PennantPark Floating Rate Capital Ltd (PFLT) 2018 Q4 法說會逐字稿

Good morning, and welcome to the PennantPark Floating Rate Capital's Fourth Fiscal Quarter 2018 Earnings Conference Call.

Today's conference is being recorded.

(Operator Instructions)

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

Mr. Penn, you may now begin your conference.

Thank you, and good morning, everyone.

I'd like to welcome you to PennantPark Floating Rate Capital's Fourth 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 a property of PennantPark Floating Rate Capital and that any unauthorized broadcast of this call in any form is strictly prohibited.

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 September 30, we invested $202 million in primarily first lien senior secured assets at an average yield of 8.4%.

The average yield of new investments has increased during 2018 and has benefited from recent increases in LIBOR.

PennantPark Senior Secured Loan Fund, or PSSL, continued to grow.

As of September 30, PSSL owned a $425 million diversified pool of 42 names with an average yield of 7.8%.

Again, the average yield in PSSL has also benefited from LIBOR increases.

Over the last several years, we have substantially grown our platform by adding senior and mid-level investment professionals in regional offices as well as New York.

The additional people in offices, combined with additional equity and debt capital we've raised, has significantly enhanced our deal flow.

This puts us in a position to be both active and selective.

The growth is evidence of this enhanced platform.

Net investment income was $0.30 per share.

Core net investment income, excluding accrued, but not payable incentive fee, was $0.29 per share.

Due to the activity level we are seeing, the increase in LIBOR, the growth of PSSL, we are pleased that our current run rate recurring net investment income covers our dividend.

Our earnings stream should have a nice tailwind based on the continuation of these factors.

As of September 30, our spillover was $0.31 per share.

With regard to the Small Business Credit Availability Act, a reminder that our board approved the modified asset coverage that was included in the law, reducing asset coverage from 200% to 150%, effective April 5, 2019.

The company has generated an excellent track record over the last 7.5 years, investing in lower risk, first lien senior secured floating rate assets.

We believe that such assets represent an appropriate risk profile that can be prudently leveraged under the revised statute to provide attractive returns for our investors.

Our successful operation of PSSL, which is today operating at the reduced asset coverage level contemplated by the new law, is evidence of this strategy.

By this quarter-end, we upsized our credit facility to $520 million from $405 million and completed the necessary amendments to enable us to use the flexibility and incremental leverage provided by the Small Business Credit Availability Act, which will enable us to reduce our asset coverage from 200% to 150%.

This will result in enhanced profitability while maintaining our prudent debt profile.

We are pleased that we received the support of all existing lenders and that we expanded our lender relationships through this credit facility.

The support also highlights the confidence they have in our excellent track record.

Our primary business of financing middle-market financial sponsors has remained robust.

We have relationships with about 400 private equity sponsors across the country and elsewhere that we manage from our offices in New York, Los Angeles, Chicago, Houston and London.

We've done business with about 180 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're only investing in about 2% of the deals that we are shown.

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.

We are first call for middle-market financial sponsors, management teams and intermediaries, who want consistent and credible capital.

As an independent provider free of conflicts or affiliations, we've become a trusted financing partner for our clients.

We're 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 turns.

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 our cash interest expense, continued to be a healthy 2.8x.

This provides significant cushion to support stable investment income.

Additionally, at cost, the ratio of debt-to-EBITDA on the overall portfolio was 4.3x, another indication of prudent risk.

In our core market of companies with $15 million to $40 million of EBITDA, our capital is generally important to the borrowers and sponsors, and we're still seeing attractive risk/reward and receiving covenants, which help protect our capital.

Our credit quality since inception over 7 years ago has been excellent.

Out of 335 companies in which we have invested since inception, we've experienced only 5 nonaccruals.

On those 5 nonaccruals, we've recovered $1.01 on the dollar so far.

As of September 30, we had no nonaccruals on our books.

With regard to the economy and the credit cycle, at this point, our underlying portfolio indicates a strong U.S. economy and no sign of a recession.

Given our long-term track record, we believe we're well positioned to weather different economic scenarios.

From an experience standpoint, we are one of the few middle-market direct lenders who was in business prior to the global financial crisis and have a strong underwriting track record during that time.

Although PFLT was not in existence back then, PennantPark as an organization was and was focused primarily on investing in subordinated and mezzanine debt.

Prior to the onset of the global financial crisis in September of 2008, we initiated investments which ultimately aggregated $480 million, again, primarily on subordinated debt.

During the recession, the weighted average EBITDA of those underlying portfolio companies declined by 7.2% at the trough of the recession.

This compares to the average EBITDA decline of the Bloomberg North American High Yield Index of down 42%.

As a result, the IRR on those underlying investments was 8%, even though they were done prior to the financial crisis and recession.

We are proud of this downside case track record on primarily subordinated debt.

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.

In virtually all these investments, we've known these particular companies for a while, have studied the industries or have a strong relationship with the sponsor.

Let's walk through some of the highlights.

We invested $36 million in the first lien of Integrative Nutrition.

The company operates an online school focused on health, wellness and nutrition.

Norwest Equity Partners is the sponsor.

NextiraOne Federal is a systems integrator and managed service provider focused on the modernization of voice, data, video for the government and defense departments.

We purchased $21 million of a first lien term loan.

Arlington Capital is the sponsor.

We purchased $15 million of Pestell Minerals' first lien term loan.

The company is an animal feed ingredient distributor and cat litter manufacturer.

Wind Point Partners is the sponsor.

Walker Edison Furniture is an e-commerce platform focused on designing and selling ready-to-assemble furniture.

We invested $16 million in the first lien term loan and another $1.4 million in common equity.

J.W. Childs is the sponsor.

Turning to the outlook, we believe that 2019 will be active due to both growth and M&A-driven financings.

Due to our strong sourcing network and client relationships, we're seeing active deal flow.

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

Thank you, Art.

For the quarter ended September 30, 2018, net investment income was $0.30 per share.

Core net investment income was $0.29 per share, excluding $0.01 per share of accrued, but not payable incentive fee.

Looking at some of the expense categories.

Management fees totaled about $4 million, general and administrative expenses totaled about $1.1 million, and interest expense totaled about $4.4 million.

During the quarter ended September 30, net unrealized depreciation on investment was about $2.7 million or $0.07 per share.

Net realized gain was about $1 million or $0.02 per share.

Net unrealized depreciation on our credit facility and notes was $1 million or $0.03 per share.

And income in excess of dividend was about $1 million or $0.02 per share.

Consequently, NAV remains flat at $13.82 per share.

Our entire portfolio, our credit facility and notes are marked-to-market by our Board of Directors each quarter using the exit price provided by an independent valuation firm, exchanges 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 highly diversified with 88 companies across 22 different industries.

91% is invested in first lien senior secured debt, 2% in second lien debt, 7% in subordinated debt and equity, including 5% in PSSL.

Our overall debt portfolio has a weighted average yield of 8.8%.

100% of that portfolio is floating rate.

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 can now take our first question from Ryan Lynch from KBW.

Art, one of the things you mentioned was that your portfolio and earnings continued to benefit from the rising LIBOR.

As LIBOR continues to rise, there's obviously a continued tailwind for your portfolio and your earnings, but that does come as a result and really at the cost of higher interest rates to your existing borrowers.

And as LIBOR continues to rise, that could potentially be a headwind for them.

So can you really just provide a little color on how your borrowers or portfolio companies are performing with rising LIBOR?

How are revenue and EBITDA trends keeping?

Are they able to keep up with that?

Just a little color on that would be helpful.

Yes.

That's certainly a great question.

And Ryan, that's -- when we underwrite deals these days, new deals, we certainly even more so are taking in that rise in LIBOR into account in terms of the cushion that these companies might have to pay us back.

As we said earlier, the average EBITDA to interest as of 9/30 was 2.8x.

EBITDA to interest which does imply there is quite substantial cushion in the portfolio for these companies to pay for higher rates, but it's something that we have to monitor and something that, I think, borrowers are going to be more sensitive to as LIBOR moves up.

I mean, we haven't really been thinking about it for, I guess, nearly a decade when LIBOR kind of plummeted down to nearly 0. But it's certainly an issue we're seeing as the Fed's been increasing rates.

And we try to maintain being well on top of it, but 2.8x, as a general proposition, we feel really good about the portfolio's ability, the underlying company's ability to pay us back.

Okay.

That's helpful.

And as far as kind of as we look, as your leverage goes into effect in April of 2019, the higher leverage, first off, congratulations on getting the facility upsized and amended to kind of clear runway for that.

As we kind of look out to that date, do you guys anticipate now that the credit facility has been amended and you guys have a clear path of when you guys are going to be able to access additional leverage above 1:1.

Is it fair to assume that you guys are willing to kind of run that portfolio closer and keep ramping that portfolio up to closer to that 1:1 presuming there's quality deals in the market to originate?

Yes, Ryan, that's accurate.

We've stated publicly now for 8 or 9 years ever since the potential legislation was initiated that we do believe that quality first lien collateral can be leveraged safely and prudently more than 1:1.

Certainly, we're doing it in our PSSL joint venture with Kemper.

Certainly, in the marketplace, there is middle-market CLOs that leverage equity 5 or 6:1.

We would not do that here, for sure.

But we do think it is prudent over time to be able to leverage this collateral over 1:1.

So we're going to -- we haven't stated any guideposts or said, here's what we're targeting at this point.

I think we just want to organically assess the deal flow that's coming in, most importantly, number one, and organically grow into things and see where it takes us.

But it is certainly nice to have the amended and upsized credit facility.

We can now take our next question from Chris York from JMP Securities.

Thomas Wenk in here for Chris York.

With the additional leverage capacity created by the SBCAA, some BDCs are considering the consolidation of off balance sheet joint ventures.

Could you guys share with us your level of interest or general thoughts about consolidation of the JV?

Yes.

So it's interesting.

The -- we started the JV and then upsized it significantly right before the law change.

We really like this partnership with Kemper.

They've been terrific partners.

It's working well.

Our goal for now is to just ramp it up.

I think it's got a little over $600 million of capacities.

Our goal is really to ramp it up and get it in really good shape.

And then, of course, we'll talk to Kemper and see what their interest is and what they'd like to do and what we'd like to do at PFLT.

But it's been certainly helpful to be able to get greater heft to get help our borrower clients, and the returns are really ramping nicely.

The portfolio is very strong and returns are very attractive to both us and Kemper.

And at this point, we have nothing to announce or say about it other than steady as she goes, we're going to ramp up the portfolio.

Understood.

That's helpful.

Pivoting a little bit to the topic of second liens.

Have you had any churn off any distributions from any obligors in your investment portfolio to second lien lenders that may be behind your position?

Thomas, I'm not so sure I understand your question that we -- have we reduced our second lien positions?

Or what's your question?

Yes.

Yes.

Look, over time, I think the second lien portions of portfolio will continue to roll off.

In essence, we believe the joint venture, the PSSL, or if we do end up having more leverage, that's where we'll get the extra return in the portfolio versus needing to buy a second lien.

So I think over time, PFLT and PSSL will focus primarily on first lien senior secured.

We can now take our next question from Mickey Schleien from Ladenburg.

Art, I just wanted to step back and ask you to refresh our memories on at a high level, what is the portfolio's average EBITDA in terms of the borrowers, the average leverage and the average amount of sponsorship?

I am just trying to gauge sort of risk level.

Yes.

So it's a great question.

So average debt-to-EBITDA is 4.3x, as we stated.

Sponsors are probably 90% -- sponsor deals are probably 90% of the portfolio and that's going up.

We do like having substantial cushion beneath us.

I think average loan-to-value these days are about 50%.

One thing we've seen is private equity sponsors have not been shy about plowing equity in this more so than any other time in the market.

So we're getting really nice loan-to-value.

And what that means, number one, we have good cushion.

And number two, should there be a bump, they're more likely to add equity capital to solve the problem if there is a bump in the road.

And then the third question on average EBITDA, look, where we're seeing the best opportunity today is below the threshold of the broadly syndicated market.

Today, that means $40 million, $50 million EBITDA companies can access the broadly syndicated market.

Those deals in this market are unfortunately covenant-light.

So our focus is on generally $15 million to $40 million of EBITDA, which is below the threshold of the broadly syndicated market, where our capital is important, where we can negotiate covenants.

In almost all cases, we get covenants in our deals that protect us, where our capital is important and where we can negotiate attractive terms.

So $15 million to $40 million is the range, I'd say, if we had to pick a median, it's probably $25 million, it's probably the median EBITDA of the PFLT portfolio.

That's really helpful.

So in terms of managing risk, Art, over the last 12 months, this company's investments grew almost 50%.

So has that growth been in that sort of sweet spot that you just mentioned where you're allowed to get the covenants in terms that you're looking for?

Yes.

I mean, what's happened, and we alluded to this in the call, over the last several years, we've really added feet on the street.

We have these offices in Los Angeles, Houston, Chicago, London, we've beefed up New York.

And this is a business that you don't originate through social media or Instagram, you need feet on the street, you need to go knock on doors, you need to develop relationships.

And what that has done is we've enhanced the number of relationships that we've had and number of looks, which allows us to be increasingly selective about what deals we do.

So we -- I just articulated kind of where our sweet spot is the $15 million to $40 million of EBITDA, where there is a relationship, where our capital is important, where we do have covenants.

And these deals have been originated by this excellent and senior team that has been here for a long time.

And then the add-on senior folks we've added over the last few years.

So we're very pleased with the flow that we're getting, we're pleased with our people, and we're pleased with the relationships that we're developing.

And would it be fair to say that your close rate probably declined over those last 12 months?

Yes.

I mean, with the number of actual investments versus looks has gone down.

So it's -- we've invested in the infrastructure and platform, which allows us to be increasingly selective and increasingly move up capital structure, and look, I feel really good about our portfolio of an average debt-to-EBITDA of 4.3x.

Average yields are kind of around 8% today, which is still among the lowest yield, I think, in the BDC space.

If you look at PFLT, it's probably got the lowest yield in the BDC space, which indicates among the lowest risk.

And we think the expenses and the expense base and the efficiency ratios are among the most attractive as well.

So we think this kind of vehicle is well set up particularly in this environment to do very well, and then obviously, 100% of the assets are floating rate.

I understand.

And one sort of housekeeping question, I'll finish.

Could you just give us what the main drivers were of the realized and unrealized losses this quarter?

Let's see if we can give you something off the top our head, and we may need to circle back.

But I'm looking at what Aviv said in his reported comments that we did have realized gain, we had some unrealized depreciation on our credit facility and notes, which helps NAV, and those were the elements.

In terms of the biggest movers, let's see here, that's largest investment changes, I mean, there weren't really -- there wasn't really anything to speak of in terms of any particular investment change that was unrealized in the PFLT portfolio.

Other than Montreign, I'll point out Montreign, which is the Resorts World casino up in the Catskills, which has had slower ramp than expected since quarter-end, and this was actually announced yesterday or day before, the sponsor has agreed to inject more junior capital, the sponsor is KT Lim, who is a global gaming entrepreneur out of Malaysia.

So the sponsor has agreed to put in about $150 million more of equity, and also that company cut a deal to do betting, which helps.

So if you look at the stocks of the underlying companies, it's up quite substantially.

And in fact, the level of quote on the paper is up substantially since those announcements.

But Montreign was the big, at least temporarily, unrealized mover in the quarter.

(Operator Instructions) We can now take our next question from Ray Cheesman from Anfield Capital.

Art, I was wondering with the recent change in the makeup of the House of Representatives in Washington and some pronouncements from the person who is going to be in charge of the banking committee going forward that the days of regulation softening are over and the days of regulation stiffening are coming.

If you -- there's been a lot of capital piling into your space, maybe the future is actually in an odd way brighter that maybe the -- some people won't be allowed in or maybe some people will be knocked on the head that giving away cheap money with no covenants is a stupid idea long term.

I mean, I'm just wondering, do you think that the environment changes during the next 2 to 4 years?

It's interesting, Ray.

And that's -- it's a great question.

We certainly don't know.

And we have -- so one thing we don't know is how to analyze the shifting political winds in Washington, D.C. We haven't seen banks as competitors to us, whether it was one administration or the other, one Congress or the other, we just don't see banks.

We have seen banks be lenders to us.

And banks in all these environments have been nice lenders to us.

If you look at what we just did with PFLT in the credit facility, banks really like to lend to these types of assets that we have in PFLT.

So that's been nice.

And you can use all kinds of technologies, I will give a shout-out to Golub Capital, just got a nice no-action relief on using securitization CLO technology, which is very applicable to BDC, certainly very applicable to PFLT, and could make capital even more efficiently come to BDC, such as PFLT.

So that was a move out of the SEC that our colleagues at Golub got through, which should be very helpful to PFLT and other BDCs over time.

That will conclude the Q&A session for today's call.

I'd like to turn the call back over to Mr. Penn for any additional or closing remarks.

I just want to thank everybody for participating today and your interest in PFLT.

We look forward to speaking to you next quarter, which will be in early February.

In the meantime, have a great holiday season and a happy new year.

Thank you.

That will conclude today's conference call.

Thank you for your participation, ladies and gentlemen.

You may now disconnect.