Pennantpark Investment Corp (PNNT) 2009 Q1 法說會逐字稿

(audio already in progress) PennantPark Investment Corporation's first fiscal quarter 2009 earnings conference call. At this time all participants have been placed in listen-only mode.

The call will be open for a question-and-answer session following the speakers' remarks. (Operator Instructions). It is now my pleasure to turn the call over to Mr. Art Penn, Chairman and Chief Executive Officer of PennantPark Investment Corporation.

Thank you and good morning everyone. I would like to welcome you to our first fiscal quarter 2009 earnings conference call.

I am 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 Investment Corporation and that any unauthorized broadcast of this call in any form is strictly prohibited. A replay of the call will be available by using the telephone numbers and pin provided in our earnings press release.

I would 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.

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 www.PennantPark.com or call us at 212-905-1000. At this time I would like to turn the call back to our Chairman and Chief Executive Officer, Art Penn.

Thank you Aviv. It's only been a short while since our last call in late November so our comments will be somewhat brief today and then we will open it up for Q&A at the end. I'm going to spend a minute discussing current market conditions and follow up with a discussion of our strategy.

As you all know, we are in the time of historic market volatility and increasing economic weakness. A crisis of confidence has led to forced selling and all-time low secondary market prices of leveraged loans and other high-yield instruments.

The fire sale prices imply default and recovery rates well outside the norm of historical peak levels seen during past steep downturns. Many of our competitors have been sidelined.

Much of the new deal flow driven by M&A has ground to a halt as buyers have a difficult time during financing. The outlook is uncertain as economists debate the length and depth of the recession.

With regard to the more liquid high-yield and leverage loans markets, there has been a bit of a thawing in recent weeks due to a belief that the fiscal and monetary support measures taken by the government will have some impact down the road. Additionally LIBOR has dropped significantly, mortgage rates have been lowered and some new issues of investment grade and high-yield bonds have been completed and traded well.

In January, high-yield and leverage loan indices gained about 6% and 10% respectively. That said, yields on the high-yield and leverage loans markets are still near high record levels.

We believe that the challenging market and economic conditions may last a while. We will continue to set a high bar in terms of our investment parameters and remain cautious and selective about which investments we add to our portfolio.

Our focus continues to be on companies that are more defensive in a recession, have low leverage, strong covenants and high returns. As prior cycles have proven, our new investments in this environment may end up being some of our best.

In terms of PennantPark, we're well positioned to deal with a challenging market and economic environment due to several factors. On our underlying existing portfolio, the average cash interest coverage ratio, the amount by which EBITDA exceeds cash interest expense, is about 2.5 times.

As a result, we feel that the cash flows coming out of the portfolio to us as interest income provide cushion to weather the recession. We generally expect that the cash interest coverage ratio will come down over the course of 2009 but should still be sufficient to provide stable investment income. Our investment income today exceeds our dividend.

The portfolio consists primarily of cash paid debt instruments and only has a limited amount of PIK and equity investments. Out of the 68 investments we have made since inception about two years ago, we have had only one small nonaccrual.

We had no new nonaccruals last quarter. To the extent we have more nonaccruals which is probable in this recessionary environment, we have ample liquidity to make more investments to fill in the gaps in income resulting from further nonaccruals.

From a value prospective, we have invested in companies at reasonable multiples of cash flow. As a reminder, if a company ever declines to pay us the cash interest they owe us, our debt security generally either receives better terms, higher yields and tighter covenants; or alternatively takes some form of equity ownership in the company.

On average, at cost we have created a portfolio at approximately five times EBITDA or cash flow. At the market value on December 31, debt value was 74% of cost or 3.7 times cash flow.

At the stock price of PNNT today, well below NAV, we the shareholders own a portfolio companies at a multiple of about 1.5 times cash flow. Even in a recession with potential declines in cash flow, value investors should be able to appreciate that attractive and low multiple.

The statistics we just mentioned relating to interest coverage and EBITDA multiples highlight an important point about the vintage of our investments. At cost, about 70% of our core investments to date were made after July 2007 when the credit markets started to crack.

As a result, the investments completed after July 2007 tend to be in more defensive sectors at lower leverage multiples and tighter covenants. The defensive, more recession-resistant industries include health care, defense and education. To date, the investment thesis on those companies remains generally on track.

To better align the measurement of asset and liability values, on October 1 we adopted FAS 157 and FAS 159 and now mark both our assets in our credit facility to market. There are many benefits to this alignment.

The volatility of NAV going forward should be significantly reduced. Due to this alignment, our asset coverage ratio, the amount by which our assets cover liabilities, has grown to about 300%, well in excess of the required 200% under BDC [req] and credit facility guidelines.

One additional benefit for shareholders is that due to the increase in NAV resulting from FAS 159, the effective hurdle rate on the incentive fee runs from 7% to approximately 9%, protecting shareholders should income decline.

From a net asset value perspective, from September 30 to December 31, our NAV went from $10 per share to $10.24 per share. On the asset side of the balance sheet, there was an unrealized loss from fair market value declines due to the volatile market for liquid, leveraged finance instruments. On the liability side of the balance sheet, there was an unrealized gain from the fair market value decrease of our credit facility.

Net investment income was $0.27 per share, exceeding our dividend of $0.24 per share. As we mentioned earlier, we are in good shape from the standpoint of liquidity.

We have about $140 million of our credit facility available to us as we invest going forward. Additionally, for liquidity purposes, we also have our noncore lower yielding first lien portfolio which is valued at about $47 million.

We could sell that portfolio and invest the capital in higher-yielding core assets if we choose, although many of those assets are quoted at levels that make it economically prudent to hold at this point. As we add assets at attractive yields over the next few quarters, our net investment income should grow. The primary offset to this would be potential portfolio companies that default on their interest.

An inevitable part of our business particularly in a recession is defaults. The combination of our existing portfolio and new investments over the next few quarters should position us to have a stable dividend even if we experience more nonaccruals.

That being said, to be clear, we will do our best to keep the dividend stable and potentially grow the dividend but it is not guaranteed. We have continued to improve our matching from the standpoint of fixed and floating interest rates and our asset liability mix.

As a result, if LIBOR continues to go down, our net investment income will not be materially impacted. For the quarter ended December 31, our new investment activity was extremely light.

We invested less than $1 million in total in two existing portfolio companies in order to preserve value. We committed about $500,000 in the (inaudible) loan for [great wide logistics] and invested approximately $300,000 in preferred stock of advanced (inaudible)

With regard to asset sales, we sold our $2 million position in Longview Power which was a noncore first lien investment. In terms of new deals, even though activity was light in the overall market, we did see several deals which were actionable.

Due to our (inaudible) activity and discipline, we elected not to make new company investments last quarter. We spent much of our time this past quarter focused on our existing portfolio, getting even closer to the portfolio companies and trying to understand the impact of the economic weakness on a company by company basis.

We reformulated our downside cases to see how the capital structures would be impacted. We spent time with the management teams and the financial sponsors. We spoke to experts in various industries and we attended board meetings.

Overall while we believe buyout volume will be slow for a while, there is a substantial opportunity to move up higher in the capital structure without sacrificing mezzanine and equity-like returns. We are continuing to build our origination franchise and are well-positioned to be one of a few players who can be active. We expect that some of the structures will contemplate us and others, filling the void of the senior secured market at high returns.

Many of these situations will not be driven by M&A but by refinancing, reorganizations and recapitalization of companies that need a financing solution and don't have many options. Part of that activity might be in providing debtor and possession or DIP loans to companies in the bankruptcy process.

These loans are super-priority secured loans at the highest point in the capital structure and will potentially provide returns that are historically similar to mezzanine. With regard to the secondary market, we will continue to be opportunistic with a focus on purchasing investments in high-quality companies at attractive prices.

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

Thank you Art. For the quarter ended December 31, 2008 investment income totaled $12.1 million and net expenses totaled $6.3 million. Management fees totaled $3.3 million.

General and administrative expenses totaled approximately $1.2 million. Interest and current facility expenses totaled $1.8 million. Accordingly, net investment income was $5.8 million or $0.27 per share, exceeding our dividend of $0.24 per share.

During the quarter ended December 31, 2008 net unrealized loss from investments was $42.4 million or $2.01 per share. Cumulative effect of adoption of the fair value option on our credit facility was $41.8 million or $1.99 per share.

Net unrealized gains from liabilities was $5.7 million or $0.27 per share and realized losses was approximately $900,000 or $0.04 per share. This resulted in NAV per share going from $10 to $10.24 per share.

As a reminder, our entire portfolio and our credit facility is marked to market by our Board of Directors each quarter using the exit price provided by independent broker-dealer quotation when active markets are available or by an independent valuation firm under FAS 157 and FAS 159. Our overall debt portfolio has a weighted average yield of 10.4%.

The noncore senior secured debt portfolio yielded 4.3% and the core debt portfolio select senior secured debt, second lien secured and subordinated debt yielded 11.9%. On December 31, 2008 our portfolio consisted of 36 companies and was invested 46% in subordinated debt, 30% in second lien secured debt, [30]% in preferred equity, 30% in common equity and 18% in senior secured loans.

Our core portfolio has 19 companies with an average investment size of $14.8 million and our noncore senior secured debt portfolio has 18 companies including one (inaudible) core portfolio with an average investment size of $2.6 million. With regard to the dividend, we increased our dividend to $0.24 per share in September 2008 from $0.22.

As of December 31, our run rate net investment income assuming no changes was greater than $0.24 per share. As you know, BDC's are obligated to pay out at least 90% of their net investment income.

If we make no new investment and our portfolio continues to perform, our income will continue to be higher than our dividend. Now let me turn the call back to Art.

Thanks Aviv. In summary, we are well positioned to deal with the challenging market and economic environment. Throughout our structure, we are well matched. Our underlying portfolio of companies generally have strong interest coverage that is paid to us as interest income and covers our dividend.

We have substantial liquidity to make new investments in this opportunistic environment to generate more cash flow either to pay off the shareholders or cushion for potential default. Our new investments will probably be at the most attractive risk reward we have seen in years.

However, we will continue to be selective and focus on companies and capital structures that we believe will be defensive in this environment. All of this should translate into a stable dividend stream and over time growth in net asset value.

Thank you all for your time today and for your continued investment and confidence in us. That concludes our remarks. At this time I would like to open up the call to questions.

(Operator Instructions) Sanjay Sakhrani, KBW.

Thank you. Just a quick question. Are there any companies that you're particularly worried about, like that are on your your watch list? Just wanted to get a sense of kind of -- I know there's that one trucking company but was there anything else that you were monitoring that was hitting up against some kind of covenant? Thanks.

Thanks Sanjay. You know, look, we're clearly and no surprised still focused heavily on Realogy and Swift which we are both pre-July '07 deals of cyclical companies that have the markdown very substantially and are reflected in the NAV. And that would have a potential significant impact on our income.

So we're monitoring them very closely and we feel like there's a substantial shot they will come out of it but I think a good skeptic should say that one or both may default at some point in '09 or later. So we are spending a lot of time on those companies and we think we are aligned in the right way with the shareholders of both of those companies where they would lose significant equity capital to the extent they stop paying us interest and default on those debt instruments.

So those are still on watch. And certainly anything in the consumer space is certainly on watch and we have some names in our first lien noncore portfolio in the betting space that are on watch and home-building related like Jacuzzi. So those are on watch. So the stuff you would expect to be more challenged right now is on watch and again, accurately reflected we think thus far in the NAV of the Company.

Okay great. And then maybe you can just talk a little bit about the dividend. Should we expect it to ramp with NOI or would you be inclined to maybe retain some given the environment we are in?

I think for '09 given the environment, we are going to create some cushion over the course of '09. And if we -- hopefully everything goes according to plan. If we have to pay out a special dividend at the end of the year to maintain the 90% plus, we will. But in this environment, we think it's prudent to keep the dividend where it is, create cushion and see how the economy behaves.

Greg Mason, Stifel Nicolaus.

Good morning gentlemen. Could you talk about what level of deployable capital you're comfortable with? I guess with the new FAS 159, essentially every dollar debt you borrow right now is being marked at $0.70 on the dollar. So theoretically you could borrow nearly all of that's left on your $300 million revolver and be within the one-to-one debt to equity. But that's probably not prudent. So what level of borrowings are you comfortable with and view as your deployable capital level?

Just so you understand, it's not only the credit facility. We have our noncore portfolio of first lien which is valued at about 45, $47 million. So that gets you to $[180-ish] million of total deployable capital. We're never going to want to be up against it. We're always going to want to have cushion.

We're nowhere near it. To us we're just value investors. We do it deal by deal and want to find a good deal and if we don't find a good deal, we won't do anything. So we are coming -- we have this recession right now we're going through.

We're going to keep plenty of liquidity. We can't give you a scientific answer. We're always going to want to have a 10, 20% at least cushion of available dry powder just for whatever reason in our system. But I can't really give you an exact exact answer right now on that. But hopefully I have given you enough guidance to answer your question.

All right, so since you have capital and you're not really constrained by the covenants, what is keeping you on the sidelines today and what will you be looking for to put new money to work?

Just to give you snapshots, the quarter ended 12-31 was very slow. Obviously everyone was just dealing with the turmoil that was going on in the market. Middle market M&A really slowed down and we saw some deals that we could have been actionable for us. We were very selective.

And we think there will be some middle market M&A during the course of '09 and we look to finance those either in the mezzanine format or in a unitrage form where we're buying a security that is a combination of first lien and mezzanine. We're focused there on industries that we think will be very recession resistant and where we think leverage will be low -- 3, 3.5 times total leverage, maybe 4 if it's really, really a special situation; covenant strong, good yields.

We're focused mostly on credit being safe and secure in this environment. As I said in the scripted remarks, there's also substantial opportunity potentially this year in '09 for senior secured super-priority DIP loans, debtor and possession loans, of companies that are in bankruptcy, that these loans are kind of protected as part of the bankruptcy process.

And you know, there's a real void of capital for those loans in this environment and we can be potentially super-priority and get mezzanine-like returns in this environment for those types of loans. So as we see more restructurings and bankruptcies come through the system in '09, that will be a nice opportunity for us.

Great; and Art, this is Troy. If you could comment real quick -- we know we heard early in January that the IRS cleared the way for RICs to use common stock even below book value for up to 90% of the dividend and we have heard rumblings that the SEC is soon going to clear the way to allow that to happen. What is your view on using common stock to pay the dividend at current levels?

Look, there's our situation and there's the industry situation. I mean we are in pretty good shape. We're more than earning our dividend today.

So in this environment for us, we wouldn't really need that. The only situation for us where it might be helpful is our float is very small. And we would like at some point to -- we think it would be helpful for the stock to have more float. But given our earnings stream at this point versus our dividend, it wouldn't really be applicable to us.

However, we are a BDC and we are in an industry and you know in our editorial opinion, the best thing for the industry would be that everyone work to get matched, right? So where income and dividends paid out can be matched on a cash basis and where assets and liabilities can be matched.

And where BDC's have gotten into trouble and could get into trouble is due to mismatch between assets and liabilities and income and dividends. So it would be helpful for the industry certainly if the industry had the ability to get from a mismatch situation to a matched situation. Fortunately for us, we're pretty well matched throughout.

James Stone, PSA Advisors.

Good morning gentlemen. Nice job. If the [Realogy] and Swift are such problems, why not sell some of the debt if there's truly marked to market and take that risk out of the portfolio?

That is a great question and certainly in hindsight we should have sold them at a different level. That has been a mistake of ours. But they're trading at very low levels now, call it $0.10, $0.15 on the dollar and we're earning a substantial amount of income from those two names.

So we think from a value standpoint, there might be more upside. The market is valuing them as if they are certain to default. We do not think so. But a proper skeptic such as yourself might say you know what? Let's just say they do default and they stop paying interest, does PennantPark have the liquidity and the ability to fill in the gaps in income if those companies default?

So, we think there's a shot they don't default but they might. We believe we have got more than enough liquidity to fill in the gaps in income and to potentially even grow income over time as we work through '09 and '10. But that's a great question. Thank you.

Now the other thing, it looks like the investment portfolio has come down very roughly 45, $50 million quarter to quarter. Can you give us a feel which companies -- because we will see it in in the Q obviously when it gets released but (multiple speakers)

The Q was released last night. So if you don't have it, we can make sure you get it. But the Q was last night. Look, the marks are across the board.

Some companies perform very well. Certainly as you look at vintage and we talked about vintage, the deals that were done post July '07 that had lower leverage and more defensive industries, the underlying performance has been better than the deals that were done before that time period.

But there was no big markdown? It was just kind of across the board type of thing?

No, Realogy and Swift continued to be marked and marked down significantly as I said a moment ago. Those are in the $0.10, $0.15 on the dollar range.

They were about 30% at the September quarter.

Yes, so those came down significantly.

That was the bulk then of the markdown?

It was across the board. You can look at it it. If you want to go through the Q and give us a shout later --.

Great, why is the core yield down? Again, I'm talking sequentially.

LIBOR came down significantly during the quarter. So you know, we do feel we're fairly well matched from a LIBOR standpoint. Our credit facility is in LIBOR and a chunk of our assets are in LIBOR. So from the net investment income standpoint, we are fairly well hedged but LIBOR coming down did hurt the overall net investment income -- or excuse me -- the topline, the income line.

Expenses I see were up about $300,000. What was the (technical difficulty) behind (technical difficulty)

That is just accrual accounting. What happened was we got to the end of last year and we realized we probably over-accrued a little bit for actual expenses. So that's why last quarter they were probably a little lower than this quarter where we are accruing again for the new fiscal year.

Great. No, one other question here. We were talking about the interest ratio being high, the cash flow to interest. Could you just give us some flavor how that is spread across companies? I mean (multiple speakers)

2.5 is probably the middle of the bell curve. We have got some including some of our ones we're watching that are kind of below 1.5 times and then we have got some that are three to four times. But 2.5 is a fairly good middle of the bell curve number.

Can you give us some idea of what one SIGMA is on that bell curve then or is it a uniformly shaped bell? Again, some flavor on --.

Yes, it's pretty uniformly.

I'm sorry?

Think of it is a traditional bell curve where at the low you're kind of that 1.3, 1.4 times. At the upper end you're at call it 3.5 to 4 times.

Very good. I will get back in the queue. Thank you.

(Operator Instructions) [Rolf Rubin], (inaudible) Corporation.

[Inaudible question - microphone inaccessible]

(Operator Instructions)

Yes, the [debtor] script right now seems to be to change debt into equity or to move debt, give up debt to kind of get a more secure position in the capital structure. I was wondering, are you being approached a lot in that area and kind of what is your philosophy? And then specifically, has Realogy approached you about anything like that?

Well the one default we have had or one nonaccrual we have had thus far is Greatwide which is a logistics company. They are in Chapter 11.

We have had the option to sell that security at $0.50, $0.60, $0.40 on the dollar over time. We've elected in that particular case to roll along with the bankruptcy and convert our debt to equity because we think over time our shareholders will get a better return from doing that.

But it really is a case-by-case basis. I mean it's kind of we have to develop our investment pieces and determine whether we are a seller and just going want to get out or whether we want to roll along and we think we're going to get more value for shareholders by working through the bankruptcy process.

Realogy did try to do an exchange a couple of months ago. There was some litigation and ultimately they elected not to go through with the exchange.

We generally on that particular situation, we were not supportive of that exchange for us. We like it when sponsors if they want to redo a deal actually inject equity along with that, restructuring as opposed to just saying you have an option to restructure. So we were not supportive of that deal for us.

That is all the questions that we have time for right now. I will go ahead and I'll turn it back to Mr. Penn for any additional or closing remarks.

I want to thank everybody for listening in today and we will talk to you in a few months when we release our next Q. Thank you very much.

Ladies and gentlemen, that does conclude today's teleconference. We would like to thank everyone for their participation and wish everyone a great day.