Q4 2021 PennantPark Floating Rate Capital Ltd Earnings Call
Good morning, and welcome to dependents Park floating rate Capital's fourth 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 call will be opened for a question and answer session. Following the Speakers' remarks.
If you would like to ask a question at that time simply press star one on your telephone keypad if.
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It is now my pleasure to turn the call over to Mr. Art, Penn Chairman and Chief Executive Officer of pennant Park floating capital raise capital Mr. Penn You May begin your conference.
Okay.
Thank you hi, good morning, everyone I'd like to welcome you to pennant park floating rate capital's fourth fiscal quarter 2021 earnings conference call I'm joined today by Richard <unk>, Our Chief Financial Officer, Richard Please start off by disclosing some general conference call information and included discussion about forward looking statements.
Okay.
I'd like to remind everyone that today's call is being recorded please.
Please note that this call is a property of <unk> 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 the telephone numbers.
Provided in our earnings press release as well as on our website.
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 to obtain copies of our latest SEC filings. Please visit our website at <unk> Dot com.
It was at 2120.
051 thousand at this time I'd like to turn the call back to our chairman and Chief Executive Officer, Pat Thanks, Richard I'm going to spend a few minutes discussing how we fared in the quarter ended September 30th.
How the portfolio is positioned for the upcoming quarters, our capital structure and liquidity the financials.
And then open it up for Q&A.
Our core net investment income grew to 28 cents per share.
Which excludes a one time expense of $2 9 million in connection with the amendment of our credit facility.
Our credit quality generally remained solid.
We are poised to significantly grow NII through a three pronged strategy, which includes one.
Growing assets on the balance sheet at <unk> as we move towards our target leverage ratio of one five times debt to equity from one three times.
Number two growing our <unk> JV with Kemper to about $730 million of assets from approximately $550 million and.
And three rotating the equity value in the portfolio that has come from our strong equity co investment program into cash paying debt instruments.
With regard to the <unk> JV with the CLO financing, we completed earlier this year as well as additional cap capital contributions from <unk> Kapur.
<unk> will grow over time.
The capital contributions from <unk> are targeted to generate a 10% to 12% return.
We intend to invest another $42 million over time in order to bring <unk> investment in the 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.
Our returns on these equity co investments have been excellent over time or.
We're all for a platform from inception through September 30th our $246 million of equity co investments have generated an IRR of 28% and a multiple on invested capital of three times.
In a world where investors may want to understand differentiation among middle market lenders are long term returns on our equity co investment program a clear differentiator.
We are well on our way to implementing the NII growth strategy joining.
During the September quarter <unk>.
Net had new originations of $240 million $48 million and PSL had new originations of $77 million far outpacing the repayment activity.
As a result, the investment portfolio as <unk> increased by approximately $46 million to $1.08 billion from $1.04 billion.
<unk> investment portfolio also grew this quarter from $565 million.
Two $565 million from 530 $530 million, an increase of $35 million.
We continue to be busy since September 30, <unk> has had new funded investments net of sales and repayments of $82 million.
PSS L has had new funded investments net of sales and repayments of $23 million.
We are focused on the core middle market, which we generally define as companies with between $10 million to $50 million of EBITDA.
We like the core middle market because it is below the threshold and does not compete with the broadly syndicated loan and high yield markets as.
As such we do not compete with markets, where leverages higher equity cushion lower covenants are light wide or nonexistent information rideshare fewer EBITDA adjustments are higher unless diligence and the timeframe for making an investment decision is compressed.
On the other hand.
Where we focus on the core middle market generally our capital is more important to the borrower.
As such Leverages lower equity cushion is higher we have real quarterly maintenance covenants, we received monthly financial statements to be on top of the companies.
EBITDA adjustments 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 a higher recovery rate.
And those loans to companies with higher EBITDA.
Our pro forma portfolio performance remains strong as of June 30th average debt to EBITDA on the portfolio was four three times and the average interest coverage ratio the amount by the amount by which cash income exceeds cash interest expense was three two times.
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 <unk>.
This represents only two 7% of the portfolio at cost and two 6% at market value.
For the quarter ended September 30, the decline in the value of <unk> holding was the largest driver of the decline in NAV.
And represented a negative impact of <unk> 29 per share.
This was somewhat offset by increases in the valuations of lash opco marketplace events and SSP holding.
Since quarter end <unk> 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 would this will play out.
In the worst case scenario.
<unk> had no recovery.
Would be negatively impacted by <unk> 28 per share.
From an NII perspective, the impact of DVA to NII is expected to be <unk> <unk> per share per quarter.
The portfolio is highly diversified with 110 companies in 45 different industries, our credit quality since inception over 10 years ago has been excellent.
At a 418 companies in which we have invested since inception, we've experienced only 14 non accruals.
Since inception, <unk> has invested over $4 4 billion at an average yield of 8%.
This compares to a loss ratio of only eight basis points annually.
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 <unk> was not in existence back then pennant park as an organization was investing at that time.
During that recession, the weighted average EBITDA of our underlying portfolio companies declined by seven 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.
Our median EBITDA decline at the bottom of Covid in June 2020 was one 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 health care 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 14 years in business, reviewing and doing new deals with our experienced and talented and growing team. Our Wi funnel is producing active deal flow that we can then carefully and thoughtfully analyzed so that we can be selective 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.
Thank you all for the quarter ended September 30 core net investment income was 28 per share, which excludes a one time expense of $2 $9 million in connection with the amendment to the credit facility.
Looking at some of the expense categories management fees and performance based incentive fee totaled about $3 3 million taxes general and administrative expenses totaled about $450000 and interest expense totaled about $8 5 million.
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 $5 million a.
<unk> 19 per share.
Net realized gains were about $2 5 million or <unk> <unk> per share and changes in the value of our credit facility and notes decreased NAV by <unk> <unk> per share.
GAAP investment income was lower than a dividend by five per share.
Sequentially GAAP NAV went from $12 81.
$12 62 per share.
Adjusted <unk>, excluding the mark to market of our liabilities was $12 43 per share down from $12 62 per share.
Our entire portfolio credit facility and notes are mark to market by our board of directors each quarter using the exit price provided by the independent valuation firm exchanges, an independent broker dealer quotations when active markets are available on the ASC 820, and <unk> 25.
In cases, where broker dealer quotes are inactive we use independent valuation firms to value of that investment.
With ample liquidity and a prudently levered, our GAAP debt to equity ratio was one three times, while GAAP net debt to equity after subtracting cash was one two times.
Regulatory debt to equity ratio was one four times and our regulatory net debt to equity ratio.
After subtracting cash was one three times.
With regard to leverage we've been targeting a debt to equity ratio of up to one five times.
We have a strong capital structure with diversified funding sources and no near term maturities.
We have a $300 million revolving credit facility maturing in 2026 with $219 million drawn as of September 30.
$118 million of unsecured senior notes maturing in 2023.
$228 million of asset backed debt associated with pennant Park sale, one due 2031 and $100 million of unsecured senior notes maturing in 2026.
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.
Capture that free cash flow, primarily in first lien senior secured instruments.
And we pay out those.
Total 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.
As a reminder, ladies and gentlemen, please press star one to ask a question.
And our first question today comes from Paul Johnson of Kate W. K.
<unk> I'm sorry.
Good morning, guys. Thanks for taking my questions.
It sounds like the pipeline is pretty strong again, some pretty strong.
Growth activity here quarter to date.
The calendar fourth quarter.
I'm just wondering.
Given the investment opportunities that you guys are looking at.
Are you getting up close to the leverage range are you compelled.
To be.
Given what you are 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.
Thanks, Paul and good.
Morning.
Yes, I think we're targeting kind of one five zone of one five times for <unk>.
That's kind of where we are targeting of course PS ourselves a joint venture.
Kind of side by side in that vehicle, we hope and think and over time grow it.
Over 700 $750 million vehicle, which.
We got a boost from the CLO financing, we did there a little while back and we will continue to to grow that platform in Europe and yes, you are right and we're at one three I think at 1.5 zone, we kind of top out <unk>.
Great I appreciate that.
And then one thing on 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 is.
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.
I think part of that's probably PSL in the growth of.
Of <unk>, that's probably the main driver of.
Of that.
Other than that no. There is no and look we do continue to on these deals where we think there is very good.
Opportunity to participate in the upside we are gradually and thoughtfully.
Doing these equity co invest which have worked out well for us over 14 years.
We don't say, yes to all of them, we declined many of them but.
But we do say, yes to the ones that we think are very attractive.
And so I would imagine.
The biggest changes the PSL.
Investments that we keep making growing that vehicle.
Got it thanks for that and my last question.
You touched on a little bit during the call, but any sort of color you can give.
The your investment in BVI, maybe exactly what the businesses.
If at all.
I'm also curious if there was any overlap with that.
Well.
Yes, so theres DVI as in both <unk> and the JV and when we.
We on the transcript kind of talked about what it would mean.
For both.
Consolidated basis between both <unk>.
The company has a labor services company that does work for municipalities and states.
Think about managing vegetation cutting lawns.
Managing laboratories.
Of that nature.
And the issue there and.
You read about newspapers and inevitably when you have a portfolio of over 100 names youre going to get you're going to you're going to you know.
One of them at least one of them. They may have some challenges. This is most of their employees are unskilled labor unskilled labor. So it's been hard to get unskilled labor and it's when you get on skilled labor it's more expensive.
On one hand on the other hand to enter into fixed price contracts with the states and cities. So Unfortunately this company got mismatched between the fixed price contracts with the states and 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 of a partial liquidation don't yet know how that is going to play out.
You gave the statistics on the transcript as to in the worst case scenario if it to zero.
What that would look like.
It may or may not be the worst case scenario.
Obviously, we have a wide range of equity co invest throughout the portfolio, which have had some lift. So if you look at this last quarter.
The quarter ended September 30th.
<unk> had a negative impact of 29 cents a share but that was offset to some extent by some of the other co invests like lash marketplace events and SSP. So we have a diversified book of these co invest some perform well overtime. They performed really well some underperform DVI as an example of an underperformer in this is an exam.
All of some of the things that are going on 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.
<unk> have 25%, 30% EBITDA margins, where they are able to increase their pricing to their customers to hopefully more than cover their costs.
Got it appreciate it thanks for the color very helpful detail.
Those are all my questions.
Thanks.
Our next question comes from Mickey <unk> of Ladenburg.
Yes, good morning, everyone.
In your prepared remarks, you mentioned a lot of the advantages of investing.
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 <unk>.
So much private debt and private equity capital available.
Are you seeing any signs of that trickling down into the middle market in the lower middle market and are you seeing competitors.
Perhaps idiosyncratically behaving erratically or rationally.
Yeah. 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 are bringing <unk> covenant light and low yield and shorter diligence.
Processes into the market.
We kind of say core middle markets $50 million and below occasionally youll see a $40 million EBITDA company kind of.
False way too to that one of the big guys will swooped down.
And pick that one off and we will kind of say you know God bless.
Kind of below 40%.
Not seeing it and that could change and we're vigilant about it but below 40, we're not saying that we really like and where our added value has been and if you look at our track record.
And we'll go into it in the P&L T calls over the last six years, its where we 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.
Our capital preservation and there is a real growth plan to take that 10 or $20 million EBITDA company up to 30, 40, 50 and higher.
Our debt capital can grow with the company, we can deploy really really attractive capital we have to front row seat. Obviously, we're the incumbent and Theres less competition by definition on the debt and then and then of course, we will co invest in the equity occasionally and participate in the upside that our debt is helping to drive so those those.
Deals are kind of where we can add the most value 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 so.
So that's kind of kind of the prototypical deal for us across our platform. Some of those companies to grow to 40, 50 100 million of EBITDA and that's terrific and sometimes they leave us on the debt side and we we hold the equity and sometimes that equity is worth a lot of money. So.
So that's kind of where we see our highest value add today.
Thanks for that art and to follow up.
Given the size of those private funds do you think there is effectively a barrier of entry into the lower middle market, where the average deal size just doesn't move the needle for them and you know even though the terms may be interesting. It's just not something that they're going to put you know of.
A lot of time in and does that benefit you.
Yes, I think that's that's that's fair win.
When youre in the AUM growth business, and it's about AUM growth and Youre 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.
Long time ago I was at a big firm I know how sometimes.
I think.
Below a certain bite size it just doesn't make sense for the model.
I understand my.
My last question is just a little more philosophical thinking about next year.
Relative to what we've had the last couple of years you know this year in particular, there's been a lot of tailwind in the in the sector apart maybe from high levels of repayments and prepayments, but next year you know.
Economic growth might decelerate, the fed might start raising rates.
Certainly defaults, probably cant go any lower than they've been historically very low and we have an election. So it could be messy when you think of those issues.
Are you considering the right hand side of your balance sheet. Both at I guess at both of your funds are all of your funds in terms of Oh do 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.
Yeah, Youre right, obviously in 2022, we've got.
Supply chain labor inflation any number of different potential challenges.
And as an economy. So how do you think about leverage.
In light of that but first we have to underwrite companies that they can.
Deal with that that have enough cushion in them. So that they can for instance raised prices relatively easily as their costs go up so we have to we have to underwrite.
You know very carefully.
In this environment, we think we're well positioned EBITDA to interest.
Roughly three times, our three two times and this portfolio so plenty of cushion in our portfolio generally to deal with rising interest rates, but it is something that we think about in terms of leverage at the vehicles.
I mean for <unk> in particular.
We're kind of saying targets one five times, we know and you know that you can take the same assets and walk them over to another department at S&P.
CLO Department and you could safely get three or four times.
Debt to equity in a box, it's very robust and safe and has weathered pandemics and weathered global financial crises et cetera. So.
For the assets that we put in <unk>, which we think are among the lowest risk assets in the BDC space, we're very comfortable kind of at that one five times knowing that another options. We could take move these assets right over in and get more leverage if we wanted to and still feel safe about about those capital structures.
And then.
We can talk about P&C later, but again you have to look at the underlying assets we have.
A lower target a ratio there because of the underlying assets are different different kind of asset so.
It's something that we <unk>.
<unk> seen us do bonds, we've done unsecured bonds recently that'll continue to be a.
An interesting and important tool for us to manage risk and always have diversified financing sources.
Thank you for that that's that's very helpful and look forward to talking to you later today.
Thanks.
The next question comes from Devin Ryan of JMP Securities.
Hi, Good morning, This is Kevin Phillips monitor Devin.
Our first question over the past few quarters, you've talked about the three pronged efforts 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 the dividend going forward. Thanks.
Yes look yes, we are.
We believe that as we continue to execute on this.
This plan that we outlined in the very near future I'm, an arc from me Kevin to kind of say.
On February 3rd so it's kind of it's dependent on the deal flow is dependent on repayments, it's dependent on rotation of equity.
It's dependent on how quickly we can ramp SSL we.
We would hope that sometime in 2022, we could we could safely covered this dividend.
Okay. It makes sense and then could you provide an update on the current amount of spillover income.
Yes, Richard do you want to handle that one.
Sure the current smell of <unk> 22 per share.
And we should be able to cover that overhead.
Distribution remains the same we should be able to cover that over the next.
Three quarters.
Okay, and that's as of September 32021.
Yes, correct, yes.
Great. Thank you that's it for me and thanks for taking my questions.
Kevin. Thank you we appreciate it.
I'm sorry, no further questions I'd like to hand, the call back to art for any additional or closing remarks.
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 the season filled of health.
Speak to you soon.
Ladies and gentlemen that concludes today's conference call.
Your participation you may now disconnect.
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