Pennantpark Investment Corp (PNNT) 2016 Q1 法說會逐字稿

Good morning and welcome to the PennantPark Investment Corporation's First Fiscal Quarter 2016 Earnings Conference Call.

Today's conference is being recorded. At this time, all participants have been placed in a listen-only mode. The call will be opened 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. Mr. Penn, you may begin your conference.

Thank you and good morning, everyone. I'd like to welcome you to PennantPark Investment Corporation's first fiscal quarter 2016 earnings conference call. I'm joined today by Aviv Efrat, our Chief Financial Officer.

Aviv, please start off by disclosing some general conference call information and included 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 a property of PennantPark Investment Corporation, and that any unauthorized broadcast of this call in any form is strictly prohibited. Audio replay of the call will be available by using the telephone numbers and PIN provided in our earnings press release, as well as on our website.

I'd like also 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 www.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.

Thank you, Aviv.

I'm going to provide an update on the business starting with financial highlights, a discussion of our energy portfolio, followed by a discussion of the overall market, the overall portfolio, investment activity, the financials and then open it up for Q&A.

For the quarter ended December 31, 2015, we invested a $130 million at an average yield of 11.9%. Expected IRRs generally range from 13% to 18%. Core net investment income excluding one-time taxes was $0.25 per share. Given the continued headwinds and volatility, for the last several quarters, we've been focused on our energy portfolio, which includes those companies in our schedule of investments listed as oil and gas and energy and utilities. We intend to continue to work with our portfolio companies to maximize our long-term recovery and to provide these companies with runway to weather this tumultuous period.

As of December 31, 2015, our energy portfolio had a cost and fair market value of $226 million and $125 million, respectively. This represents 16% of the cost and 10% of the market value of the overall portfolio, respectively. Valuations on our energy investments fell by $42 million from the quarter ended September 30, 2015, representing $0.58 per average share. As we have mentioned previously, independent third-party valuation firms value all of our non-actively quoted investment.

Many have asked us, what happens to NAV and NII, if our energy investments are completely written off. While we do not think our energy investments are worthless and we believe they are fairly valued, as of December 31, NAV would have been $7.28 per share, if all the energy investments were written off. If all the energy investments were put on non-accrual, NII would decrease by less than $0.05 per share per quarter.

As shareholders and managers, we are disappointed with the performance of our energy portfolio and intend to work diligently to recover our capital on our energy investments and to grow our NII back to historical levels. We do not believe that the short run option of selling attractive assets at fire sale prices is prudent. In this challenging environment for oil prices, we intend on taking an approach that will maximize value in the long run.

We do not see the turmoil in the energy space easing in the near term. For the quarter ended December 31, management waived management and incentive fees equal to the percentage of the cost value of our energy portfolio, 16%. This waiver amounted to $1.6 million representing $0.02 per share. After discussions between management and our Board, management has agreed to extend their waiver arrangement and will waive 16% of its management and incentive fees for the next four quarters through December 31, 2016. We believe that this waiver demonstrates a strong commitment to our shareholders and our focus on our energy portfolio.

In addition to this fee waiver, two other positive factors are helping to offset the energy issues. First, subsequent to quarter end, Z Wireless or AKA Diversified was sold and we realized a capital gain of $3 million or $0.05 per share, and prepayment fees of $6 million or $0.08 per share of other income. Other income is a category that we have in our income statement to represent prepayment fees or waiver and amendment fees that are not part of ongoing interest income. Other income has averaged $0.04 per share per quarter over the last few years.

Second, in December, SBIC legislation was passed, which raised the amount of available borrowings to $350 million, which will enable us to continue to use this program and create value for our shareholders. We are finding attractive investments for our SBICs and believe that our SBIC licenses will enable us to avail ourselves of that capital. Since quarter-end, we have started borrowing on our SBIC II facility. We look forward to fully utilizing the [upsides of $150 million] of borrowing capacity in SBIC II and utilizing an additional $50 million of borrowing capacity in a potential SBIC III.

With regard to our dividends, our Board regularly evaluates the earning power of the Company relative to the dividend. Our substantial spillover cushion, which was $0.53 per share as of last September 30, the fee waiver through December 31, 2016, substantial other income from prepayment fees and SBIC usage give us the flexibility to continue to evaluate our portfolio and the market without rushing to make a decision on any change to the dividend at this point.

With regard to the market, the economic signals are mixed. With regard to the more liquid capital markets and in particular the leveraged loan in high-yield markets, during the quarter ended December 31, those markets softened as high-yield and leveraged loan funds experienced outflows due to expectations of Fed tightening, turmoil in the energy market and weakening Chinese economy. This has impacted the tone of the middle market and has generally resulted in a better opportunity to invest in attractive risk reward.

As debt investors and lenders, a flat economy is fine, as long as we've underwritten capital structures prudently. A healthy current coupon with deleveraging from free cash flow over time is a favorable outcome for us. We remain focused on long-term value and making investments that will perform well over several years, and can withstand different business cycles. Our focus continues to be on companies and structures that are more defensive, have low leverage, strong covenants and high returns.

As credit investors, one of our primary goals is preservation of capital. If we preserve capital, usually the upside takes care of itself. As a business, one of our primary goals is building long-term trust. Our focus is on building long-term trust with our portfolio companies, management teams, financial sponsors, intermediaries, our credit providers, and of course our shareholders.

We are a first call for middle market financial sponsors, management teams and intermediaries, who want consistent credible capital. As an independent provider free of conflicts or affiliations, we've become a trusted financing partner for our clients. Since inception, PennantPark entities have financed companies backed by over a 150 different financial sponsors. We are excited to be approaching this improving investing market with substantial financial and human capital across our platform.

From the standpoint of financial capital, we have SBIC-enhanced liquidity in PNNT. Our sister company, PennantPark Floating Rate Capital, has recently nearly doubled its financial resources due to the merger with MCG Capital. With regard to human capital, we've made investments in senior and mid-level investment professionals across different geographies. With senior investment professionals in the Midwest, West Coast, Texas and London, our geographic footprint has broadened. All of these senior professionals have worked with us in the past and come onboard sharing our culture. As a result, we should be able to drive significantly enhanced deal flow as PennantPark entities get more looks, and can be even more relevant to our borrower clients.

We continue to make significant progress on our stock buyback program. Last quarter, we purchased about 1.2 million shares for about $8.4 million, bringing our total purchases so far to 3.3 million shares for approximately $26 million.

Our portfolio is constructed to withstand market and economic volatility. In general, our non-energy portfolio is performing well. We have cash interest coverage ratio of 2.4 times and a debt-to-EBITDA ratio of 4.8 times at cost on our cash flow loans.

Additionally over the last 12 months, the percentage of the portfolio that is in first lien secured assets has increased from 28% to 38% reducing the risk of the underlying portfolio. We are pleased that we have diversified funding sources with several features that reduce overall risk to the Company.

First, we have $321 million of long-term unsecured bonds and have only utilized about 25% of our long-term $545 million credit facility. Second, as we discussed, we intend to utilize the expanded capacity under the new SBIC legislation. SBIC financing creates financial cushion, now we have exemptive relief from the SEC to exclude SBIC debt from our BDC asset coverage test and SBIC accounting is cost accounting, not mark-to-market accounting. Third, to better align the measurement of asset and liability values for both GAAP and the BDC asset coverage test, we marked both our assets and our liabilities to market. As a result of all these features, we have provided substantial safety to our shareholders, bondholders and lenders in the event of market volatility.

We've had some attractive realizations. In addition to Z Wireless last quarter, Foundation Building Materials was sold resulting in our $80 million second lien loan getting taken out of 102 and our $2 million equity co-invest getting realized at over $8 million. The blended IRR on this $82 million investment was about 20%.

Last quarter, we placed New Gulf Resources on non-accrual. In December 2015, the company filed for Chapter 11 bankruptcy protection. We are a member of the ad-hoc group of lenders. There is a $75 million, 11% DIP loan of which we have committed $13.1 million. The restructuring support agreement, the RSA, is subject to change due to the bankruptcy court approval process. The RSA contemplates a [$50 million] rights offering of first lien convertible notes of which our share would be $8.4 million. Under the RSA, the DIP loan would also roll into the first lien convertible notes.

Similar to other energy restructurings that have occurred recently, under the proposed plan, the secured creditors would own the majority of the company going forward and the largest holders including PennantPark would have an active role in the ownership of the company. Under the RSA, our equity ownership would be approximately 13%. Due to the bankruptcy process, unfortunately, we cannot comment further on New Gulf.

Across PennantPark entities, we've had only 11 companies on non-accrual out of nearly 400 investments since inception nine years ago, despite the recession during that timeframe. Further, we are proud that even when we've had those 11 non-accruals, we've been able to preserve capital for our shareholders. Through hard work, patience and judicious additional investments in those companies, we've been able to find ways to add value. We constantly monitor our deals and re-underwrite them in the face of new information. Situations where our best long-term value for shareholders is created by taking control of the companies and providing capital and the expertise we do. Based on values as of December 31, to date we have recovered nearly 80% of the capital invested in those 11 companies that have been on non-accrual since inception of the firm. Historically, our realized gains have nearly offset any realized losses.

In terms of new investments, we had another quarter of investing in attractive risk-adjusted returns. And virtually all of these investments, we've known these particular companies for a while and studied the industries or have a strong relationship with the sponsor. Let's walk you through some of the highlights.

We lent $18 million of a senior secured term loan to Broder Bros. Broder is a distributor of promotional power products; Littlejohn & Co. is the sponsor. Corfin Industries is a provider of electronic components refinishing services. We lent $23 million of first lien and purchased $1 million of common equity; SML Capital is the sponsor. We purchased $12 million in mezzanine loans to Goldsun Trading Limited, which designs, manufactures and distributes adaptive bathroom and kitchen products for the elderly and disabled individuals; ECI Partners is the sponsor. Triad Manufacturing is an employee-owned manufacturer and distributor of custom retail display fixtures. We lent $37 million of our first lien term loan.

Turning to the outlook, we believe that the remainder of 2016 will continue to be active due to growth in M&A driven financings. Due to our strong sourcing network and client relationships, we're seeing active deal flow.

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, 2015, recurring net investment income totaled $0.21 per share. In addition, we had $0.02 per share of other income and $0.02 per share from the fee waiver. As a result, core net investment income for the quarter was $0.25 per share. Additionally, there were $0.02 per share of one-time taxes resulting in GAAP net investment income of $0.23 per share.

Looking at some of the expense categories, net management fees totaled $8.7 million, general and administrative expenses totaled $1.8 million, and interest expense totaled $6.7 million.

During the quarter ended December 31, unrealized losses from investment was [$14 million or $0.55 per share]. Unrealized gains from our various debt instruments was $7.7 million or $0.11 per share. Realized loss from investment was $25 million or $0.35 per share. The accretive effect of our share buyback was $0.04 per share and excess dividend over net income was $3 million or $0.05 per share. Consequently, NAV per share went down $0.80 per share from $9.82 per share to $9.02 per share.

As a reminder, our entire portfolio credit facility and senior notes are mark-to-market by our Board of Directors each quarter using the exit price provided by independent valuation firms, Securities and Exchanges or independent broker-dealer quotes, when attractive markets are available under ASC 820 and ASC 825. In cases where broker-dealer quotes are inactive, we use independent valuation firms to value the investment. Our overall debt portfolio has a weighted average yield of 12.2%.

On December 31, our portfolio consisted of 62 companies across 30 different industries. The portfolio was invested in 38% senior secured debt up from 28% a year ago, 38% in second lien secured debt, 14% in subordinated debt and 10% in preferred and common equity. 75% of the portfolio has a floating rate including 69% with a floor and the average LIBOR floor is 1.2%.

Now, let me turn the call back to Art.

Thanks, Aviv.

To conclude, we want to reiterate our mission. Our goal is a steady, stable and consistent dividend stream coupled with long-term preservation of capital. Everything we do is aligned to that goal. We try to find less risky middle market companies that has high free cash flow conversion. We capture that free cash flow primarily in debt instruments, and we pay out those contractual cash flows in the form of dividend to our shareholders.

In closing, I'd like to thank our extremely talented team of professionals for their commitment and dedication. Thank you all for your time today and for your 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) Rick Shane, JPMorgan.

I'm actually going to be pretty pointed here, which is that when I look back at the history of PennantPark, and what we saw during the crisis, and again I don't think things are that bad, but there are certainly some challenges, you personally were pretty active buyer of the stock, and looking at Bloomberg and again, I maybe misreading this, but I haven't seen you in there buying stock. I see Aviv in there, I see some of the directors along the way. But given the buybacks that are in place, is it something that you're considering personally supporting at this point as well?

Sure. And as you can imagine, Rick, and it's a great question also, any investment that the advisor or management company makes in the business has a big impact on me. So for instance, the fee waiver over the next 12 months and over the last quarter is -- it does have a personal impact, the $11 million that the management company invested to build the platform with the PFLT, MCG acquisition was a big commitment. And I think about a year ago, I did buy a bunch of stocks. So, you'll see continued investment by myself, as well as the rest of the firm. You should know when we reiterate this all the time. Everybody in the firm takes 30% of their after-tax bonus and buys the stock. So, that's an ongoing program that -- it does not show up in public information, but that continues as an ongoing program.

Got it. And again, I asked a question, but I do also want to acknowledge that in things like the fee waiver, and the way you are handling this, I really do think that you guys are doing the right things managing through a challenging time, but I wanted to put that question out there as well. So, thank you.

Arren Cyganovich, DA Davidson.

The fee waiver clearly helps over the next 12 months in terms of your -- getting more of sustainable earnings, growth for earnings rate. What can you do -- what actions can you take over the following period to increase the recurring level of earnings beyond there?

Well, look, and that's a good question. If we come to next year and where the energy still in the doldrums, of course, we'll consider extending waiver at that point in time, it will be based on the facts and circumstances of what's going on in the market, the portfolio and energy. So, really, we just want to put our head down for the next 12 months, optimize as best we can, what's going on with energy portfolio as well as the rest of the portfolio, work on building up the SBIC, financing portion of our business. We'll continue to hopefully have continued events like Foundation Building Materials, like Z Wireless, which will supplement us both on a realized gain and in other income basis.

And when you look at it, other income has averaged $0.04 a share last few years per quarter. Next quarter, by definition, we are going to have at least $0.08 a share of other income. So these positive hits are very helpful. We've got substantial spillover, we're going to work it really hard over the next year, (inaudible) from now we see what's going on and make a decision at that point in time.

Thanks. And then just secondly, with the SBIC expanded capacity, are you looking to actually increase total leverage with that or just essentially recycle your existing investments?

It's a great question. We're very focused on keeping overall leverage reasonable. We like having a cap structure that is heavily [weighed on unsecured] bonds and has a relatively lightly drawn revolver, just have extra liquidity. So, we think of it more as a recycling, more so than an increase in leverage.

Ryan Lynch, KBW.

Just want to say I do appreciate the fee waiver you guys are providing on your energy investments first off. Second, actually relating to energy, Ram Energy, that's one of your largest investments, it's still accruing income right now. Can you just give us an update on that business model, and maybe the current hedges you have in place, and how that company performs maybe longer term with oil sub $50 per barrel?

Yes, I mean, I'll just on the -- great question, Ryan. Just on the overall, where is oil need to be, overall, we tell people look, once oil gets back above $60, $70 we feel like we have a good shot of getting all of our money back and that applies to that name as well. Look at Ram, we are and the management team is an excellent management team, is looking at every expense to make sure we keep the business operating, but also being absolutely prudent with cash flow. Our goal and we think they are going to do, it is to be cash flow neutral. Again, we're right at top of the capital structure, have very good collateral underlying the loan. There are some hedges in place, they do roll off over the course of 2016, and we're hunkering down and playing for long run there.

Okay. And then, just a question on the buyback. It looks like you guys have about $9 million outstanding or remaining on your original $35 million buyback, that can probably be easily used in this current quarter. So just given where your current stock price is today, what are your thoughts on reissuing or increasing your current buyback program?

So at this time, we're going to continue with the existing plan. Obviously, we'll be -- obviously, management, the Board and our whole investment team are buyers of the stock. And then we'll [pick it head up] a quarter from now when this program expires and discuss things with the Board, discuss our liquidity, see where the stock is and make a decision at that point in time.

Doug Mewhirter, Suntrust.

I just had two questions. First, just a clarification on the fee waiver. So, is it 16% of your management fee sort of on a flat basis going forward or is it constantly readjusted with where your energy portfolio at cost basis, say, if for some reason, you had an exit of one of your energy in portfolio, and it went from 16% to 12%, you would then ratchet down that waiver to 12% of management fees?

The way it works is, we want to make it very easy for people to model. We're going to calculate the normal base and incentive fee each quarter based on the whole portfolio at that point in time, and then cut 16% off of it. So, take 84% of whatever the overall base and incentive fee would be.

Okay, great. Thanks for that. The second question, you talked about performance of your portfolio, your non-energy portfolio, if you could just add a little bit more detail in terms of -- if you would add up all of your companies, your non-energy companies into one portfolio and measured, say, the year-over-year revenue or EBITDA growth, would there be -- is there still sort of a small amount of growth there or is it flattened out or how is it doing on that basis?

I don't have the exact number on my fingertips, but anecdotally, we think it would be a slow growth kind of scenario 2%, 3%, 4% growth on average.

(Operator Instructions) Douglas Harter, Credit Suisse.

Just again on the buyback, can you just say how you're thinking about buyback versus making any new investments, and how you kind of weigh those alternatives?

It's something we think about all the time, it's a balancing act. We're happy with the buyback thus far. We think we've gotten attractive pricing on that. At the same time, to the extent we can find SBIC-eligible investments and most of the deals that we mentioned today that we did last quarter and the deals that we're doing this quarter so far, fit the SBICs. We think that's very accretive as well. So that's really -- that's a balancing act we're trying to work on keeping leverage manageable and reasonable, at the same time, is using SBIC eligible financing.

Jonathan Bock, Wells Fargo Securities.

Art, I appreciate the commentary you had regarding the credit facility, in particular kind of the provisions that you have in place to help protect investors in light of volatility and owning second lien and sub debt assets as a result of near-term marks that's important. First, the question is, do you actually have a minimum net worth provision in your credit agreement for the credit facility, and if so, what is that?

We do have a net worth, it's a very low amount, I'm going to, off the top of my head, say it's a $150 million, $200 million of net worth.

$150 million, $200 million net worth. Okay, and then walk us through -- they likely have a calculation of how the one-to-one or kind of how you look at leverage and most credit facilities have a one-to-one trigger. So, could you walk us through what your bank cares about in terms of how these assets are marked. Now, forget the SEC for a moment, just what's your bank is kind of looking at in terms of fair value movements of the portfolio. What do they include, what do they exclude, what's the -- what are the limitations that's just helpful for investors to gauge downside?

Yes, so they -- it's same to mark-to-market methodology. The nice thing about the credit facility is it, for their one-to-one test, it excludes the SBIC financing. So, again lots of cushion there.

So they exclude the SBIC financing assets on the one-to-one, even though your bank has no recourse to those, you see what I'm saying?

Yes, no, no. Look, it's -- look, we've got a very good relation with our banks, we've lived together for a long time including through the great recession. So, yes, so even if again, you wrote all the energy portfolio off to zero, and you took more losses than that, you don't trigger the one-to-one.

Got it. Okay, I appreciate that. Then the next question is just walking through the math, and I know, investors kind of heard you outlined with, what would you consider to be kind of stable income on a per share -- so we've got get to [$0.28], right? And so let's say you got stable income at the [$0.23] level, and then you need, your fee waiver adds $0.02. And then we get other income and SBIC. Can you kind of give us a sense over time, let's do other income historically, what's that kind of per share number normally been? And then help us offer if you put all the SBIC, if you lever the SBIC today, what's the net per share impact that you could likely be able to grow NOI from on a quarterly basis? That would be helpful.

Yes, that's a great one. I'm happy to share and I'm happy to be very transparent with both bull case and a potential bear case. So, recurring as you said is roughly $0.23 a share, the fee waiver is another $0.02, other income has averaged $0.04 a share for quarter. Next quarter, it's going to at least $0.08 a share, or it's averaged $0.04 per share. SBIC, over time will be $0.01 to $0.03 per share as you leverage into it. And look, we're hoping that in this down market, we will get increased yields in the -- we'll see yield expansion in our portfolio, which is something that people -- they look at BDCs may not be factoring in at this point, but we should be getting some yield expansion. So, you can see that, that is a reasonable bull case scenario, it should well cover the $0.28.

And then you have to sit there and say, okay, what if all the energy goes to zero when it stops paying, that's about $0.045 to $0.05 a share. So, that's kind of all the moving parts, everyone can handicap what they think, those scenarios are again the reason that we're not looking to change our dividend at this point as we play this all through.

Great. And so another question because when we talk about other income and the ability to collect fees etcetera, which here I mean, it's certainly sweetener and it's nice. Often times, those numbers can be challenged by drops in economic activity. And so what provides -- let's say, we're walking into some lean years from an economic perspective, I don't necessarily believe we are, but the confidence that comes in that number, are the other income -- what's the other income that you received over the past two years? Is it really indicative of the types of other income that you could receive going forward in light of slower economic activity, if that's where the market is going?

Yes. Look, certainly that could be the case. If you just take the $0.08 per share for Z Wireless, we know that at a minimum for 2016 that averages $0.02 a share. So, we've set a floor for 2016, but you're right that might not be $0.04 a share per quarter. We know at a minimum for the next four quarters on average is $0.02, because that's already booked. It could be more, it could be less.

I appreciate that. And then also if we're looking at -- would you mind walking through the Affinion investment, because I believe that was the majority of -- a decent amount of the realized loss that you took this quarter?

Right. So, what we have in Affinion is we have a relatively large equity position at this point, and we have two pieces of debt. We have a piece of second lien debt and then we have some new notes that were issued to help get the deal done. So those are the two debt instruments, those are both cash paying debt instruments relatively low levered, we think safe risk awards and we have an equity stake.

Okay. And so the other question that folks always kind of ask, so I know that, that kind of has migrated away from the energy book, but a question that people would look at is that, at times there can be credit losses in other areas, and so while you've been very upfront and shareholder friendly with regard to the energy portfolio, could you talk about how, why or why not you would include or consider a look back on the NOI incentive fee to protect not only investors who've lost income, but protect investors who have lost NAV in other areas of the portfolio over time. And again, it's not an easy question to answer, but it's one that lots of folks are always interested in in light of a lot of the discussions that have surfaced on these types of fee structures.

Okay, that's a great question, Jon, and until this energy downturn, our performance has been one of the best in the industry even through the recession going back to 2008 or 2009, we've had realized capital gains up until this point. So, we think we've delivered for shareholders on a capital preservation basis. And right now, we're recognizing the -- [everyone's pain on] energy and we're taking the hit for the next 12 months, we are going to work extremely hard to maximize value in these investments and we think this waiver is aligned to that objective.

Christopher Nolan, Friedman, Billings, Ramsey, & Co.

Art, what is the spillover income, I missed it, if you mentioned it?

Yes, so we only disclosed publicly spillover income in September, which was $0.53. But just to give you a sense, since then, for the quarter ended December, we paid dividends $0.05 in excess of our NII. We have also disclosed that we -- in this quarter we have $0.08 per share of other income from the sale of Z Wireless. So we feel like, we are in pretty good shape for the quarter ended March. So that directionally give you a sense of how to think about the spillover.

Great. And then just a quick follow-up on the leverage ratio question that Jon Bock roached. For the credit rating agencies, are they looking at a 0.85 debt-to-equity ratio excluding SBIC, is that a fair way to look at it?

Well, look, you can -- both the agencies have reports out and you can look at it, and there is differences in how they do it. I think as importantly for us as management, we're focused on overall leverage too and we're focused on the style of leverage and the kind of leverage we have. We like having the majority or a lot of our leverage being unsecured bonds that are long term, and we like having a lot of our leverage being SBIC, and we like having a lot of excess dry powder in our revolver. And I think one of the earlier questions was how do you look at the leverage between the SBIC and the revolver. We are going to prioritize the SBIC financing at this point and think of it, perhaps over time, as a rotation.

As I recall in the past, finding deals for the SBIC for you guys was sort of a slower process, has that changed at all or is that wrong or?

That's a great question. It has been I think one of the benefits of this softer market that we have had over the last quarter is we've got an awful lot of looks and obviously, first and foremost, we never want to let our guard down from our credit standpoint and I want to make sure, we keep our credit standards high. That said, we've gotten a lot of nice looks in the majority of the deals we did in the December quarter and the stuff that we're looking at and have done so far this quarter have been by and large SBIC eligibles. So we're fortunate that the market softening is coinciding with this extra availability.

Final question on management compensation. The fee waiver, my apology, [you guys work], but still your base management fee before the fee waiver was 2% of assets. You don't have to look back -- your compensation structure tends to be at the richer end of the scale for BDCs. How you're looking at the industry? Do you think as we go forward that the compensation structure for BDCs in general and also PNNT will need to modify to a new investor environment, what are your thoughts on that front?

Chris, we're focused on what's going on in our portfolio. We don't have any great prognostications about the industry. That said, again, we think our performance over nine years through the downturn has been one of the best with realized gains offsetting realized losses up until this energy downturn. We think this fee waiver representing 16% on both the base fee and the incentive fee is appropriate at this point in time given what's going on in energy.

John Hecht, Jefferies.

Just curious that you gave us some of the metrics of the deployment in the new deals from last quarter. I'm wondering, if you look at your pipeline, are you seeing anything with respect to widening of spreads and or declining of leverage ratios?

That's a great point. This is kind of something perhaps we didn't highlight enough. By definition, unfortunately, BDC stocks are out of favor when there is better risk reward to buy in new deals. So, we are seeing reduced leverage ratios, we're seeing tighter covenant packages, we're seeing better upfront fees, we're seeing higher yields. So, over time, as these portfolios mature and rotate and you're doing new deals, the vintages should be getting better. So we're very excited about having the dry powder that we have to take advantage of that.

Okay. And then kind of more of a conceptual question, I guess, and largely part because of some of the restructurings recently, your equity composition of your total portfolio has moved upward. And I'm wondering, if you can just describe kind of what's the difference when you kind of approach in equity investment versus a credit investment in terms of time and things you're focused on. And then to what degree can you or are you able to kind of sell and reposition the current equity portfolio, maybe, transition back to yielding securities?

Okay. That's a great question and that's also potentially the upside over time, but when you basically convert debt-to-equity, you're becoming -- you make an investment in private equity and when you make an investment in private equity, you have to, in your mind, think about as a three year to five year hold period, while these companies work in and try to establish growth and cut costs. So that's the way we think about it in our mind. Obviously, in some certain cases, there is upside, and if you look at our track record of recovering on our non-accruals, about $0.80 on the $1 on those non-accruals. Given enough time and energy, effort and a little bit of capital, we've had a very good track record of recovering that money, and then taking that money and redeploying back into cash paying debt instruments to build the NII.

So that's our goal. Here, obviously, we want to work the equity percentage of the portfolio down, return that to cash, and then into cash paying debt instruments.

Chris York, JMP Securities.

Most of my questions have been asked, but I did want to follow up on a previous question. I'd say, you talked a little bit about how Ram's hedges roll off in the current year. Are there any other expirations of hedges at oil and gas companies and what were those price levels? And then secondly, how much impact do you expect to hurt that service or the price of reserves in the current year?

Other than Ram, almost all the other hedges have basically rolled off at this point or rolling off over the coming couple of quarters. So, I think the game plan is the same for these companies, as well as probably what's going on in the rest of the industry, it's people are looking at every expense, they are looking at every dollar of CapEx, trying to figure out how to cut back, live within their means during a downturn and preserve the option for the long run.

Got it. And then one last clarification, so in your prepared remarks you talked about if all your oil and gas or energy companies were on non-accruals, [about $0.05 per share], is that based off of the $0.25 that you earned in net investment income this quarter?

Yes. So again, just to be clear, think about recurring as $0.22, $0.23 before you talk about other income and the fee waiver, and the SBIC upside and the fact we might have upside from spread widening, you could reduce that up to $0.05, if all the energy names went on non-accrual.

Based off of the core, the $0.22 to $0.23?

Yes.

David Chiaverini, Cantor Fitzgerald.

A couple of questions for you. The first is a follow-up on the asset mix. So, first lien loans went from 27% of the portfolio on March 31 to 38% on December 31. How high do you plan on taking that number, and do you see better risk rewards in this environment in that asset class?

It's a great question. Look, we take deals as they come. Most important thing is the quality of the deal, but that's the nice thing about what happens in a softening environment. In a softer market, we can move up capital structure, be in a great position and get very attractive yields. So, we will look to continue to keep personally at a high percentage or perhaps a higher percentage if the deal flow dictates.

Okay. And my second question is on dividend policy. So, you mentioned about the spillover at $0.53 at September 30, and that's come down a few cents as of December 31. Would you guys wait to take that spillover down to zero before taking into account potentially changing the dividend or at what level -- how does that factor into a potential change in the dividend level?

It's a great question and I wish there were scientific answer to it, like a lot of things, it's about judgment, about what's going on in the portfolio, what's going on in the market. So, our Board regularly discusses this at quarterly Board meetings, and there will be discussion every quarter going forward. But we do feel comfortable with the cushion we have as well as with some of the features we have to increase income at the same time as we're dealing with the challenging energy portfolio.

And at this time, that does conclude our question-and-answer session. I would now like to turn the call back over to Mr. Penn for any additional or closing remarks.

Just like to thank everybody for listening in today, and we will catch you next quarter. Thank you very much.

Thank you, sir. That does conclude our call today. We do thank you all for your participation.