PennantPark Floating Rate Capital Ltd (PFLT) 2024 Q1 法說會逐字稿

Good morning and welcome to the PennantPark Floating Rate Capital's first fiscal quarter 2024 earnings conference call, today's conference is being recorded.

(Operator Instructions) This is now my pleasure to turn the call over to Mr. Arthur Penn, Chairman & Executive Officer of PennantPark Floating Rate Capital.

Mr. Pen, you may now begin your conference.

Thank you, and good morning, everyone, and I'd like to welcome you to PennantPark Floating Rate Capital's First Fiscal Quarter 2024 earnings conference call.

I'm joined today by Rich Allorto, our Chief Financial Officer; Rich please start off by disclosing some general conference call information and included discussion about forward-looking statements.

Thank you, Arth.

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 and 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 those projections.

If 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 2129051000

At this time, I'd like to turn the call back to our Chairman and Chief Executive Officer, Arthur Penn.

Thanks, Rich.

We're going to spend a few minutes discussing the current market environment for middle-market lending, how we fared in the quarter ended December 31, how the portfolio is positioned for the upcoming quarters.

A detailed review of the financials then open it up for Q&A.

For the quarter ended December 31, GAAP and core net investment income was $0.33 per share.

GAAP and adjusted NAV increased 0.6% to $11.20 per share from $11.13 per share.

The increase in NAV for the quarter was due primarily to the positive valuation adjustments on both debt and equity investments.

As of December 31, our portfolio grew to $1.3 billion or 19% from the prior quarter.

During the quarter, we continued to originate attractive investment opportunities and invested $303 million in 13 new and 34 existing portfolio companies at a weighted average yield of 11.9%.

For the investments in new portfolio companies, the weighted average debt to EBITDA was 3.8 times the weighted average interest coverage was 2.4 times and the weighted average loan to value was 51%.

On average, we have seen a 25 basis point tightening on first lien spreads.

However, we continue to believe that the current vintage of core middle market directly originated loans is excellent.

Leverage is lower spreads in upfront OIDR higher covenants are tighter than in the upper middle market.

Despite covenant erosion in the upper middle market in the core middle market, we are still getting meaningful covenant protections.

Our deal flow continues to be very active.

And since quarter end, we invested $103 million into new and existing investments.

As of December 31, our debt to equity ratio was 1.02 to 1 with a target ratio of 1.5 to 1.

We believe that we are well positioned to drive additional growth in net investment income going forward.

We expect additional growth in NII in part to be driven by our investment in the joint venture.

As of December 31, the JV portfolio totaled $837 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 $76 million in four new and nine existing portfolio companies at a weighted average yield of 12.3%, including $75 million of assets purchased from PFLT.

We believe that the increase in scale of the JV's balance sheet will continue to drive attractive mid-teens returns on invested capital and enhanced PFLT's earnings momentum.

Credit quality of the portfolio was stable.

We had no new non-accruals in the quarter ended December 31, and we restructure to investments that were on non-accrual resulting in their return to accrual status.

As of December 31, the portfolio's weighted average leverage ratio through our debt security was 4.8 times.

And despite the steep increase in base rates during 2023.

The portfolio's weighted average interest coverage ratio at December 31 was 2.1 times.

In an uncertain market environment.

We liked being positioned for capital preservation as a senior secured first lien lender focused on the United States.

We continue to believe that our focus on the core middle market provides the company with attractive investment opportunities where we provide important strategic capital to our borrowers.

We have a long-term track record of generating value by successfully financing growing middle market companies in five key sectors.

These are sectors where we have substantial domain expertise.

Now the right questions to ask and have an excellent track record.

They are business services, consumer government services and defense, healthcare and software and technology.

These sectors have also been resilient and tend to generate strong free cash flow.

Approximately 12% of our portfolio is in government services and defense, which is a sector with strong tailwinds in this geopolitical environment, our software vertical and in our software vertical, we don't have any exposure to ARR loans to core middle market, which is companies with $10 million to $50 million of EBITDA is below the threshold and does not compete with a broadly syndicated loan or high-yield markets, unlike our peers in the upper middle market in the core middle market because we are in 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 spreads upfront OID and equity co-investments.

Additionally, from a monitoring perspective, we receive monthly financial statements to help us stay on top of the companies with regard to covenants, unlike the erosion in the Upper Middle Market, 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.

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 a higher recovery rate than loans to companies with higher EBITDA.

We believe that the meaningful covenant protections of core middle market loans, more careful diligence and tighter monitoring had been an important part of this differentiated performance.

Our credit quality since inception over 13 years ago has been excellent PFLT has invested $5.6 billion in 481 companies, and we have experienced only 18 non-accruals since inception PFLT has loss ratio on invested capital is only 13 basis points annually as a provider of strategic capital that fuels the growth of our portfolio companies.

In many cases, we participate in the upside of the company 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 December 31, we have invested over $448 million in equity.

Co-investments have generated an IRR of 26% and a multiple on invested capital of 2.1 times.

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, our 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 Rich, our CFO, to take us through the financial results in more detail.

Thank you, Arth.

For the quarter ended December 31, GAAP and core net investment income was $0.33 per share.

Operating expenses for the quarter were as follows.

Interest and expenses on debt were $8.9 million.

Base management and performance-based incentive fees were $7.8 million.

General and administrative expenses were $1.6 million and provision for taxes were $154,000 for the quarter ended December 31.

Net realized and unrealized change on investments, including provision for taxes, was a gain of $3.1 million or $0.05 per share.

The unrealized appreciation on our credit facility and notes for the quarter was $0.1 million as of December 31, our GAAP NAV was $11.20 per share, which is up 0.6% from $11.13 per share last quarter.

Adjusted NAV, excluding the mark-to-market of our liabilities was $11.20 per share, up 0.6% from [$11.13] per share last quarter.

As of December 31, our debt to equity ratio was 1.02 times, and our capital structure is diversified across multiple funding sources, including both secured and unsecured debt.

During the quarter, we used liquidity from our revolving credit facility to repay the $76 million of unsecured notes that matured on December 15.

As of December 31, our key portfolio statistics were as follows.

Our portfolio remains highly diversified with 141 companies across 33 different industries.

The weighted average yield on our debt investments was 12.5% and approximately 100% of the debt portfolio is floating rate. [Pick] income equaled only 2% of total investment income.

For the quarter, we had one non-accrual, which represents 0.1% of the portfolio at cost and 0% at market value.

We did not put any new investments on non-accrual during the quarter.

The portfolio is comprised of 86% first-lien senior secured debt less than 1% in second lien debt, 4% in the equity of PSSL and 9% in other equity.

The debt to EBITDA on the portfolio is 4.8 times and interest coverage was 2.1 times.

Now let me turn the call back to Arth.

Thanks, Rich and 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) Brian McKenna, JMP.

Great.

Thanks.

Good morning, everyone.

So it's good to see the pickup in origination activity during the quarter and then it seems like this momentum is carried into the new calendar year.

So what's the base case expectation for investment activity looking out over the next few quarters?

And then when you look at the new portfolio companies, you've invested two more recently.

Where does the majority of these investments sets from a sector perspective?

Thanks, Brian.

Good morning.

I'll just I'll answer the second first, the sectors remain the same.

We're doing quite a bit in government services and defense, which, as you might imagine, is an act sector.

We're doing quite a bit in health care in sectors of healthcare that we like that have strong free cash flow and that are that are performing.

And then just running the gamut of business services are kind of where we've been most active recently in terms of expectations, it's a great question.

Of course, we don't really know.

We do believe that 2024 will be an active year.

Overall, certainly in the first calendar quarter of '24, it's been more active than normal.

Usually the first calendar quarter is light from the standpoint of activity level.

We had been more of a moderate our activity for us of Q1.

So, you know, kind of we do believe as you as you know, if we're sitting here a year from now, will be an act with 2024.

I don't know what the ensuing quarters will bring data.

Helpful.

And then maybe just a follow-up on leverage increased pretty meaningfully in the quarter, but that's from a pretty low base in the prior quarter.

So you're sitting at about one times today.

It's still kind of at that lower end of the range so I guess how should we think about the trajectory of leverage from here?

And then I guess, again, what scenario or deployment environment would ultimately drive leverage notably higher from here yes.

So with Ericsson, our long term target is still about 1.5 times area of leverage for this portfolio, which is a lower risk first lien portfolio.

Look, we take it as it comes.

We have a nice a in essence, war chest right now.

We believe that this vintage is likely to continue to be a great vintage.

You will share with you some of the credit stats and low leverage and good loan-to-value and high interest coverage that we're getting in this vintage.

So we're going to trying to be active when we can find high-quality deals.

We're still highly selective about what fits our box.

As you can tell.

We've refined our box over time and we've gotten to be better and better over time, which results in kind of the low non-accrual rate that we've been seeing and good credits that.

So when do we get to 1.5 times leverage again, that goes back to kind of expectations around origination where the markets are, et cetera.

But we feel good having this nice war chest being able to take advantage of an excellent vintage.

And you know, if we can earn these kinds of NIIS and ROEs are less levered, hopefully others.

There's some really nice upside for our shareholders as we judiciously deploy over time.

Okay, great.

I'll leave it there.

Thank you.

Paul John, KBW.

Yeah, good morning.

Thanks for taking my questions.

Tom, you sort of answered my question there of sort of on your outlook for activity.

And just I mean, I'm curious is still given recent quarter a what drove the higher originations?

And was it just the attractive lows that you saw?

Or was it anything due to kind of timing, things pending, et cetera?

It's really all just on what drove the high activity in Q4?

Yeah, and it's a good question.

And you know, our business model is one where in many cases we're providing that initial loan to a company that's a platform investment for private equity sponsors who sees a growth opportunity typically add on acquisitions in a particular industry or sector on.

So much of this was not refinancing or opportunistic financing, which is probably a lot of what you see in the upper middle market.

Vast majority of this is kind of platform deals.

And then the add on the add-on investments to fuel the growth of these sectors.

So, you know, typical DNO investment for us, we'll start out with a company that does 20 of EBITDA, but the goal is to get it to 40 or 50 or higher over time, we make our initial platform alone and then we become their strategic partner.

And you saw quite a bit of a kind of add-on incremental up to late draw activity.

And that's kind of that's a big part of what we do and remains.

So kind of certainly, overall M&A trends are important around here, but in many cases, this is driven by fundamental opportunity in particular sectors where our private equity sponsor partners are finding, you know, areas of opportunity.

So in our kind of active active Q4 calendar Q4, and that's where we remain active, not as active, we're not as active as they were in calendar Q4.

We're active, but not the.

And I'd say we're moderately active as we speak on, but that's just fine.

You know, we're not in a rush to deploy capital.

We want to be careful and judicious and selective.

And we've learned I've learned a lesson that if you force investment that always backfire.

So we're taking a one deal at a time.

Yeah, thanks for the detail on that.

That's very helpful.

And then I mean, are these investments that you would expect to probably hold onto or are these going to fine there?

We ended the JV?

Yes.

So it's a good question.

The JV typically kind of takes a pro rata piece to extent it has liquidity and does pro rata piece of the deals that we originate the JV has a couple hundred million of liquidity.

So over time, you know, much of what's what's new will find its way into the JV, which is a highly diversified portfolio.

And certainly, it's certainly been a nicely accretive vehicle for PFLT shareholders and and we hope it continues to be so that.

And then my last question was just on the large increase in equity investments this quarter.

I'm just curious if there was any kind of significant investments that you guys made in the quarter that drove that?

Or was that just more of a function of the higher activity and co-investments that you received during the quarter?

Yes.

No, there were there was just a really a function of the high activity.

And in many cases, we say we will co-invest in the equity and we are starting to see thankfully, some some repayments and many of those repayments are actual exits where we hope to be rotating a successful equity co-investments that we've made in now.

There's one that just closed the other day, which is a three times MLIC.

So we're starting to see harm some rotation, which is nice.

But again, this will go back to kind of deal activity.

You know, kind of what's overall deal activity is a good time to exit or the sponsors who've been holding on.

Are they going to exit and take the wind?

Are they going to hold on?

So I do expect as things get busier, we'll be able to rotate that equity portfolio from existing names into new names.

Thanks for the detail, and congratulations on a good quarter.

Thank you.

Mickey Schleien, Ladenburg.

Yes, good morning, everyone.

A part of this quarter's fee income was the highest it's been in a couple of years.

Were there any outsized pre-payment fees in the activity this quarter or what else could have caused that amount?

It was just a lot.

There's just a lot of activity that was one or two amendments that were bigger pieces of it, but it was not it wasn't the main driver.

So there was just and I have quite a bit of activity like that.

We had quite a bit of new loan activity, which has been an active quarter overall.

Okay.

And in terms of your unfunded commitments in the Q, it says it's about $270 million.

What proportion of that is at the discretion of the portfolio companies?

So it's about 50-50 revolver and delayed draw.

All right.

So the revolvers are at the company's discretion to delay draw.

Typically they have to meet some kind of covenants or performance thresholds.

And you know, as and they have to find out on deals.

Typically that's why they do delay draws is because of they want to consolidate a particular industry.

And as we found in times of turmoil like COVID or even back in the GFC, although delayed draws were lesser a part of it then in times of turmoil is many borrowers will we'll borrow from the revolver, but delayed draw activity will go to zero because there's no add-on acquisitions.

So if you look at the couple hundred million that we have, it's about half and half, if there were to be any kind of a COVID type or emergency scenario, you know, the revolvers would not maybe not be fully drawn, but at least half drawn, but the delay draw activity would would go to zero Okay.

Fair enough.

I'm talking about the right side of the balance sheet or you're now in a position where about three quarters of your debt liabilities are in the credit facility at floating rates, are you comfortable leaving it that way and potentially taking advantage of declining rates later this year, or are you looking at issuing some more unsecured debt and unlocking some of the capacity from the revolver.

I think before unsecured debt as the CLO securitization technology is a really good liability management tool, particularly for these lower risk first lien loans so on the I know your middle market CLOs are kind of becoming a darling in the CLO market.

And you may know this I know you kind of cover CLOs making and we have we have a very good track record of a CLO middle market manager in our BDCs in our JVs and as well as for third party investors.

So probably step one to create liquidity for the revolver is a securitization.

And then, of course, we're always looking at the unsecured markets.

We have a big slug of unsecured paper that doesn't mature until 2026.

That's a four handle.

So we're in no rush with yields coming down.

We can be opportunistic about unsecured.

It certainly is part of the tool chest, but we don't really need it right now, particularly when we can get for efficient securitization financing.

And Art, if you were to do a new series securitization through a CLO structure, any sense of where that would be priced in today's market?

Yes.

I mean, it would probably be low 200's-ish to 230-ish

Okay.

That's interesting.

Those are all my questions this morning.

Thank you for your time.

Thank you, Mickey.

Mark Hughes, Truist.

Good morning.

Some argue described a pretty good interest coverage 2.1 times.

I think for the portfolio continue to think about though what proportion may be closer to one time or below?

And any sense on how you think of credit will trend over the next 6, 12 months?

Yeah.

So I don't have it at our fingertips the end of the lower interest coverage, but there's a handful of deals, you know, well over 100 deals, 100 loans.

I mean, there's always going to be a handful of loans that our underperforming, we have that two, I'm going to call it.

It's only handful, which to me means around three to five to six that are kind of on a major watch and they show up.

If you look at the mark-to-market and fair value Phil, you'll be able to ascertain which ones there are some.

But by and large, it's really kind of a very clean portfolio at this point.

Is this going to persist or are things going to fray as high interest costs continue to eat away quite possibly.

I mean, this has been a very benign environment, certainly for us and maybe for the market is it going to stay benign for the long term, though?

Unclear certainly we should assume that it's not going to be as benign as it has been, but the economy seems strong and certainly if and when interest rates start coming down, the Fed starts easing that will create some cushion in some of the capital structures that are a little tighter that are kind of grinding away here, you know, kind of with tighter coverage.

So right now, we're in a pretty good position.

You've seen some very low non-accruals there.

Again, only a handful of names that are kind of more on the severe watch list.

But you know, we're staying watchful and cautious and certainly on the new deals that we're doing and we shared with you that the credit stats were finding some really great lower risk, attractive return investments.

And as the portfolio grows and gets populated with this vintage of some of the handful of deals that are underperforming or become even less significant in the overall scheme.

Yes.

Understood.

And then you mentioned the covenants you think you're seeing erosion at the upper end of the market, you're holding pretty firm that those covenants.

How do they compare to what you might have seen the normal course of business of, say, pre COVID.

So pretty rich, you are going to see some erosion even perhaps within your your packages?

Yeah, I'd say we're kind of back to kind of pre-COVID levels with reasonable questions that protect us on that on when we do get the monthly financial statements.

So I'd say we're back to pre-COVID.

Certainly, if you look at 2022 and early '23, it was tighter.

We could get tighter.

And I kind of we kind of said that spreads have come down '25.

I think in line with that, the covenants are kind of normalizing to pre-COVID.

So if you remember going into COVID, we had at that point across our book, about 150 loans across our platform and between the quarterly maintenance test that we had and had and the monthly financial statements that we get that they were obligated to be shared with us week we could during a COVID ended during a COVID scenario, really get to the table early because of the quarterly maintenance tests, which you know of many of the sponsors and companies knew that they were not going to make.

And because they have to share with us, the monthly financial information really got us to the table early to tell be proactive and then figure out how to solve problems and figure out what liquidity was needed.

So we're back to the pre-COVID covenants and the information rights, which really was worked out very well for us in the core middle market.

You know, when when COVID hit and some of the 150 deals loans that we had across our portfolio, just to refresh, 15 of those were about 10%, actually needed cash liquidity to get through COVID.

And in all of those cases, the sponsored offer to put capital in to solve the problem.

So that's the benefit of monthly information rights, quarterly maintenance covenants.

When we talk about the core middle market versus the upper middle market and the pluses and the minuses and now we really like this core middle market where these protections and information rights really kind of get us to the table quick.

Thank you very much.

Vilas Abraham, UBS.

Hey, everybody.

I just had a question on repayments.

Can you share any kind of line of sight that you have into repayments prepayments for the first half of the year, but presumably origination activity continues to be strong in rebates should pick up as well.

And just kind of talk about that and if that would be a bit of a impediment getting to your leverage goals?

Yeah.

Look, we are starting to see repayments.

It's not a wave there and they're not there.

And certainly nowhere near being equal to our originations on the repayments indicate that M&A is it may be starting to percolate a little bit.

Some pluses and minuses.

We get repaid.

We we say thank you very much for repaying us because sometimes they don't.

So we're very appreciative when we get repaid.

And in many cases, that also means working at ringing the cash register from the equity co-investment side.

So some of that is starting to happen, which we're happy with.

And as I said, we're originating new deals like again, we don't sit here and say, see, we got to get to 1.5 times because the research community wants to see it happen in their model in the next 10, two or three quarters we tried to and what we do is each deal has to make sense on its own two feet.

It's a very rigorous process that we go through and we'll get there when we get there.

You know, we're healthily beating our dividend even as we speak in an under-levered environment and also in an environment where JV is also now fully deployed.

So we're earning a healthy cushion to the dividend.

We think the rest of this, whether it be on balance sheet leverage or the balance sheet balance sheet JV kind of gives us a war chest Select, hopefully great deals in what should be what remains what we think a really good vintage.

So we'll get there when we get there.

We're not in a rush because we know if you're in a rush, then that usually doesn't work out well and the deal flow will come.

We think 2024 will be an active year.

Okay.

Great.

And then just my other question, just on a on yield and spread dynamics.

Look like come, take your Q4 average yields for new deals were 11.9%.

The average portfolio is higher than that, but then quarter to date yields, I think I saw around 13% on a weighted average yield.

But can you just kind of talk about what looks like a little bit of choppiness there and kind of what and what to expect trend-wise there in the near term?

Yeah, that's a typo 13% to typo.

It's closer to 12% for quarter to date.

So that's very much in line with what we've been doing.

Got it.

Okay.

Thank you.

We do not have any further questions in the queue.

I will now turn the call back to Mr. Arthur Penn for closing remarks.

Thank you.

I want to thank everybody for their participation.

We look forward to speaking to you next in early May.

This concludes today's call.

Thank you for your participation.

You may disconnect.