PennantPark Floating Rate Capital Ltd (PFLT) 2020 Q2 法說會逐字稿

Good morning and welcome to the PennantPark's Floating Rate Capital's Second Fiscal Quarter 2020 Earnings.

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 Second Fiscal Quarter 2020 Earnings Conference Call.

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 I 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 who you work with are staying healthy and navigating through these challenging conditions.

We are pleased to report that Pennant Park continues to operate smoothly and effectively and remains committed to working diligently on behalf of our investors.

I am going to spend a few minutes discussing our portfolio going into the COVID-19 crisis.

How we fared in the quarter ended March 31, how the portfolio is positioned in the upcoming quarters, our capital structure and liquidity and the value proposition of our stock, the financials and then open up for Q&A.

We believe that our rigorous underwriting process and disciplined approach has successfully positioned us to manage through the challenges ahead.

We have an excellent team of talented and dedicated professionals many with decades of experience managing through multiple economic cycles to help ensure the best possible outcome in this type of difficult environment.

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've had a portfolio that was among the lowest risk in the direct lending industry as proven by a portfolio that has had among the lowest yields in the industry.

As of March 31, 91% of the portfolio was in first-lien senior secured debt with a weighted average yield of 7.8%.

The portfolio is constructed to withstand market and economic volatility.

As of March 31, average debt-to-EBITDA in the portfolio was 4.2x, and the average interest coverage ratio, the amount by which cash income exceeds cash interest expense, was 2.7x.

This provides significant cushion to support stable investment income.

These statistics are among the most conservative in the direct lending industry.

Our focus has been on traditional middle market companies, where we have benefited from terms, covenants and structures much more attractive to lenders than those of larger companies.

These terms enable us to see potential challenges in portfolio companies and be positioned to assist and protect our capital much sooner than the low-to-no covenant loans, which are typical of larger borrowers.

We have largely avoided some of the sectors that have been hurt the most by the pandemic, such as retail, restaurants, apparel and airlines.

PFLT also has no exposure to oil and gas.

The portfolio is extremely diversified with 108 companies and 43 different industries.

As of March 31, we had only 2 non-accruals, representing only 0.6% of the portfolio cost and 0% market value of the portfolio.

On average, our assets were marked down approximately 5.6% in the quarter, reflecting primarily softening market conditions due to COVID-19, not underlying portfolio performance.

We believe this valuation as of March 31, during a time of extreme volatility, reflects that point in time and is not necessarily indicative of a long-term impairment of the portfolio.

Our growing team in capital resources have put us in a position to be both active and selective, whereby we only invested in approximately 4% of the opportunities that we were shown over the past year.

Our credit quality since inception 9 years ago has been excellent and the 380 companies in which we have invested since inception, we have only experienced 9 nonaccruals.

Since inception, PFLT has invested over $3.7 billion at an average yield of 8%.

This compares to an annualized realized loss ratio of only 7 basis points annually.

If we include both realized and unrealized losses, including the unrealized losses through March 31, the annualized loss ratio was only 30 basis points annually.

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 wise, and at that time, was focused primarily on investing in subordinated 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 that recession, the weighted average EBITDA of those underlying portfolio companies declined by 7.2% at the trough of the recession as it compares to the average EBITDA decline of the Bloomberg North American High Yield Index of down 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.

Now let's turn to the outlook ahead in the coming quarters and how our portfolio is positioned.

We've been communicating on a constant basis with management teams and the private equity sponsor owners of our portfolio companies.

As mentioned previously, we are gratified that our historical investment focus has protected us from some of the worsted areas of the economy such as retail restaurants, hospitality, apparel, airlines and energy.

And we've been pleased with the way our portfolio companies have moved to rapidly adjust costs and are focused on shoring up liquidity.

As of March 31, all of the companies in the portfolio paid their principal and interest in full, although 2 asked for and received an amendment to pay a portion of their interest in kind.

Looking forward to the quarter ended June 30 and beyond, there remains meaningful uncertainty about the timing and pace of reopening the economy and its impact on the portfolio.

Nevertheless, where things stand today, our analysis suggests that the vast majority of the companies in our portfolio have significant and sufficient liquidity to pay their interest payments as they come due in the coming quarters.

Having said that, we expect that certain portfolio companies will ask for amendments allowing temporary covenant relief given the substantive impact of the shutdown on their operating performance.

We are confident that most of the loans in our portfolio benefit from real covenants who'd step down.

These covenants may require some amendments in the current environment but they allow us to monitor the portfolio closely and to ensure companies are taking appropriate actions to protect our investment.

There are some companies in our portfolio that have seen significant drops in revenue due to COVID, such as companies in the gaming industry.

Gaming represented only 5.4% of the portfolio as of March 31 across 7 investments.

Our largest gaming investment last quarter was substantially refinanced.

The remaining residual loan is to a wholly owned subsidiary of a large investment-grade company with a full interest reserve until early 2021.

Two of the other gaming companies are undertaking construction phase projects, which provide them with interest reserves into mid-2021.

The other 4 properties are regional facilities, its primary customer base does not need to get on a plane.

Those properties were experiencing record performance prior to the shutdown, and owners of those facilities have aggressively cut costs.

While we do not know when the properties will reopen, I'll have cash on the balance sheet that will allow cushion to reopen in the third or fourth quarter, and we expect strong performance once these properties reopened.

On the positive side, many of our portfolio companies are in businesses such as government services, defense contracting, software, communications and cybersecurity, which collectively comprise a substantial portion of our portfolio and should be less impacted by COVID.

With regard to our financials, I'll give some summary highlights, and Aviv will go into more detail.

Our net investment income was $0.30 per share, which exceeded our dividend of $0.285 per share.

Based on the earnings stream, at this point in time, we do not intend to adjust the dividend.

Of course, we will continue to evaluate our earnings stream over time relative to the dividend.

Our GAAP debt-to-equity ratio was 1.57x, while GAAP net debt to equity after subtracting cash was 1.5x.

Regulatory debt-to-equity ratio was 1.81x and our regulatory net debt-to-equity ratio after subtracting cash was 1.74x.

As many of you know, in early 2009, in response to the global financial crisis, we started marketing many of our liabilities, our credit facilities and bonds to market to better align asset and liability values.

This reduces the volatility of NAV in times of market volatility such as we have today.

The additional benefit at the time and for the ensuing decade was that it reduced the volatility of our leverage as calculated for the regulatory asset coverage test.

About 9 months ago, the SEC guided us that for the regulatory asset coverage purposes, they will prefer remarked liabilities at cost, not market, which we now do for that test.

As a result, we will be highlighting both GAAP leverage and regulatory asset coverage leverage in times such as these when there is a material difference.

With regard to NAV, our GAAP NAV was $12.12 per share as of March 31, down approximately 6% from the prior quarter, which reflects both the markdown of assets and certain liabilities.

Depending liabilities were not mark-to-market adjusted NAV would have been $11.10, down approximately 13% from the prior quarter.

With regard to leverage, we've been targeting a debt-to-equity ratio of 1.4 to 1.7x.

Our net of cash regulatory asset coverage ratio of 1.74x was at the upper end of our range this past quarter.

This was primarily due to a 5.6% decrease in the mark-to-market of our portfolio as well as more active drawing of revolvers by our borrowers.

We have ample liquidity of funding revolver draws and we're in compliance with all of our facilities at March 31.

As of today, we have liquidity to support our commitments.

We are looking to carefully manage our leverage over time, and we expect sustaining 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 of revolving credit facility maturing in 2023 with the syndicate of 11 banks, $413 million drawn as of March 31, the $139 million of unsecured senior notes maturing in 2023 and $228 million of asset-backed debt associated with PennantPark CLO through 2031.

We've been in consistent dialogue with our lenders and are thankful for their support.

We are primarily focused on our existing portfolio.

We will selectively make new investments, although the borrower is currently high.

Our focus continues to be on companies and structures that are more defensive, have reasonable leverage, covenant protections and attractive returns.

With regard to our stock price, we believe that the share price of PFLT does not accurately reflect the long-term value of the company.

As we stated earlier, the average debt-to-EBITDA of our underlying portfolio as of March 31 was 4.2x.

Translating this into the language of value investors at the stock price of PFLT today well below NAV we and shareholders own a portfolio of companies at a multiple of about 2.6x cash flow, even in a recession with potential declines in cash flow, value investors should be able to appreciate an attractive low multiple.

As previously disclosed, directors, officers and employees of PennantPark investment advisers purchased about 535,000 shares of PFLT in February and March because we thought it was an excellent investment opportunity and to demonstrate strong alignment of interest with our shareholders.

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 March 31, net investment income was $0.30 per share.

Looking at some of the expense categories.

Management fees totaled about $5.9 million, taxes, general and administrative expenses totaled about $1 million, and interest expense totaled about $7.6 million.

During the quarter ended March 31, net unrealized depreciation on investment was about $65 million or $1.67 per share.

Net realized losses were about $1.6 million or $0.04 per share.

Net unrealized appreciation of our credit facility and notes was $0.86 per share.

Net investment income exceeded the dividend by $0.02 per share.

Consequently, NAV went from $12.95 to $12.12 per share.

Adjusted NAV, excluding the mark-to-market of our liabilities was $11.10 per share.

The decline in NAV was primarily due to a 5.6% average valuation decline on the investment portfolio, combined with increased leverage.

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 an independent valuation firm, exchanges or independent of the dealer quotes 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 108 companies across 43 different industries.

91% is invested in first-lien senior secured debt, including 10% in PSSL, 3% in second-lien debt and 6% in equity, including 4% in PSSL.

Our overall debt portfolio has a weighted average yield of 7.8%.

99% of the portfolio is floating rate, and about 90% 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 goals are steady, stable and protected dividend stream, coupled with the preservation of capital.

Everything we do is aligned to that goal, and 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'd like to open up the call to questions.

(Operator Instructions) And we'll go first to Mickey Schleien of Ladenburg.

Art, just in terms of risk assessment -- and I'm sorry if you mentioned it in the prepared remarks.

But can you give us a sense of what the portfolio's average EBITDA is at this point?

The average EBITDA is -- Mickey, can you hear me?

Yes.

Okay.

Average EBITDA is roughly $35 million to $40 million on average in terms of the average size of the company.

Okay.

So right in the middle market level.

And what trends could you see in the first quarter?

Look, we had a very strong first calendar quarter.

We had a very strong quarter up until the end of March.

So we saw very strong performance across the portfolio going into the COVID-19 crisis.

Okay.

And in terms of sponsors, how would you characterize their behavior in April and in May in terms of helping to support liquidity of your portfolio companies?

Yes.

We've seen very, by and large, good behavior and actions from the sponsors, both in doing what it takes in terms of reducing expenses, in terms of shoring up liquidity and managing their liquidity.

In many cases, they have cut off their fees that they're earning from these companies.

So by and -- and that's one of the benefits you see from kind of a sponsor portfolio with an embedded equity from the sponsors underneath of us.

There's certainly a strong alignment of interest.

Going into this, the average loan-to-value was about 50%.

So there's a lot of equity beneath us, a lot of support and the actions that we've seen are -- have been helpful.

Okay.

My last question, Art, can you remind me what the target debt-to-equity is for PFLT in a normal market?

Yes.

So in the normal market, we've been saying 1.4 to 1.7x.

So here we are at the upper end of that due to both the mark-to-market as well as the drawing on the revolvers from even many of the underlying portfolio companies.

So we're managing that leverage carefully.

There's been some sell-downs at nice prices post quarter end to create additional liquidity, additional cushion.

And because so much of our portfolio is away from the COVID-19 risk, it's a -- we have a bunch of attractive deals.

They're both attractive for us as well as for certain other parties.

We haven't had problem finding some nice levels post quarter end and still we want to create more cushion and more liquidity in the system.

Next, we'll go to Ryan Lynch of KBW.

My first one just has to do with your asset-backed notes.

As you kind of evolve through this process, I think we've seen that the asset-backed notes or securitizations or CLOs for different BDCs can be seen in those concerning liability tranches because they're not as flexible.

They don't work with a banking partner and could come in there and work with the borrower.

So can you just talk about your comfort level surrounding the current covenants, whether it's the CCC bucket or the OC test or any other covenants that did you guys feel in those asset-backed notes?

Yes.

Thanks, Ryan, and that's an excellent question.

So with our CLO, we have a 17.5% CCC bucket.

And we have plenty of cushion now against that.

It's something that we're watching, and we manage, but there's no issues that we see happening with that.

The other thing I'll note is that with our securitization in addition to retaining the equity, we also retained a BBB tranche.

So it's a less levered -- in essence, it's a less-levered CLO to begin with.

Okay.

And then what about the credit facility that you guys had in PSSL?

Can you talk about your comfort around that?

Obviously that has a little bit -- that's high leverage as well.

Can you talk about -- you guys talk about what's the ability to not hurt any covenants in that?

Yes.

So we have a -- in our joint venture, PSSL, we have -- that's again a joint to refresh everyone's memory.

That's a joint venture we have with Kemper.

The bank there is Capital One and a syndicate of other banks.

We've been having great conversations with Capital One, even, kind of very transparently sharing with them what's going on in the portfolio.

And those conversations are ongoing, but we feel very good about the context of that dialogue and the relationships.

And I think just to kind of take it to a bigger level, I think the banking regulators in United States, the Fed, the OCC, their control over the currency have been very clear with the people that regulate that COVID-19 risks and portfolios that the bank should be very -- should have soft hands, should be working with borrowers and should be giving people room.

And certainly, as we've been having conversations with all of our banks across the PennantPark platform, we've seen very excellent behavior, backed up by many years of long-term partnership that we've had with them.

So good open dialogue.

Certainly, COVID-19 is having a significant impact on the economy and our banks seem to understand that.

Okay.

And then I know you guys touched on this earlier and provided some comments around the gaming industry, talked about 4 of your properties or regions where you don't have to get on plane, a couple of them are under some construction, one with slowdown and kind of folded into a higher quality investment-grade company.

But just can you talk about kind of how those businesses operate?

Obviously, I would assume that they're all shut down right now producing 0 revenues.

What is the ability and how can those companies run during a downturn like this as far as cutting costs, increasing the runway to conserve cash for the longer term?

And then lastly, just what is kind of the ultimate outlook of those businesses in your mind right now?

Obviously, it's going to be largely dependent on when the economy opened, but I would think that some of those businesses, maybe some of the last ones to be able to reopen just because those crowded places they aren't really essential.

So just any additional commentary would be helpful on that.

Sure.

So look, I think you hit on all the right points, which are -- if you're one of those companies, you really cut all your costs to the absolute minimum fixed cost, a skeletal staff, unfortunately, means your variable costs, such as your employees furloughed or laid off and you are maximizing your liquidity in every way you can maximize in your liquidity and creating several quarters of runway being shut down.

And by and large, most of them have done that.

They harbored their liquidity well.

They have kind of cut their ongoing costs to the bare minimum.

And based on what we can see, they've got plenty of runway to deal with a gradual reopening at a time and even when there is a reopening, a gradual increase in traffic.

So we think they've done a good job and certainly since the vast majority of them are regional facilities where the customers are local, they don't need to get on a plane, we think they're as well set up as anybody to deal with a prolonged downtime.

So the playbook is there.

They've operated the playbook.

Now we just need to kind of see how things go.

And now we will go to David Miyazaki of Confluence Investment Management.

So Art, just a question for you.

I think way back when you guys elected to mark your liabilities to market, we had some really great conversations around that.

I think one of the central points you made was that is -- you better align the movement of the asset side of the balance sheet with the liability side of the balance sheet.

I think that was something that, to my recollection, is -- was very helpful for PNNT during the financial crisis of '08.

So I was wondering if you could share with us some of the maybe details of what the SEC said when they expressed some preference for a cost base mark on your liabilities.

I presume that you made a point to them that this was a better alignment of both sides of the balance sheet.

So what was sort of the nature of that conversation?

Yes.

What I think, because these were very quiet conversations and just suffice to say that we really liked the marking liabilities to market for a lot of reasons, including the reduction of volatility and also for SEC asset coverage purposes to the extent you can use it.

It's a terrific insurance policy.

It's a really -- could be a solution for the broader industry in times of volatility, like we're having today.

But 9 months ago, of course, after using it for a decade, the SEC guided us that for the SEC regulatory asset coverage ratio, they would prefer that we do not use it going forward.

So we are not for the regulatory assets.

And certainly, it's already part of our GAAP financial statements.

And the way it works is every time you take down a liability, whether it be a credit facility or a bond, you have a onetime option to mark that liability to market under GAAP.

So that's what we have been doing until recently, using that option under GAAP.

And until recently, GAAP and regulatory asset coverage are virtually the same because you have very common markets.

So here we are in a volatile market as of 3/31.

And for GAAP purposes, we mark many of our liabilities to market, which does even to the volatility of NAV, but does not get taken into account for the regulatory asset coverage test, which is kind of why we're now -- and you'll see it on the press release why we now do regulatory as well as GAAP debt to equity.

And we do also show an adjusted NAV per share, which takes out the mark-to-market of the liabilities.

So it makes it complex.

I apologize to everybody.

It was done with the best of intentions of reducing the risk of our vehicles when we did it.

Today, it just makes it more complex from the standpoint of our financials, but we do think there is an underlying logic of doing it.

In terms of the SEC dialogue, I did not have the dialogue, it was our attorneys having the dialogue with the SEC, and our attitude is when the SEC guides us to do something, we should be listening to that.

So we are listening to their guidance and we still are in fine shape as you've seen.

We'd be in better shape in some sense if we're under the old regime, but it is what it is, and we will live under the constraints that we're given at this point in time.

I appreciate that.

I know that there's -- it's really a multidimensional sort of data, so whether or not that's the best disclosure is to market or not.

But certainly, I think that we now have 2 different cycles of extreme market or liquidity to show that this can help dampening some of the big swings that take place in at least for BDCs in their net asset value.

So I guess I was just a little surprised to see that there wasn't a little bit of recognition that there's some utility that you had in that timely interpretation.

The other question I had was, Art, you mentioned -- I think you said that you -- there is no shortage of deal flow and that you have a lot of different opportunities to put capital to work right now that looks pretty attractive.

And that's a little bit in contrast to what we've heard from some BDCs that lend and I guess what you'd call the upper middle market, not the $35 million to $40 million EBITDA.

They're probably more in the $75 million to $100 million neighborhood, where I think kind of somebody said nothing is happening, lenders and borrowers today can't even agree on what they have agreed to do.

So your comment on the $35 million to $40 million, is that something that the market gets lower in the middle market that there's more deal flow taking place right now?

Just to clarify.

So I said, I don't know, I think this was part of my remarks.

There really is not a lot of deal flow at this point in time in the primary.

So there's not a lot of primary deal flow.

Certainly in some of the areas that are completely unimpacted as we've seen in certain defense contractors, government services, there's a little bit of deal flow.

And it's in part because that sector never really -- that's kind of motoring along.

That's a reasonable chunk of our portfolio, and there still are private equity sponsors trying to get deals done.

But it's not like there's been a lot of deals done in that space.

So there's not a lot going on in the market.

But buyers and sellers of companies as well as lenders are trying to figure out where risk-adjusted returns should be for non-COVID impacted companies and think that there is activity, some activity in that space.

So there really isn't a lot new.

There is some secondary opportunities that we think could be attractive.

For PFLT, I think our mission today is really to focus on the portfolio.

We will selectively, and we'll look to selectively make investments that are new but the bar is high at this point.

I think we've just got to kind of focus on our portfolio and kind of make sure we have focused on those portfolio companies first.

And with that, I'd like to turn the call back to Art for any additional or closing comments.

Thank you, everybody, for listening in today.

We appreciate and we wish everyone safety and health in these times, and we look forward to speaking with you next in August, which will be our next quarter.

Thank you very much.

With that, ladies and gentlemen, that does conclude today's call.

We'd like to thank you again for your participation.

You may now disconnect.