Q3 2023 PennantPark Floating Rate Capital Ltd Earnings Call
Please standby.
Good morning, and welcome to the pennant park floating rate Capital's third fiscal quarter 2023 earnings conference call.
Today's conference is being recorded at this time, all participants have been placed in a listen only mode.
Call will be opened for a question 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 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. Palmer you may begin your conference.
Thank you and good morning, everyone I'd like to welcome you here dependent parts. What are you ready Capital's third fiscal quarter 2023 earnings conference call I'm joined today by Rick, Florida, 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 floating rate capital 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 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 discussing the current market environment for middle market lending how.
How we fared in the quarter ended June 30th how the portfolio is positioned for upcoming quarters. The detailed review of the financials and then open it up for Q&A.
For the quarter ended June 30, with our net investment income was 36 cents per share.
Core NII was 31 cents per share and that excludes <unk> <unk> per share for a one time dividend income related to our equity investment in Dominion voting.
Adjusted NAV, excluding the mark to market adjustments on our liabilities decreased slightly to $11 per share or 0.9%.
<unk> decreased to $10 96 per share or one 7%. This was due primarily to valuation adjustments on a nonaccrual investment and certain equity co investments, partially offset by net investment income in excess of the dividend.
But the debt portfolio thats, 100% floating rate, we continue to benefit from the increase in base rates.
As of June 30, our weighted average yield to maturity was 12, 4%, which is up from 11, 8% last quarter and eight 5% last year.
During the quarter, we continued to originate attractive investment opportunities and invested $80 million of new and existing portfolio companies at a weighted average yield of 12, 5%.
For the investments in new portfolio companies the weighted average debt to EBITDA was three four times. The weighted average interest coverage was two five times and the weighted average loan to value was 25%.
We continue to believe that the current vintage of middle market directly originated loans is excellent.
Origin is lower.
Breads and upfront fees and OID are higher and covenants are tighter.
We are seeing an increase in deal flow compared to the first half of 2023, and we have a growing pipeline of interesting and attractive investment opportunities additional.
Additional capital we are raising across the <unk> platform will allow <unk> and the JV to capitalize on the attractive lending environment.
As of June 30, the JV portfolio equaled $105 million and together with our JV partner, we continue to execute on the plan to grow the JV portfolio to approximately $1 billion of assets.
During the quarter, the JV invested $78 million in six new and 15 existing portfolio of companies at a weighted average yield of 12, 1%, including $75 million of assets purchased from <unk>.
Also during the quarter the JV closed its second CLO financing and the six CLO for the pennant Park platform.
New financing provides the JV with over $100 million of capital for new investments and will allow the JV to further diversify its assets increases balance sheet and grow its return on capital.
We believe that the increase in scale of the Jv's balance sheet will continue to drive attractive low to mid teens return on invested capital and enhanced <unk> earnings momentum.
As detailed in the earnings release, we raised $99 million of equity capital under our ATM program and together with additional leverage capacity, we have over $300 million of capital available for new investments at <unk>.
The ATM proceeds will be used to fund additional investments into the JV, where we are earning an attractive return as well as investments into new portfolio investments.
We expect to drive growth in NII in the quarters ahead, as we deploy capital into new investments and optimize the balance sheet.
As we look forward, we like being positioned for capital preservation as a senior secured first lien lender focused on the United States.
We're floating rates on our loans can protect against rising inflation.
We continue to believe that our focus on core middle market provides the company with attractive investment opportunities.
We are an important strategic capital provider to our borrowers.
We have a long term track record of generating value by successfully financing high growth middle market companies and five key sectors. These are sectors, where we have substantial domain expertise and the right question to ask and have an excellent track record they.
They are business services consumer government services, and defense healthcare and software technology.
These sectors have also been resilient intend to generate strong free cash flow and.
And our software vertical we don't have any exposure to <unk> loans.
In many cases, we are typically part of the first institutional capital into a company and the loans that we provide are important strategic capital that fuel the growth and help that $10 million to $20 million EBITDA company.
<unk> to 30, 40 $50 million of EBITDA or more we typically you participate in the upside by making an equity co investment.
Returns on these equity co investments have been excellent over time.
We're off our platform from inception through June 30, we've.
<unk> invested over $403 million in equity co investments have generated an IRR of 26% and a multiple on invested capital of two two times.
Because we are an important strategic lending partner the process and package of 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 cushions to protect our capital attractive upfront fees and spreads and equity co investment in.
In addition 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 have meaningful covenants, which help protect our capital.
This is a significant reason 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 <unk>.
Middle market is below the threshold and does not compete with the 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.
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 higher recovery rate the lowest the companies with higher EBITDA.
We believe that the meaningful covenant protections of the core middle market, where there's more careful due diligence and tighter monitoring has been an important part because this depth of differentiated performance.
Our credit quality since inception over 10 years ago has been excellent PFS. He has invested $5 $2 billion and 464 companies.
We have experienced only 18 non accruals since inception <unk> loss ratio is only 17 basis points annually.
Our experienced and talented team and our wide origination funnel is producing active deal flow.
<unk> focus remains on capital preservation and being patient investors.
Our mission and goal or a steady stable and protected dividend stream, coupled with the 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, we capture that free cash flow primarily in first lien senior secured 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 <unk>, our CFO to take us through the financial results in more detail.
Thank you art for the quarter ended June 30th net investment income was 36 per share and core net investment income was <unk> 31 per share.
Core net investment income excludes <unk> <unk> per share of one time dividend income received from our equity investment in Dominion voting net of incentive fees.
Operating expenses for the quarter were as follows interest and expenses on debt were $10 million base management and performance based incentive fees were $7 5 million.
General and administrative expenses were $1 6 million and provision for taxes were 150000.
For the quarter ended June 30th net realized and unrealized change on investments.
Including provision for taxes was a loss of $12 9 million or <unk> 25 per share.
The unrealized depreciation on our credit facility and notes for the quarter was $5 8 million or <unk> 11 per share.
Okay.
As of June 30, our GAAP <unk> NAV was $10 96 per share, which is down one 7% from $11 15 per share.
Adjusted <unk>, excluding the mark to market of our liabilities was $11 per share down 0.9% from $11 10 per share.
As of June 30th our debt to equity ratio was 0.91 times.
And our capital structure is diversified across multiple funding sources, including both secured and unsecured debt.
We have sufficient liquidity and our revolving credit facility to repay the $76 million of unsecured notes maturing in December .
As of June 30, our key portfolio statistics were as follows.
Our portfolio remains highly diversified with 130 companies across 45 different industries.
The weighted average yield on debt investments was 12, 4% and 100% of the debt portfolio is floating rate.
We had three non accruals out of 130 companies, which represent 1% of the portfolio at cost and zero percent at market value.
We did not put any new investments on non accrual during the quarter.
The portfolio was invested in 86% first lien senior secured debt.
Less than 1% in second lien debt.
4% in equity of PSL and 10% in other equity.
Debt to EBITDA on the portfolio is five points Euro times and interest coverage was two two times.
The portfolio as a whole has a meaningful cushion with regard to interest coverage.
On a sensitivity basis for overall interest coverage to decrease to 1.0 times base rates would need to go up 200 basis points and EBITDA would need to decrease by 35%.
This analysis is based upon the current run rate interest coverage, assuming a five 5% base rate.
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.
Their continued commitment to <unk> and its shareholders. 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.
If you would like to ask a question. Please signal by pressing star one on your telephone keypad.
Youre using a speakerphone. Please make sure your mute function is turned out to allow your signal to reach our equipment.
Again, Please press star one to ask a question, we'll pause for just a moment.
We will go to our first question from Paul Johnson with K B W.
Okay.
Hey, good morning, Eric Good morning, guys. Thanks for taking my questions.
Could you just kind of speak broadly.
On the portfolio you know about <unk> and maybe also just kind of across other funds that you guys manage what kind of the trend has been.
<unk>.
Okay.
And then bid activity.
Yeah. Thanks, Paul Good question look we've seen gradually increasing amendments.
Either due to higher interest coverage.
Or because of the higher interest coverage theyre not companies are not paying down debt as quickly we have yes.
Debt to EBITDA covenants, which stepped down.
So good news bad news, where are the interest rates that we're getting are very attractive 12 plus percent.
And these companies in some cases.
That's taken a chunk of their cash flow out. So the amendment activity has increased I would say, it's not dramatic I would say, it's not a spike.
I would say, it's a gradual a gradual increase over time as the higher interest rates take hold.
Got it thanks and then.
<unk>.
Sure.
In terms of like.
The new investments that you guys are seeing obviously, we've kind of gone through sort of a lull in activity I'm not sure if that's.
Quite the same so much in the core middle market has been in the in the upper part of the middle market right.
In terms of the deals that you are seeing on the equity co investment side are you guys seeing anything more interesting than you have historically, whether it would be better valuations are getting in at or higher or larger equity co investments.
Is there anything interesting going on with the deal said that you guys have.
It's a good question, we haven't seen anything.
Materially different in the co invest opportunities to the market in the M&A market is a little bit of a tale of two cities. There is companies that are there.
But I mean, our buyers and sellers feel very strongly about they've got good growth parameters that very stable steady growing and that city number one where people are paying fairly high multiples and leverages is fairly high even in this high interest rate environment and then you have the other city, which is kind of companies where there is not a consensus.
The growth is there or there is a little bit of concern about.
Economic volatility and those deals are tougher to get across the finish line.
Sellers may still have.
Sugarplum.
Sugar plums and they're in their brain about valuations that they that they were getting a year or two ago and the buyers arent quite there for a variety of reasons, including higher interest rates. So.
So nothing materially different on the equity co invest side, we look at each one of these.
Investments on a standalone basis, the equity versus the debt and in certain cases, we will graciously decline the equity co invest in other cases, we will we will fight hard to get more equity call invests and thats kind of that.
It's kind of similar yes, we do have a fairly well embedded.
Equity co invest portfolios and our vehicles <unk> among them as we stated we've had a very good 16 year track record a gain of $2 two times MLC on those.
At times, there is greater activity at times, Theres, lesser and lesser activity recently, but we're confident over time those those equity co invest will turn into cash, which we can then.
Reinvest so nothing materially different in short in terms of the equity co invest opportunity.
Okay.
Got it I appreciate that.
Color and then.
Kind of lastly, just on NII for the quarter I know, there's some a little bit of noise, obviously with the one time dividend that you guys got it but I'm curious.
No.
If I back out kind of that that item you know, we're looking at around <unk> 31 per share which is.
Lower than than where we were.
Is there anything thats kind of in in the quarter outside of the one time stuff, that's kind of driving NII down for the quarter. I know you guys had net repayments. So maybe the deleveraging as part of that along with the ATM issuance, but any sort of comment on what you kind of would expect I guess for for NII to do that after this quarter.
You kind of hit it right, Paul it's deleveraging and it's the ATM were probably the two primary drivers.
We obviously think.
Although we are aware of quarterly earnings and it's important because it is important to eurosport and our investors were thinking.
Out in the intermediate and long term and for us having a.
Having a fortress balance sheet and having a lot of dry powder at this time, both for defensive and offensive purposes for the intermediate to long run. We think is is a good way to run the company and create long term shareholder value. So.
No.
Yes, we continue to be sold very selective again.
In the long run it's about credit selection. So we continue to be very selective about credit some of our good credits have getting have gotten paid off and certainly the JV continues to grow so were selling assets from <unk> over to the JV. The JV is generating an excellent return on capital. So a combination of all of these things.
<unk>.
But we feel very good about kind of our fortress balance sheet.
In this vintage and <unk>.
Being able to over time achieve our target leverage of one five times.
One five times debt to equity that still remains our target overtime. We think in this mid to end of 'twenty three vintage 2004 vintage will be able to fill the fill the vehicle and the JV with with high quality loans.
Got it appreciate it that's all.
All for me.
Thank you.
We'll go next to <unk> Abraham with UBS.
Hi, everybody and thanks for taking the question.
Maybe just a little bit more color on that quarter to date.
ATM issuance, so leveraging just mentioned much much lower now.
So one the end of the end of last quarter.
Just wondering on the on the need to issue more quarter to date is that a signal that you guys are seeing very very strong near term opportunities that you want to.
I wanted to deploy into relatively quickly or is it just.
Really just kind of preparing for the longer haul.
Yes, so I'd say its a good and there's a there's a little mechanical issue here, which is <unk>.
Our ATM window closes.
<unk> closed at the end of <unk>.
The quarter of $6 30.
The issuance.
Issuance that was that we logged as done post quarter end those trades were executed on let's call. It June 29th June 30th and he did not settle until.
Early July so thats why the extra $34 million.
Post quarter end, the trades were done kind of.
June 29th June 30, so, we're or that kind of wrapped up that window.
We saw some interesting incoming block demand for the stock and we elected to take it.
Those last couple of days of June .
Got it that makes sense.
And you mentioned the.
One five times.
Bill.
So what you're thinking.
How should we should we think of that as well as a longer term target at this point, given where you are right now with leverage.
Yes, yes look our goal would certainly be within the next 12 months you never know what the flows are going to be in.
And certainly we never want to force it.
Uh huh.
Kind of you want to you want credit again credit selection of the most important thing we do so we're not going to force it but at the at the flow that we're seeing are at the flow that we believe certainly we think over the next several quarters to four quarters.
And the outside case, we should be able to to.
To achieve that target.
Okay, and then just lastly on <unk>.
Sales and repayment.
Jumped up a little bit.
This quarter.
Any thoughts on how we should think about the cadence of that over the next.
A couple of quarters. It was the back half of the year here. Thank you.
Yeah. So.
Most of the sales repayments or sales to the JV.
So.
To us that's.
<unk> owns 87, 5% of the JV. The JV has been generating really good return on capital given the given the balance sheet. There. The JV is an ability to grow with the securitization CLO financing and then we're.
Again, because we are selecting hopefully solid credits, we havent selecting solid credits you get repayments from time to time so.
Lumpy hard to predict.
As activity levels pick up by and large youll youll see both repayments and Youll see new deals come on the balance sheet.
We've never had a really hard time ramping.
In general we have a really good.
Origination network and great relationships in existing.
Incumbent portfolio of 170, some names across the platform. So.
Again, one of the hardest things we do is.
Select credit with balancing.
Desired.
Generate good NII and solid dividends four.
For our shareholders. So credit quality first keep the balance sheet strong as part of that being in a position to take advantage of the vintage in and repayments come when they come.
Got it thank you everyone.
Thank you.
We'll go next to Mark Hughes with Kearl.
Yes, Thank you with respect to the CLO financing.
Finding any change.
Change in the appetite among investors for those.
<unk>.
<unk> improved what do you see.
Yes in terms of a middle market CLO.
So some people are trying to rebrand the phrase direct lending CLO, but whatever you want to call. It. It's not these are not broadly syndicated did not CLO sort of broadly syndicated loans.
Certainly as the market gets started getting choppy or post fed increases.
The cost of liabilities went up.
As well as the spread yields and spreads on the assets went up so there where there has been a gap in the cost of liabilities as you might imagine in the choppy market over the last 18 months.
At the same time as spreads and yields have gone up on the asset side, we had a month or two of increased uncertainty during the.
Silicon Valley banking turmoil.
Earlier this year.
But that was that only seen in the last in the CLO market, a few weeks and kind of levels kind of settled back to where they were pre so liability levels have been kind of where they've been we've printed several ceos in the last 12 months and the middle market and they still make a lot of air.
Economic sense in terms of return on invested capital for our JV as well as for our third party CLO.
There is third party institutional investors, who own the junior junior tranches. So.
It's it's been it's been good a good source of liability, particularly for books, such as ours, where it's a very solid.
Lower risk portfolio of senior secured floating rate loans.
Understood. Thank you for that.
You described some pretty good.
<unk> on the origination the three four times EBITDA.
25% loan to value.
The deal flow begin picking up what's your sense of how.
<unk>.
The profile of those originations might change in a more active market do you think this will stick around for a while or will that.
Sure.
Just as deal flow picks up.
Yes. It was when you look at it you say debt to EBITDA three four times interest coverage with the higher base rates of two five times and our loan to value of 25%.
I would agree with the implication of your question, which is that's abnormally good.
And Thats terrific and we want to grab that while we can.
And the other implication of your question is is are things going to start to normalize.
Our leverage is going to go up interest coverage come down a little bit more on the value stretch a little bit and the answer is it's got to.
Particularly as the market settle down if this whole kind of.
A soft landing.
Perception becomes reality.
For sure.
All of the statistics will normalize the question is is.
How long will it take to normalize.
How much flow will there be an a normalization process.
So again one of the reasons, we wanted to have lots of dry powder and a fortress balance sheet.
If things start normalizing and if we start to see a lot of solid core middle market M&A flow.
We want to be prepared and ready to access.
High quality deals.
That starts to come so.
I don't know if I answered your question, there, but a little nuance, but I think thats kind of our kind of our view.
I think you've proposed my question better than I did.
But.
We'll see.
Thank you very much.
Thank you.
There are no other questions at this time.
Terrific just want to thank everybody for their participation today.
Minder that the September 30 quarter for us as our 10-K, so you won't be alone.
We're usually a few days later due to the 10-K versus 10-Q, so we're targeting mid November .
For our next quarterly earnings conference call and wishing everybody a healthy and enjoyable rest of the summer. Thank you very much.
This does conclude today's conference call. Thank you for your participation you may now disconnect.
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