple of follow ups on.
On the equity co invest given kind of your track record in.
The experience on the portfolio over over more than a decade is now the time to lean in there I appreciate it.
Sticking to your Socratic, but as you kind of look.
Back over your history as you know markets are strong right now and you are clearly a lot of momentum same kind on valuations are high from them.
Curious how you guys are thinking about kind of a risk reward in that in my notes on a general comment, but love a little bit more color there yes.
Yes, that's a great question and we're typically not the type to say.
Now is there isn't the time, it's kind of a bottoms up.
Deal by deal approach, we do have to obviously look at the economy and what's going on in the economy and of course the economy is.
Recovering quite nicely.
What drives our equity co invest decisions on where we're a little bit more aggressive are either too two facts fact, a day.
The valuation is very attractive to the enterprise value to EBITDA is.
Attractive relative to the comps are the peers or low relative to the cash flow that we think is going to be generated so.
<unk> value investing.
So if the value is very attractive that will.
That will be something we will prioritize and conversely, or as an adjunct.
And maybe this is having a kicking needed to when we see very strong growth trajectory.
That can be very attractive to us are typical prototypical deals. We are doing these days are where a sponsor identifies a sector.
They think growth is going to be high it's a fragmented industry. They can do add on acquisitions or are there secular wind behind it and they buy a platform with 10 or $15 million of EBITDA.
They want to grow to 2030, 40, 5100 of EBITDA either through add on acquisitions.
Or or just organic growth.
And generally that fact pattern in our debt capital by the way is going to fuel that right. So the capital commitment were making is going to fuel that moved from 10 or 15 of EBITDA to 50 to 100.
And therefore, we're we have a front row seat on seeing the growth.
And therefore, they know we're fueling the growth with our debt generally more than happy to share.
Share of the equity co invest with us and.
That's kind of our prototypical deal. These days, that's where that kind of fits our box perfectly that's kanno, that's Walker Edison and Thats Biolife.
That's over <unk>, that's wheel pros.
That's kind of where if you want to look at look at a prototypical pennant Park deal. These days.
And it's going to be in industries that we know unlike that have high free cash flow industries, where we can be.
Among the smartest people in the room with a domain expertise, that's kind of our bread and butter. So take it from 10 or 15 of EBITDA at that fuel it to 40 or 50 or greater ride the equity come on vest and the equity co invest can be nice upside kind of the example, as they took us out they took the debt out of the broadly syndicated loan, but we still have a very attractive co invest they were right.
<unk>.
Walker Edison adjusted a dividend recap, we still let the equity there. So you can look at these deal by deal by deal by deal that's where we've had very nice strong track records. So I don't know if that really shed light on how we look at equity co invest and how we look at our business, but that's kind of what we're doing these days.
Yeah, No that's great context I appreciate it.
Follow up here on.
The PSL JV, obviously, great growth, there and compelling for shareholders. As you look ahead and think about that incremental $100 million or so of capacity how should we think about timing.
And is it reasonable to think that you could kind of get there over the next one or two quarters or.
Any other context, you can give us would be helpful.
Yeah, I'd say, probably two to three quarters on on optimizing PSL.
Okay terrific. Thank you very much.
Thanks, Dan.
Thank you and as there are no further questions in the queue I would like to hand, the call back over to art Penn for any additional or closing remarks.
Thank you everybody. Thanks for your time today, we really appreciate your interest.
We wish you continued good health hopefully as we come out of the out of COVID-19.
And looking forward to speaking to you all in early August on.
Our next quarterly earnings call. Thank you very much.
Thank you. This concludes today's conference call. Thank you for your participation ladies and gentlemen, you may now disconnect.