PennantPark Floating Rate Capital Ltd (PFLT) 2018 Q1 法說會逐字稿

Good morning, and welcome to the PennantPark Floating Rate Capital's First Fiscal Quarter 2018 Earnings Conference Call. (Operator Instructions)

It is now my pleasure to turn the call over to Mr. Art Penn, Chairman and Chief Executive Officer of PennantPark Floating Rate Capital. Mr. Penn, you may begin your conference.

Thank you, and good morning, everyone. I'd like to welcome you to PennantPark Floating Rate Capital's First Fiscal Quarter 2018 Earnings Conference Call. I'm joined today by Aviv Efrat, our Chief Financial Officer.

Aviv, please start off by disclosing some general conference call information and include a 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 PennantPark 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 by using the telephone numbers and PIN provided in our earnings press release as well as on our website.

I'd also like to call your attention to the customary safe harbor disclosure in our press release regarding forward-looking information. Today's conference call may also include forward-looking statements and projections, and we ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these projections. We do not undertake to update our forward-looking statements unless required by law.

To obtain copies of our latest SEC filings, please visit our website at www.pennantpark.com or call us at (212) 905-1000.

At this time, I'd like to turn the call back to our Chairman and Chief Executive Officer, Art Penn.

Thanks, Aviv. I'm going to spend a few minutes discussing financial highlights, followed by a discussion of the portfolio, investment activity, the financials and then open it up for Q&A.

For the quarter ended December 31, we invested $177 million in primarily first-lien senior secured assets at an average yield of 8%. PennantPark Senior Secured Loan Fund or PSSL continued to grow. As of December 31, PSSL owned $148 million diversified pool of 25 names with an average yield of 7.3%.

Core net investment income was $0.25 per share. As of September 30, our spillover was $0.45 per share.

In addition to being active on the investing front, during the quarter, we recast the entire right-hand side of the balance sheet with attractive financing. In October, we issued 6 million shares of equity; and in November, we amended, extended and upsized our attractively priced L+200 credit facility and also issued long-term unsecured bonds at an attractive fixed rate of 3.83%.

We're actively investing the proceeds of our debt and equity financings into well-priced and structured first-lien secured, floating-rate loans and into PSSL. As we invest, we expect that our NII will grow to more than cover our dividend on a sustainable basis.

Our primary business of financing middle-market financial sponsors has remained robust. We have relationships with about 400 financial sponsors across the country and elsewhere, and we manage from our offices in New York, Los Angeles, Chicago, Houston and London. We've done business with 181 sponsors to date. Due to the wide funnel of deal flow that we receive relative to the size of our vehicles, we can be extremely selective about what we ultimately invest in.

We remain primarily focused on long-term value and making investments that will perform well over several years and can withstand different business cycles. Our focus continues to be on companies and structures that are more defensive, have low leverage, strong covenants and high returns.

As credit investors, one of our primary goals is preservation of capital. If we preserve capital, usually the upside takes care of itself. As a business, one of our primary goals is building long-term trust. Our focus is on building long-term trust with our portfolio companies, management teams, financial sponsors and intermediaries, our credit providers and of course, our shareholders.

We are a first call for middle-market financial sponsors, management teams and intermediaries, who want consistent credible capital. As an independent provider free of conflicts or affiliations, we've become a trusted financing partner for our clients.

We are pleased that we've been approaching this investing market with substantially more capital and resources in order to drive significantly enhanced self-originated deal flow. This enhanced deal flow has meant that we can get more looks and be even more relevant to our borrower clients. Being more relevant means that we can be increasingly selective about which investments we make as well as giving us the ability to be an important leader in transactions who can drive terms.

We've taken several steps in order to build this increased relevance over the last few years, including the MCG Capital merger, the addition of senior and mid-level professionals across different geographies, 2 follow-on equity offerings, the launching of PSSL and our recent bond offering.

PSSL is our joint venture with Trinity Universal Insurance Company, a subsidiary of Kemper Corporation. Similar to PFLT, PSSL invests primarily in first-lien secured loans for companies that are more defensive, have low leverage and have strong covenants. PSSL has the additional benefit that PFLT and PSSL together can write larger checks for our sponsor clients and can be more relevant to them, driving enhanced deal flow and better terms.

We expect the ROE on our overall investments in PSSL to be in the low- to mid-teens, which should be accretive to PFLT and increase net investment income over time. Although PFLT's investment in PSSL is considered as a nonqualifying asset, we still have plenty of cushion since only 13% of the maximum 30% basket is currently nonqualifying. We are actively considering a second senior loan joint venture.

As a result of our focus on high-quality companies, seniority in the capital structure, floating-rate assets and continuing diversification, our portfolio is constructed to withstand market and economic volatility. The cash interest coverage ratio, the amount by which EBITDA or cash flow exceeds cash interest expense, continue to be a healthy 3.1x. This provides significant cushion to support stable investment income.

Additionally, at cost, the ratio of debt-to-EBITDA on the overall portfolio was 4.1x, another indication of prudent risk. Our credit quality since inception 7 years ago has been excellent. Out of 314 companies in which we have invested, we have experienced only 5 nonaccruals. On those 5 nonaccruals, we've recovered $1.07 on the dollar so far. On December 31, we had one nonaccrual on our books, representing 0.4% of the portfolio on a cost basis and 0.2% on a market value basis.

In terms of new investments, we had another active quarter investing in attractive risk-adjusted returns. Our activity was driven by a mixture of M&A deals, growth financings and refinancings. And virtually with all of these investments, we've known these particular companies for a while and have studied the industries, or have a strong relationships with the sponsor.

Let's walk through some of the highlights. We invested $11 million in the first-lien debt of Cadence Aerospace. Cadence is a Tier 2 precision manufacturer and integrator of flight critical components, subassemblies and assemblies. Arlington Capital is the sponsor. Deva Holdings produces and sells hair care products. We purchased $27 million of first-lien term loan. Ares Management is the sponsor. We lent $15 million of first-lien term loan and invested $1 million of equity in GCOM -- GCOM Software, which is a software and IT services, IT solutions provider for state and local governments. Sagewind Capital is the sponsor. SONNY'S Enterprises manufacturers and distributes carwash equipment, parts and supplies. We lent $15 million of first-lien term loan, Sentinel Capital is the sponsor.

Turning to the outlook. We believe that 2018 will be active due to both growth and M&A-driven financings. Due to our strong sourcing network and client relationships, we are seeing active deal flow.

Let me now turn the call over to Aviv, our CFO, to take you through the financial results.

Thank you, Art. For the quarter ended December 31, 2017, core net investment income was $0.25 per share. We had $0.29 per share of nonrecurring upfront fees relating to the renewal of our credit facility and the issuance of our $139 million unsecured notes. Additionally, we had about $0.01 per share of incentive fees accrued, but not payable. This resulted in GAAP NII of negative $0.05 per share.

Looking at some of the expense categories. Management fees totaled $2 million, including $100,000 of accrued, but not payable incentive fees. General and administrative expenses totaled about $1.1 million, and recurring interest expense totaled about $2.6 million.

During the quarter ended December 31, net unrealized appreciation on investment was about $3.5 million or $0.10 per share. Net realized losses were $2.8 million or $0.08 per share. Net unrealized depreciation on our credit facility and notes was $3.1 million or $0.08 per share. And dividend in excess of income was $12.4 million or $0.34 per share. Consequently, NAV went from $14.10 per share to $13.86 per share.

Our entire portfolio and our credit facility are mark-to-market by our Board of Directors each quarter using the exit price provided by an independent valuation firm or independent broker-dealer quotations when active markets are available under ASC 820 and 825. In cases where broker-dealer quotes are inactive, we use independent valuation firms to value the investments. Our portfolio is relatively low risk. It is highly diversified with 84 companies across 24 different industries. 84% is invested in first-lien senior secured debt, 5% in second lien debt, 6% in subordinated debt and 5% in equity. Our investment in PSSL, whose underlying investments are first-lien senior secured loan, represents about 77% of the subordinated debt and equity investment in PFLT's portfolio. Our overall debt portfolio has a weighted average yield of 8.3%. 99% of the portfolio is floating rate, including cash.

Now let me turn the call back to Art.

Thanks, Aviv. To conclude, we want to reiterate our mission. Our goal is a steady, stable and protected dividend stream, coupled with the preservation of capital. Everything we do is aligned to that goal. We try to find less risky middle-market companies that have high free cash flow conversion. We capture that free cash flow primarily in first-lien senior secured floating-rate debt instruments, and we pay out those contractual cash flows in the form of dividends to our shareholders.

In closing, I'd like to thank our extremely talented team of professionals for their commitment and dedication. 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.

(Operator Instructions) We will, at this time, hear first from Ryan Lynch of KBW.

I have a couple of questions on the senior loan fund first. Can you provide -- do you have any, I guess, updated timing on when you would expect to launch a second JV or potentially expand the first JV?

Thanks, Ryan. We are actively having discussions. I would not want to commit publicly to when we would launch that, but it is a high-priority of the firm to do so. So we're spending a lot of time on it.

Okay. Fair enough. And then if I look at the assets in PSSL, they increase by about 50% in the quarter, but income was only up about 14% and it looks like the overall return of the income for [Pennant Float] was only about a 4% return on that fund for the quarter. So can you just talk about why the returns were so low this quarter? Is it a timing issue? And when do you hope to be able to ramp up to that low- to mid-teens type of ROE?

Yes. So it's a good question. It is timing. It depends on when you ramp and how much credit facility you roll down versus the 2 forms of junior capital we've rolled down. We still believe, as we fully ramp, and again, when it's a new portfolio, your bite sizes are a little smaller, the leverage is a little bit lower. But as you ramp, both the bite sizes can get a little bigger and your leverage can be a little bit more optimized. So no doubt, as we continue to grow the vehicle in a methodical, cautious and careful way, but still grow it, we're going to get to our target, low- to mid-teens ROE.

Okay. That kind of goes to my next question, as far as bite-size goes. When I actually looked at the portfolio for PSSL, as you guys disclosed in your 10-Q, it shows that the 5 largest portfolio companies are about $40 million, $41 million, which represents about 27% of PSSL's portfolio. So I was just wondering, that feels fairly large. Do you expect the bite sizes to basically stay the same going forward and as that portfolio grows from roughly $150 million to closer to $300 million that concentration shrinks? Or will you actually expand the bite sizes as PSSL grows and it will still have a fairly concentrated portfolio?

Yes. I mean look, we're taking at least 30 names in the portfolio, i.e., 3% positions, 4% would be a big position for us. I'd say the majority of positions will be 2% to 3% over time.

Okay. And then, I just noticed, you guys had, at the end of the quarter, about $128 million of cash on the balance sheet. Why was there also, I guess, $193 million drawn on the credit facility with all that cash on the balance sheet?

So the cash came primarily from our bond offering, which we're very pleased with that bond offering and attractive long-term fixed rate. That came there -- the credit facility financing we have is a securitization style of financing, one of the reasons we can we only play L+200, it's a securitization style. So there is an SPV that holds the assets and it's not immediately -- it's not as easy to redeem as possible. So for us, the cash, the $120 million of cash is just going to be used initially to buy our next wave of assets. That will sop up the cash and then once those -- those assets will be contributed to either the SPV for our credit facility or they'll be contributed to PSSL subject to approval of Kemper and our lender or they'll be held at the parent company. But to us, that was the most efficient way to do that.

Yes. That makes sense. And then just one last one, if I can. Can you just give any outlook, now that we're about a month -- a little over a month into the first quarter of 2018, just how you guys are viewing capital deployment and repayments so far?

It's early. Typically, there is a seasonality to our business, which I'm sure you and a lot of people on the call know. A lot of deals get done in the December quarter. January is a little slow. We have started to see, in the last couple of weeks, activity pick up. So we think it's going to be kind of a normal quarter for us. Whatever that means, we -- our first and foremost goal is capital preservation. We never want to rush, but we are active -- the teams that we've built around the country and elsewhere, the relationships we're building remain very strong and are getting stronger every day. So we continue to be very excited about the commercial opportunity to grow the portfolio over time.

And we'll hear next from Mickey Schleien of Ladenburg.

Art, clearly the SLF had strong growth this quarter in terms of assets. But I have seen some SLFs shrink a bit as money is being taken off the table given how tight the markets are. So I'd like to understand where you're finding value in the more liquid markets where the SLF is investing?

Yes. So just to be clear, Mickey, our PSSL is doing the same types of deals that are going to PFLT, which are primarily self-originated first lien loans directly for middle-market financial sponsors. So just to take a step back, we've been investing in our team and our infrastructure over the last 3 years with offices around the country and elsewhere. So we're originating more deal flow actually right now than we have the capability, while still maintaining diversification. So we have the nice problem of our middle-market financial sponsor client saying to us, "Gee we wish we could write bigger checks into our deals." And we say look, we have to maintain profit diversification for our vehicle so we can write check of whatever it is, $30 million, $35 million between PFLT and PSSL. So we're in that nice fortunate position of being able to be very picky and selective about what comes into these portfolios and much of what is going into PSSL is very similar to what goes into PFLT.

Art, are there any particular industries, perhaps, where you're seeing some better value than you're targeting at the moment?

It's all across the map. We, in this environment, are very focused on finding companies that we believe our recession-resistant and industries that we believe are recession-resistant industries, where the leverage is low, where we get covenants. We are still getting covenants, by the way, and where we can be an important lender to the borrower. So if you were to ask our team, in New York and around the country, our biggest opportunity is to find more capital to channel into some of these companies, which is why we did the equity deal going back, why we did the credit facility and the bonds. And by the way, we thought doing both the bonds and the credit facility were very well timed. We're thrilled to be able to lock-in a long-term credit facility L+200. We're thrilled to lock-in long-term bonds at 3.8%. We paid the onetime upfront cost and it came through the income statement this quarter, but that will be nonrecurring. So we really think we have a really good hand right now. We have a lot of liquidity. Our teams are originating interesting deal flow. And we feel good about the market opportunity.

Okay. My last question. Art, I think yesterday you said PNNT's average -- I don't remember if you mentioned PNNT's average EBITDA. I'd be interested in knowing what that number is and also what the average EBITDA number is at PFLT in the portfolio?

Yes. Something we typically do not disclose as a general proposition. On average, the EBITDAs tend to be between $15 million and $40 million in PFLT, I'd say, probably the bell curve is $20 million to $30 million or so.

Okay. And is it similar, PNNT?

PNNT is pretty similar.

And our next question comes at this time from Chris York of JPM -- JMP securities.

So most of them have been asked. I was going to focus on the PSSL. So just one clarifying question for you. You had net realized losses of $2.8 million in the quarter. How much of that was in Charming Charlie?

That was Charming Charlie. So we sold -- we got out of Charming Charlie, which is a bankruptcy. We decided for us, it didn't make sense to pursue it. It made sense for us to exit the field. So that was where that number came from.

Got it. So no additional realized losses outside of Charming Charlie?

That's right.

(Operator Instructions) Our next question comes from Doug Mewhirter of SunTrust.

Most of my questions have been answered. On the PSSL, just to get an idea, it looks like you've had a nice little uptick in growth this quarter. Do you expect that to sort of grow as proportionately with your origination activity or would you, maybe, ramp that up a little bit quicker than the growth rate of your -- on balance sheet portfolio?

Yes, it's a great question. We certainly are prioritizing the PSSL given the higher ROE it generates. So I'd say, by and large, they're going to grow together. But if we have a deal that fits the PSSL and it's a smaller bite and it can -- we'll just probably slot it into the PSSL. That's very ROE accretive for the company.

Okay. Thanks for that. My second and final question, on -- more of a market-related question. How are you seeing spreads? I mean, obviously LIBOR is a nice tailwind for you now. But how are spreads doing in terms of the competitive environment? I mean, obviously there is a lot of talk in high yield markets and the traditional middle markets where spreads have tightened a bit. I'm just not sure how that's affecting the top end of the capital structure for these smaller and mid-market companies that you're looking at for PFLT?

Nothing out of the ordinary relative to the last quarter or 2. It's been roughly flattish in terms of our experience in terms of spreads.

And our next question comes from Ray Cheesman of Anfield Capital.

Art, I just -- I want to give you an opportunity to speak while we're all here together on the phone. The shares are down 4.5% during the call. What is the market missing?

I don't know. We did have some onetime costs this quarter for redialing basically the whole right-hand side of our balance sheet, which are a onetime nonrecurring expense. We made those investments essentially -- or that investment essentially because we think it was a very good time to do so, to lock in a attractively priced long-term credit facility long term, to lock in long-term 3.8% unsecured notes opportunistically. And we take those expenses upfront so that we then do not amortize those expenses over the life of those deals. So number one, it's easier to model -- for people to model the expenses, but also our interest expense going forward. Our interest expense going forward is lower than our peers because we do not amortize that $10.9 million over the life of the deals. So it doesn't impact our taxable spillover, but it does impact our GAAP on a nice basis. So even though it's a big onetime expense, we're going to make it up and, I think shareholders will feel really good about both the credit facility and the bonds every quarter going forward, as they see the result of this company. So don't know -- we don't spend our day trying to understand why the market trade is the way it is. We put our head down and try to find good deals and where we can lock in great financing and liability side, we do. And that's exactly what we did.

A broader kind of market-type question. I know that about 70% of the deals done last year had 0 LIBOR floor. I'm wondering if you think that -- you mentioned earlier, that you were still getting some covenants. I'm wondering if you're still able to hang on to the protection of a LIBOR floor. I don't know how long the current up cycle will go, but I think there is a lot of people who are going to be rather surprised when this cycle, as it naturally does, goes back the other direction again, and without LIBOR floors, wow, some of those loans they make that they may be holding for a couple of years won't end up being very profitable. So I'm just wondering what are you seeing in the LIBOR floor business.

We're still getting LIBOR floors typically of 1%-or-so. That's a typical loan that we do, grant a 3-month LIBOR. I think, as of yesterday, it was 1.8%. So right now, they don't have a lot of value, but we have them in the downside case as you point out, Ray, as LIBOR goes back lower again. So we are getting them in the vast majority of the cases.

And lastly, I just wondered if you had any color that you would be able to share with us. It's -- we don't see very many BDCs get 3.83% money out of Israel. I'm just wondering if there is any back story you're able to give us so we understand your creativity.

Yes, sure. We've been looking at that market for a few years. The real estate industry has tapped that market over the last few years on a consistent basis. So it looked attractive. We developed a relationship with a merchant bank that focuses on FCC, which focuses on the Israeli capital markets. We investigated and we spent a lot of time thinking about it. We talked to the rating agencies, were rated by an affiliate of S&P over there. We got a very attractive rating, AA-. And we did some test marketing, and we thought it would be attractive capital. So we pulled the trigger and did a roadshow, and we're very pleased with the result. And we think that's -- again, the upfront fees are a onetime nonrecurring item in this quarter's income statement. But at 3.8%-or-so for the average life of like 4.6 years unsecured, we think that's going to be really, really helpful to shareholders on an ongoing basis and that piece of paper will generate very nice accretion on an income basis over time.

Yes, we wanted to say thank you for your timing. It was perfect.

I thank you. I mean, that's -- we felt good about that as well as our credit facility redialing. So granted, it's a onetime expense in this quarter's income statement. We think it's noncore. It's a nonrecurring noncore, that's why we disclosed core NII. But we feel really fortunate to have a lot of liquidity where the market may or may not be going through some turbulence, locking in really great long-term capital. Granted taking the onetime and nonrecurring income statement item, but in the long run, we're -- we think our shareholders will look back on this investment we've made in both the credit facility and the bonds and say those were very well timed and opportunistic financings.

And at this time, there are no further questions in the queue. Mr. Penn, I'd now like to turn the conference back to you for any additional or closing remarks.

Just like to thank everybody for their interest in PennantPark Floating Rate Capital. And we look forward to speaking with you in early May. Thank you very much.

And again, that does conclude our call. We would like to thank everyone for your participation. You may now disconnect.