Q3 2021 PennantPark Floating Rate Capital Ltd Earnings Call
Good morning, and welcome to the pennant Park floating rate capital third fiscal quarter 2021 earnings conference call.
Today's conference is being recorded.
At this time all participants have been placed placed in a listen only mode. The call will be open for a question and answer session. Following the Speakers' remarks, if you would like to ask a question at that time simply press star 1 on your telephone keypad.
If you would like to withdraw your question Press Star 2 on your telephone keypad.
It is now my pleasure to turn.
Turn the call over to Mr Art, Penn Chairman and Chief Executive Officer of pennant Park floating rate capital. Mr. Penn You May begin your conference.
Yeah.
Thank you and good morning, everyone I'd like to welcome you here dependent part floating rate capital third fiscal quarter 2021 earnings conference call.
Joined today by Richard <unk>, our new Chief Financial Officer, Richard joined US in June from Guggenheim Partners, where he was head of alternative investment accounting for many years per.
He was at Ian why we're thrilled that Richard has joined US and are confident that his extensive experience will be a tremendous asset to the company.
Officer at Penn.
Thanks, Richard I'm going to spend a few minutes discussing how we faired in the quarter ended June 30th.
How the portfolio is positioned for the upcoming quarters, our capital structure and liquidity the financials and then opening up for Q&A.
We are pleased with our performance this past quarter hour net investment income grew to 27 per share, while our credit quality and performance remains solid.
We are poised to significantly grow NII through a 3 pronged strategy, which includes number 1 growing assets on balance sheet at <unk> as we move towards our target leverage ratio of 1.5 times debt to equity from 1.1 times.
Number 2 growing our PSL JV with Kemper to about $730 million of assets from approximately $500 million and number 3 rotating the equity value in the portfolio that has come from a strong equity coinvestment program into cash paying debt instruments.
With regard to the PSS LGB with the seal of financing we completed earlier this year as well as additional capital contributions from <unk> Kemper the JV will grow over time.
The capital contributions from <unk> are targeted to generate a 10% to 12% return.
During the June quarter, <unk> invested $20 million of capital and we intend to invest in other 42 million overtime in order to bring <unk> investment into PSL to approximately $243 million.
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.
The returns on these equity call investments have been excellent overtime.
Overall for our platform from inception through June 30th or $237 million of equity call investments have generated an IR of 28% in a multiple on invested capital of 2.9 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.
We are well on our way to implementing the NII growth strategy. Since June 30th <unk> has had new originations of $102 million and PSL has a new origination of $29 million.
Although in the June quarter repayments exceeded new loans and the September quarter, So far repayment activity has abated and new originations have accelerated.
Our portfolio performance remains strong as of June 30th average debt to EBITDA in the portfolio was 4.2 times, an average interest coverage ratio the amount by which cash income exceeds cash interest expense was 3.3 times. This provides significant cushion to support stable investment income.
These statistics are among the most conservative in the direct lending industry.
We have we have only 2 nonaccruals out of 105 different names and <unk>. This represents only 2.8% of the portfolio of cost and 2.7% at market value.
We have largely avoided some other sectors that have been hurt the most by the pandemic such as retail restaurants health clubs apparel and airlines and <unk> also has no exposure oil and gas.
The portfolio is highly diversified with 100 companies 42 different industries.
Our credit quality since inception over 10 years ago has been excellent out of 381 companies in which we have invested since inception, we've experienced only 14 nonaccruals.
Since inception, <unk> has invested over $4.2 billion and an average yield of 8%. This compares with a loss ratio of only 7 basis points annually.
We are 1 of the few middle market direct lenders, who was in business prior to the global financial crisis, and I have a strong underwriting track record during that time.
Although <unk> was not in existence back then pennantpark as an organization was and 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 the recession. This compares to the average EBITDA decline of the Bloomberg North American high yield index of 42%.
Based on tracking EBITDA of our underlying companies to recovered our EBITDA decline was substantially less than it was during the global financial crisis or.
Our median EBITDA decline at the bottom of Covid and June 20th 20 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 an industry such as government services healthcare technology software business services, and select consumer companies and where are we haven't meaningful domain expertise.
The outlook for new loans as attractive we are as busy as we've ever been in 14 years in business reviewing and doing new deals with our experienced talented and growing team are wide funnel is producing active deal flow that we can then carefully and thoughtfully animal analyze so that we can be selective as to what ends up.
In our portfolio.
We are focused on the core middle market, which we generally defined as companies with between 10 and $50 million of EBITDA.
We liked the core middle market because it is below the threshold and does not compete with a broadly syndicated alone 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 or higher and less Dylan.
<unk> 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 Leverages lower equity cushion is higher we are real quarterly maintenance covenants, we received monthly financial statements to be on top of the companies.
EBITDA adjustments are more diligence, then achievable and we typically have 6 day weeks to make thoughtful and careful investment decisions.
According to S&P loans to companies with less than $50 million of EBITDA have a lower default rate and a higher recovery rate than those loans to companies with higher EBITDA.
Let me now turn the call over to Richard R. CFO to take us through the financial results in more detail.
Thank you Lord for the quarter ended June 30, net investment income was 27 cents per share Lucky.
Looking at some of the expense categories management fees total about $4.3 million taxes general administrative expenses totaled about $450000 and then interest expense totaled about $5.9 million.
During the quarter ended June 30, net unrealized appreciation on investments was about 14 months.
37 cents per share net realized losses were about $13 million 33 per share and changes in the value of our credit facility and notes increase and navy by 8 per share.
Net investment income was lower than a dividend by too.
Consequently, GAAP and 1 from $12.71 to $12.81 per share adjusted NTV, excluding the mark to market of all I believe was $12.62 per share up from $12.60 per share.
Our entire portfolio craft facility and not some mark to market our board of directors each quarter using the exit price provided by an independent valuation firm exchanges independent broker dealer quotations when active markets available on the AFC 820, and 25 in cases, where broker dealer qualified inactive we use.
Independent valuation firms to value of investments.
We have ample liquidity and apparently Lubbock, our GAAP debt to equity ratio was 1.1 times, while GAAP net debt to equity after subtracting cash was 1 time.
Regulatory debt to equity ratio was 1.2 times.
In our regulatory net debt to equity ratio after subtracting cash was 1.1 types.
With regard to leverage we have been targeting a debt to equity range of up to 1.5 times.
We have a strong capital structure with diversified funding sources and no near term maturities, we have a $400 million revolving credit facility maturing in 2023 with $133 million drawn as of June 30.
$181.
Of unsecured senior notes from maturing in $2023.228 million of asset backed debt associated with Pennantpark CLO.
1 do 2031, and 100 men of unsecured senior notes from maturing in 2026.
Portfolio remains highly diversified with 100 companies across 42 different industries.
85% is invested in first lien senior secured debt, including 14% in Psf L..2 per cent and secondly in debt and 13% in equity, including 5 per cent and Pff's L.
Our overall debt portfolio has a weighted average yield up 7.5% 90.
98 per cent of the portfolio is falling rate and 82% of the portfolio has a liable for the average LIBOR flow as 1% now let me turn to call back to art.
Thanks Richard.
To conclude we want to reiterate our mission or goes a steady stable unprotected dividend stream, coupled with the preservation of capital.
Everything we do as a line to that goal, we tried to find less risky middle market companies that at high free cash flow conversion recapture that free cash flow, primarily and first lien senior secured instruments and we pay out those contractual cash flows 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 would like to open up the call to questions.
Thank you if you would like to ask a question. Please signal by pressing star 1 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 our equipment.
Again.
Star 1 to ask a question.
We paused for a moment to low everyone an opportunity to signal for questions.
I will now take our first question.
It comes from Mickey Sling from Ladenburg.
Please go ahead.
Good morning, Art and welcome Richard.
This quarter from seeing mixed results in terms of the market opportunity and I'd appreciate your insight clear.
Clearly the private debt in private equity markets have a lot of dry powder and spreads are tightening, which can result in a high level of repayments as we've seen it PSL 2 year to date on the other hand is you know the economy's growing sharply and M&A is very active in I think borrowers also seemed to be moving toward private debt.
Solutions.
I understand that repayments can be a function of vintage and and call protection, but broadly speaking I would like to understand how you expect your portfolio's across dependent platform to develop in.
In the second half of this year and maybe going into next.
Thanks, Mickey and good morning.
Quarter to date repayments have been light.
A new originations had been heavy so.
Last quarter, there were a lot of repayments this quarter so far.
We've seen lighter lighter and repayment, we're seeing a lot of new companies come in you know sometimes there's the same all companies that get recycled indigo from 1 private equity firm to another 1 private.
Tender to another.
This quarter, we're seeing many more new.
New companies come into the system, usually and again, we're focused on kind of a $10.50 million of EBITDA space as we talked about in many cases.
The deals were doing so first time, there's institutional capital and a founder own business or a family owned business or an entrepreneur in the private equity sponsor who's buying that companies that first institutional capital at first institutional equity and where the first institutional debt. So we're kind of on the front lines of bringing new.
Growing companies into the system.
And over time, they may growth from 15 of EBITDA to 50, or 60, and they end up going off to Bali syndicated market are going off to the big cap sponsors.
Where we play and where we're getting our best returns is when those companies are starting out of 10 to 20 of EBITDA. The sponsor sees a fragmented industry or an organic growth opportunity. They are willing to plough a lot of equity behind it which is great cushion for us our debt can help fuel that growth or equity coinvest can participate in the upside of that group.
Both.
And it ended up being a nice win win so this quarter just to answer your question, we're seeing many more new companies come in to the system versus the recycling of some very good older companies.
For instance, we we had an exit over NP PNT and Decaux back it's a great company and went off to another sponsor in another.
Direct lender, but the companies now now bigger than than when we started with it.
Thanks for that art and that kind of leads into my next question in terms of the the target market can you remind us what the average size of the borrower isn't the PSS sales portfolio compared to your own balance sheet portfolio and how would you compare the incidence investment opportunities in those 2 segments.
Love PSL is roughly similar to <unk> PSL gives us an ability to write a bigger check and solve a borrower problem bring some smart institutional capital I Kemper into.
Into our ecosystem.
And also offer a higher Ro.
For <unk> shareholders. So roughly the same portfolio just increases the wingspan the bite size and it's very accretive from <unk> shareholders. So.
<unk> EBITDA 25 to 30.
And both.
And both vehicles now some of those where companies where we started out of 15 or 20 and they've grown some of those companies started out of 30 or 40. So it's a blend of the 2 and the entire portfolio doesn't start out of 10 of 20, but a chunk of it does and that tends to be the ones, where those equity coinvest can be so valuable.
When we are helping fuel the growth of that company up to a bigger company, where then the sponsors season real opportunity for growth and is willing to plough substantial equity behind that that opportunity. So blended it's still 2500.30 million. Some are some are bigger companies from the gecko. Some some are smaller companies.
Own up.
And art, how how can you remind us how you allocate then between those 2 portfolios given that the borrowers are similar.
Yeah. So it's each portfolio has to stand on its own 2 feet and have proper diversification. So.
We want at least 50 names and in each portfolio, which we have and we wanted to be increasingly diversified.
And that that's a that's a smart way to run a senior loan book So.
So they're both highly diversified portfolios and it's based on available capital, there's an available capital capital calculation.
It's mathematical.
That when it when it gets time, there's a mathematical calculation some based on available capital.
And again Tfl PLT owns 87, 5 percentage of the joint venture so.
It's a pretty substantial ownership.
Right.
Of the Economics Lastly, a housekeeping question I don't know if it's for you or for Richard but what was the main driver of your realized lost this quarter.
Yeah. It's.
We had we did have a non accrual where an additional non accrual American teleconferencing, which is called Premier global that was unrealized loss from the main driver is a realized loss was country fresh which wasn't non accrual which went through bankruptcy.
And is now not on the balance sheet anymore.
I understand that was and that was the main drivers and realized loss.
I understand.
For me Thanks for your time and again welcome Richard.
Thanks for making.
When they will take our next question.
It comes from Ryan Lynch of K B W. Please go ahead.
Good morning, Thank you for taking my questions.
First 1 is kind of a follow up to.
The previous question regarding the balance sheet of net.
Now.
Because you mentioned that the simple goals for increasing operating earnings increasing leverage increasing the portfolio size a P. S is now well.
On those first 2 goals, they're both kind of seating Austin.
The same the same.
Deal flow.
<unk> current platforms, bringing in so.
Assuming that deals.
Both of those strategies, which it sounds like they do is there any preference.
Will 1 versus the other meeting add more balance sheet leverage versus trying to ramp up the PSS now.
Which isn't it.
With the leverage.
Within that fund is kind of a higher yielding entity is there any preference 1 burst young I know, they're both a goal.
But the kind of conflict with each other.
Far as you know.
Your originations go where they can be placed yet.
It's a great a nuanced question, Ryan and I want to say to necessarily conflict, but I would say they work and.
In a complementary fashion.
<unk> itself or were.
Or target leverage over time is up to 1.5 times.
We have credit ratings to to think about there we have some unsecured bonds to think about there and we have more market convention is these.
Sets that we're putting in both Tfl team PSL, we also put in.
Outside of the Bdc's that we run so you could put the same day again, if you look at the underlying assets that we have an <unk> PSL there among the lowest yields lowest risk assets in the BDC industry.
Our expense load is commensurately low as a result, we think we can also run the same assets safely in the CLO format, and 3 or 4 times debt to equity and we have and we've run them safely through COVID-19. So.
Outside the Bdcs, we can we can run them.
And a more leveraged fashion and PSL, we probably would target running them in a more leveraged fashion than than 1.5 times debt to equity again why is it and why can't it be so accretive from <unk> is because in the Jv's, we do target running the leverage a bit higher than that 1.5 times. So if you said.
We have stated publicly here today or target over time for the JV $750 million excuse me $730 million, a total bite size and total junior capital is $275 million.
By definition the leverage is higher.
Mmm.
Understood and and as you guys are looking to deploy capital out in the market certainly.
Overall market activity has increased but obviously competition is kind of resume back to pre COVID-19 levels. I am just curious you guys use any sort of.
Macroeconomic backdrop.
And it's kind of a base cage. When you guys are underwriting. These loans. Obviously you guys are going to do a bottoms up due diligence on each loan, but you guys look at alone today with same terms that that alone may be added 2018, 2019, as a better better risk.
A better proposition just given that the economy today is kind of on an upswing from from a credit cycle versus.
<unk> 2018, 2019, we were 10 years from moving last credit cycle does that inform your guys' willingness to deploy capital in today's environment you know obviously.
Knowing that it's going to be ultimately a bottoms up approach per credit, but you guys use that macroeconomic backdrop to kind of inform how aggressive you'll be in today's market.
Yeah. It's a good question and we do I mean, just if you if you look back at the 2017 in 2019 time period.
We were very public and others were too that we were getting concerned that the cycle was getting long in the tooth.
And.
There would be some sort of softness of course, we never could have predicted COVID-19, but I think a lot of us and we were public about it thought that we're getting late in the cycle and therefore operating in a more defensive posture.
Today.
We see it in our portfolio companies, we get the monthly numbers, the economy's in strength and a strengthening position sometimes quite dramatically. So for sure we feel more comfortable playing offense as a general macro matter today than we did say 2017 in 2019.
That said, you're right, it's bottoms up industry by industry specific.
The companies that were financing today, all all came through Covid and very strong fashion. So in many cases, they they benefited from COVID-19. So.
So we are we are playing a little bit more offensive late a little bit more offensive posture.
And these are companies that we think are very high quality companies that.
We're prepared to back 1 of the big lessons for us over all of our years in business you've got to find the right companies you got to pick the rate companies.
And you can stretch a little bit of leverage you might be able to be willing to stretch a little bit on yield if you find the right companies. The rest of it takes care of itself.
And that's that's the business we're in.
Yeah that makes sense.
And then the last 1 that I had was.
I know <unk> L. T equity portfolio is smaller than T. N T and I know <unk> had some some cash proceeds was curious did did P. F. L. P have.
Any level of cash proceeds either from.
Dividends dividend recaps or anything like that or actually exits it's quarter and what is your outlook as far as obviously, that's 1 of your goals is after your location what is your outlook.
On your ability.
Have meaningful.
Activity equity accidents over the next 12 months or so.
Yeah. That's a good question, so tfl TMP and MTF roughly the same investment size and and Walker Edison, So last quarter and we'll talk about it.
We'll talk about it a little later I mean, there were 2 capital events for for Walker Edison and this past quarter, 1 was a dividend recap.
2 times, we got back to times, our money on the equity and then there was an investment by Blackstone.
Where are we got another 2 times.
Our investment so that was a nice.
Cash realisation on on wall per Edison that that came out of direction.
On equity.
Just looking at the quarter I mean that was the big 1 was about 4 point.
That was a realized gain of about $4.3 million in the quarter. It was offset by country fresh through the realisation of the country fresh loss offset that we had about a 1.4 million realized gain an eco pack.
Equity.
And we have about $700000 gain on W. B b equity. So some of the same names different order of magnitude.
And <unk> going to the book itself and the equity Coinvest. There you can see there's some that are that are performing very well based on based on the marks by light is 1 that we talk about a lot that's about a 12 million dollar market value there.
Got a company called info soft about 3 and a half million dollars excuse me about $5.7 million of equity G. Com over $4 million of equity can always in is in tfl's as well $7.6 million of equity, there's still another 6.9 million of equity value and Walker Edison.
So still some still some nice equity bites to be to be potentially exited and rotated over the coming year too.
Okay. That's that's helpful detail.
<unk> designs a day.
Thank you Brian.
When would that take our next question.
It comes from Devon line of JMP Securities. Please go ahead.
Great Good morning, Art and Richard.
A couple of follow ups from Us I guess.
First 1 the past couple of quarters, you had I believe characterize the current percentage of loans being the most attractive in the past decade or so.
I'm just curious if that's still the case today.
Respect that speaks to the strong originations and all sorts of posture, but how is the pipeline evolving I guess more recently from the track from this perspective.
And is there any other color you can share around that.
Yeah, that's a good question Devin.
The best thing about vintage is again the companies that were financing today.
Came through Covid in really good shape in some cases strengthened through COVID-19. So.
We.
We're in the credit selection business, we have to pick good credits, we have to avoid mistakes. So the quality of the company is Paramount and.
And that's the most attractive thing is we're seeing companies that have come through the last couple of years of chaos and uncertainty and with with a strong posture, which gives us confidence that our capital will be preserved and in some cases.
Some cases with the equity Coinvest B B B, B Gainesville will be increasing value through these equity combat so.
That's really the most attractive thing and look the deal the deal machinery was put on hold for a year and a half right. There were no no deals are very little deals. So all of this pent up.
Deal demand is kind of coming to fruition today and that's 1 of the things driving it.
I also think there's a piece of it that's potentially focused around the potential capital gains increase.
Some time in the future and a desire.
By some sellers to capture again before potential capital gain inquiry, so I think that playing into it.
A little bit kind of kind of the the pent up demand from a year and a half and the potential capital gains increase on the horizon are both working together to bring to bring a lot of deals.
Yeah, Okay, great. So that makes a lotta sense. Thank you are and then just.
Just follow up.
I'm 1 of your prior comments just about recent repayment activity slowing I know, it's episodic, but do you see any any trend there around that and are there any other factors that you see shipping.
Yeah, I mean, it could be and I'm, just making a supposition Devin net.
As I said earlier, we're seeing more new names to our ecosystem.
The repayments and Refis are done with names are already in the ecosystem.
It's an opportunistic market the company is getting sold or there's a refi or whatever.
And when you are bringing new companies into the ecosystem and they might be companies that we start out west of where it starts out with 10 to 20 of EBITDA and in 3 years, It's a 50 and it goes to somewhere else scenario ecosystem, maybe the mega lenders or whoever the bit the big private equity shops.
Today, we are seeing more new names that are new to this middle market credit middle market direct lending ecosystem and again many of the companies that we see where we are focused are this is the first institutional capital. It's a family it's an entrepreneur.
It's a it's an owner.
Family, who is selling their baby that day built up over over 2030, 40, 50 years and they are selling it to a private equity firm.
And it does 10 or 15 or 20 or 25 of EBITDA and it's the first time institutional capital has been in there and that private equity firm brings all kinds of things like audited financial statements and policies and procedures and financial controls with the goal of taking that $15 million to $20 million EBITDA company and getting it to 40 or 50 or 70.
Or the first kind of private debt lender in that company.
Our debt helps show that growth from 20 million to 50 million.
In certain cases, and this has worked we've come investing in the equity and we're we're helping helping participating that and that upside there were helping to create with our debt capital. So so I'd say I'm, making a supposition that this quarter, we're seeing many more new names into the ecosystem and we were our last quarter, where it was just.
Refinancing the same old moving some of those animal names very good names, but the same old names.
Yeah Okay.
Okay terrific you I appreciate it.
A little bit of a crystal ball question, but that's a great color. So I'll leave it there. Thank you.
This concludes our question and answer session now I'd like to hand, the call back to Mister Art Penn for any additional comments or closing remarks.
I wanted to just thank everybody for their participation a day and the call and our next call will be in November. It's our 10-K, so he'll be slightly later in the quarter than our normal queues, but kind of mid November timeframe. We'll we'll have our next quarterly conference call in the meantime up everybody has a great and safe summer. Thank you very much.
This concludes today's call. Thank you for your participation you may now disconnect.
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