Q4 2022 Pennantpark Investment Corp Earnings Call
Good day, ladies and gentlemen, and welcome to the pennant Park investment Corporation's fourth fiscal quarter 2022 earnings Conference call. At this time, we are getting additional participants and should begin in a couple of minutes. We appreciate your patience and ask that you. Please remain online.
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Good afternoon, and welcome to the pennant Park investment Corporation's fourth fiscal quarter 2022 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 questions and answers.
It shouldn't following the Speakers' remarks, if you'd like to ask a question at that time simply press star one on your telephone keypad. If you like to withdraw your question. Please press star two on your telephone keypad. Thank you. It is now my pleasure to turn the call over to Mr. Art, Penn Chairman and Chief Executive Officer of Pennant Park Investment Corporation.
Mr. Penn You May begin your conference good afternoon, everyone I'd like to welcome you dependent Park investment Corporation's fourth fiscal quarter 2022 earnings Conference call I'm joined today by Rick <unk>, Our Chief Financial Officer, Rick. 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 of pennant Park investment Corporation.
Any unauthorized broadcast of this call in any form is strictly prohibited.
The audio replay of the call will be available on our website.
I'd also like to call your attention to the customary safe Harbor disclosure in our press release regarding forward looking information.
Today's conference call May also include forward looking statements and projections and we ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these projections.
We do not undertake to update our forward looking statements unless required by law.
Obtain copies of our latest SEC filings. Please visit our website at pennant Park 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 Art Penn.
Thanks, Ric we're going to spend a few minutes and comment on our target market environment provide a summary of how we fared in the quarter ended September 30th has.
How the portfolio is positioned for the upcoming quarters, our capital structure and liquidity a detailed review of the financials and then open up for Q&A.
From an overall perspective in this market environment of inflation rising interest rates geopolitical risk and potentially weakening economy, we are well positioned as a lender focused on capital preservation in the United States.
The floating interest rates on our loans can protect against rising interest rates and inflation.
We continue to believe that our focus on the core middle market and provides important attractive investment opportunities where.
Where we are important strategic capital to our borrowers.
In times of market volatility, our opportunistic credit strategy focuses on creating value from the dislocation in the markets.
Specifically, we've been active buying first lien loans in the secondary market at discounts in companies, where we have differentiated institutional knowledge it.
It could be a company that we used to finance in a sector, where we have domain expertise or a direct relationship with the management team or financial sponsor.
<unk> been buying loans, where we think we can generate double digit or low teens are ours.
The loans returned to par in three years.
We employed a similar strategy during the global financial crisis and generated excellent returns.
In prior quarters, we outlined the game plan for growth of net investment income and dividends. We continue to execute on our plan to increase long term shareholder value and I'm pleased to announce that the board of directors has approved another increase of our quarterly dividend to $16 five per share.
Table on January three to shareholders of record as of December 19th.
Additionally, during the September quarter, and we continued buying shares under our stock buyback program and purchased approximately 189000 shares during the quarter for $1 $2 million in total we have bought back $13 $2 million of shares or 1.8 million shares.
Some highlights for the quarter ended September 30th whereas follows.
That portfolio continues to benefit from rising base rates, our weighted average yield to maturity increased to 10, 8% from nine 3% last quarter.
Approximately 96% of our assets are floating rate compared to 47% of our liabilities that are fixed rate.
Holding everything else constant every 100 basis point increase in base rates translates into approximately <unk> <unk> per share and NII.
Another highlight was that our portfolio performed well during the quarter and we did not put any new investments on non accrual as of September 30th we have one nonaccrual, which represents 1% of the portfolio cost and zero percent end market value.
Yeah.
Thirdly during the quarter, we completed the amendment extension and expansion of the truest credit facility.
Size increased from 465 million to $500 million and the maturity was extended three years until 2027.
Thank you to our lending partners for their confidence and support of the company.
And fourth we continue to grow our PSL F joint venture the joint venture grew from $608 million to $730 million during the quarter and continues to generate an attractive double digit ROE for P. N N T.
We are targeting a $1 billion vehicle over time, where we can drive substantial growth in NII P. N N T.
We believe that this late 2022, and 2023 vintage of middle market directly originated loans should be excellent.
Leverage at lower spreads and upfront fees, and OID or higher covenants are tighter and loan to value continue to be attractive.
Our capital, which we believe is always value added is adding even more value in this environment.
For the quarter ended September 30, we invested $134 million in new and existing portfolio companies and add sales and repayments of $176 million.
Now to review the operating results for the quarter ended September 30th core net investment income was <unk> 18 per share, including one cent per share and other income. This excludes one time upfront financing cost from the amendment and extension of our credit facility.
<unk> was down due primarily to unrealized mark to market adjustments in our portfolio tied to the overall market and not due to fundamental credit factors.
As you might expect most of the mark to market volatility came from our equity portfolio overall.
Overall GAAP any V decreased by six 9% comprised of three 6% decrease due to the fair value adjustments on our equity holdings and a two 5% decrease due to the fair value adjustments on our debt holdings.
The remaining 1% was attributed to fair value adjustments on our credit facilities.
With regard to increasing net investment income our strategy remains focused on number one optimizing the portfolio and balance sheet are P. N N T. As we move towards our target leverage ratio of one five times debt to equity number two growing P. S. L. Lotte JV with pantheon to $1 billion of assets from approximately <unk>.
130 million of assets at quarter end and number three rotating out of our equity investments overtime and redeploying the capital into cash pay yield instruments.
We have a long term track record of generating value by successfully financing high gross middle market companies and five key sectors. These.
These are sectors, where we have substantial domain expertise.
The right questions to ask and have an excellent track record.
They are business services consumer government services, and defense healthcare and software technology.
These sectors have also been resilient intended to generate strong free cash flow. It's important to note that we do not have any crypto exposure in our software and technology investments.
In many cases, we're typically part of the first institutional capital into a company, where a founder entrepreneur families selling their company to a middle market private equity firms in.
In these situations Theres typically defied 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 the growth and help that $10 million to $20 million EBITDA company grew to 30 or 40 <unk>.
Millions of EBITDA or more.
We typically participate in the upside by making an equity co investment.
Our returns on these equity co investments had been excellent over time.
We're all for our platform from inception through September 30th our $355 million of equity call investments have generated an IRR of 28% and a multiple on invested capital of 2.5 times.
With the current volatility in the broadly syndicated market.
We have seen more private equity sponsors tap the private credit markets.
We are selectively looking at these new opportunities and believe the vintage for these loans will yield compelling returns.
Because we're an important strategic lending partner to process and package. If terms. We receive is attractive we have many weeks to do our diligence with care, we thoughtfully structure transactions with sensible credit statistics meaningful covenants substantial equity cushion is to protect our capital attractive upfront fees and spreads and an equity co investment.
Additionally from a monetary perspective, we received monthly financial statements.
Stay on top of the companies.
With regard to covenants virtually all of 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 and why we believe we are well positioned in this environment.
This sector of the market companies with 10 to 15 million of EBITDA is the core middle market. The core middle market is below the threshold and does not compete with a broadly syndicated loan or high yield markets.
Many of our peers, who focus on the upper middle market state that those bigger companies are less risky.
That is a perception that may make some intuitive sense, but the reality is different according to S&P.
Loans to companies with less than $50 million of EBITDA had a lower default and higher recovery rate the loans to companies with higher EBITDA.
We believe that the meaningful covenant protections of core middle market loans more careful diligence and tighter monitoring had 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 September 30, the weighted average debt to EBITDA on the portfolio was four six times.
And the average interest coverage ratio the amount by which cash interest exceeds cash interest expense was three six times.
<unk> significant cushion to support stable investment income, even when interest rates rise.
Just on this substantial cushion even with a 200 basis point rise in base rates and flat EBITDA our portfolio companies will cover their interest to three times on average.
Since inception P. N N T has invested $7 3 billion and the average yield of 11%.
This compares to a loss ratio of approximately nine basis points annually.
This strong track record includes our energy investments.
Our primarily subordinated debt investments made prior to the financial crisis and recently the pandemic.
With regard to the outlook, our new loans in our target market are attractive and this vintage should be particularly attractive or.
Our experienced and talented team and our wide origination funnel is producing active deal flow.
Our continued focus remains on capital preservation and being patient investors.
I want to reiterate our mission our goal is to generate attractive risk adjusted returns through income coupled with long term preservation of capital everything we do is aligned to that goal, we seek to find investment opportunities and growing middle market companies that have high free cash flow conversion.
Capture that free cash flow, primarily through debt instruments and we pay.
Pay out those contractual cash flows in the form of dividends to our shareholders.
Let me now turn the call over to Rick our CFO to take us through the financial results.
Thank you art for.
For the quarter ended September 30, net investment income totaled <unk> 14 per share, including one cents per share of other income.
Operating expenses for the quarter were as follows.
Base management fees was $4 9 million interest and credit facility expenses were $13 7 million.
General and administrative expenses were $1 million and provision for taxes was 200000.
During the quarter, we expensed $5 $1 million of credit facility expenses related to the amendment and extension of our revolving credit facility.
Excluding the $5 1 million of credit facility expenses core NII was <unk> 18 per share.
For the quarter ended September 30, net realized and unrealized change on investments and debt, including provision for taxes.
<unk> of $44 1 million or <unk> 68 per share.
The reversal of the provision for taxes of $7 2 million or <unk> 11 per share was due primarily to the decrease in the value of Ram energy.
Change in the value of our credit facility decreased our NAV by.
<unk> <unk> per share.
Core net investment income exceeded the dividend by $1 five per share.
As of September 30th our NAV per share was $8 98.
Which is down six 9% from $9 65 per share from the prior quarter.
Our GAAP debt to equity ratio net of cash was one two times.
As of September 30th our key portfolio statistics, whereas follows.
Our portfolio remains highly diversified with 123 companies across 32 different industries.
The portfolio was invested in 51% in first lien secured debt.
11% in second lien secured debt.
12% in support subordinated debt.
Including 7% in <unk>.
And 26% in preferred and common equity, including 4% in <unk>.
The weighted average yield on debt investments was 10, 8%.
96% of the debt portfolio is floating rate with an average LIBOR floor of 1%.
As base interest rates rise, we are well positioned to participate on the upside.
Holding everything else constant in the portfolio, a 1% increase in base rates translates into approximately <unk> <unk> per share of NII upside per quarter.
As of September 32022, the company had approximately 71 cents.
Per share of spillover taxable income.
Now, let me turn the call back to art. Thanks, Rick.
Closing I would like to thank our dedicated and talented team of professionals for their continued commitment to P. N N T and its shareholders. Thank you all for your time today and for your continued investment and confidence in US that concludes our remarks at this time I'd like to open up the call to questions.
Thank you, ladies and gentlemen, if you'd like to ask a question. Please signal by pressing star one on your telephone keypad.
Please make sure the mute function on your phone is turned off so the signal can be read by our equipment again. Please press star one to ask a question, we'll pause just a moment to give everyone an opportunity to signal for questions.
Okay.
We'll take our first question from Casey Alexander with Compass point. Please go ahead.
Yes, Hi can you hear me.
Yes, we can thanks Keith.
Yes, okay.
My first question is I'm intrigued by your ability to buy first lien loans in the secondary market.
Would these be new relationships or would you be picking up some pieces of loans that you already have.
Or what is there some sort of breakdown of what percentage of your new originations in this quarter.
We're as a result of buying first lien loans in the secondary market as opposed to direct origination.
Alright, Thanks Casey.
These are typically loans, where we feel like we.
A differentiated viewpoint.
We're we're not buying the market. It's typically a company we might've financed when it was a little smaller in the core middle market and maybe graduated to the broadly syndicated loan market.
And in the industries, where we think we have domain expertise, we know the management, we know the sponsor.
And where we think we're buying a dollar or between 85% to 95 cents.
And we think there'll be a potential pull to par.
Over a two or three year time period, which get you kind of a low to mid teens kind of IRR. So all first lien senior secured all credits that we feel are.
Our strong credits with good cash flow it just happened to be a little bit of a baby's thrown out with the bathwater.
In the choppy market environment that we've had.
We it's been primarily in this in terms of timing, it's been primarily more recently I think we did a little bit in the quarter ended 930.
Certainly a big piece of what we're doing in the quarter that we're in today.
Would you characterize these as broadly syndicated loans or are these private debt loans that are put out by private debt lenders.
Now. These are these are loans, where we can access in the broadly syndicated loan market they trade with a big broker dealers.
And.
And given the market environment.
There are at a discount so in virtually all I got.
We think we have a differentiated info edge.
But their BSL.
Greg.
Cases graduated from middle market over time.
Alright, okay.
Thank you for that and secondly.
Can you explain.
Why.
Pennant Park takes the 5 million dollar amend and extend the upfront when most platforms amortize that over the life of the credit facility and if you'd like to make a case why that's better for investors love to hear it.
Yes.
Upfront fee, there's a couple of ways you can do it accounting wise.
We are obligated under our the way we account for our credit facility to take it upfront as a one time versus amortizing that over the life of loan. So we're taking our pain today.
<unk>.
But then we don't have to take.
Schedule expense over the life of the loan also from a shareholder standpoint. It obviously this quarter meant that we as management company or no no incentive fee again, thats a shareholder friendly way to do this.
Going back in time in history.
Back to the global financial crisis, we elected to Mark our liabilities to market that was a very good matching mechanism for dealing with the SEC asset coverage ratio.
And we're still dealing with the residual of that the SEC would prefer that we don't do that.
And we prefer we don't do that you've seen these credit facilities narrow mark closer to par or obligated to do the one time fee because this credit facility that we keep amending and extending is essentially.
The same from the accounting standpoint credit facility that we've had for many years. It's the same lenders into the same lead lender.
The terms arent really changing other than the extension.
We are obligated to take the fee is a one time hit in this quarter. We do we do differentiate between core and non core in our NII disclosure.
Okay. Thank you for that.
That's clear.
Probably maybe.
Amy more clearer to me than most probably.
But but I actually think it's a very good answer.
That was very helpful. Lastly.
John Walker Edison, you Mark that similar to you.
Where you actually have a partner in that loan that also market and Walker Edison has been a company that is has given pennant park substantial benefits in the past.
Do you want to kind of get it through the history of that where you stand with that loan today. What you think is going to happen and you know there is also another big private equity shop that is actually behind you on that.
You know that might be helping you drive a positive outcome there.
I would love to hear your thoughts on that one.
Yes, So Walker Edison was a company that we financed let's say five six years ago.
It's a company that.
Is in the furniture business and their distribution channel as it is way fair Amazon and E. Commerce distribution channel, we did a loan to the company. We took an equity co invest in five six years ago. It did very very very well.
Covid accelerated things.
Our equity co investment we added four times MLR IC on.
In cash.
To date.
About a year year and a half ago.
A division of a large private equity sponsor Blackstone.
<unk> $250 million of junior capital into the into the company.
We rolled into a new debt piece with other partners in the direct lending industry.
And we felt it was a safe loan obviously at that point at that point in time.
We wouldn't have done it.
Got it.
Enhanced by the equity cushion by the by the large private equity sponsored companies massively underperformed since then.
The post Covid World is different in this company in and of their own right.
Did not manage that well.
So they did pay us cash interest as of 930. So we we for the 930 quarter kept it on accrual.
All bets are off for the 12 31 quarter and we'll see what happens between now and then.
Our restructuring conversations going on as we speak.
And I think Thats, probably all I can report at this point in time.
Alright, great. Thank you very much for that answer and that's all my questions I appreciate it thanks art.
Thanks Keith.
As a reminder for questions or comments Star one please star one.
We will take our next question from Paul Johnson with K B W. Please go ahead.
Yeah. Good afternoon, guys. Thanks for taking my questions.
First one just was.
Hoping to understand the mark on Ram energy, a little bit more this quarter and kind of what drove that mark down.
I understand you guys have taken a very patient approach to <unk>.
Turnarounds in the past.
And there's a lot of moving pieces that potentially go into the valuation here as you guys are evaluating strategic alternatives.
One of the things I look at I'm looking just in the public market comps for.
E&P companies.
So six 5% in the quarter I know oil prices were down in the quarter.
And about 25% or so Ram energy I think this quarter you guys marked at about 32% lower but a lot of the public comps comps for energy companies specifically the.
The E&P sector is obviously up.
So I'm wondering is it anything thats going on fundamentally with the operations of the company that would cause you guys to mark the investment down or is it related to the.
Strategic alternative.
Exploration process.
Or potentially maybe you've seen lower offers then then the evaluation in two Q, but anything that you can say.
It would be helpful.
Thanks, Paul and just to be very careful the company is exploring strategic options.
So I'm somewhat limited.
And really answering your question Paul.
To say many factors go into valuation.
The price of oil and gas between June 30, and September 30 was down quite substantially.
And that was one of the factors that went into the valuation.
Got it I understand.
I understand you can't say a lot.
But taking I guess, a little bit of a step back.
The Mark on the investment I'm just wondering.
Again this is Ben.
I think you guys have had some successful turnarounds in the past.
Certainly don't want to take away from that I think you guys have had.
Yes.
The patient approach in the past that's worked.
But at any point.
Has this ever become.
Does this become essentially like a drain on resources, where.
Have.
Faculty that you have.
Employees and.
Important people I guess at the firm that are obviously, dedicating time and resources into turning this around.
Does that begin to I.
I guess disrupt the normal course of the.
The investment process.
Yes.
Just a clarification on your prior question just to be clear Ram is performing well there's no operational issues. There is nothing new or different on Ram, It's let's say.
Performing company that is doing well and is healthy on the time resource question.
Look we may have a different attitude than some of our peers.
We get paid to maximize value.
And that's what we do and if it takes time and resources.
It takes time and resources.
And we will do what it needs to whatever is the best interest of the shareholder and so we get paid to do.
To to try to get the best outcome possible, sometimes that means full blown restructurings pivot was a recent example, where there was a conversion of debt to equity. We took control we became the sponsor we changed management.
We dealt with all the various tranches of loans.
And we worked with the company to turnaround the operations and we were fortunate enough to exit at a very high price at a really really good time in hindsight.
And that Ram is another one ram we've been in longer than even obviously.
Our view is.
This is what we do.
And it takes time and resources it takes time and resources.
Thanks.
That's our job.
Thanks I appreciate it.
And then just on the secondary purchases you guys made this quarter.
Curious.
Obviously, you saw good value and you're using your informational and expertise advantage.
There to potentially make some powertrains, but I'm just curious how.
How you evaluate I guess those trades.
Are these secondary purchase just kind of more or less supplementing.
Depressed deal flow or deal volume in the third and fourth quarter of this year.
Or are these just very advantageous trades that happened to become available that.
Yes.
You felt were good investments for the BDC.
Yes.
Each investment needs to stand on its own two feet, we do though compare and contrast and say okay. We.
You can put a dollar to work at 90 cents on the dollar.
Or we can do this new loan where we can do both.
How do we look at it so we look at it through the lens of.
We do not exist any capital we have plenty of capital, but we do not have infinite capital. So we will.
We do compare and contrast, and debate and really tried to through our investment Committee.
Find the best risk adjusted returns, we can whether it would be in the primary market or the secondary market.
And.
And do our best to synthesize all of that and allocate capital as best we can.
Thanks, and I mean would you consider those investments to be hold to maturity type.
<unk> that youre planning on holding to maturity or are these kind of more held for trading where if there is any kind of recovery to par or you'd be looking to exit.
Sure so when youre dealing with more liquid investments.
Those if they were the kind of trade from 90 to par.
We could say, okay. We can sell this loan at par.
A new primary middle market loan we can do.
Same question, what's the best risk adjusted return in most cases as these loans get pull to par, which we hope they do we would trade out of them and reallocate that money into core middle market originations.
Got it thanks that makes sense and then last question.
Just on your equity co investment strategy.
I'm just curious.
It's obviously been a big part of your strategy since you guys have been in business.
Equity co investments.
I'm just curious when you go into a deal.
You essentially given the option of equity co investment, where you can get it and versus like fees or OID.
Essentially do you have the option of one or the other.
Perhaps exit fees or OID and if there is an option I guess between the two when you're evaluating it you have really a preference.
For either one I am just kind of thinking of a time like now where.
Youre actually.
We're actively looking to reduce your equity exposure in the portfolio I mean is that something you've pulled away from or is it.
Bill a pretty normal part of the.
The investment.
Yes.
Yeah in general.
Many of our deals are kind of buy and bill.
And our debt capital is strategic.
Capital too to make that buy and build happen, we feel as though in general if we believe in the growth of the company, having some form of equity participation makes sense for the den <unk>.
We are helping to drive that value we should.
Why wouldn't we have some participation in that upside so by and large it is.
Something we do it may be a differentiator versus some of our peers. We think it's particularly important in the buy and build growth growth year.
Types of deals, which is primarily what we're doing these days right. So it is important rarely is it a trade.
Trade off you can get the combed STB take less yield or you take less OID.
Usually it's just kind of baked in and part of the understanding that we have with the private equity sponsor.
This is how we do business.
And it's not a trade off situation certain cases, they wanted limit limit us or not let us have in which case we will.
Sometimes we're like Okay that is so good we don't need the equity.
Some cases were kind of like okay. The equity is not that attractive that's fine in other cases, it may be a situation, where we want from a deal because we think the equity.
Is a really important part of our package. So we try to look at each deal and each part of the capital structure on their own two feet.
Such that in some cases the debt is really good.
We may not be so excited about the equity and Thats fine and in other cases, we may be really excited about the equity and try to try to get more so case by case each piece of the capital structure needs to stand on its own two feet, but rarely is it rarely is it kind of a trade off scenario.
Got it appreciate it very interesting and that's all for me.
Yeah.
Ladies and gentlemen. This concludes today's question and answer session. At this time I would like to turn the conference back to Mr Art Penn for closing remarks.
Thank you everybody wishing everybody a terrific.
Thanksgiving full gratitude.
Terrific holiday season, and we will be talking to you next in early February for December 31st earnings. Thank you very much.
Ladies and gentlemen. This concludes today's conference. We appreciate your participation you may now disconnect.
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Right.
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Okay.
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