Q4 2023 PennantPark Floating Rate Capital Ltd Earnings Call

Please standby.

Good morning, and welcome to the pennant park floating rate Capital's fourth 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.

Al will open with a question answer session. Following the Speakers' remarks.

If you would like to ask a question at that time simply press star one on your telephone keypad. If you would like to withdraw your question. Please 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 dependent part floating rate capital fourth fiscal quarter of 2023 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 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 filing 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 we fared in the quarter ended September 30th how the portfolio is positioned for the upcoming quarters. A detailed review of the financials and then open it up for Q&A.

For the quarter ended September 30th GAAP and core net investment income was 32 cents per share.

<unk> increased one 6% to $11.13 per share from $10 96 per share.

Adjusted NAV, excluding the mark to market adjustments on our liabilities increased to $11 13 per share or one 2% the.

The increase in NAV for the quarter was due primarily the positive valuation adjustments on both debt and equity investments.

But the debt portfolio that is 100% floating rate, we continue to benefit from the current base rate environment.

As of September 30th our weighted average yield to maturity was 12, 6%, which is up from 12, 4% last quarter and 10% last year.

During the quarter, we continued to originate attractive investment opportunities and invested $94 million in three new and 31 existing portfolio companies at a weighted average yield of 12, 1%.

For the investments in new portfolio companies the weighted average debt to EBITDA was three six times. The weighted average interest coverage was two three times and the weighted average loan to value was 36%.

We continue to believe that the current vintage of core middle market directly originated loans is excellent.

Leverages lower spreads and upfront OID or higher and covenants are tighter than the upper middle market.

Despite reports of covenant erosion in the upper middle market and the core middle market, we are still getting meaningful covenant protections.

We are seeing an increase in deal flow compared to the first half of 2023 and have a growing pipeline of interesting and attractive investment opportunities.

Since quarter end, we've continued to be active from September 30th through November 10th we've invested $76 million into new and existing investments and are continuing to see strong deal flow going into year end.

As of September 30, our debt to EBITDA ratio was <unk> 76 to one.

With a target ratio of one five to one we believe that we're positioned to start to drive strong growth in net investment income going forward.

Additional growth in NII can be driven by our joint venture as of September 30th the JV portfolio totaled $786 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 52 million into five new and eight existing portfolio companies at a weighted average yield of 12%, including $37 million of assets purchased from <unk>.

We believe that the increase in the scale of the JV balance sheet will continue to drive attractive mid teens returns on invested capital and enhance <unk> earnings momentum.

Credit quality of the portfolio is stable, we had no new non accruals in the quarter ended September 30th.

As of September 30, the portfolio portfolios weighted average leverage ratio through our debt security was five one times and despite the steep increase in base rates over the last 12 months. The portfolio's weighted average interest coverage ratio at September 30 was two one times.

From an overall perspective in this market environment of elevated inflation rising interest rates geopolitical risk in a potentially weakening economy we'd.

We like being positioned for capital preservation as a senior secured first lien lender focused on the United States, where the floating rates on our loans can protect us 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 provide important strategic capital to our borrowers.

We have a long term track record of generating value by successfully financing growing 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 are business services consumer government services, and defense health care and software and technology <unk>.

These sectors have also been resilient intend to generate strong free cash flow.

Approximately 12% of our portfolio is in government services and defense.

Which is a sector with strong tailwind in this geopolitical environment.

And our software vertical we don't have any exposure to a or our loans.

The core middle market companies with $10 million to $50 million EBITDA is below the threshold and does not compete with a broadly syndicated loan or high yield markets. Unlike our peers in the upper middle market.

In the core middle market, because we are an important strategic lending partner to process and package of terms. We receive is attractive we have many weeks to do our diligence with care, we thoughtfully structured transactions with sensible credit statistics meaningful covenants substantial equity cushions to protect our capital attractive upfront.

O I D.

And equity co investment.

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

With regard to covenants. Unlike the erosion in the upper middle market virtually all of our originated first lien loans had meaningful covenants, which help protect our capital.

This is a significant reason why we believe we are well positioned in this environment.

Many of our peers, who focus on the broadly syndicated loan and upper middle market state that those companies are less risky.

That might make 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 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.

Our credit quality since inception over 10 years ago has been excellent.

<unk> has invested $5 $3 billion and 468 companies and we have experienced only 18 non accruals.

Since inception, <unk> loss ratio was only 15 basis points annually.

As a provider of strategic capital.

Fuels the growth of our portfolio companies in many cases, we participate in the upside of the company by making an equity co investment.

Our returns on these equity co investments have been excellent over time overall.

Offer a platform from inception through September 30th we've invested over $410 million in equity co investments and have generated an IRR of 26%.

And a multiple on invested capital of two two times.

Our experienced and talented team and why origination funnel is producing active deal flow. Our continued focus remains on capital preservation and being patient investors, our Michigan and Golar, a steady stable and protected dividend stream, coupled with preservation of capital everything we do is aligned to that goal, we seek to find investment opportunities.

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.

I'll now turn the call over to Rick our CFO to take you through the financial results in more detail.

Thank you art for the quarter ended September 30th GAAP and core net investment income was 32 per share operating expenses for the quarter, whereas follows interest and expenses on debt were $8 6 million.

Base management and performance based incentive fees were $7 4 million.

General and administrative expenses were $1 1 million.

Provision for taxes were 150000.

For the quarter ended September 30, net realized and unrealized change on investments, including provision for taxes was a gain of $9 5 million or <unk> 16 per share.

The unrealized appreciation on our credit facility and notes for the quarter was $2 6 million or <unk> <unk> per share.

As of September 30th R Gap, and EV was $11.13, which is up one 6% from $10.96 per share last quarter.

Adjusted NAV.

Excluding the mark to market of our liabilities was $11 13 per share up one 2% from $11 per share last quarter.

As of September 30th our debt to equity ratio was <unk> seven six 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 on December 15th.

As of September 30th our key portfolio statistics, whereas follows.

Our portfolio remains highly diversified with 131 companies across 45 different industries.

Average yield on our debt investments was 12, 6%.

And approximately a 100% of the debt portfolio is floating rate.

We had three non accruals, which represent 1% of the portfolio at cost at zero percent at fair market value we.

We did not put any new investments on non accrual during the quarter.

The portfolio is comprised of 85% first lien senior secured debt.

Less than 1% in second lien debt.

5% in equity of PSS L and 10% in other equity.

The debt to EBITDA on the portfolio is five one times and interest coverage was two one times.

The portfolio as a whole has a meaningful cushion with regard to interest coverage.

On a sensitivity basis for the portfolios overall interest coverage to decrease to one times base rates would need to go up 200 basis points and EBITDA would need to decrease by 40%.

This analysis is based upon 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.

For 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.

Thank you, ladies and gentlemen, if you would like to ask a question. Please signal by pressing star one on your telephone keypad.

If you're using a speaker phone. Please make sure. Your mute function is turned off to allow your signal to reach our equipment and again that is star one we'll pause for a moment to assemble our queue.

And we'll take our first question from Brian Lynch from K B W. Please go ahead.

Hey, good morning, Thanks for taking my questions.

First one I had was just on the level of repayments and exits you guys had thats been pretty hard the last couple of quarters can you just talk about.

Is there something going on that's really been in the marketplace has really been driving the higher level of repayments or is it just.

A combination of kind of normal size repayments and in your.

Desire to kind of drop down some of those some of those into the JV.

Thanks, Brian Good morning, Yes, certainly some of those deals ended up in the JV for sure and then I'd just say it's normal activity you know when you when you pick solid credits.

And they perform well and in most of our portfolio is performing very well you you get paid off.

Our origination flow has been a little lighter.

Up until through 930, we've been busier since 930, I think we're gonna be busier kind of coming into year end and beyond so deal flow has picked up.

None of this was kind of intentional for us we we certainly can manage repayments.

Other than if they fit the JV and then when we see our you know our attractive new deals come through we we we clearly want to select those and we've been seeing more of those.

In the recent weeks.

Okay.

So I would love to just touch on that that last point, a little bit more.

Can you just talk about the deal environment. Obviously the deals that you guys are doing some pretty incredible SaaS with a leverage interest coverage and loan to value on new law.

All of us as well.

The spreads in the absolute yields are pretty high.

I know Theres certainly in.

The upper middle market Theres certainly.

Hope that the deal activity is going to pick up as a private equity in <unk>.

Buyers and sellers start to get a little more clarity with interest rates and pricing I'd love to just hear kind of your insights on what you're seeing in kind of the core middle market and when do you think that that would translate into a meaningful pickup in deal activity in your world.

Yeah. So we think that activity is picking up we've seen it.

No in lifetime, which is why we've added the recent developments subsequent event disclosure.

To the to the to the to the press release.

And our sense is is you know kind of its Ben.

Sellers have been.

Have needed some time to adjust.

So the new environment, the multiples that they could get selling their companies.

The end of 'twenty, one are no longer generally available to them. So it's taken them a while too.

To adjust to get their mind around it.

Clearly if you're a buyer of one of these companies you have to absorb higher interest rates by definition.

So multiples have come down certainly from where they were and then in 2021 and that's taken some time to find its equilibrium.

So that's been a big big biggest part of it and I think most are mostly.

The big part of it is there's a general sense that we're in kind of the interest rate zone that we're going to be in for a while maybe it goes up a little bit maybe goes down a little bit but in general you know.

Kind of people arent going to be waking up you know.

So kind of and seeing much higher interest rates were much lower interest rates to decisions can be made you know kind.

Kind of where the base rate to five 5% or five and three quarters percent or 5.25%. This is the zone people.

Have accepted and they can therefore price price that into the to.

So the deals that they are trying to do.

Okay. That's all from me I appreciate your time today.

Thank you. Thank you and next we will go to Mickey <unk> from Ladenburg. Please go ahead.

Yes, good morning, Art and Rick Art.

The portfolio has some exposure to what could be considered.

Considered cyclical sectors, like construction, and consumer and auto and hotels and leisure things like that.

Can you describe how those credits are generally doing.

And the prospects for those credits going into next year as.

Things, we've read in the headlines with savings rates go down in credit cards, being tapped out and things like that.

Yeah, No we are.

We thank you Mickey we we specifically try to avoid kind of cyclical names. So if something's has the word construction next to it it'll be some kind of service business typically something that's architectural or engineering services, where the underlying market is is less cyclical. So if we're in.

In architectural and engineering services business and won't really be tied to homebuilding it might be tied to infrastructure spending which has been an area of growth.

Or it might be tied to a renovation, which goes on whether or not you know.

People have had capital or not.

Consumer is something we're watching clearly.

When we do consumer we're very aware of the.

Of the environment, So, we specifically keep leverage or lower on our consumer deals than we do on our on our average deals and we typically try to find companies that have brands.

That.

That value and meaning in their marketplace. So you know Dr. Shoals as an example, it's a big brand as a branded consumer company.

Leverages reasonable on it people are aware of the brand so.

Kind of Arctic which is.

Uh huh.

A yeti comparable it's a lower cost version of yeti in our portfolio. When we can when we did the deal leverage was very low.

And because it's a lower cost version its actually doing pretty well in this kind of environment. So that's kind of how we think about consumer thats, how we kind of think about construction I'm happy to to dive deeper if you'd like.

Well just in the auto sector or any of those credits materially impacted by the strikes.

Okay.

You know, Jeff named specifically on and on.

On which named specifically sometimes these.

No.

Breakdown of the industries in the last year, so yeah, I mean the auto.

Yes.

It would be something typically tied to auto aftermarket.

Which is.

Which is kind of a hopefully a steady stable we don't have any kind of.

Exposure to OEM or exposure to to stuff that was related to the strike. It will be it will be products that are sold in the in the in the aftermarket.

Carwash companies I don't know, whether thats I forget whether that's.

Auto or whether that's consumer or something else, but.

Things like that.

Okay.

Following up on Ryan's question about <unk>.

Terms.

The upper middle market as you know, we started to see some spread compression, particularly for higher quality borrowers.

Have you seen that starting to trickle down into the middle market at all yet.

Yes, I'd say kind of in our core market of 10% to 50 of EBITDA in the upper end of that if a credit is perceived as.

Really an excellent credit in a space that people love It may get a little competitive you know and spreads may tighten a little bit.

And then there's a piece of the world of <unk>.

Get to the middle of the 10% to 50 or certainly the lower end, where there's a lot less competition.

And we haven't really seen much spread tightening there.

Okay. My last question I appreciate the recent developments.

Language in the press release can.

Can you tell us anything about repayments for this quarter apart from things that you might be transferring to the senior loan fund.

Is it the prepayments have been light.

Prepayments have been like quarter to date.

Okay. That's it for me. This morning, Thanks for taking my questions and have a nice holiday.

You too.

Thank you and next we're going to go to Maxwell Fritcher from <unk> Securities. Please go ahead.

Hi, good morning, I'm, calling in for Mark Hughes, so of the companies that have.

Had amendments in fiscal 'twenty, three what percent would you judge.

<unk> has received additional capital support from the sponsor.

I'm going to say.

Probably certainly the minority I'm going to I'm going to guess maybe about a third most of these are very minor amendments.

In certain cases, the sponsors we do ask them to put up additional capital.

And in all cases, so far that additional capital has been been forthcoming and Thats one of the nice things about where we are with the covenants. We have the information rights we have.

And the loan to value that we have for a relatively small checks.

Sponsor relative to their initial investment in these companies. The sponsor can can solve a problem. So certainly the minority where theres a cash investment we haven't seen any any issues with.

With sponsors coming forward to date.

Okay. Thank you and in regard to the interest coverage have you seen a meaningful amount of portfolio companies, forego capex or or hiring in order to keep a favorable ratio.

It's a great question.

I said, we certainly sense that.

With less cushion in the system.

I mean these are very thoughtful companies anyway. The vast majority owned by private equity firms. So they are always looking at.

The return on capital, where the return on equity.

So there are always focused on it I think there is an even higher.

Higher focus today, but you know on average today are companies are covering our interest two times or something so it's certainly not the lush times of a year ago. When it was kind of three times and interest coverage now youre down to two times. So we still think there's a reasonable cushion, but theres certainly a heightened awareness of.

The interest cost that that that they have to bear in some ways. That's good theyre focused you know they've got a lot of equity beneath us and they want to make sure you know.

That their equity is as safe.

Okay.

That's helpful. Thank you very much.

Thank you I'd now like to turn the conference back over to our speakers for any closing remarks.

Thanks, everybody for being on the call today.

We wish everybody a happy Thanksgiving Thanksgiving of gratitude.

And we look forward to speaking with you in early February at our next earnings release. Thank you very much.

Thank you ladies and gentlemen that does conclude today's conference. We appreciate your participation have a wonderful day.

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