PennantPark Floating Rate Capital Ltd (PFLT) 2020 Q4 法說會逐字稿

Good morning, and welcome to the PennantPark Floating Rate Capital's Fourth Fiscal Quarter 2020 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 at 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 Fourth Fiscal Quarter 2020 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. 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, Aviv. First, we hope that you, your families and those you work with are staying healthy. I'm going to spend a few minutes discussing how we fared in the quarter ended September 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.

Despite the challenging economic conditions brought on by the pandemic, we are pleased with our performance this past quarter. We achieved a 3.2% increase in adjusted NAV as our portfolio continued to improve during the quarter. We have several portfolio companies in which we have substantial equity positions who are benefiting from the K-shaped recovery. This is solidifying and bolstering NAV. Over time, rotation of that equity into debt instruments should help grow PFLT's income. We will highlight those companies in a few minutes.

Additionally, we have been pleased with the stable performance of our long-term securitization CLO financing through COVID. That financing has continued to perform well and is well matched to finance our senior debt positions, which we believe are among the lowest risk in the industry. As a result, we are exploring, using the same type of financing, to grow and efficiently finance our PSSL JV, which should generate additional income for PFLT.

The combination of potential income growth from equity rotation and the larger, more efficiently financed PSSL should help grow PFLT's net investment income relative to the dividend over time. Those factors, combined with strong portfolio performance through COVID and our $0.22 spillover have led us to conclude that we will be keeping our dividend steady at this point. Although we never predicted a global pandemic, as you may know, we have been preparing for an eventual recession for some time. Prior to the COVID-19 crisis, we proactively positioned the portfolio as defensively as possible.

Since inception, we have had a portfolio that was among the lowest risk in the direct lending industry. As of September 30, average debt-to-EBITDA in the portfolio was 4.2x and average interest coverage ratio, the amount by which cash interest exceeds cash interest expense, was 2.9x. This provides significant cushion to support stable investment income. These statistics are among the most conservative in our industry.

We have only 3 nonaccruals out of 105 different names in PFLT and PSSL. This represents only 2.1% of the portfolio at cost and 1.8% 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. PFLT also has no exposure to oil and gas. The portfolio is highly diversified with 102 companies in 44 different industries.

Our credit quality since inception over 9 years ago has been excellent. Out of 382 companies in which we have invested since inception, we have only experienced 12 nonaccruals. Since inception, PFLT has invested over $3.7 billion at an average yield of 8.1%. This compares to an annualized realized loss ratio of only 10 basis points annually. If we include both realized and unrealized losses, the annualized loss ratio is only 19 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 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 down 42%. We are proud of this downside case track record in the prior recession. Based on tracking EBITDA of our underlying companies through COVID so far, we believe that our EBITDA decline will be substantially less than it was during the global financial crisis.

Now let's turn to the outlook ahead in the coming quarters and how our portfolio is positioned. As mentioned previously, we are gratified that our historical investment focus has protected us from some of the worst hit areas of the economy, such as retail, restaurants, health clubs, apparel, airlines and energy. We have been pleased with the way our portfolio companies have moved to rapidly adjust cost and have focused on shoring up liquidity.

Looking forward to the quarter ended December 30 and beyond, where things stand today, our analysis suggests that the vast majority of the companies in our portfolio are in a strong position to perform well in the coming quarters. Many of our portfolio companies are in businesses such as government services, health care, software, communications and cybersecurity, which collectively comprise a substantial portion of our portfolio and are less impacted by COVID.

Additionally, alongside the debt investments we make in many companies, we invest in the equity, usually as a co-investor with a financial sponsor. Our returns on these equity co-investments have been excellent over time. Overall for our platform from inception through September 30, our $209 million of equity co-invests have generated an IRR of 25.3% and a multiple on invested capital of 2.3x.

We believe that we are experiencing a K-shaped recovery with some companies and industries being large beneficiaries of the environment. We are pleased that we have attractive debt and significant equity investments in 3 of these companies, which can substantially move the needle in both NAV and over time, net investment income. I would like to highlight those 3 companies. The 3 companies are Cano, Walker Edison and By Light.

Cano Health is a national leader in primary health care, who is the leading -- who is leading the way in transforming health care to provide high-quality care at a reasonable cost to a large population. Our equity position has a cost and fair market value on September 30 of $766,000 and $2.3 million, respectively. Cano has been experiencing rapid growth with revenues quintupling and EBITDA more than tripling over the last 3 years. We believe there is a massive market opportunity for Cano to grow in the years ahead with the Medicare Advantage program.

Based on the recently announced transaction with Jaws Acquisition, and where Jaws is trading, that position would be valued at approximately $9 million. About 12% of that value is in cash that we will receive before and at consummation of the deal in early 2021, and the rest is in shares of Jaws Acquisition. Our shares are locked up in a limited partnership controlled by the financial sponsor and will likely be valued by the independent valuation firm at a discount to the traded value.

Walker Edison is a leading e-commerce platform focused on selling furniture exclusively online through top e-commerce companies. Since our investment was made in 2018, sales have more than tripled and EBITDA is up almost 4x. Our position has a cost of $1.4 million and a fair market value of $8.7 million as of September 30.

By Light is a leading software, hardware and engineering solutions company focused on national security challenges across modeling and simulation, cyber and global defense networks. Since our initial investment was made nearly 4 years ago, sales have gone up 1.5x, and EBITDA has more than doubled. Our position has a cost of $2.2 million and a fair market value of $7.6 million as of September 30.

All 3 of these companies are gaining financial momentum in this environment, and our NAV should be solidified and bolstered from these substantial equity investments as their momentum continues. Over time, we would expect to exit these positions and rotate those proceeds into debt instruments to increase income at PFLT.

As we discussed earlier, our securitization financing has performed well during COVID. We think this type of financing is well matched to our lower risk assets. As a result, we are exploring using the same type of financing at PSSL to help grow and efficiently finance the vehicle. We would hope that doing so would increase NII at PFLT.

With regard to our gaming portfolio, it is proven to be extremely resilient and continues to perform well. With the repayment of Peninsula Pacific Colonial Downs since quarter end, our gaming exposure is now 4.2% of our portfolio, down from 5.1% as of September 30. We exited Peninsula Pacific Colonial Downs with an 11% IRR. Our regional properties, such as Fantasy Springs and Kentucky Downs have experienced strong performance since reopening after periods of closure due to COVID. We expect the strong performance to continue.

The outlook for new financing is attractive. We believe that middle-market lending is a vintage business. This upcoming vintage of loans is likely to be the most attractive we've seen since the 2009 to 2012 time period. Leverage levels are lower, equity cushion is higher, yields are higher and the package of protections, including covenants, are tighter. After enjoying about 5 years of late cycle market for middle-market lending, it's refreshing to have an attractive risk-reward available to us.

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

Thank you, Art. For the quarter ended September 30, net investment income was $0.27 per share. Looking at some of the expense categories. Management fees totaled about $4.8 million; taxes, general and administrative expenses totaled about $1.1 million; and interest expense totaled about $5.5 million.

During the quarter ended September 30, net unrealized appreciation on investments was about $20 million or $0.51 per share. Net realized losses were about $4.7 million or $0.12 per share. Net unrealized depreciation on our credit facility and notes was $0.22 per share. Net investment income was lower than the dividend by $0.02 per share. Consequently, GAAP NAV went from $12.16 to $12.31 per share. Adjusted NAV, excluding the mark-to-market of our liabilities was $11.81 per share, up 3.2% from $11.44 per share last quarter.

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 spillover as of September 30 was $0.22 per share. We have ample of liquidity and are prudently levered. Our GAAP debt-to-equity ratio was 1.4x, down from 1.5x last quarter. While GAAP net debt-to-equity after subtracting cash was 1.2x, down from 1.3x last quarter. Regulatory debt-to-equity ratio was 1.5x, down from 1.6x last quarter and our regulatory net debt-to-equity ratio after subtracting cash was 1.4x, down from 1.5x last quarter.

With regard to our leverage, we have been targeting a debt-to-equity ratio of 1.4 to 1.7x. Our net of cash regulatory asset coverage ratio of 1.4x was at the low end of our range this past quarter. This was primarily due to pay downs from borrowers, selected asset sales and an increase in the mark-to-market of our portfolio. We have ample of liquidity to fund revolver draws, and we are in compliance with all of our facilities as of September 30. We have readily available borrowing capacity and cash liquidity to support our commitments. We're looking to carefully manage our leverage over time. We expect to stay in compliance with both regulatory requirements and covenants under our credit facilities.

We have a strong capital structure with diversified funding sources and no near-term maturities. We have $520 million revolving credit facility maturing in 2023 with a syndicate of 11 banks with $309 million drawn as of September 30, $139 million of unsecured senior notes maturing in 2023, and $228 million of asset-backed debt associated with PennantPark CLO 1 due 2031. We have been in consistent dialogue with our lenders and are thankful for their support.

Our portfolio remains highly diversified with 102 companies across 44 different industries. 89% is invested in first lien senior secured debt, including 11% in PSSL, 3% in second lien debt and 8% in equity, including 4% in PSSL. Our overall net portfolio has a weighted average yield of 7.3%. 99% of the portfolio is floating rate and 86% of the portfolio has a LIBOR floor. The average LIBOR floor is 1%.

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 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 take our first question from Paul Johnson at KBW.

Congratulations on the Cano Health acquisition. That's obviously very positive news yesterday, but I just kind of have a few questions here today. I know over the last few quarters, investments have, obviously, been fairly -- new investments, originations have been fairly muted, understandably so. I'm just kind of curious, so now that you're back sort of within the leverage range target, what is sort of your outlook for new investments going forward? Can we expect to see maybe more active origination?

And then also on that, for any sort of new investments that you are looking at today, what is the environment that you're seeing? Are you still able to extract the same sort of covenants that you were and terms that you were before? Has that diminished? But -- yes, any commentary on that would be very helpful.

Terrific. Thanks, Paul. Yes. Look, we -- for the last couple of quarters, we've been evaluating the economy and our portfolio, and we are indeed back actively originating deals for both PFLT and PSSL. We also are getting repayments, of course, as part of that. So the wheels of commerce are starting to move again. And we're out there actively looking at doing deals. So net target leverage is still kind of in the 1.5x zone debt to equity. As we say, we think our portfolio is among the lowest risk in the industry. You could see it in the yields, kind of our first lien, typically, is a lower-yielding first lien, maybe more of a classic first lien than some of the others, which means we believe that we can comfortably be in that 1.5x leverage zone and feel very safe and feel like it's prudently capitalized and judicious in terms of the debt-to-equity ratio because the risk we're taking is lower than most and is lower than the industry.

In terms of kind of the risk reward we're seeing, again, remember, another definitional thing. We tend to focus on companies with between $15 million and $50 million of EBITDA, average EBITDA of $20 million to $30 million in this portfolio. We like staying away from the fray of the broadly syndicated loan market, which has bounced back very dramatically where it's all covenant light, where yields are low, or EBITDA adjustments are back and where leverage is high.

And some of our bigger brethren who have to write bigger checks in the bigger companies are up competing against the broadly syndicated loan market and accepting lower covenants, lower yields, more EBITDA adjustments, et cetera. With us, we always got covenants even pre COVID. We're getting tighter covenants now. We're getting fewer EBITDA adjustments. The EBITDA adjustments, if we accept them, are thoroughly diligenced. We're seeing more equity from our sponsors. We're seeing more yield.

So the whole package of risk-adjusted return that we're seeing today versus pre COVID is better and much better, which is why we say we like this vintage. We think this vintage over the next year, 2 or 3 where we play in the middle market is -- we think it could be similar to 2009 to 2012. I don't think it's going to be as good as 2009, where the average debt-to-EBITDA was 3.3x. Our Central Bank and the fiscal authorities made sure that we weren't going to repeat 2009 again. But we think that this upcoming vintage will look a lot like 2009 to 2012. So we're excited about what we're seeing, and we're active.

That's good. That's very good to hear. Do you ever see a time where, obviously, you guys have built a very high quality, more conservative, like you said, traditional first lien portfolio -- but in that environment that you sort of described, do you see any opportunity? Or do you have any thoughts around potentially getting slightly more aggressive to enhance sort of the portfolio yield or top line return? I'm talking about potentially doing maybe slightly more aggressive deals or more second lien, do you have any thoughts on that?

Yes. Look, I think we're going to stay away from second lien in this portfolio. And I think we're going to be cautious about stretch your senior. For us, as you can see in PFLT itself, we would prefer to have a lower-risk, lower-reward portfolio and maybe have the leverage a little bit higher, 1, 1.5x than some of our brethren. So I think that's the way we think about it. Every once in a while, of course, we'll -- if we think we have a real angle, a real edge, sort of special situation, we may do a little bit more of a stretch senior from time to time or unitranche, but I think we're going to specifically stay away from second lien and mezzanine in this particular portfolio.

Okay. And then on the JV, I think quarter-over-quarter, I think you guys have been taking the leverage down actually for the past few quarters in this inside of the JV. I noticed that the return this quarter or at least what was paid out to the BDC was relatively stable from the last quarter, maybe up slightly. Is that kind of the return that we can expect going forward in terms of where the leverage is at in the JV and what return it's spitting out? Or do you guys have any other plans as far as the JV goes?

Yes. So and I highlighted this -- tried to highlight this in the script. So let me be clear. We -- again, same thing with PFLT, the last X number of quarters, we've been wanting to see how the economy did, wanting to see how our portfolio did, and one of the nice things out of all of this is that our securitization CLO financing at PFLT has been terrific. It's been a great way to finance these lower-risk assets, and we're going to explore over PSSL using the same type of financing, and we're going to explore growing PSSL from where it is today, about $400 million to something like $550 million, maybe $600 million of the total portfolio, utilizing the securitization-style financing that works so well for us over at PFLT. So in terms of NII growth at PFLT itself and at PSSL, we would hope that growing the portfolio and using securitization financing could be a big part of that.

Got you. And then finally, I'm just -- I'm actually very curious as far -- I don't know if you have any commentary around the SPAC market? Obviously, that's become very popular this year. It's grown significantly. Do you see that as a potential meaningful driver of more middle-market acquisitions, such as Cano Health? Or is this more of being a sort of middle market, maybe not as highly prized of an acquisition for like a SPAC company? But -- yes, any sort of thoughts you have on that acquisition and if it could potentially be a driver of further exits in the portfolio?

Yes. Look, I mean, I think our view of the SPAC market is it's really just another form of an IPO. And the SPACs and IPOs that do well, they would have done well anyway or the SPACs or IPOs that wouldn't have done well, wouldn't have done well. So in the case of Cano, it's been such a high-growth business and the addressable market for what they do is so enormous that an IPO of some sort made a lot of sense for the company because of its growth trajectory and it's -- the white space that it has out there, so -- and there's also a comparable out there that Oak Street Health, which is a great company, trades at an $11 billion or $12 billion market cap. And if you line up Cano against Oak Street and you look at revenues, EBITDA, members, medical loss ratio, Cano lines up very favorably to Oak Street Health, which is a terrific company.

So it's quite possible that Cano could, over time, trade in line or even better than Oak Street Health. So to us, that makes -- we're not experts in IPOs, you guys may be more experts, but it seems like it's an attractive deal from the get-go, but as importantly or maybe more importantly, there's a lot of runway on the upside for Cano, both in its markets as well as where it trades versus its comps.

Great. And actually one more, if I may. I think you may have mentioned in your prepared remarks, but I didn't possibly catch it. Do you know the percentage of your portfolio that has LIBOR floors?

Yes. It was in our prepared remarks. It's 90 -- 86% has a LIBOR floor, 86%.

That is correct. That's one of the prepared remarks. Yes. LIBOR floor is 1%, but about 86%, yes.

We take our next question from Mickey Schleien at Ladenburg.

I just wanted to follow up quickly on the senior loan fund. I calculate a blended ROI, taking into account the equity and the debt investments of a little north of 9%. Are you satisfied with that level of return? Or are you looking for something higher than that with more leverage on that balance sheet?

Yes. So it's a great question, Mickey. Obviously, over the last few quarters, we've specifically wanted, again, to see how our portfolio did, see how the economy went, which is why we are looking to grow PSSL back up again to a larger entity and using the securitization financing potentially to finance that. So I think over time, we're going to target 11%, 12% on that vehicle.

That's a blended sort of ROI.

Blended on the -- yes, on the 2 pieces of paper, yes.

Okay. And Art, could you be a little more specific about the damages of the securitization versus the credit facility in that fund? Because I'm no expert like you guys, but I'm curious what are the features there that attracted to that?

It's just very efficient. It's low cost, and it's kind of permanent financing, it's not permanent, but it's long-term financing and there's a box. And there's no individuals you need to talk to. There's no credit guys who may have a sleepless night or 2, it's just the box. And if we're comfortable in our underwriting, which we are, we like that box for what we're doing in this portfolio, the lower-risk, low-reward deals. As we looked at kind of the amount of CCCs that we got through this time period, it was very low. Very low. I think if you looked at the equity return on that granted the CLO -- in this case, the equity is owned by PFLT, I think we had something like a 20% return on the equity because of the strength in the underwriting in the underlying box, so...

That's a very solid number relative to what I'm seeing elsewhere.

Yes. The CCC basket kind of -- you have up to 17.5% in middle market. I think we're like 8%, something like that. So it's -- for us, because our underwriting works, it's a very good box.

So Art, if I could paraphrase, are you suggesting that it's just perhaps an easier piece of capital to manage from your perspective?

It's -- look, that's part of an overall mix. And as we look at PSSL, and we look to grow PSSL, it could be part of the overall mix of PSSL and of PFLT along with credit facilities and along with bonds occasionally. So we believe in diversified financing tools. We're just saying kind of here we are kind of 8 or 9 months into COVID, and we did our CLO over PFLT, I guess, last September and then COVID hit in March, it's performed very, very well. So we're taking that as a data point thing. Yes, that's really interesting for us. Maybe we should use that technology over PSSL.

I understand. And just in terms of the mechanics, I haven't done the math, but I imagine most of the senior loan funds assets are in the borrowing base for the credit facility, right? So how do you extract those assets and form the CLO? And what is the timing of all of that?

Yes, it's a great question. We're starting to explore now. I don't have a firm answer, but, obviously, the banks involved in PSSL are our partners, and we're going to be talking to them about partnering on kind of growing PSSL, including the securitization, including a new revised credit facility. So all of this is in play, and it's something over the next quarter or 2, we're going to hopefully finalize.

Okay. So it sounds like it's sort of mid-next year sort of timing to put it all together?

I'm hoping earlier, but that's fine. For your expectations, assume mid-next year. We have a shot at being better.

And just a couple of sort of more housekeeping questions. Are -- your cash on your balance sheet is built up. Is that to make the principal payment on the CLO notes that are due next month?

We have an amortization payment on the Israeli bonds coming up in the next month. So that's what it makes it.

It's not the CLO. Okay. So that's going to be paid out of cash?

Yes.

Okay. And if I'm not mistaken, last quarter, you said average EBITDA in the portfolio was $35 million to $40 million. And I think you just said $20 million to $30 million this quarter. Maybe my previous number's wrong, but where is the ballpark for the portfolio?

We're working -- Mickey, we're being (inaudible) now. The mean is what I gave you last quarter and that $35 million to $40 million, the median is more like $25 million.

(Operator Instructions) We take our next question from Devin Ryan at JMP Securities.

A few of our questions were asked, but maybe just ask one here on nonaccruals and credit. And just curious how you guys are thinking about the broader portfolio, to the extent we have another shut down here or COVID-related disruption. And then also, if you could just leave in some context on the first lien loans to marketplace events. I know a little bit of pressure there in the quarter and just whether there's been any dialogue with the sponsor and whether they may be adding more support.

Yes. So thank you. Thank you, David, and nice to meet you. I look forward to spending time with you as you take on the BDC industry. So welcome to the new industry.

Absolutely.

So Marketplace Events is finalizing its restructuring as we speak. So hopefully, by next quarter, I'm pretty sure by next quarter, that restructuring will be done, and that will move off of nonaccrual. In that particular name, the lenders are going to be taking control of the company, injecting capital to be able to get the company through to the other side. When events inevitably start coming back, certainly, it's about as clear as mud today as to when events start coming back, but events will come back, and we think that's a really great company in the space. And we're actually happy to make that equity investment in Marketplace Events.

PRA is an event planning company, again, events related. That is in restructuring talks right now as we speak. Again, that probably comes off nonaccrual next quarter. Looks like the sponsor is injecting equity in that one to help that company. So those are -- that's 2 of the 3 nonaccruals. Two of -- both of them are kind of in the events space.

In terms of outlook, we think it's going to be relatively light. Of course, there's going to be nonaccruals from time to time that hit this portfolio. But we don't think there's anything particularly abnormal. We think that the COVID impacts, to the extent there were, have been identified, have been or are being dealt with and are kind of already baked into the pie here.

It appears there are no further questions at this time. Mr. Penn, I would like to turn the call back to you for any additional or closing remarks.

I just want to thank everybody for being on the call today. We appreciate it, and we will -- because we had a late reporting period this quarter, it's only relatively short time until early February when we have our next quarter numbers. So looking forward to speaking to everybody then. Thank you very much.

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