PennantPark Floating Rate Capital Ltd (PFLT) 2022 Q3 法說會逐字稿

Good morning, and welcome to the PennantPark Floating Rate Capital's Third Fiscal Quarter 2022 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 2022 earnings conference call. I'm joined today by Rick Allorto, our Chief Financial Officer.

Rick, 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 we 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, Rick. First, I'd like to welcome you as the new CFO of our BDC's. 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, a detailed review of the financials, then open it up for Q&A.

For the quarter ended June 30, our net investment income was $0.29 per share, which includes $0.01 of other nonrecurring income. The credit quality of the portfolio remains solid and the largest nonaccrual investment marketplace events has returned to full accrual status.

Our GAAP NAV decreased by 3.2%, driven primarily by a decrease in investment valuations. The decrease was largely attributed to mark-to-market adjustments resulting from the overall choppy market as opposed to a specific credit-driven items within the portfolio.

During the quarter, we continue to originate attractive investment opportunities and grew both the PFLT portfolio as well as the JV portfolio. At quarter end, the JV portfolio was at $747 million, and we remain confident that we will execute on our plan to grow the JV portfolio to $1 billion of assets over time. We believe that the increase in scale and the JV's attractive ROE will enhance PFLT's earnings momentum.

From an overall perspective in this era of inflation, rising interest rates and geopolitical risk, we believe we are well positioned as a senior secured first-lien lender focused on the United States, while the floating rates on our loans can protect against rising inflation. The portfolio of assets that is 100% floating rate, we're well positioned to substantially grow our net investment income as base rates rise.

Holding everything else constant in the portfolio, every 100 basis point increase in base rates translates into about $0.04 per quarter of net interest income. We have a long-term track record of generating value by successfully financing high-growth middle market companies in 5 key sectors. These are the sectors where we have substantial domain expertise. We know the right questions to ask and have an excellent track record.

They are business services, consumer, government services and defense, health care and software -- health care and software and technology. These sectors have also been resilient and tend to generate strong free cash flow.

As an aside, government services and defense is approximately 15% of the portfolio, inclusive of the JV and should be a beneficiary of the geopolitical environment. In many cases, we are typically part of the first institutional capital into a company where a founder, entrepreneur or family is selling their company to a middle market private equity firm.

In these situations, there's typically a defined game plan in place with substantial equity support from the private equity firm to significantly grow the company through add-on acquisitions or organic growth.

The loans that we provide are important strategic capital that fuel that growth and help that $10 million to $20 million EBITDA company grow to $30 million, $40 million, $50 million of EBITDA or more. We typically participate in the upside by making an equity co-investment. Our returns on these equity co-investments have been excellent over time. Overall, for our platform from inception through June 30, our $335 million of equity co-investments have generated an IRR of 28% and a multiple on invested capital of 2.5x.

Because we are an important strategic lending partner, the process and package of terms we receive is attractive. We have many weeks to do our diligence with care. We thoughtfully structured transaction with sensible credit stats, meaningful covenants, substantial equity cushions to protect our capital, attractive upfront fees and spreads and equity co-investment.

Additionally, from a monitoring perspective, we received monthly financial statements to help us stay on top of the companies.

With regard to covenants, virtually all our originated first-lien loans had meaningful covenants, which help protect our capital. This is one reason why our default rate and performance to our coverage was so strong. This sector of the market, the company is with $10 million to $50 million of EBITDA is the core middle market.

Within the core middle market, we think our capital can add the most value, and we believe the opportunity to get the strongest package of risk return is in the $10 million to $30 million of EBITDA range. The core middle market is below the threshold and does not compete with the broadly syndicated loan or high-yield markets.

As many of you know, there's been an enormous amount of capital raised by some of our large peers. And as such, they're forced to focus on the upper middle market, which are companies with over $50 million of EBITDA. Those upper middle market companies can typically also efficiently access the broadly syndicated loan market. And as a result, in the upper middle market, our large peers need to aggressively compete with the broadly syndicated loan market and among themselves.

This results in transactions where leverage is high, covenants are light or nonexistent, spreads and upfront fees are compressed, and decisions need to be made quickly.

Additionally, from a monitoring perspective, they generally receive financial statements quarterly instead of monthly. The argument you will hear is that the bigger companies are less risky. That's certainly a perception and may make some intuitive sense, but the reality is different. According to S&P, loans to companies with less than $50 million of EBITDA had a lower default rate and a higher recovery rate than loans to companies with higher EBITDA.

We believe that the meaningful covenant protection of core middle market loans, more careful diligence and tighter monitoring have been an important part of this differentiated performance. The borrowers in our investment portfolio are performing well, and we believe we're well positioned for future quarters.

As of June 30, the weighted average debt-to-EBITDA in the portfolio was 4.7x and the average interest coverage ratio, the amount by which cash interest income -- excuse me, cash income exceeds cash interest expense, was 3.1x. This provides significant cushion to support stable investment income even as interest rates rise.

Based on this substantial cushion, even with a 350 basis point rise in base rates and flat EBITDA, our portfolio of companies would still cover their interest 2x on average. These statistics are among the most conservative in the direct lending industry.

As of June 30, we had only 2 nonaccruals out of 123 different names in PFLT. This represents only 0.9% of the portfolio at cost and 0.1% at market value, which is a significant decrease from the prior quarter.

As mentioned in my earlier comments, our investment in marketplace events has returned to full accrual status. Our credit quality since inception over 10 -- excuse me, 11 years ago has been excellent. PFLT has invested over $4.9 billion in 447 companies, and we have experienced only 50 nonaccruals.

Since inception, PFLT's loss ratio was only 6 basis points annually. Against the market backdrop of rising interest rates, high inflation and geopolitical risk, our target market remains active. Our experienced and talented team and our wide origination funnel is producing active deal flow, our continued focus remains on capital preservation in being patient investors. Our mission and goals are steady, stable and protected dividend stream, coupled with preservation of capital and everything we do is aligned to that goal.

We seek to find investment opportunities in growing 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 as dividends to our shareholders.

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

Thank you. Thank you, Art. For the quarter ended June 30, net investment income was $0.29 per share, including $0.01 per share of other income. Operating expenses for the quarter were as follows: management fees and performance-based incentive fees were $5.6 million, interest expense was $7.4 million, general and administrative expenses were $800,000, and provision for taxes were $100,000.

For the quarter ended June 30, net realized and unrealized change on investments was a loss of $16.9 million or $0.41 per share. There were no changes in the value of our credit facility and notes for the quarter.

We sold 136,000 shares this quarter through the aftermarket program above our NAV, which resulted in $0.01 per share of accretion to NAV. As of June 30, our GAAP NAV was $12.21, which is down 3.2% from $12.62 per share.

Adjusted NAV, excluding the mark-to-market of our liabilities was $12.02 per share, down from $12.41 per share last quarter. Our debt-to-equity ratio was 1.5x, and our net debt to equity after subtracting cash was also 1.5x. Our capital structure is diversified across multiple funding sources, and we do not have any near-term maturities.

As of June 30, our key portfolio statistics were as follows: our portfolio remains highly diversified with 123 companies across 45 different industries. The portfolio was invested in 87% invested in first-lien senior secured debt, including 16% in PSSL, less than 1% in second-lien debt and 13% in equity, including 5% in PSSL.

Our overall debt portfolio has a weighted average yield of 8.5%. 100% of the debt portfolio is floating rate and 82% has a LIBOR floor. The average LIBOR floor is 1%.

As Art previously commented, as base rates rise, we are well positioned to participate on the upside. Holding everything else constant in the portfolio, a 1% increase in base rates translates into $0.17 per share annually of net interest income upside and a 2% increase translates into $0.32 per share annually of net interest income.

I'll now turn the call back over to Art.

Thanks, Rick. 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 take our first question from Ryan Lynch with KBW.

Art, and welcome, Rick. The first question I had was, if I kind of look at your overall unrealized losses recorded in the quarter of around a little over $17 million. Is there a way to break that down? Can you give us a ballpark estimate of what percentage of that was driven by widening spreads and lower equity valuation, so more kind of technical mark-to-market versus specific credit events that were marked down?

Thanks, Ryan. As I'm looking at kind of the big movers over the quarter, there were really very little big movers. I think Walker Edison equity was the biggest mover and that was down $2 million as an example. But other than that, it's all kind of the market and credit spreads not idiosyncratic name spreads.

Okay. And then congratulations on marketplace eventually back on accrual status. Can you just talk about usually talk about how sort of negative events and what went on the portfolio companies is a positive event? Can you talk about what drove this change and this company's ability to pay its interest on the full status?

Yes. So the company is a home goods trade show business, which is obviously impacted by COVID. And the world is normalizing, as you know, and the company is doing much, much better. So it was a -- we believe it would be a temporary thing as the world normalizes, so they're the leading company in their space. It's an excellent company. It's a very strong management team. They just were directly impacted by COVID.

Okay. It's kind of a recovery story. Then just a final question that I had. The PSSL has grown significantly over the last several quarters. You mentioned kind of you hope to get that to $1 billion at some point. Obviously, this is very dependent on market opportunities. Because as you kind of sit here today, do you have any sort of rough estimate of a target year that you would like to get to that size?

I think probably in the next 18 months to 2 years, we have the ability today to ramp it to about $8.50, $8.75. We would look at some point to bring in another middle market CLO into that vehicle. We already have 1 and that CLO financing, as you know, is low cost, efficient long-term and really optimizes ROE.

So you could probably get it to $8.50 sometime in the next 6 to 12 months. Actually we get a middle market CLO done, which the market has been a little turmoil. As you may know, it presumably come back at some point, that's when we could optimize it even further and take it, let's say, from a $50 million to $75 million to about $1 billion.

Okay. Makes sense. I appreciate you taking my questions and the time today.

And we'll take our next question from Kevin Fultz with JMP Securities.

You touched on this a bit in your prepared remarks. Clearly, rising rates will boost core earnings in the back half of the year given the rate increases in the second quarter that will flow through in third quarter earnings, have you run the numbers on the incremental NII per share impact the rising base it will have in the third quarter?

Kevin, we've been thinking and working on this one quite a bit. There are, unfortunately, a lot of variables in that count. So I can't communicate a simple, straightforward, easy answer for you, but let me give you a couple of statistics to help you with your own modeling.

So 100% of the portfolio, as you know, is floating rate. And at 6/30, 11% of that was still subject to a floor and that average floor was 1%. That compares to 59% at 3/31 of the portfolio was still subject to an average 1% floor. So obviously, during the 6/30 quarter, we captured already some of the rising rate environment.

At 6/30, some additional statistics at 6/30. Our average base rate was 1.9%, and that compares to 1-month LIBOR today of approximately 2.35%. 1 month so for 2.3%. So as the portfolio companies continue to roll their LIBOR contracts and they have the option between 1, 3 and 6 months. We'll continue to see some increase in interest income, NII coming from the rising rates.

And again, we'd expect that small portion of the portfolio that's currently subject to the floor to exceed that 4% and again, add incrementally to top and bottom line with the rising rates.

Okay. That's really helpful. Richard, and welcome. Just one more, if I may. In regards to portfolio positioning, just curious if there are any pockets or industries that you find particularly attractive in the current environment?

Yes. We -- as you know, we have a big expertise and focused on government services and defense not a lot of our peers or focused on our industry. We've got a really good experience over many years. I think it's about 15% of this portfolio. And given geopolitical events, there's really a tailwind against that industry right now.

So we'll continue to lead into that industry. Obviously, we like the creditworthiness of the customers in that industry. We like the trends. We like the stability. So we'd probably lean into that sector even a little bit more so than we have in the past. Health care also big expertise, a big sector for us. The demographic trends there continue to be very, very strong. Obviously, there's things you got to be careful of in health care, but we've got an excellent track record in health care at some of our biggest wins in health care.

So I think those are probably -- there are 2 largest sectors, I think we keep leaning into those sectors. I think consumer, which is a sector for us, we've gone out of our way to be conservative and cautious in that sector and only leverage those companies, a small amount. So we think we're well protected. But I think we're going to be a little bit more careful around consumer at this point in time until we see where the latest economy heads.

Got it. I appreciate you taking my questions this morning.

Pleasure to have you Kevin cover the stuff. So with that, I think it doesn't look like we have any more questions. I really just want to thank everybody for being on the call. Today, the next quarter is the quarter ended September 30, that's our 10-K quarter. So a reminder that due to the 10-K, we usually report a little bit later, I think we're kind of targeting mid-November for the next earnings release next call. So in the meantime, we really appreciate everyone's support, and wishing everybody a great rest of the summer.

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