Q3 2022 PennantPark Floating Rate Capital Ltd Earnings Call
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Good morning, and welcome to the pennant Park floating rate capital third fiscal quarter 2022 earnings conference call.
<unk> conference is being recorded.
At this time all participants have been placed in a listen only mode. The call will be open for a question and answer session. Following the Speakers' remarks.
I 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 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 pennant Park floating rate capital. Mr. Penn You May begin your conference.
Thank you and good morning, everyone I'd like to welcome you to pennant Park floating rate Capital's third fiscal quarter 2022 earnings conference call I'm joined today by Rick a lot of our Chief Financial Officer Rick.
Rich please start off by disclosing some general conference call information and included discussion about forward looking statements.
Thank you art I'd like to remind everyone that today's call is being recorded.
Please note that this call is the property opinion <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 and pin provided in our earnings press release as well as on our website.
I'd also like to call your attention to the customary safe Harbor disclosure in our press release regarding forward looking information.
Today's conference call May also include forward looking statements and projections and we ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these projections.
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 or call us at 212905 1000.
At this time I'd like to turn the call back to our chairman and Chief Executive Officer.
Thanks, Rick first I'd like to welcome you as the new CFO of our Bdcs.
We're going to spend a few minutes discussing how we fared in the quarter ended June 30th how the portfolio is positioned for the upcoming quarters, our capital structure and liquidity.
A detailed review of the financials and then open it up for Q&A.
For the quarter ended June 30th our net investment income was 29 cents per share which includes <unk> of other nonrecurring income.
The credit quality of the portfolio remains solid.
The largest non accrual investment marketplace events has returned to full accrual status.
Our GAAP earnings decreased by three 2% driven primarily by a decrease in investment valuations. The decrease was largely attributed to mark to market adjustments, resulting from the overall choppy market as opposed to specific credit driven items within the portfolio.
During the quarter, we continued to originate attractive investment opportunities and grow both the P. F L T portfolio as well as the JV portfolio.
At quarter end, the JV portfolio was $747 million and we remain confident that we will execute on our plan to grow the JV portfolio to $1 billion of assets overtime.
We believe that the increase in scale in the JV as attractive or are we well enhance <unk> earnings momentum.
From an overall perspective in this era of inflation.
Interest rates and geopolitical risks, we believe we are well positioned as a senior secured first lien lender focused on the United States, where the floating rates on our loans can protect against rising inflation.
The portfolio of assets that it's 100% floating rate, we're well positioned to substantially grow our net investment income as base rates rise.
Holding everything else constant and the portfolio every 100 basis point increase in base rates translates into about four cents per quarter of net interest income.
We have a long term track record of generating value by successfully financing high growth middle market companies and five key sectors.
These are the sectors, where we have substantial domain expertise and the other way.
Questions to ask and have an excellent track record.
They are business services consumer government services and defense.
Health care and software and technology.
These factors have also been resilient and tend to generate strong free cash flow.
As an aside government services and defense is approximately 15% of the portfolio inclusive of the JV and should be a beneficiary of the geopolitical environment.
In many cases, we are typically part of the first institutional capital into a company, where a founder entrepreneur our family of selling their company to a middle market private equity firm and.
In these situations theres typically typically it defined game plan in place with substantial equity support from the private equity firm to significantly grow the company through add on acquisitions or organic growth.
So long as we provide our important strategic capital that fuel that growth and hope that $10 million to $20 million EBITDA company grow to 30, 40 50 million of EBITDA or more.
We typically participate in the upside by making an equity co investment.
Our returns on these equity call investments have been excellent over time.
Overall for our platform from inception through June 30th are $335 million of equity co investments.
We have generated an IRR of 28% and a multiple on invested capital of two five times.
Because we are an important strategic lending partner the process and package if terms we receive is attractive.
We have many weeks to do our diligence with care.
Thoughtfully structure transaction with sensible credit stats meaningful covenants substantial equity cushions to protect our capital attractive upfront fees and spreads and equity co investment.
Additionally from a monitoring perspective, we received monthly financial statements. They help us stay on top of the companies.
With.
Hard to covenants.
Virtually all our originated first lien loans had meaningful covenants, which help protect our capital.
This is one reason why our default rate and performance during Covid was so strong.
This is a sector of the market the companies with 10 to 15 million of EBITDA as the core middle market.
Within the core middle market, we think our capital can add the most value and we believe the opportunity is to get the strongest package you risk return is in the 10 to 30 million of EBITDA range.
The core middle market is below the threshold and does not compete with a broadly syndicated loan or high yield markets.
As many of you know theres been an enormous amount of capital raised by some of our large peers and as such they are forced to focus on the upper middle market, which are companies with over 50 million of EBITDA.
Those upper middle market companies can typically also efficiently access the broadly syndicated loan market and as a result in the upper middle market, our large peers need to aggressively compete with a broadly syndicated loan market and among themselves.
This results in transactions, where leverage is high covenants are light or nonexistent spreads in upfront fees or compress and decisions need to be made quickly.
Additionally from a monitoring perspective, they generally receive financial statements quarterly instead of monthly.
Okay.
The argument you're all here is that the bigger companies are less risky.
Certainly a perception and may makes 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 a higher recovery rate than loans to companies with higher EBITDA.
We believe that the meaningful covenant protection of core middle market loans, more careful diligence and tighter monitoring have been an important part of this differentiated performance.
The borrowers in our investment portfolio are performing well and we believe we're well positioned for future quarters as of June 30, the weighted average debt to EBITDA on the portfolio was four seven times and the average interest coverage ratio the amount by which cash interest income excuse me cash income exceeds cash interest expense.
Three one times.
This provides significant cushion to support stable investment income even as interest rates rise.
Based on this substantial question, even with the 350 basis point rise in base rates and flat EBITDA our portfolio of companies would still cover their interest two times on average.
These statistics are among the most conservative in the direct lending industry.
As of June 30, we had only two non accruals out of 123 different names and P. F. L T.
This represents only 0.9% of the portfolio at cost and 0.1% at market value.
She is a significant decrease from the prior quarter as.
As mentioned in my earlier comments, our investment in marketplace advance has returned to full accrual status.
Our credit quality since inception over 10, excuse me 11 years ago has been excellent Tfl T has invested over $4 9 billion and 447 companies and we have experienced only 15 non accruals.
Since inception, <unk> loss ratio was only six basis points annually.
Against the market backdrop of rising interest rates high inflation geopolitical risks.
Target market remains active and.
Our experienced and talented team and our wider origination funnel is producing active deal flow.
Our continued focus remains on capital preservation and being patient investors.
Michigan, Golar steady stable and protected dividend stream, coupled with trailer preservation of capital and everything we do is aligned to that goal we.
We seek to find investment opportunities and growing middle market companies that have high free cash flow conversion, we capture that free cash flow primarily in first lien senior secured instruments.
When we pay out those contractual cash flows in the form of dividends to our shareholders. Let me now the turn let me now turn the call over to Rick our CFO to take us through the financial results in more detail.
Thank you. Thank you art for the quarter ended June 30th net investment income was 29 per share, including <unk> <unk> per share of other income.
Operating expenses for the quarter were as follows management fees and performance based incentive fees were $5 6 million.
Interest expense was $7 4 million general and administrative expenses were 800000 and provision for taxes.
100000.
For the quarter ended June 30th net realized and unrealized change on investments was a loss of $16 9 million or <unk> 41 per share.
There were no changes in the value of our credit facility and notes for the quarter.
We sold 136000 shares this quarter through the at the market program above our NAV.
Which resulted in <unk> per share of accretion to NAV.
As of June 30th our GAAP was $12 21.
Which is down three 2% from $12 62 per share.
Adjusted <unk>, excluding the mark to market of our liabilities was $12 <unk> per share.
<unk> from $12 41 per share last quarter.
Our debt to equity ratio was one five times and our net debt to equity after subtracting cash was also a one five times.
Yes.
As of June 30, our key portfolio statistics were as follows.
Our portfolio remains highly diversified with 123 companies across 45 different industries.
The portfolio was invested in 87%.
Invested in first lien senior secured debt.
<unk>, 16% in PSS L.
Less than 1% in second lien debt.
And 13% in equity, including 5% in PSS sales.
Our overall debt portfolio has a weighted average yield of eight 5%.
100% of the debt portfolio is floating rate and 82% has a LIBOR floor the.
The average LIBOR floor is 1%.
As our previously commented as base rates rise, we are well positioned to participate on the upside.
Holding everything else constant in the portfolio, a 1% increase in base rates.
Late into <unk> 17 per share annually of net interest income upside.
And a 2% increase translates into 32 cents per share annually.
Net interest income.
I'll now turn the call back over to art.
Thanks, Rick.
In closing I'd like to thank our extremely talented team of professionals for their commitment and dedication. Thank.
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 again.
Ask a question please signal by pressing star one on your <unk>.
Telephone keypad.
We're using a speaker phone. Please make sure your mute function is turned off to allow your.
A signal to reach our equipment.
Press Star one to ask a question.
Well pause for just a moment to allow everyone an opportunity to signal for questions.
And we will take our first question from Ryan Lynch with K B W.
Please go ahead.
Hey, good morning, Art and I'd welcome Rick.
Yeah.
First question I had was if I kind of look at your overall.
Unrealized losses recorded in the quarter ground.
Over $17 million.
Is there a way to break that out can you give us a ballpark estimate.
<unk>.
Of what.
<unk> of that was driven by widening spreads and lower equity valuations are more kind of technical mark to market versus a spin.
Specific credit events.
That were marked down.
Yeah, Thanks, Ryan as I'm looking at kind of the big movers there over the quarter there were really very very little big movers.
You know.
I think Walker Edison equity was the biggest mover and that was down $2 million as an example.
But other than that it's all that's all it's all kind of.
The market in credit spreads and not idiosyncratic.
Named spreads.
Okay.
And then congratulations on marketplaces and coming back on accrual status can you just talk about.
Usually you talk about you know negative.
And what went on with portfolio companies as a positive.
Can you talk about what what what drove this change.
The company's ability to pay its interest in putting on accrual status.
Yeah, So there's a company as a home goods.
<unk> business.
Which was obviously impacted by Covid.
And.
The World is normalizing as you know and the companies.
Doing much much better so yeah.
Yes.
We believe there will be a temporary thing as the world normalizes.
Are the leading company in their space, It's an excellent company very strong management team. They just were directly impacted by Covid.
Okay.
Okay recovery story.
Yes.
<unk>.
And then just my final question that I had.
The the Psf Sal has grown significantly over the last several quarters.
You mentioned kind of you hope to get that to 1 billion at some point. Obviously this is very dependent on it.
On market.
Opportunities just as you kind of sit here today do you have any sort of rough estimate of the <unk>.
Target.
The year that you would like it to get to that size.
I think probably in the next 18 months to two years.
We are we have the ability today to ramp up to about 850 875, we will look at some point to bring in another middle market CLO into that vehicle, we already have one.
And that CLO financing as you know is low cost efficient long term and really optimize Roe.
So you could probably could get it to 850 sometime in the next six to 12 months.
Assuming we can get a middle market CLO Dawn, which you know the market's been a little in turmoil as you may know, presumably will come back at some point, that's why we could optimize it even further and say if you have let's say from a $50 75 to about $1 billion.
Okay.
I appreciate you taking my questions and the time today, Thanks art.
Thanks, Brian .
And as a reminder, its star one to ask this.
Question.
Will take our next question is from Kevin <unk> with JMP Securities. Please go ahead.
Hi, good morning, and thank you for taking my questions.
You touched on this a bit in your prepared remarks, clearly rising rates will boost core earnings in the back half of the year given the rate increases in the second quarter that will flow through in third quarter earnings have you run the numbers on the incremental NII per share impact of the rising base, which will happen in the third quarter.
Sure.
Hi, good morning, Kevin.
Yeah, we've been we've been thinking and working on this one.
Quite a bit.
<unk>.
There are unfortunately, a lot of variables in that count So I can't communicate a simple straightforward easy answer for you, but let me give you a couple of statistics to help you with your own modeling.
So a 100% of the portfolio as you know it is floating rate.
And at 630 <unk>.
11% of that was still subject to a floor and that average average floor was 1%.
That compares to 59% at $3 31.
<unk> of the portfolio is still subject to to an average 1% floor.
So obviously during the $6 30 quarter, we captured already.
Some of the rising rate environment.
At 630, some additional statistics at 630.
Our average base rate was one 9%.
And that compares.
To one month LIBOR today of approximately $2 three 5% one month so for two three.
So.
<unk>.
Portfolios portfolio of companies continue to.
Roll their LIBOR contracts and they have the option between one three and six months.
We will continue to see some increase.
In interest income NII coming from the rising rates and again, we'd expect that small portion of the portfolio that is currently subject to the floor to to exceed that floor.
And again add add incrementally to top and bottom line.
With the rising rates.
Okay, that's really helpful. Richard welcome.
Just one more if I may.
<unk> portfolio positioning just curious if there are any pockets or industries that you find particularly attractive in the current environment.
Yeah, we are.
You know, we have a big expertise and a focus on government services and defense.
Not a lot of our peers.
Very focused on that industry, we've got a really good experience over many years I think it's about 15% of this portfolio and given geopolitical events.
There's really a <unk>.
Tailwind against that industry right now so we will continue to lean into that industry. Obviously, we liked the credit worthiness of.
The customers in that industry, we like the trends, we like the stability so.
So we've probably lean into that sector, even a little bit more so than we have.
In the past.
Health care also a big big expertise Vic a big sector for us the demographic trends there continue to be very very strong. Obviously, there's things you got to be careful of in health care, but we've had an excellent track record in health care that some of our biggest wins in health care. So I think those are probably the.
<unk> two largest sectors I think we keep leaning into those.
Sectors.
Consumer which is a sector for a for US we we've gone out of our way to be conservative and cautious in that sector only leverage those companies.
A small amount. So we think we're well protected but I think we're going to be a little bit more careful around consumer at this point in time until we see where we're at.
On the head.
Got it thanks Art I appreciate you taking my questions. This morning.
Pleasure to have you Kevin cover that cover the stock.
So with that I think it doesn't look like we have any more questions I really just want to thank everybody for being on the call.
Today.
The next quarter is the quarter ended September 30, if that's our 10-K quarter. So reminder, that due.
Due to the 10-K, we usually report a little later I think we're kind of targeting mid November for the next earnings release next call. So.
In the meantime, we really appreciate everyone's support and wishing everybody a great rest of the summer.
And this concludes today's call. Thank you for your participation you may now disconnect.
Yeah.
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