PennantPark Floating Rate Capital Ltd (PFLT) 2023 Q3 法說會逐字稿

Good morning, and welcome to the PennantPark Floating Rate Capital's Third Fiscal Quarter 2023 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 2023 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 is strictly prohibited. An audio replay of the call will be available 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. We're going to spend a few minutes discussing the current market environment for middle-market lending, how we fared in the quarter ended June 30, how the portfolio is positioned for upcoming quarters, the detailed review of the financials and then open it up for Q&A.

For the quarter ended June 30, our net investment income was $0.36 per share. Core NII was $0.31 per share, and that excludes $0.05 per share for a onetime dividend income related to our equity investment in Dominion Voting. Adjusted NAV, excluding the mark-to-market adjustments on our liabilities decreased slightly to $11 per share or 0.9%. GAAP NAV decreased to $10.96 per share or 1.7%. This was due primarily to valuation adjustments on a nonaccrual investment in certain equity co-investments, partially offset by net investment income in excess of the dividend.

With the debt portfolio that's 100% floating rate, we continue to benefit from the increase in base rates. As of June 30, our weighted average yield to maturity was 12.4%, which is up from 11.8% last quarter and 8.5% last year. During the quarter, we continued to originate attractive investment opportunities, and invested $80 million in new and existing portfolio companies at a weighted average yield of 12.5%. For the investments in new portfolio companies, the weighted average debt-to-EBITDA was 3.4x, the weighted average interest coverage was 2.5x and the weighted average loan to value was 25%.

We continue to believe that the current vintage of middle-market directly originated loans is excellent. Leverage is lower, spreads in upfront fees and OID are higher and covenants are tighter. We are seeing an increase in deal flow compared to the first half of 2023, and we have a growing pipeline of interesting and attractive investment opportunities. Additional capital we are raising across the PennantPark platform will allow PFLT and the JV to capitalize on the attractive lending environment.

As of June 30, the JV portfolio equaled $105 million. And together with our JV partner, we continue to execute on the plan to grow the JV portfolio to approximately $1 billion of assets. During the quarter, the JV invested $78 million in 6 new and 15 existing portfolio companies at a weighted average yield of 12.1%, including $75 million of assets purchased from PFLT. Also during the quarter, the JV closed its second CLO financing and the sixth CLO for the PennantPark platform. This new financing provides the JV with over $100 million of capital for new investments and will allow the JV to further diversify its assets, increase its balance sheet and grow its return on capital.

We believe that the increase in scale of the JV's balance sheet will continue to drive attractive low to mid-teens return on invested capital and enhance PFLT's earnings momentum. As detailed in the earnings release, we raised $99 million of equity capital under our ATM program. And together with additional leverage capacity, we have over $300 million of capital available for new investments at PFLT. The ATM proceeds will be used to fund additional investments into the JV where we are earning an attractive return as well as investments into new portfolio investments. We expect to drive growth in NII in the quarters ahead as we deploy capital into new investments and optimize the balance sheet.

As we look forward, we like being positioned for capital preservation as a senior secured first-lien lender focused on the United States, where floating rates on our loans can protect against rising inflation. We continue to believe that our focus on core middle market provides the company with attractive investment opportunities where we are an important strategic capital provider to our borrowers. We have a long-term track record of generating value by successfully financing high-growth middle market companies in five key sectors. These are sectors where we have substantial domain expertise, know the right question to ask and have an excellent track record. They are business services, consumer, government services and defense, health care and software technology.

These sectors have also been resilient and tend to generate strong free cash flow. In our software vertical, we don't have any exposure to ARR loans. In many cases, we are typically part of the first institutional capital into a company and the loans that we provide are important strategic capital that fuel the 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, we've invested over $403 million in equity call investments, have generated an IRR of 26% and a multiple on invested capital of 2.2x. 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 structure transactions with sensible credit statistics, meaningful covenants, substantial equity cushions to protect our capital, attractive upfront fees and spreads and equity co-investment. In addition, from a monitoring perspective, we receive monthly financial statements to help us stay on top of the companies.

With regard to covenants, virtually all of our originated first-lien loans have meaningful covenants, which help protect our capital. This is a significant reason why we believe we are well positioned in this environment. This sector of the market, companies with $10 million to $50 million of EBITDA is the core middle market. The core middle market is below the threshold and does not compete with a broadly syndicated loan or high-yield markets. Many of our peers who focus on the upper middle market state that those bigger companies are less risky. That may make some intuitive sense, but the reality is different. According to S&P, loans to companies with less than $50 million of EBITDA, have a lower default rate and higher recovery rate than loans the companies with higher EBITDA.

We believe that the meaningful covenant protections of the core middle market where there's more careful due diligence and tighter monitoring have been an important part of this differentiated performance. Our credit quality since inception over 10 years ago has been excellent. PFLT has invested $5.2 billion in 464 companies, and we have experienced only 18 nonaccruals. Since inception, PFLT's loss ratio is only 17 basis points annually. Our experienced and talented team and our wide origination funnel is producing active deal flow. Our continued focus remains on capital preservation and being patient investors. Our mission and goal are a steady, stable and protected dividend stream, coupled with the preservation of capital. 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 of 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, Art. For the quarter ended June 30, net investment income was $0.36 per share and core net investment income was $0.31 per share. Core net investment income excludes $0.05 per share of onetime dividend income received from our equity investment in Dominion Voting net of incentive fees. Operating expenses for the quarter were as follows: Interest and expenses on debt were $10 million, base management and performance-based incentive fees were $7.5 million, general and administrative expenses were $1.6 million and provision for taxes were $150,000.

For the quarter ended June 30, net realized and unrealized change on investments including provision for taxes was a loss of $12.9 million or $0.25 per share. The unrealized appreciation on our credit facility and notes for the quarter was $5.8 million or $0.11 per share.

As of June 30, our GAAP NAV was $10.96 per share, which is down 1.7% from $11.15 per share. Adjusted NAV, excluding the mark-to-market of our liabilities was $11 per share, down 0.9% from $11.10 per share.

As of June 30, our debt-to-equity ratio was 0.91x, and our capital structure is diversified across multiple funding sources, including both secured and unsecured debt. We have sufficient liquidity in our revolving credit facility to repay the $76 million of unsecured notes maturing in December.

As of June 30, our key portfolio statistics were as follows: Our portfolio remains highly diversified with 130 companies across 45 different industries. The weighted average yield on debt investments was 12.4% and 100% of the debt portfolio is floating rate. We had 3 nonaccruals out of 130 companies, which represent 1% of the portfolio at cost and 0% at market value. We did not put any new investments on nonaccrual during the quarter.

The portfolio was invested in 86% first-lien senior secured debt, less than 1% in second-lien debt, 4% in equity of PSSL and 10% in other equity. Debt-to-EBITDA on the portfolio is 5.0x, and interest coverage was 2.2x. The portfolio as a whole has a meaningful cushion with regard to interest coverage. On a sensitivity basis for overall interest coverage to decrease to 1.0x, base rates would need to go up 200 basis points, and EBITDA would need to decrease by 35%. This analysis is based upon the current run rate interest coverage, assuming a 5.5% base rate.

Now let me turn the call back to Art.

Thanks, Rick. In closing, I'd like to thank our dedicated and talented team of professionals for their continued commitment to PFLT and its shareholders. 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'll go to our first question from Paul Johnson with KBW.

Could you just kind of speak broadly on the portfolio, both the PFLT and maybe also just kind of across other funds that you guys manage, what kind of the trend has been in terms of amendment activity?

Yes. Thanks, Paul. Good question. Look, we've seen gradually increasing amendments either due to higher interest coverage or because of the higher interest coverage, they're not -- companies are not paying down debt as quickly. We have debt-to-EBITDA covenants, which step down. So good news, bad news. We're -- the interest rates that we're getting are very attractive 12-plus percent. And these companies, in some cases, that's taken a chunk of their cash flow out. So the amendment activity has increased, I would say, it's not dramatic. I would say it's not a spike. But I would say it's a gradual increase over time as the higher interest rates take hold.

Got it. And then in terms of like the new investments that you guys are seeing, obviously, we've kind of gone through sort of a lull in activity. I'm not sure if that's quite the same so much in the core middle market has been in the upper part of the middle market. But in terms of the deals that you are seeing on the equity co-investment side, are you guys seeing anything more interesting than you have historically, whether it be just better valuations you're getting in at or higher or larger equity co-investments? Is there anything interesting going on with the deal set that you guys have?

It's a good question. We haven't seen anything materially different in the co-invest opportunities. The market -- the M&A market is a little bit of tale of two cities. There's companies that are -- that -- but buyers and sellers feel very strongly about. They've got good growth parameters. They're very stable, steady growing. And that's city #1, where people are paying fairly high multiples and leverage is fairly high even in this high interest rate environment. And then you have the other city, which is kind of companies where there is not a consensus that the growth is there or there's a little bit of concern about economic volatility.

And those deals are tougher to get across the finish line. Sellers may still have sugar plums in their brand valuations that they were getting a year or 2 ago and the buyers aren't quite there for a variety of reasons, including higher interest rates. So nothing materially different on the equity co-invest side. We look at each one of these investments on a standalone basis, the equity versus the debt. In certain cases, we will graciously decline the equity co-invest. In other cases, we will fight hard to get more equity co-invest, and that's kind of similar. We do have a fairly well embedded equity co-invest portfolios in our vehicles, PFLT among them.

As we stated, we've had a very good 16-year track record of again, the 2.2x MOIC on those. At times, there's greater activity. At times, there's less. There's been lesser activity recently. But we're confident over time, those equity co-invests will turn into cash which we can then reinvest. So nothing materially different in short in terms of the equity co-invest opportunity.

Got it. Appreciate that. That's helpful color. And then kind of lastly, just on NII for the quarter. I know there's some -- a little bit of noise, obviously, with the onetime dividend that you guys got. But I'm curious, if I back out kind of that item, we're looking at around $0.31 per share, which is lower than where we were. Is there anything that's kind of in the quarter outside of the onetime stuff that's kind of driving NII down for the quarter? I know you guys had net repayments, so maybe the deleveraging is part of that along with the ATM issuance. But any sort of comments on what you kind of would expect, I guess, for NII to do after this quarter?

Yes, you kind of hit it right, Paul. It's the deleveraging and it's the ATM were probably the 2 primary drivers. We obviously think -- although we are aware of quarterly earnings, and it's important because it's important to you and it's important to our investors, we're thinking out in the immediate and long term. And for us, having a fortress balance sheet and having a lot of dry powder at this time, both for defensive and offensive purposes for the intermediate to long run, we think, is a good way to run the company and create long-term shareholder value. So -- we continue to be very selective. Again, in the long run, it's about credit selection.

So we continue to be very selective about credit. Some of our good credits have getting -- have gotten paid off. And certainly, the JV continues to grow. So we're selling assets from PFLT over to the JV. The JV's generating an excellent return on capital. So a combination of all of these things, but we feel very good about kind of our fortress balance sheet in this vintage and being able to, over time, achieve our target leverage of 1.5x debt-to-equity. That still remains our target. Over time, we think in the end of '23 vintage, '24 vintage, we'll be able to fill the vehicle and the JV with high-quality loans.

We'll go next to Vilas Abraham with UBS.

Maybe just a little bit more color on the quarter-to-date ATM issuance. So leverage, as you just mentioned, much lower now, below 1, the end of last quarter. Just wondering on the need to issue more quarter-to-date. Is that a signal that you guys are seeing very, very strong near-term opportunities that you want to deploy into relatively quickly? Or is it just really just kind of preparing for the longer haul?

Yes. So it's a good -- there's a little mechanical issue here, which is our ATM window closes at the end -- it closed at the end of the quarter of 6/30. The issuance that was -- that we logged as done post quarter end, those trades were executed on, let's call it, June 29, June 30, and they did not settle until early July. So that's why the extra $34 million kind of post quarter end, the trades were done kind of June 29, June 30. So we're -- that kind of wrapped up that window. We saw some interesting incoming block demand for the stock, and we elected to take it in those last couple of days of June.

Got it. That makes sense. And you mentioned the 1.5x target -- still what you're thinking. Should we think of that as a longer-term target at this point, given where you are right now with leverage?

Yes. Look, our goal would certainly be within the next 12 months. You never know what the flows are going to be. And certainly, we never want to force it, kind of you want credit -- again, credit selection is the most important thing we do. So we're not going to force it. But at the flow that we're seeing or at the flow that we believe certainly, we think over the next several quarters to 4 quarters in the outside case, we should be able to achieve that target.

Okay. And then just lastly on sales and repayments, jumped up a little bit this quarter. Any thoughts on how we should think about the cadence of that over the next couple of quarters into the back half of the year here?

Yes. So most of the sales repayments were sales to the JV. So to us, that's AOK. PFLT owns 87.5% of the JV. The JV has been generating really good return on capital given the balance sheet there. The JV has an ability to grow with the securitization CLO financing. And then we're -- again, because we are selecting hopefully solid credits, we have been selecting solid credits, you get repayments from time to time. So lumpy, hard to predict. As activity levels pick up, by and large, you'll see both repayments and you'll see new deals come on the balance sheet.

We've never had a really hard time ramping in general. We have a really good origination network and great relationships and existing incumbent portfolio of 170-some names across the platform. So -- look, again, one of the hardest things we do is select credit with balancing, a desire to generate good NII and solid dividends for our shareholders. So credit quality first, keep the balance sheet strong as part of that, be in a position to take advantage of the vintage and repayments come when they come.

We'll go next to Mark Hughes with Truist.

With respect to the CLO financing, finding any change in appetite among investors for those CLOs, steady, improved? What do you see?

Yes. In terms of middle market CLOs, some people are trying to rebrand the phrase direct lending CLOs. But whatever you want to call it, these are not broadly syndicated, these are not CLOs until it's broadly syndicated loans. Certainly, as the market gets -- started getting choppier post Fed increases, the cost of liabilities went up as well as the yields and spreads on the assets went up. So there has been a gap in the cost of liabilities, as you might imagine, in the choppier market over the last 18 months, at the same time as spreads and yields have gone up on the asset side.

We had a month or 2 of increased uncertainty during the Silicon Valley banking turmoil earlier this year, but that was -- that only seemed to last in the CLO market a few weeks and kind of levels kind of settled back to where they were pre. So liability levels have been kind of where they've been. We've printed several CLOs in the last 12 months in the middle market. And they still make a lot of economic sense in terms of return on invested capital for our JVs as well as for our third-party CLOs where there's third-party institutional investors who own the junior tranches. So -- it's been a good source of liability, particularly for books such as ours, where it's a very solid, lower-risk portfolio of senior secured floating rate loans.

Understood. On the -- you described some pretty good terms on the origination, the 3.4x EBITDA, the 25% loan-to-value. The deal flow begins picking up. What's your sense of how those -- the profile of those originations might change in a more active market, do you think this will stick around for a while? Or will that start to adjust as the deal flow picks up?

Yes, it was -- when you look at it, you say debt-to-EBITDA 3.4x, interest coverage with the higher base rates at 2.5x and a loan-to-value of 25%. I would agree with the implication of your question, which is that's abnormally good and that's terrific, and we want to grab that while we can. And the other implication of your question is, are things are going to start to normalize? And is leverage going to go up, interest coverage come down a little bit, loan to value stretch a little bit, and the answer is it's got to, particularly as the markets settle down, if this whole kind of soft landing perception becomes reality, for sure, all those statistics will normalize.

The question is -- how long will it take to normalize, how much flow will there be in that normalization process. So again, one of the reasons we want to have lots of dry powder and a fortress balance sheet is if things start normalizing and if we start to see a lot of solid core middle market M&A flow, we want to be prepared and ready to access high-quality deals that start to come. So I don't know if I answered your question there, but a little nuance, but I think that's kind of our view.

I think you proposed my question better than I did, but we'll see.

There are no other questions at this time.

Terrific. I just want to thank everybody for their participation today. A reminder that the September 30 quarter for us is our 10-K. So we'll be a little -- we're usually a few days later due to the 10-K versus the 10-Q. So we're targeting mid-November for our next quarterly earnings and conference call. And wishing everybody a healthy and enjoyable rest of the summer. Thank you very much.

This does conclude today's conference call. Thank you for your participation. You may now disconnect.