Q1 2023 Pennantpark Investment Corp Earnings Call

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Good afternoon, and welcome to the pennant Park investment Corporation's first fiscal quarter 2023 earnings Conference call Today's conference is being recorded.

This time, all participants have been placed in a listen only mode. The call will be open for question and answer session. Following the Speakers' remarks, if he would like to ask a question at that time simply press star one on your telephone keypad, if you'd 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 kind of Park Investment Corporation. Mr. Penn You May begin your conference.

Good afternoon, everyone I'd like to welcome you to the pennant Park investment Corporation's first fiscal quarter 2023 earnings Conference call I'm joined today by Rick a lot of our Chief Financial Officer 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 of pennant Park investment Corporation and that any unauthorized broadcast of this call in any form is strictly prohibited.

An 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.

To obtain copies of our latest SEC filings. Please visit our website at pennant Park Dot com or call us at 212905 1000 at.

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 December 31.

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.

The results were mixed for the quarter ended December 31.

However, P N N T is now well positioned to be a more stable higher earning at a higher dividend paying BDC.

We saw a significant reduction of AAV.

Primarily due to fair value adjustments to Ram energy and the publicly traded stocks of Canada.

Additionally, our NII was reduced by <unk> <unk> per share due to an increased accrual for excise taxes, resulting from over earning our dividend and prior time periods.

We are closing the chapter on our legacy investment in Ram energy and moving forward with the investment strategy that has served us well over the last seven years, including during the Covid time period.

Our debt portfolio is performing well and is positioned to withstand volatility and the current economic environment. Our income has been growing and we are significantly raising our dividend in line with the new earnings power of the company.

The debt portfolio continues to benefit from rising base rates as of December 31, our weighted average yield to maturity was 11, 9%, which is up from 10, 8% last quarter and eight 8% last year.

PSL lab JV continues to generate an attractive double digit ROE for P. N N T.

We are targeting a $1 billion vehicle overtime, which can drive additional growth and NII at TNMP.

As a result of a stable debt portfolio and the growing net investment income the board of directors has approved another increase in the quarterly dividend to <unk> $18.05 per share.

One 1% increase from the prior quarter.

The dividend will be paid on April three to shareholders of record as of March 16th.

We're confident that with the continued strong credit performance the increased dividend will be more than fully covered by net investment income.

Now let me review the results for the quarter ended December 31.

GAAP earnings decreased 14, 1% to $7 71 per share from $8 98 per share.

This decrease was driven by unrealized losses of which over 85% was from our equity investments in Ram energy and Cano health.

In December Ram energy closed on the sale of its first assets to a public E&P company.

Yeah. It was completed after running a broad auction process in the second half of 2022.

Assets sold.

Comprised the majority of the value at Ram.

After repaying indebtedness expenses hedging contracts in other liabilities, we expect to receive approximately $32 million of net proceeds from the sale.

At December 31st Fair value for Ram equals the estimated proceeds from the sale.

As many are well aware this has been a long and challenging investment. We are disappointed that we were not able to produce a better outcome.

However, we are happy to finally close the book on this legacy investment.

The December 31st fair value for our equity investment in Caddo health decreased significantly from the prior quarter as a result of the significant decline in Canada as a publicly traded equity.

Net investment income for the quarter was 16 cents per share. However, NII was reduced by <unk> <unk> per share due to an increased accrual for excise taxes.

And I would've been <unk> 18 per share after adjusting for this additional expense accrual.

We have substantially executed on our goal to reduce the equity portion of the portfolio, which at December 31, adjusting for the Ram Energy investment was 14%. This compares to a peak in March of 2021 up 30%.

Now, let me turn to the current market environment.

From an overall perspective in this market environment of inflation rising interest rates geopolitical risks and a potentially weakening economy, we are well positioned as a lender focus on capital preservation in the United States.

Or where 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 provides the company with attractive investment opportunities.

Where we are important strategic capital to our borrowers we believe that the current vintage of your middle market directly originated loans should be excellent.

Leverages lower spreads in upfront fees are higher covenants are tighter and loan to value continue to be attractive.

For the quarter ended December 31st we invested $86 million in new and existing portfolio companies at a weighted average yield of 11, 2%.

And that sales and repayments of $31 million.

For the investments in new portfolio companies, the weighted average debt to EBITDA was four three times.

Weighted average interest coverage was two one times and the weighted average loan to value was only 24%.

We have a long term track record of generating value by successfully refinancing high growth of the middle market companies and five key sectors. 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 health care and software and technology. These sectors have also been recession resilient and tends 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 are typically part of the first institutional capital and do a company.

Largely we provide are important strategic capital that fuel the growth and help 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 co investments have been excellent overtime.

Overall for our platform from inception through December 31.

We invested over $375 million in equity co investments.

Generated an IRR of 27% and a multiple on invested capital up to three times.

Because we are an important strategic lending partner the process and package in terms of 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 to protect our capital attractive upfront fees and spreads and equity co investment additions.

Additionally from a monitoring perspective, we received monthly financial statements to help us stay on top of the companies.

With regard to covenants virtually all of our originated first lien loans had meaningful covenants to 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 as a core middle market. The core middle market is below the threshold and does not compete with the broadly syndicated loan and 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 and may makes some intuitive sense, but the reality is quite different.

According to S&P loves the companies with less than 59 of EBITDA have a lower default rate and a higher recovery rate and launched the companies with higher EBITDA.

We believe that the meaningful covenant protections of the core middle market, where we have more careful due diligence and tighter monitoring has been an important part of this differentiated performance.

The borrowers in our investment portfolio are performing well and we believe there we are well positioned for future quarters as.

As of December 31, the weighted average debt to EBITDA on the portfolio was four seven times and the average interest coverage ratio the amount by which cash income exceeds cash interest expense was three two times calculated based upon the last 12 months interest expense.

The interest coverage ratio of one calculated using the annualized interest expense at current LIBOR and so for base rates is two three times. This compares favorably to a market average of one six times.

Which is according to Lincoln International.

Since inception P. N N T has invested $7 $4 billion at an average yield of 11%. This compares to a loss ratio of approximately 21 basis points annually.

This strong track record includes our energy investments, primarily subordinated debt investments made prior to the financial crisis.

And recently the pandemic.

With regard to the outlook new loans in our target market are attractive and this vintage should be particularly attractive our experienced and talented team and our wide origination funnel is producing active deal flow.

Our focus remains on capital preservation and.

And being patient investors.

We want to reiterate our goal 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.

Have high free cash flow conversion we.

We capture that free cash flow, primarily through debt instruments, and we 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 the quarter ended December 31.

Net investment income totaled <unk> 16 per share, including <unk> <unk> per share of other income.

Operating expenses for the quarter were as follows interest and credit facility expenses were $9 7 million base.

Base management and incentive fees were $6 8 million.

General and administrative expenses were $1 1 million.

And provision for excise taxes was 2.0 million.

The provision for excise tax of $2 million included an additional accrual of $1 $5 5 million we.

We estimate that the quarterly run rate provision for excise taxes will be 450000.

NII would have been <unk> 18 per share if adjusted to exclude the additional accrual.

As of December 31, we had two non accruals, which represent two 7% of the portfolio at cost and one 1% at market value.

For the quarter ended December 31, net realized and unrealized change on investments and debt, including provision for taxes was a loss of $82 2 million or $1 26 per share.

The change in the fair value of our credit facility increased our GAAP earnings by <unk> 11 per share.

As of December 30, <unk>, our NAV per share was $7.71, which is down 14, 1% from $8 98 per share from the prior quarter.

Our GAAP debt to equity ratio was one three times.

As of December 31, our key portfolio statistics, whereas follows.

The portfolio remains highly diversified with 125 companies across 32 different industries.

The portfolio was invested in 55% first lien secured debt.

11% in second lien secured debt.

5% in subordinated debt.

Excluding P S L F.

17% in preferred and common equity, excluding <unk> and 12% in <unk>.

The weighted average yield on debt instruments was 11, 9%.

96% of the debt portfolio is floating rate with an average LIBOR floor of 1%.

Now, let me turn the call back to art.

Thanks, Rick and closing I would like to thank our dedicated and talented team of professionals for their continued commitment to Pan N T and its shareholders. Thank you all for your time today and for your continued investment and confidence in us.

Closing remarks at this time I would like to open up the call to questions.

Thank you.

To ask a question. Please signal by pressing star one on your telephone keypad and if youre using a speakerphone. Please make sure your mute function is turned off.

Equipment again, Brett Star one to ask a question.

I'll talk for just a moment to allow everyone an opportunity to signal for questions.

Okay.

We will go first to Robert Dodd with Raymond James.

Hi.

First question Ive got on.

The buyback program, obviously, you have a you didn't utilize the buyback program.

The December quarter I can understand why.

I had a lot of information and things going on.

It expires.

If I remember right at the end of March could you give us any color on whether you expect to utilize that.

Extend it.

Any any thoughts on that.

Thanks, Robert Yeah, we're always considering a stock buyback program.

I think this might be our second or third program we've done.

We are now one four times, Levered, PMT, which is a bit above our target leverage.

We're working with the rating agencies on our ratings so.

Stay tuned nothing nothing really to announce at this point.

Got it got it and then.

What are the other portfolio companies Walker Edison.

Well, that's you did get.

It's been an issue you talked about it last quarter I mean, you're you're not the only BDC that obviously, you're in with with several of them.

Oh, okay.

Credit platforms.

This effect.

With.

So meaningful.

Tablets are lot of other investors.

The syndicated market.

Does that make any more complicated slow oh.

With difficulty in resolving that.

That's it.

No.

Walker Edison has been troubled now for a couple of quarters.

In restructuring as we speak.

There is three public bdcs, including US who have the asset there's a fourth lender in it so there's not a public BDC. So there is.

Four lenders in total in that name.

We're all getting along very well, it's all very consensual I think we all see things the same way so.

It's really just about it.

Executing the restructuring.

And.

And then operating the company hopefully well, we still think the company is a viable company that has a real place to be a real reason to be in the marketplace and adds value.

We'll be converting the majority of the debt.

We have into equity will still add some debt and then where were all putting in additional debt.

On liquidity needs a small amount.

Do you need for the company.

Over the next few quarters, but we all are doing that in the belief that.

We think it's a viable long term business, which.

And some nonrecurring issues going on primarily with supply chain.

But over the long run should.

Good.

A lot of value.

Got it got it thank you.

And last one if I can on the dividend obviously increased it again earnings power trending up.

That's even without rates obviously.

The proceeds from Ram won't be.

Available in principle cooling Baxter will yielding assets what are your comments at the beginning the board raised the dividend.

Growth in earnings power. So is that is that something investors can look forward to potentially again.

Because in all likelihood.

Earnings powers, Maggie will likely to have to ramp a little higher at least over the next several quarters.

Yes look we believe based on today's interest rates.

Our NII is.

<unk> is well covering well covering the $18.05 dividend.

We're well covering it now.

And Youre right with the with the growth of the joint venture.

<unk> two $1 billion.

Really we got any incremental capital from us as well as the potential for Ram rotation.

We think we have potential additional upside above and beyond that.

Got it thank you.

Thank you.

We will go next to Ryan Lynch with K B W.

Hey, Good afternoon, My first question obviously.

Talked about the exit of Ram energy that's been.

Our long standing investment you guys have worked through a lot, obviously youre sort of turning the page on that.

But I would just love to just.

Before we completely turned the page on that just for you or is it kind of what occurred over the last six to nine months you guys.

That investment started being written up pretty meaningfully.

Earlier in 2022 and then.

Last quarter, it had a pretty meaningful write down in N. The exit this quarter was was significantly below the previous value. So can you just talk about I guess.

What occurred was it something fundamentally in that business that that didn't play out as expected or is it just the purchase.

The market. When you guys were looking to sell didn't come to fruition as yes, you would have liked or just any sort of comments on what sort of took place and how the ultimate.

Value was was decided.

Yes, so it's certainly again we are.

Disappointed.

With the outcome and ultimately decision do you turn the page.

Or do you take a disappointing result.

We decided to.

Two.

Yeah.

Or do you keep the keep.

Keep it alive and to keep going and.

What happened unfortunately over the last six months or so those last well or two the results were not.

And there were some operational issues.

That came into freight with the last well came in the floor with the last well that.

Unfortunately hurt the ultimate valuation it was a very robust process.

The the.

M&A Bank.

I went out to over 100 people under parties.

And this was the end result is disappointing.

Sure.

Again this is why we will never.

Oil and gas again.

When the value of the company relies so much on.

One or two wells so.

Certainly it's a it's been a.

Pointing investment from the get go and continue to be disappointing, we were hopeful and optimistic a while back but the results were really good.

Oil and gas prices at one point were much higher than they are today.

And.

I feel that we ran a very robust process of course, we're not pleased with the outcome.

We are pleased to hopefully be turning the <unk>.

Chapter here not mentioning this company again on future conference calls, but this is kind of the fact and we ran into a robust process and this is this is the outcome.

Okay.

Maybe on that you gave guidance for the the additional excise taxes on a quarterly basis going forward I'm, just curious I would assume presume the answer is no but does the exit and the loss.

I lost you guys will occur in Ram energy will that have any potential to lower those excise taxes at all.

No Ram is held within the corporate blocker.

Uh huh.

So that.

Short answer is no.

Okay.

And then maybe following up on Robert's question regarding the buyback and leverage I would just love to get any kind of mentioned you're talking with credit rating agencies. Today you guys are above your targeted leverage range I think thats, maybe even a little bit high for where rating agencies. We're typically comfortable is it the plan do you think.

Get that leverage range down closer to the $1 25 level or.

In the near term or is this a level that you guys are comfortable operating at.

For the foreseeable future.

Yes look we're still we're still working on the answer to that question to be Frank with you.

The argument would be and we believe it which is the portfolio that remains is mostly senior debt first lien debt.

H.

Might be justifiable to be it is kind of one four times.

Our ratio, it's certainly less than equity heavy portfolio than we had.

So I think we're going to be kind of somewhere between the one and a quarter and one four ish debt to equity.

And certainly the discussions with the rating agencies are an important.

Part of that that analysis.

Of course.

Okay. That's all for me I appreciate the time today.

Thank you.

Sure.

We'll go next to Casey Alexander with Compass point.

Yes, good afternoon.

Switch gears, just a little bit to a different topic.

The company's in.

Our position in <unk>.

<unk>.

Has been handcuffed in that it's under the control of the private equity sponsor.

Have you considered restructuring your equity co invest.

Or not making equity co invest if they fall under the control of the private equity sponsor because the company has missed several attractive opportunities to monetize that investment, but the lack of control has all of a sudden resulted in you know what at this point in time.

This is another core surprise or a poor outcome.

And is there something that you can do to mitigate that loss of control that gives you a better positioned to take advantage of attractive equity prices when they exist and future investments or not make them at all and get better terms on the debt.

Great question and there's a couple couple.

Discussion points that you brought up.

Really good discussion points first of all on turnover help itself.

It's a mark to market deal is not done yet.

Largest competitor Oak Street health.

Yesterday that they were getting bought by Cvs at a very high price.

There is a bit of a.

Grab going on in that primary care space. So we're not done yet.

I would remind you that humana is a minority shareholder of Keno Hill.

Whether they are or other parties see value in Canada. This company the company itself yet to be determined and has been a volatile stock. It has been painful to watch the stock trade lower over the course of the last three six months.

Not done yet.

And our belief is our belief is over time this company will ascertain real value above and beyond where it's been marked today. So that's that's kind of well.

Look part and parcel of the equity co investment business, if you want to call. It that is.

You are lending money to the company you are saying the sponsor we want to ride alongside of you.

Because we are helping to drive the growth and we want to participate in the upside of the growth and we're also good partners. So.

And most of the cases, the exits are to strategic buyers or other larger private equity firms rarely is the exit to an IPO like China was so in most cases <unk>.

We put it out there the MLR ico in your equity co invest over 17 years.

Is two three times about a 27% IRR and there are times Casey win when equity looks really good and there are times when it looks less good. We're now in one of the times, where it looks less good a year year and a half ago look better.

We're long term investors and we try to think about things long term and understand every once in a while we're going to have a quarter where.

We don't look that smart and then theres going to other quarters, where we look really smart Canada was a public stock we have zero control over where it trades most of our equity co invest our private and winders liquidity it usually to a strategic buyer.

Or another private equity buyer.

So we look at it over the 17 years, let's say being in the equity co investment business alongside the debt.

And create the upside with the debt for US for 17 years has been good point to point and you can pick any point over that 17 years and of course, theres going to be quarters, where it doesn't look as smart as it does in other times so.

It's when you're when you're right alongside the private equity firms, which is kind of is what it is and they are the control shareholder we're not we become control. Unfortunately, sometimes when we have to convert debt to equity and sometimes that works that really worked well and pivot it.

It did not work well in Ram it did not work well and Ram. So if it's in the health care space, we have a deep expertise in health care, We think got a good track record in healthcare.

We know what we're doing in healthcare, obviously in oil and gas.

We know what happened there as well and we're very disappointed.

My next question is relative to the JV.

Given the fact that that you're effectively not only fully levered, but but somewhat over levered and likely are going to have to use repayments to reduce your leverage ratio to a certain extent.

How does the JV go to.

<unk> a $1 billion. If you don't currently have the capability to add additional equity to support that growth.

The JV is financed.

To some extent with securitization slash.

Hello leverage.

The middle market first lien loans that we do have proven to be really terrific cash collateral.

For the CLO securitization box strong box, we've lived through it during a COVID-19, it's really good for middle market credit, there's lots of elements of middle market credit that makes it even more appropriate than broadly syndicated loan credit.

To get to $1 billion, we don't need to.

Due to the degree on the CLO, we don't anticipate doing that but we do anticipate continuing to use securitization technology to finance.

So youre, saying that youre going to add leverage to the JV.

Overtime, the leverage will be kind of probably two to one.

Type of type of leverage again, we own <unk>.

Okay.

It's about 40%.

And what's the leverage in the JV right now.

It's about two to one.

Alright, thank you.

We will go to your question from Mickey Schlein of Ladenburg.

Yes art.

Good questions. This afternoon I just have one follow up to Casey on the on the JV the dividend that you accrued on the JV was up sharply versus the previous quarter.

And it was also well above the GAAP net income for the quarter and I realize there is differences between GAAP and tax and cash and things like that but is the current dividend run rate at the JV, that's being upstream to the BDC.

Sustainable or is there a sort of one time.

Non recurring dividends received this quarter.

Theres not theres no nonrecurring into sustainable.

Dividend in fact, we're.

Same thing we over earned the dividend in the JV.

You over earned it in terms of cash.

Yes.

Alright, those are my only questions. Thank you.

And we'll go to our next question from Mark.

Charities.

Yes.

Yes. Thank you good afternoon, what is the timing on when you get clarity from the rating agencies or when you.

Work through that process does that impact your <unk>.

<unk> two <unk>.

First in the.

Second quarter here.

Yes look I think it's over the next couple of months.

Again, the difference between 1514.

It is really not that material.

Particularly with the type of portfolio, we have but it's something that we do need to get.

We do need to focus on.

Fair enough and then of the five sectors that you target anything in particular, there that you're.

Do you feel like Theres more deal flow or you have more interest in at this point given the macro backdrop.

Yes, certainly we're one of the largest lenders to the government services defense space, we think of that as a very steady stable space, we have a real domain expertise there given the geopolitical environment around the world, We think Thats a.

A space that will continue to grow and well experience tailwind.

Also health care is a big space for us.

Healthcare services.

There are there is usually tailwind is demographics.

There, we just want to make sure that we keep our leverage appropriate and reasonable.

We've had a very nice track record in that in that vertical as well.

Thank you.

And we will go to.

Now with J P. Morgan.

Good afternoon, Thanks for taking my questions today.

Just a follow up.

Sort of the portfolio rotation.

You talked about today I mean, this has been something that.

You talked about for more than just longer than yesterday.

And given that the.

Exit firms Ram.

Should bring equity the equity component of the portfolio down significant role.

It would be helpful. I think if you could update us on how youre thinking about equity as a component of the portfolio.

We look forward.

Where do you still target sort of a long term, 10% allocation or has your thinking evolved.

Yes, so it's a great question because it.

So there's some nuance in the answer which is.

We have this joint venture and PSL at of course.

That is equity, but we don't count that as kind of a true.

True equity coming back like we would elsewhere so.

So.

We have to exclude that.

And I don't have it at my fingertips, when our equity would with Ram out of the portfolio.

Excluding PSL lab.

When our equity percentage would be.

Do you have at 14% to 14%, so 14% excluding PSL at excluding Ram.

It's still kind of in the zone, probably a little high I think we'd still probably target and.

The 14% is not wildly off kind of.

Our long term target.

Okay. That's helpful. Thanks, and then as a follow up to the question about sort of recycling capital given where leverage is right. Now is there anything that we should be thinking about in terms of visibility that you have additional repayments outside of the 32 million.

Second from Ram and the near term thank.

Thank you.

Yes no.

Yes.

In this environment, both deal activity and repayments have slowed down a little bit in there they.

They are usually related and they're usually corollary between new deals and repayments to.

Slow down a little bit, but we do we are getting methodical.

Episodic repayments.

That's one of the nice things about our loan portfolio is underwritten correctly, you will get repayments, sometimes it's faster sometimes it's slower it's been on the slower and recently.

We are getting repayments nothing.

Nothing that that material in and of itself, but kind of a a drip drip drip overtime on the repayments.

Thank you Matt.

And I would now like to turn the call back to art Penn for any additional or closing remarks.

Okay. Thank you everybody for participating today on our conference call.

We will speak with you next in early May as we go through the $3 31 results. Thank you for participating today.

Yeah.

And this concludes today's call. Thank you for your participation you may now disconnect.

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