PennantPark Floating Rate Capital Ltd (PFLT) 2021 Q3 法說會逐字稿

Good morning, and welcome to the PennantPark Floating Rate Capital's Third Fiscal Quarter 2021 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 2021 Earnings Conference Call. I'm joined today by Richard Cheung, our new Chief Financial Officer. Richard joined us in June from Guggenheim Partners, where he was Head of Alternative Investment Accounting for many years. Prior to Guggenheim, he was at E&Y. We are thrilled that Richard has joined us and are confident that his extensive experience will be a tremendous asset to the company.

We thank Aviv Efrat for all his contributions to PFLT since inception and are grateful that he is continuing with PennantPark focusing on strategic initiatives. Richard, 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 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, Richard. I'm going to spend a few minutes discussing how we fared in the quarter ended June 30, how the portfolio is positioned for the upcoming quarters, our capital structure and liquidity, the financials and then open it up for Q&A.

We are pleased with our performance this past quarter. Our net investment income grew to $0.27 per share, while our credit quality and NAV performance remains solid. We are poised to significantly grow NII through a 3-pronged strategy, which includes: number one, growing assets on balance sheet at PFLT as we move towards our target leverage ratio of 1.5x debt to equity from 1.1x; number two, growing our PSSL JV with Kemper to about $730 million of assets from approximately $500 million; and number three, rotating the equity value in the portfolio that has come from our strong equity co-investment program into cash-paying debt instruments.

With regard to the PSSL JV, with the CLO financing we completed earlier this year as well as additional capital contributions from PFLT and Kemper, the JV will grow over time. The capital contributions from PFLT are target to generate a 10% to 12% return.

During the June quarter, PFLT invested $20 million of capital and we intend to invest another $42 million over time in order to bring PFLT's investment into PSSL to approximately $243 million. As part of our business model, alongside the debt investments we make, we selectively choose to co-invest in the equity side by side with the financial sponsor. The returns on these equity co-investments have been excellent over time.

Overall for our platform from inception through June 30, our $237 million of equity co-investments have generated an IRR of 28% and a multiple on invested capital of 2.9x. In a world where investors may want to understand differentiation among middle-market lenders, our long-term returns on our equity co-investment program are a clear differentiator.

We are well on our way to implementing the NII growth strategy. Since June 30, PFLT has had new originations of $102 million and PSSL has had a new origination of $29 million. Although in the June quarter, repayments exceeded new loans in the September quarter so far, repayment activity has abated and new originations have accelerated.

Our portfolio performance remained strong. As of June 30, the average debt-to-EBITDA in the portfolio was 4.2x, and average interest coverage ratio, the amount by which cash income exceeds cash interest expense was 3.3x. This provides significant cushion to support stable investment income. These statistics are among the most conservative in the direct lending industry.

We have only 2 nonaccruals out of 105 different names in PFLT and PSSL. This represents only 2.8% of the portfolio at cost and 2.7% at market value. We have largely avoided some of the sectors that have been hurt the most by the pandemic, such as retail restaurants, health clubs, apparel and airlines and PFLT also has no exposure to oil and gas.

The portfolio is highly diversified with 100 companies in 42 different industries. Our credit quality since inception over 10 years ago has been excellent. Out of 381 companies in which we have invested since inception, we have experienced only 14 nonaccruals. Since inception, PFLT has invested over $4.2 billion at an average yield of 8% and. This compares with a loss ratio of only 7 basis points annually.

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 investing at that time. During that recession, the weighted average EBITDA of our underlying portfolio companies declined by 7.2% at the bottom of the recession. This compares to the average EBITDA decline of the Bloomberg North American high-yield index of 42%.

Based on tracking EBITDA of our underlying companies through COVID, our EBITDA decline was substantially less than it was during the global financial crisis. Our median EBITDA decline at the bottom of COVID in June 2020 was 1.4%. This compares favorably to the 7% decline in EBITDA during COVID of the Credit Suisse High Yield Index.

Many of our portfolio companies are in industries such as government services, health care, technology, software, business services and select consumer companies and where we have meaningful domain expertise. The outlook for new loans is attractive. We are as busy as we have ever been in 14 years in business, reviewing and doing new deals. With our experienced, talented and growing team, our wide funnel is producing active deal flow that we can then carefully and thoughtfully analyze so that we can be selective as to what ends up in our portfolio.

We are focused on the core middle market, which we generally define as companies with between $10 million and $50 million of EBITDA. We like the core middle market because it is below the threshold and does not compete with the broadly syndicated loan or high yield markets. As such, we do not compete with markets where leverage is higher, equity cushion lower, covenants are light, wide or nonexistent, information rights are fewer, EBITDA adjustments are higher and less diligence. And the time frame for making an investment decision is compressed.

On the other hand, where we focus in the core middle market, generally, our capital is more important to the borrower. As such, leverage is lower, equity cushion is higher. We have real quarterly maintenance covenants. We receive monthly financial statements to be on top of the companies. EBITDA adjustments are more diligent than achievable and we typically have 6 to 8 weeks to make thoughtful and careful investment decisions.

According to S&P, loans to companies with less than $50 million of EBITDA have a lower default rate and a higher recovery rate than those loans to companies with higher EBITDA. Let me now turn the call over to Richard, our CFO, to take us through the financial results in more detail.

Thank you, Art. For the quarter ended June 30, net investment income was $0.27 per share. Looking at some of the expense categories, management fees totaled about $4.3 million. Taxes, general and administrative expenses totaled about $450,000 and net interest expense totaled about $5.9 million.

During the quarter ended June 30, net unrealized appreciation on investments was about $14 million or $0.37 per share. Net realized losses were about $13 million or $0.33 per share. And changes in the value of our credit facility had no increased NAV by $0.08 per share.

Net investment income was lower than the dividend by $0.02. Consequently, GAAP NAV went from $12.71 to $12.81 per share. Adjusted NAV, excluding the mark-to-market of our liabilities was $12.62 per share, up from $12.60 per share. Our entire portfolio, our credit facility and notes 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 and active, we use independent valuation firms to value the investments.

We have ample liquidity and are prudently levered. Our GAAP debt-to-equity ratio was 1.1x, while GAAP net debt to equity after subtracting cash was 1x. Regulatory debt-to-equity ratio was 1.2x, and our regulatory net debt-to-equity ratio after subtracting cash was 1.1x. With regard to leverage, we have been targeting a debt-to-equity range of up to 1.5x. We have a strong capital structure with diversified funding sources and no near-term maturities.

We have a $400 million revolving credit facility maturing in 2023 with $133 million drawn as of June 30. $118 million of unsecured senior notes maturing in 2023, $228 million of asset-backed debt associated with PennantPark CLO 1 due 2031 and $100 million of unsecured senior notes maturing in 2026.

Our portfolio remains highly diversified with 100 companies across 42 different industries. 85% is invested in first-lien senior secured debt, including 14% in PSSL. 2% in second lien debt and 13% in equity, including 5% in PSSL. Our overall debt portfolio has a weighted average yield of 7.5%. 98% of the portfolio is falling rate and 82% of the portfolio has a LIBOR floor. The average LIBOR floor is 1%. Now let me turn the call back to Art.

Thanks, Richard. 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 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 now take our first question. It comes from Mickey Schleien from Ladenburg.

Welcome, Richard. Art, this quarter, I'm seeing mixed results in terms of the market opportunity, and I'd appreciate your insight. Clearly, the private debt and private equity markets have a lot of dry powder and spreads are tightening, which can result in a high level of repayments as we've seen at PFLT year-to-date. On the other hand, as you know, the economy is growing sharply and M&A is very active. And I think borrowers also seem to be moving toward private debt solutions. I understand that repayments can be a function of vintage and comp protection. But broadly speaking, I'd like to understand how you expect your portfolios across the Pennant platform to develop in the second half of this year and maybe going into next.

Thanks, Mickey. Quarter-to-date, repayments have been light and new originations have been heavy. So last quarter, there were a lot of repayments. This quarter, so far, we've seen lighter repayment. We're seeing a lot of new companies come in. Sometimes there's -- the same old companies get, they get recycled and they go from one private equity firm to another, one private lender to another. This quarter, we're seeing many more new companies come into the system. Usually -- and again, we're focused on kind of the $10 million to $50 million of EBITDA space, as we talked about.

In many cases, the deals that we're doing, it's the first time there's institutional capital in a founder-owned business or a family-owned business or an entrepreneur and the private equity sponsor who is buying that company is that first institutional capital and first institutional equity and we're the first institutional debt. So we're kind of on the front lines of bringing new growing companies into the system. And over time, they may grow from $15 million of EBITDA to $50 million or $60 million and they end up going off to the broadly syndicated market or going off to the big cat sponsors. But where we play and where we're getting our best returns is when those companies are starting out in the $10 million to $20 million of EBITDA. The sponsor sees a fragmented industry or an organic growth opportunity. They're willing to plow a lot of equity behind it, which is a great cushion for us. Our debt can help fuel that growth. Our equity co-invest can participate in the upside of that growth and it ends up being a nice win-win. So in this quarter, just to answer your question, we're seeing many more new companies come into the system versus the recycling of some very good older companies. We -- for instance, we added an exit over PNNT and DecoPac great company. It went off to another sponsor and another direct lender, but the company is now bigger than when we started with it.

And that kind of leads into my next question in terms of the target market. Can you remind us what the average size of the borrower is in the PSSL portfolio compared to your own balance sheet portfolio? And how would you compare the investment opportunities in those 2 segments?

Look, PSSL is roughly similar to PFLT. PSSL gives us an ability to write a bigger check and solve a borrower problem, bring some smart institutional capital at Kemper into our ecosystem and also offer a higher ROE for PFLT shareholders. So roughly the same portfolio, just increases the wing span, the bite size and it's very accretive for PFLT shareholders. So average EBITDA is $25 million to $30 million in both vehicles. Now some of those were companies where we started out $15 million or $20 million, and they've grown. Some of those companies started out in $30 million or $40 million. So it's a blend of the 2. And the entire portfolio doesn't start out of $10 million or $20 3million, but a chunk of it does, and that tends to be the ones where those equity coinvest can be so valuable when we are helping fuel the growth of that company up to a bigger company where the sponsor sees a real opportunity for growth and is willing to plow substantial equity behind in that opportunity. So blended, it's still $25 million, $30 million. Some are bigger companies from the getgo. Some are smaller companies that have grown up.

And Art, how -- can you remind us how you allocate them between those 2 portfolios given that the borrowers are similar?

Yes. So it's -- each portfolio has to stand on its own 2 feet and have proper diversification. So we want at least 50 names in each portfolio, which we have, and we want to be increasingly diversified. And that's a smart way to run a senior loan book. So they're both highly diversified portfolios. It's based on available capital. There's an available capital calculation. It's mathematical. That when a deal gets done, there's a mathematical calculation that's based on available capital. And again, PFLT owns 87.5% of the joint venture. So that's a pretty substantial one.

Right, in terms of the economics. Lastly, a housekeeping question. I don't know if it's for you or for Richard, but what was the main driver of your realized loss this quarter?

Yes. It's -- we had -- we did have a nonaccrual. We had additional nonaccrual American teleconferencing, which is called Premier level, that was unrealized loss. The main driver to realize loss was Country Fresh, which was a nonaccrual, which went through bankruptcy and is now not on the balance sheet anymore. And that was the main driver of the realized loss.

Again, welcome Richard.

Thanks, Mickey.

We'll now take our next question. It comes from Ryan Lynch of KBW.

The first one is kind of a follow-up to a previous question regarding the balance sheet because you mentioned the several goals for increasing operating earnings, increasing leverage, increasing the portfolio size of PSSL. Well, on those first 2 goals, they're both kind of feeding off the same deal flow that, that PennantPark as a platform is bringing in. So assuming that the deals fit both of those strategies, which it sounds like they do, is there any preference to grow one versus the other? Meaning add more balance sheet leverage versus trying to ramp up the PSSL, which is -- with the leverage within that fund, it's kind of a higher-yielding entity. Is there any preference one versus the other? I know they're both a goal. But they kind of conflict with each other as far as your originations go where it can be placed.

It's a great and nuanced question, Ryan. And I wouldn't say necessarily conflict, but I would say they work in a complementary fashion. PFLT itself more -- our target leverage over time is up to 1.5x. We have credit ratings to think about there. We have some unsecured bonds to think about there. And we have where market convention is. These assets that we're putting in both PFLT and PSSL, we also put in CLOs outside of the BDCs that we run. So you could put these same -- again, if you look at the underlying assets that we have in the PFLT and PSSL they're among the lowest yield, lowest risk assets in the BDC industry. Our expense load is commensurately low as a result. We think we can also run these same assets safely in the CLO format at 3 or 4x debt to equity and we have. And we've run them safely through COVID. So outside the BDCs, we could run them in a more leveraged fashion. In PSSL, we probably would target running them in a more leveraged fashion than 1.5x debt to equity. Again, why is it? And why can't it be so accretive for PFLT is because in the JVs, we do target running the leverage a bit higher than that 1.5x. So if you said, we've stated publicly year-to-date, our target over time for the JV is $750 million -- excuse me, $730 million of total bite size and total junior capital is $275 million. By definition, the leverage is higher.

Understood. And then as you guys are looking to deploy capital out in the market, certainly, overall market activity has increased, but obviously, competition has kind of resumed back to pre-COVID levels. I'm just curious, do you guys use any sort of macroeconomic backdrop at kind of a base case when you guys are underwriting these loans? Obviously, you guys are going to do a bottoms-up due diligence on each loan. But you guys look at a loan today with same terms that a loan maybe had in 2018, 2019 as a better risk, a better proposition, just given that the economy today is kind of on an upswing from a credit cycle versus in 2018, 2019, we were 10 years from moving from the last credit cycle. Does that inform your guys' willingness to deploy capital in today's environment? Obviously, knowing that it's going to be ultimately a bottoms-up approach per credit, did you guys use that macroeconomic backdrop to kind of inform how aggressive you'll be in today's market.

Yes. It's a good question, and we do. I mean, just if you look back at the 2017 to 2019 time period, we were very public and others were, too, that we were getting concerned that the cycle was getting long in the tooth. And there would be some sort of softness, of course, we never could have predicted COVID. But I think a lot of us, and we were public about it, thought that we're getting late in the cycle and we're therefore operating in a more defensive posture. Today, we see it in our portfolio companies, we get the monthly numbers, the economy is in a strengthening position sometimes quite dramatically. So for sure, we feel more comfortable playing offense as a general macro matter today than we did, say, 2017 to 2019. That said, you're right, it's bottoms up industry-by-industry specific. The companies that we're financing today all came through COVID in very strong fashion. So in many cases, they benefited from COVID. So we are playing a little bit more offensively, a little bit more offensive posture. And these are companies that we think are very high-quality companies that we're prepared to back. One of the big lessons for us over all of our years in business, you got to find the right companies. You've got to pick the right companies. And you can stretch a little bit on leverage. You might be able to be willing to stretch a little bit on yield. If you can find the right companies, the rest takes care of itself. And that's the business we're in.

Yes. That make sense. And then the last one that I had was I know PFLT equity portfolio is smaller than PNNT. And I know PNNT have some cash proceeds. I was curious, did PLP have any level of cash proceeds either from like dividends, dividend recaps or anything like that or actually exits this quarter? And what is your outlook as far as obviously -- that's one of your goals is accurate your rotation. What is your outlook on your ability to have meaningful equity exits over the next 12 months or so?

Yes. It's a good question. So PFLT and PNNT roughly the same investment size in Walker Edison. So last quarter, and we'll talk about -- we'll talk about it a little later. I mean, there were 2 capital events for Walker Edison in this past quarter. One was a dividend recap were 2x -- we got back 2x our money on the equity and then there was an investment by Blackstone where we got another two times our investment. So that was a nice cash realization on Walker Edison that came our direction on equity. Just looking at the quarter. I mean that was the big one. That was about 4 point -- that was a realized gain of about $4.3 million in the quarter. It was offset by Country Fresh. The realization of the Country Fresh loss offset that. We had about a $1.4 million realized gain on DecoPac equity, and we had about a $700,000 gain on WBB equity. So some of the same names, different order of magnitude in PFLT, going to the book itself and the equity co-investor. You can see there's some that are performing very well based on the marks. Bilat is 1 that we talk about a lot, that's about a $12 million market value there. We've got a company called Info off about $3.5 million -- excuse me, about $5.7 million of equity, GCOM, a little over $4 million of equity. Cano is in PFLT as well, $7.6 million of equity. There's still another $6.9 million of equity value in Walker Edison. So still some nice equity bites to be potentially exited and rotated over the coming year or two.

We will now take our next question. It comes from Kevin Fultz of JMP Securities. Please go ahead. Great

Art and Richard. Just a couple of follow-ups from us. I guess, the first one, the past couple of quarters, you had, I believe, characterized the current vintage of loans being the most attractive in the past decade or so. And I'm just curious if that's still the case today. I suspect that speaks to the strong originations and offensive posture. But how is the pipeline evolving? I guess, more recently from an attractiveness perspective, and is there any other, I guess, color you can share around that?

Yes, it's a good question, Kevin. The best thing about vintage is, again, the companies that we're financing today came through cover in really good shape in some cases, strengthened through COVID. So we're in the credit selection business. We have to pick good credits. We have to avoid mistakes. So the quality of the company is paramount. And that's -- the most attractive thing is we're seeing companies that have come through the last couple of years of chaos and uncertainty with the strong posture, which gives us confidence that our capital will be preserved and, in some cases, with the equity co-invest we gained will be increasing value through these equity compass. So that's really the most attractive thing. And look, the deal machinery was put on hold for 1.5 years, right? There were no deals or very little deals. So all of this pent-up deal demand is kind of coming to fruition today, and that's one of the things driving it. We also think there's a piece of it that's potentially focused around the potential capital gains increase sometime in the future and a desire by some sellers to capture a gain before a potential capital gain increase. So I think that's play into it a little bit, kind of kind of the pent-up demand from 1.5 years and the potential capital gains increase on the horizon are both working together to bring a lot of deals.

Yes. Okay. Great. Now that makes a lot of sense. And then just a follow-up on one of your prior comments just about recent repayment activity slowing. I know it's episodic. But do you see any trend there around that? And are there any other factors that you see shipping?

Yes. I mean it could be, and I'm just making a supposition Kevin that as I said earlier, we're seeing more new names to our ecosystem. -- the repayments and refis are done with names are already in the ecosystem. It's an opportunistic market, the company is getting sold or there's a refi or whatever. And when you're bringing new companies into the ecosystem, and there may be companies that we start out with the starts out with 10% to 20% of EBITDA. And in 3 years, it's a 50% and it goes to somewhere else in our ecosystem, maybe the mega lenders or whoever the big private equity shops. Today, we're seeing more new names that are new to this middle-market credit, middle market direct lending ecosystem. And again, many of the companies that we see where we are focused are this is the first institutional capital. It's a family. It's an entrepreneur. It's an owner, a family who is selling their baby that they've built up over 20, 30, 40, 50 years, and they're selling it to a private equity firm. And it does $10 or $15 or $20 or $25 million of EBITDA. And it's the first time institutional capital who has been in there. And that private equity firm brings all kinds of things like audited financial statements and policies and procedures and financial controls with the goal of taking that $15 million or $20 million EBITDA company and getting it to $40 million or $50 million or $70 million. We're the first kind of private debt lender in that company. Our debt helps fuel that growth from $20 million to $50 million in certain cases, and this has worked. We've co-invested in the equity and we're helping -- we're participating in that upside that we're helping to create with our debt capital. So I'd say I'm making a supposition that this quarter, we're seeing many more new names into the ecosystem than we were last quarter where it was just refinancing the same old names. Although some of the sample names are very good names, but they're same old names.

This concludes our question-and-answer session. I'd now like to hand the call back to Mr. Art Penn for any additional comments or closing remarks.

I want to just thank everybody for their participation today in the call. And our next call will be in November. It's our 10-K. So it'll be slightly later in the quarter than our normal Qs. But kind of mid-November time frame, we'll have our next quarterly conference call. In the meantime, I hope everybody has a great and safe summer. Thank you very much.

This concludes today's call. Thank you for your participation. You may now disconnect.