PennantPark Floating Rate Capital Ltd (PFLT) 2019 Q3 法說會逐字稿

Good morning, and welcome to the PennantPark Floating Rate Capital's Third Fiscal Quarter 2019 Earnings Conference Call.

Today's conference is being recorded.

(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 Third Fiscal Quarter 2019 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 of our 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 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 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 June 30, we invested $183 million in primarily first-lien senior secured assets at an average yield of 9.3%.

PennantPark senior secured loan fund, or PSSL, continued to perform well.

As of June 30, PSSL owned a $470 million diversified pool of 43 names with an average yield of 7.9%.

Credit quality has improved since last quarter.

The number of nonaccruals on our books today is 2, down from 4 as of March 31.

The 2 nonaccruals represent only 1.4% of cost and 0.5% of the market value of the portfolio.

Over the last several years, we've 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 the additional equity and debt capital we have raised, has significantly enhanced our deal flow.

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

Net investment income was $0.29 per share.

Due to our activity level and the maturation of PSSL, we are pleased that our current run rate net investment income covers our dividend.

Our earnings stream should have a nice tailwind based on a gradual increase in our debt to equity ratio, while still maintaining a prudent debt profile.

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.

Over time, we are targeting a debt-to-equity ratio of 1.4 to 1.7x.

We will not reach this target overnight.

We will continue to carefully invest, and it may take us several quarters to reach the new target.

Given the seniority of our assets, in the near term, we are actively considering utilizing CLO financing to help achieve the target.

A careful and prudent increase in leverage against a primarily first-lien portfolio should lead to higher earnings.

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 and Houston.

We've done business with about 180 sponsors to date.

Due to the wide funnel of deal flows that we receive relative to the size of our vehicles, we can be extremely selective with our investments.

We remain primarily focused on long-term value and making investments that will perform well over several years and can withstand changing business cycles.

Our focus continues to be on companies and structures that are more defensive, have low leverage, strong covenants and high returns.

We continue to be 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 are a trusted financing partner for our clients.

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 2.6x.

This provides significant cushion to support stable investment income.

Additionally, at cost, the ratio of debt to EBITDA on the overall portfolio was 4.8x, another indication of prudent risk.

In our core market of companies with $15 million to $50 million of EBITDA, our capital is generally important to the borrowers and sponsors.

We are still seeing attractive risk reward, and we're receiving covenants, which help protect our capital.

Credit quality has improved since last quarter.

Today, we only have 2 non-accruals on the books, represent only -- representing only 1.4% of the portfolio at cost and 0.5% at market.

As of June 30, we had 3 nonaccruals, which represented about 2.3% of our overall portfolio at cost and 0.8% at market.

We are pleased with the progress we are making on this front.

Our credit quality since inception 8 years ago has been excellent.

Out of 357 companies in which we have invested since inception, we've experienced only 9 nonaccruals.

Since inception, PFLT has made investments totaling about $3 billion at an average yield of 8.1%.

This compares with an annualized loss ratio, including both realized and unrealized losses of only about 8 basis points annually.

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

From an experience standpoint, we're 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, at that time, focused primarily on investing in subordinating and mezzanine debt.

Prior to the onset of the global financial crisis in September 2008, we initiated investments, which ultimately aggregated $480 million, again, primarily in 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 42%.

As a result, the IRR of those underlying investments was 8%, even though they were made 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've 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 of 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 purchased $35 million of first-lien term loan; $4.5 million of revolver; and $1 million of preferred and common equity of MeritDirect.

The company is a provider of B2B database products.

Mountaingate Capital is the sponsor.

We purchased $5 million of the first-lien term loan and $1 million of the revolver of Riverpoint Medical.

The company is a suture manufacturer for the veterinary, dental and sports medicine markets.

Arlington Capital is a sponsor.

Signature Systems is a designer, manufacturer of ground protection products.

We purchased $30 million of a first-lien term loan; $1.7 million of our revolver; and $1.2 million of preferred and common equity.

Center Rock Capital is the sponsor.

We purchased $13.8 million of a first-lien term loan and $2.6 million of the revolver of TWS Acquisition Corp.

TWS is a for profit provider of post secondary education focused on technical careers and skills of trades.

Halifax Group is the sponsor.

Turning to the outlook.

We believe that the rest of 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 June 30, 2019, net investment income was $0.29 per share.

Looking at some of the expense categories.

Management fees totaled about $4.9 million, general and administrative expenses totaled about $1 million and interest expense totaled about $5.7 million.

During the quarter ended June 30, net unrealized appreciation on investments was about $12 million or $0.30 per share.

Net realized losses was about $18 million or $0.47 per share.

Net unrealized appreciation on our credit facility and notes was $0.01 per share.

Net investment income exceeded the dividend by about $0.01 per share.

Consequently, NAV went from $13.24 to $13.07 per share.

Our entire portfolio, our credit facility and notes are mark to market by our Board of Directors each quarter using the exit price provided by the independent valuation firms, 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 remains highly diversified with 93 companies across 36 different industries.

88% is invested in first lien senior secured debt, including 11% in PSSL; 3% in second lien debt; and 9% in equity, including 5% in PSSL.

Our overall debt portfolio has a weighted average yield of 8.9%.

99% of the 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 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 continued 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 take our first question from Michael Ramirez of SunTrust.

It seems that the growth in the PSSL has slowed, but the contribution to, I guess, your NII has remained strong.

Could you give us a sense of where you think you are with the JV, I guess, prospects for continued growth and if you're at a steady state with the NII contribution?

Or is there some other -- some upside remaining?

Yes, it's a great question, Michael.

We just had some repayments in PSSL.

So it's a temporary slight reduction.

Our goal is to continue to ramp it and upsize it over the coming quarters.

So it's hard to -- again, hard to complain when you get repayments, and we did.

So it's temporarily a little lower than our expectation, but we expect to ramp it.

And it's a kind of -- we say it's a maturing portfolio because it's kind of almost fully ramped, and it's performing well and it's generating a nice dividend for PFLT.

Okay.

That's helpful.

I appreciate that.

I guess maybe one other one here.

I guess we've already seen some spread compression in the space.

Is there any opportunity on the liability side of the ledger for you to reduce costs?

In your prepared remarks, you mentioned CLO.

Can you maybe just dive a little bit deeper into how that would impact your P&L?

Yes.

Look, yes, as we said, we're actively considering CLO financing.

The vast majority of that is floating.

There are some pieces of CLO tranches that do get fixed.

We will assess, as we do this, fixed versus floating options along the way.

Cost of capital is not going to be that dramatically different than our existing revolver, which is a very attractive and low-cost revolver, but it is a differentiated financing source, new set of debt investors for us.

And it is a very nice long-term financing.

CLO financing has a nice long term, longer than our credit facility.

So we're actually -- we're actively assessing that option.

And as we think about gradually and prudently increasing leverage, that could be a key element of doing that, really doing CLO financing, contributing assets to that and then freeing up the revolver to finance future growth.

Okay.

That's very helpful.

And I guess just on return on equity.

You guys have done a nice job over the prior year of improving that along with your strategy.

And it seems like it has picked up quite a bit.

Can you maybe detail -- spell out for us like any opportunity to enhance this going forward?

Yes, it's really going to be through the gradual increase in leverage.

Really, obviously, the G&A costs are fixed.

So as the portfolio grows, the G&A costs are relatively fixed.

And actually, the G&A costs are coming down over time as we grow the rest of our platform and as we get more and more efficient on the G&A side.

So a combination of growth of the portfolio, G&A gradually working down and then the leverage gradually working up, we hope to have a very nice ROE.

Okay.

Perfect.

And one last housekeeping one.

In your prepared remarks, you had spoke about the nonaccruals compared to your companies since inception.

Can you just update us on the recovery rate?

I believe, last quarter, you said it was $0.98 per dollar.

Yes.

It's now down into the 80s as of the last mark to market.

Of course, some of these, we get -- end up getting equity pieces, which we hope will add value, but it's not as high as it was due to these last couple of nonaccruals.

We're hopeful that we're going to get some good recoveries.

We also look at it on a what's the annualized basis points per year loss realized and unrealized.

And as we said, it's only about 8 basis points realized and unrealized since inception now over 8 years ago on our $3 billion or so of capital.

So that's kind of another way we look at it.

That includes both realized and unrealized.

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

Art, could you help us understand what drove the increase in the weighted average debt-to-EBITDA ratio and then the decline in the debt service coverage ratios in the quarter?

Yes.

We think this is temporary.

It's just some of the underperforming deals dragged it up a little bit.

And as we work through that, I think we're going to end up back into the mid-4s debt to EBITDA.

If you look at the new originations that we've been putting on, they're kind of between 4 and 4.5x debt to EBITDA.

But we think that's going to end up coming down a little bit over time and kind of to a more normalized mid-4s kind of range.

Very helpful.

So it's more a product of underperformers than new originations.

That's right.

The new originations, and I said we're being highly selective right now as we should be, and we're getting really good looks.

I mean we're getting some nice looks.

And some of the deals I highlighted in the comments are from newer relationships that have come out of some of the regional offices that we've opened in Chicago and Texas and on the West Coast as well as some senior folks we've hired here in New York.

So we're getting more and more looks from the investment we made in our team about 4 years ago and into some very senior people.

And that allows us to be highly selective.

So the new deals that are coming on are tied in the mid-4s and on a blended basis.

Very nice equity cushions in this market.

We're trying to be very, very disciplined.

So we think 4.8 is a temporary phenomenon.

And over time, it's going to get back down into the mid-4s.

Okay.

And then just maybe a little bit more detail there.

You talked a little bit about the equity cushion is -- are LTVs, maybe 50%?

Or where are you seeing LTVs today?

Yes.

It's -- I think -- the higher end of the LTV range is kind of 65-ish percent these days, where we're seeing a 35% equity cushion.

Sometimes, we're looking at deals where it's a 70% equity cushion.

And we're evaluating one later this afternoon where it's a 75% equity cushion.

So I'd say 50, if I had to kind of pick an average, middle of the bell curve that might be it in this market.

So there's lots of equity coming underneath those by and large now.

That's comforting on one hand, and we've seen this play out when sponsors put a lot of equity.

And if there's a problem, they are, in many cases, more likely to add to that equity to solve the problem.

But we have to be prudent underwriters and careful and skeptical.

And sometimes, just because there's 50% or 70% equity beneath us, it doesn't necessarily mean it's a money good loan.

So we have to be very clear-eyed that these companies, in the long run, may or may not be worth what the sponsors are paying them.

And we need to be careful about where we are in the capital structure and are we at a good spot to recover our capital.

It makes a lot of sense, and that color is appreciated.

And then could you just remind us what your loss assumptions are on maybe a yearly basis and then on, like, a peak severity basis?

These are great questions.

The -- people would say, in the market, you're going -- the market for first lien loans is you're going to have a 2% default rate and an 80% recovery rate.

That's what the market is.

We think we're going to do better than that.

We've obviously, since inception 8 years ago, which does not include a financial crisis, we can talk about what we did in the financial crisis at PNNT.

We've had an 8 basis point annualized loss.

PNNT on sub debt, has had a 30 basis point or so annualized loss ratio, and that's on a portfolio that over time yielded 12%, including a global financial crisis.

So I mean that gives you some sense of our historical track record on both senior debt and sub debt.

Our track record now is over 12 years as an institution.

But look, we -- past performance is never a guarantee of future performance, as they say, so we have to remain very vigilant and focused right now.

Okay.

So I mean, yes, so I know you quote the 8% realized and unrealized loss rate and then that kind of compares to the market expectation of 160 basis points.

So I was just curious on kind of how you guys were thinking about this for your models going forward, so just to reexamine that.

So the color is very helpful.

I just wanted to revisit it with you.

We will take our next question from Mickey Schleien of Ladenburg.

It's always entertaining how your people pronounce my name.

Regardless, I have a couple of questions.

I haven't had a chance, frankly, to thoroughly scrub the Q. It looks like New Trident was one of the main drivers of your realized and unrealized gains and losses.

What were the other drivers?

Yes.

New Trident was certainly a big driver.

The other ones were Hollander, which remains a problem, that was one of nonaccruals; and Country Fresh, which got restructured intra-quarter.

Those were the negative drivers.

A positive driver was By Light equity co-invest, which went up nicely.

And I do want to -- we tend to, on these calls, focus, as we should on the nonaccruals, but we do have some very nice co-invests, like By Light, DecoPac, Kaino Health and Walker Edison, which have been performing well, which the theme there, of course, is we are going to make mistakes from time to time.

We are going to have nonaccruals.

And these equity co-invest investments are meant to have some upside that could, in part or in full, fill some of those gaps.

So New Trident certainly was a negative outcome for sure.

Art, do you have any visibility on monetizing some of those equity co-invests this year?

Yes.

We'll see.

It's hard to say, but you didn't -- look, you can rest assured that when a private equity sponsor has a nice gain, the wheels are turning in terms of what amount is that in the next 6 months and the next 18 months.

Who knows, but the wheels are turning.

Fair enough.

One more question.

I know it's not a large position for you, but another BDC exchange, it's Unitech cumulative preferred -- or preferreds and they booked a large pick dividend to income, which, as we know, can cause stress on cash flow.

I noticed you didn't do that.

And I think it would be interesting to understand your thoughts about a situation like that as it relates to your overall portfolio management process.

Aviv?

Yes, certainly.

So we chose not to do it because you look in the underlying performance of the company and say, "Do they have enough earnings and profits to support that income?" And we decided answer is no.

So we stayed as is.

We did not convert.

I know some of the peers did convert.

We think it might be aggressive.

But for us, we stayed as a regular equity position, which does not accrue income.

At the end of the day, you need to look at the facts and circumstances.

It might be that the underlying company does declare dividends, and then it's great to book that income that they declare.

But you also need to look, do they have enough earnings to support that dividend.

So BDCs, this is what makes the market.

Sometimes, you'll see different BDCs on a mark-to-market basis, mark different assets to market.

These are judgment calls.

And our judgment on Unitech was not to convert it to a kicking instrument at this point in time.

I understand.

So the cumulative dividends are booked to fair value, right, of the investment, over time, and eventually, you hope to realize that.

Is that correct?

That is correct.

So we do, obviously, compute what is the cumulative preferred, but we mark it in the mark to market, which you should see growing, but not in income.

We will take our next question from Ray Cheesman of Anfield Capital.

I believe on the last call, you mentioned activity from the sponsor of Montreign, the casino in the Catskills.

And with the announcement over the last few days about the sponsor possibly taking out the minority shareholders, I'm wondering how does that all flow through to your holding in it and the value you assign to that holding.

Yes.

So it's a great question.

It's very topical, Ray.

Thank you.

Montreign is -- the equity there is controlled by an entrepreneur named KT Lim, who's well known in the gaming sector.

He controls Genting, which is a large gaming company.

Montreign is owned in a public company called New York, New York.

NYNY is the ticker.

KT Lim has made an announcement that he wants to take NYNY private.

He already owns 80-plus percent of it.

At the enterprise value that he's proposed to take the company private, it values the equity around $300 million.

That $300 million of equity, of course, is junior to $500 million of debt.

Montreign -- we own a piece of the Montreign debt, which, today, is marked in the mid-80s or so.

We still think this is par.

Obviously, if the entrepreneur behind it is valuing the equity at $300 million beneath the debt, we think the debt is par.

The entrepreneur is indicating that he thinks the debt is par.

We'll see.

We think we have a fairly full position right now in PFLT, so we're not going to add any more debt.

But for all those of you in the market who want to buy what we think is very attractive piece of paper that is broker-dealer quoted in the mid-80s.

Montreign first-lien debt is, and we think it's going to end up being a par piece of paper.

I would now like to turn the call back over to Art for any final remarks.

I want to thank everybody for being on the call today and their interest in PFLT, and we look forward to speaking to you next in November.

Reminder that November is our 10-K, which means our call will be slightly later than it normally is after quarter and because it takes a little while to get -- a while longer to get the 10-K done versus 10-Q, so kind of mid-November time frame for our next conference call.

Thank you very much, and have a great end of August, everybody.

This concludes today's call.

Thank you for your participation.

You may now disconnect.