Pennantpark Investment Corp (PNNT) 2018 Q2 法說會逐字稿

Good morning, and welcome to the PennantPark Investment Corporation's Second Fiscal Quarter 2018 Earnings Conference Call. Today's conference is being recorded. (Operator Instructions) It is now my pleasure to turn the call over to Mr. Art Penn, Chairman and Chief Executive Officer of PennantPark Investment Corporation. Mr. Penn, you may begin your presentation.

Thank you, and good morning, everyone. I'd like to welcome you to PennantPark Investment Corporation's Second Fiscal Quarter 2018 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 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. Audio replay of the call will be available by using the telephone numbers and pin provided in our earnings press release as well as on our website. I'd also like to call your attention to the customary safe harbor disclosure in our press release regarding forward-looking information. Today's conference call may also include forward-looking statements and projections, and we ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these projections. We do not undertake to update our forward-looking statements unless required by law. To obtain copies of our latest SEC filings, please visit our website at 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.

Thanks, Aviv. I'm going to provide an update on the business, starting with financial highlights, followed by a discussion of the overall market, the portfolio, investment activity, the financials, and then we'll open it up for Q&A. For the quarter ended March 31, 2018, we invested $97 million. Net investment income was $0.19 per share. We have applied for our third SBIC license. After quarter-end, we paid down an additional $15 million of SBIC I debt. Our Board of Directors has authorized a stock repurchase program of up to $30 million worth of stock over the next 12 months. The quarter included substantial portfolio rotation, including the exit of 1 of our 4 energy-related names. We have also substantially reduced our PIK income. As a reminder, the board approved an amended investment advisory agreement, lowering the base management fee to 1.5% per annum and the incentive fee to 17.5%. The incentive fee floor will remain at 7%. This new agreement has taken effect on January 1, 2018. As of September 30, we had taxable spillover of $0.26 per share.

With the new fee agreement, a stable underlying portfolio and substantial spillover, we believe that PNNT stock should be able provide investors with an attractive dividend stream along with a potential upside as energy market stabilizes and our equity investments mature. Our primary business of financing middle-market sponsors has remained robust. We manage relationships with about 400 private equity sponsors across the country from our offices in New York, Los Angeles, Chicago, Houston and London. We have done business with about 180 sponsors. Due to the wide funnel of deal flow that we receive relative to the size of our vehicles, we can be extremely selective with our investments. In this environment, we've not only been extremely selective, but we have generally moved up the capital structure to more secure investments.

A reminder about our long-term track record. PNNT was in business in 2007 primarily as a subordinated and mezzanine investors, then as now focused on financing middle-market financial sponsors. Our performance through the global financial crisis and recession was excellent. Average EBITDA of the underlying portfolio of companies was down about 7% to the bottom of the recession. The average high-yield company EBITDA was down about 40% during that time frame. As a result, we have few defaults and attractive recoveries on that primarily subordinated and mezzanine portfolio. In this environment, due to our deep and broad investment team, we are seeing more deals than ever. We are using our tried-and-true underwriting discipline in middle-market sponsored deals. We are generally high in the capital stack, and have substantial junior capital beneath us to provide cushion. As a result, we believe that we can continue to provide attractive risk-adjusted returns for our shareholders even in this environment. We remain focused on long-term value and making investments that will perform well over an extended period of time 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. We are 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.

Our portfolio is constructed to withstand market and economic volatility. In general, our overall portfolio is performing well. We have cash interest coverage ratio of 2.7x and a debt-to-EBITDA ratio of 5x at cost on our cash flow loans. With asset yields coming down over the last several years, we're looking to create attractive risk-adjusted returns in our portfolio. We have a 3-point plan to do so. Number one, we are focused on lower risk, primarily secured investments, thereby reducing the volatility of our earnings stream. Investments secured by either a first or second lien are about 79% of the portfolio. Number two, we are also focused on reducing risk from the standpoint of diversification. As our portfolio rotates, we intend to have a more granular portfolio with modest bite sizes relative to our overall capital. Number three, we look forward to continuing to monetize the equity portion of our portfolio. Over time, we are targeting equity being 5% to 10% of our overall portfolio. As of March 31, it was 17% of the portfolio.

As you all know, the Small Business Credit Availability Act was signed into law in late March. At the current time, we're not going to increase leverage at PNNT. Our intention is to maintain our investment grade ratings at this time. As we get closer to October 2019, which is when our public bonds mature, we will assess investment and financing landscape and evaluate our strategy in order to maximize long-term value for our stakeholders. We remain comfortable with our target regulatory debt-to-equity ratio of 0.6 to 0.8x. We are currently at about 0.5x regulatory debt-to-equity. On an overall basis, we are targeting overall GAAP leverage of 0.8x. As of March 31, we are at about 0.76x overall GAAP leverage. And our net leverage, debt minus cash, was 0.46x.

We had significant cash realizations in the quarter ended March 31. We realized $231 million of total sale proceeds, including about $46 million of proceeds on equity positions. Equity positions were realized in American Gilsonite, Galls, Convergent, Corfin, EnviroSolutions and TRAK, generating a realized gain of about $24 million. With regard to our energy-related portfolio, we're pleased that one of those exits was American Gilsonite, which generated a total realized gain of $8.1 million in the quarter. Despite the energy downturn and conversion of debt-to-equity a couple of years ago in Gilsonite, we ended up with an 8.6% IRR and 1.4x multiple on invested capital of our hold period of 5.5 years. We co-led the restructuring and took an active approach in setting strategy with our board positions. This approach enabled us to have more than a full recovery on our capital. This example further demonstrates our strong track record and expertise towards preserving value when our credits have issues from time to time. 1 of our 3 remaining energy names is in oil field services. U.S. Well is performing better, as drilling activity has picked up. With regard to our 2 E&P names, Ram and ETX, they have been aided by the higher oil and gas prices. It will take time for us to maximize our recovery. ETX's capital structure was recast during the quarter to best position the company for growth, including acquisitions. Our convertible debt instrument was converted into equity at a value approximating cost, which is the basis for evaluation for the quarter. This conversion and valuation was driven by the majority shareholders. We are a minority shareholder in ETX, and we own approximately 14% of the equity.

The company is planning an acquisition, and believes that a debt-free balance sheet will allow them to obtain the most attractive terms from RBL lenders. We are encouraged that the energy markets are rebounding. This enhances the M&A environment in the sector and our ability to evaluate strategic options for our energy-related companies. We've had only 12 companies go on nonaccrual out of 199 investments since inception over 11 years ago. Further, we are proud that even when we've had those nonaccruals, we've been able to preserve capital for our shareholders. Through hard work, patience and judicious additional investments in capital and personnel in those companies, we've been able to find ways to add value. Based on values as of March 31, today, we have recovered about 80% of capital invested on those 12 companies that have been on nonaccrual since inception of the firm. We currently have no investments on nonaccrual. It might be helpful to highlight our long-term track record over 11 years, including the global financial crisis and recession. Since inception, PNNT has made 199 investments, totaling about $4.7 billion and an average yield of about 13%. Including both realized and unrealized losses, PNNT lost only about 34 basis points annually. We are proud of this track record, which includes both our energy investments as well as our primarily subordinated debt investments made prior to the financial crisis.

In terms of new investments, we've known these particular companies for a while. We have studied the industries or have a strong relationship with the sponsor. Let's walk through some of the highlights. We purchased [$50 million] of Bazaarvoice, which provides ratings and reviews software to consumer products companies and retailers. Marlin Equity Partners is a sponsor. Ox Steel is a specialty manufacturer of structural sheathing and thermal insulation building products. We invested $22.5 million in the first lien term loan and $2.5 million of our revolver. The company is owned by Wind Point Partners.

Turning to the outlook, we believe that the rest of 2018 will 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 you through the financial results.

Thank you, Art. For the quarter ended March 31, 2018, net investment income totaled $0.19 per share. We had about $0.03 per share of other income. Looking at some of the expense categories: management fees totaled $6.7 million; general and administrative expenses totaled $1.1 million; and interest expense totaled $5.9 million. During the quarter ended March 31, unrealized loss from investment was $29 million or $0.42 per share. We had about $22 million or about $0.31 per share of realized gains. Excess income over dividends was $0.01 per share. Consequently, $10.80 per share went from $9.10 per share to $9 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, security and exchanges or independent broker-dealer quotations when active markets are available under ASC 820 and 825. In cases where broker-dealer quotes are inactive, we use independent valuation firms to value the investments.

Our overall debt portfolio has a weighted average yield of 11.5%. On March 31, our portfolio consisted of 49 companies across 23 different industries. Their portfolio was invested in 40% first-lien secured debt, 39% in second-lien secured debt, 4% in subordinated debt, and 17% in preferred and common equity. 87% of their portfolio had a floating rate. Now let me turn the call back to Art.

Thanks, Aviv. To conclude, we want to reiterate our mission. Our goal is to generate attractive risk-adjusted returns through income 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 have 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 dividends 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) And we'll take our first question from Rick Shane with JPMorgan.

Yes. Look, our thesis on the stock has been that the book value discount or the NAV discount reflects the exposure to the energy patch in discounting of that. But there's another way to look at this, which is if we look at the ROE trend over the last several years, it's down, call it, 150 to 200 basis points from where it was. The question I have is, do you think, in the current environment, with spreads compressing, there's an opportunity to start enhancing ROE? Is it going to be a function of the asset sensitivity of the portfolio or are there are going to be selective opportunities to deploy capital in a way that's accretive to ROE?

That's a great question, Rick. I think we have several different irons in the fire for improving ROE. One is finding good investments. We have $50 million of cash sitting in SBIC II right now. Obviously, as we deploy that, that will enhance ROE. And then we have equity that we hope to convert into cash, and then cash paying debt instruments. So over time, as we take the equity percentage from 17% hopefully down to 5% to 10%, that should be helpful. What we do, we all, as BDCs, have LIBOR as a wind at our back helping us. So really using our capital, using the SBIC financing, reducing equity, LIBOR and, of course, the stock buyback. We're very happy to be able to do the stock buyback. Our intention is to do it over the next 4 quarters, just like we did a stock buyback a few years ago. So we're going to put the money to work and buy the stock because we agree it's cheap.

Got it, okay. And you're right. It is interesting because of the -- sort of the math of how the Street looks at BDC, is you really do get very little credit for the equity investments because the gains are considered to be episodic. And so you don't get a lot of credit, and it looks like a drag on the ROE. So that's a fair point. And again, what do you think is an appropriate hurdle rate here?

Hurdle rate in terms of expected return on the portfolio? Or what specifically are you...

Ultimately, I guess, what I would boil it down to is, what do you really think is an appropriate risk-adjusted return-on-equity capital for a BDC of this size at this point in the cycle?

Look, we've always wanted and targeted as double-digit ROE. We continue to do so. And our underwriting, other than for a couple of errors we've made, historically, has been pretty strong and generated a very nice return even through a global financial crisis and recession. So we're still double-digit. We're still under the belief and goal that we're generating double-digit ROE.

And we'll take our next question from Doug Mewhirter with SunTrust.

Two questions. First, Aviv, could you -- if you have that handy, could you quantify the contribution from higher LIBOR rates on this particular quarter's earnings compared with last quarter's or the same quarter last year?

Certainly. So as you know, we're including a chart at the end of the Q that kind of shows the sensitivity of what happens when LIBOR goes up. So in general, let's say, last quarter LIBOR went up approximately, let's say, 50 bps. If it continues to go 50 bps next time, based on this chart, to go back on the Q, it should be close to a $0.01 increase in NII. That's the impact on net investment income.

Okay. And I had a specific company-related question or portfolio company-related question. I noticed Superior Digital, even though the first-lien loan seems to have been marked down, I forget whether you had talked about that in previous quarters. Is there -- I guess, is that something that's stabilized now? Or is that something that maybe we need to keep a closer eye on in the future? And what's sort of the background behind...

It's a little bit of both. It's a billboard company focused in New York Times Square. It is improving. The operations are improving, but it is something we're watching. And so it's kind of both. It's -- we're subject to getting advertisers on those billboards, which we have an excellent management team in there. They're making good progress doing that.

And we'll take our next question from Kyle Joseph with Jefferies.

Just following up on Doug's questions. Just trying to get a sense for revenue and EBITDA growth trends broadly across the portfolio, and sort of any changes you've seen versus last year.

It's a good question. We're continuing to see as -- by and large, a healthy U.S. economy between our vehicles. We have something like 150 different companies across the economy. And we're seeing some nice growth, 5% to 10% in general EBITDA growth across the portfolio. So it's been a healthy time in the economy and for our portfolio of companies.

Got it. And then just thinking about your outlook for new deal flow. I know you mentioned that your pipeline's pretty strong. Just so -- and obviously, your credit's very stable. But just wondering, which industries are the most attractive and which you're avoiding currently?

Look, we're kind of underwriting the same way we always have. We avoid a lot of the fashion fad, retail, restaurant-type credits. We're done with energy. We've got enough energy and exposure. So we're generally across the economy. One thing I'd like to point out is that if you look at our deal flow, it's coming from a broader cross-section of sponsors, from a broader cross-section of geography. Several years ago, we purposely invested in our platform, opened up an office on the West Coast, opened up an office in Chicago, an office in Texas, one in beefed-up New York. And we're developing new relationships which are showing up in our portfolio. The Bazaarvoice deal I mentioned earlier is from a sponsor on the West Coast. The Ox Steel investment that I discussed earlier is from a sponsor in Chicago. So this has given us a wider funnel, which allows us to be both active and selective. And those investments we've made in our infrastructure and our team are really starting to pay off.

And we'll take our next question from Mickey Schleien with Landenburg.

Art and Aviv, I wanted to start with a high-level question. Just to ask you, what proportion of the portfolio is in sponsored cash flow-based loans that are -- and what is their EBITDA -- average EBITDA?

Yes. So about 90% of the portfolio is AA sponsors, and that's gone up over time. Again, I'm partial of where we are in the credit cycle. We like having a lot of equity beneath of us. And that's one of the nice things in this environment, is there's quite healthy equity checks beneath us. In most of the case, it's 50%, sometimes 60%. So that's a nice thing. In terms of kind of the middle of the bell curve for us, it's kind of a $20 million to $30 million EBITDA size in the middle of the bell curve. Once you start getting the $50-ish million of EBITDA, the broadly syndicated market is very aggressive financing those companies. So we're -- we think the sweet spot for us is $20 million, $30 million of EBITDA, probably as low as $10 million, as high as $40 million, but that's the sweet spot for us in this environment.

I appreciate that, Art. But even at that $20 million, $30 million level, from what I'm hearing, that's a pretty challenging market right now. And I'm curious whether you're considering strategies to diversify into new markets. Or is the game plan to let the market come back to you, and if the balance sheet shrinks as a result of that, then so be it?

Yes. Look, we might be in a different place than some of our peers. But given the build out we've had in our platform over the last few years, and with all these regional offices and more depth in New York, we can be very, very selective. And still, with the size of our vehicles, we are -- I don't know if you want to call us medium-sized or whatever you want to call us. The size of our vehicles, relative to the deal flow and the new relationships we're developing with these regional offices in more depth than New York, we're still only doing 2% or 3% of the deals that come in. But we're seeing a lot of interesting flow, and that allows us to be picky even in the $20 million or $30 million EBITDA range.

So if you were to characterize this quarter, where we saw fairly meaningful contraction in the portfolio, was that proactive on your part? Or was that prepayments that you weren't expecting?

Well, these companies were performing well. So when companies are performing well, in some sense, you expect prepayment. And that's what's you're hoping for. I mean, again, we thank people when they pay us back. The nice thing was, is we got about $46 million of exits on equity investments, which we're really good at, and tend to be -- has tended to be good equity co-investments we made alongside sponsors, plus the excellent Gilsonite, which was terrific because it reduced our energy exposure. So we're very pleased with that. We've been doing, on average, $100 million-ish, maybe $125 million a quarter. In new investments, we're a little light this past quarter. The quarter we're in right now, we're fairly active. So it's kind of steady as she goes. We really like the fact that with the -- with all the exits we got, we could both maintain our investment-grade rating and also initiate a stock buyback. So we're very pleased about that because we've wanted to do the stock buyback for some time, but did not want to lose our investment-grade rating as part of that. So the exits here are giving us this opportunity.

That's helpful. I wanted to also follow up and ask a little bit about the cash position, which is pretty significant. I think you said in the prepared remarks, $50 million, 5 zeros in the second SBIC. Is that right?

Yes, that's correct.

And is there a meaningful amount in the first one, apart from the money that you used to -- or, I guess, you've prepaid some more SBA debentures there. Is there a significant cash balance in the first SBIC?

No. We're -- that's a gradual wind-down. SBIC wanted a gradual wind-down, where we're eager to use the $50 million of cash in SBIC II, and we're on file with the SBA for, hopefully, SBIC III. We've had an excellent track record with the SBA. I think we've had like a 14% IRR on the investments we've put in the SBIC. So you never know, because it's Washington, but we've had a very nice track record and we hope to, at some point, to get SBIC number III. So the cash is going to be used for the stock buyback, for new investments, for SBIC II and also to maintain our investment grade credit rating.

And as SBIC I winds down, are you in a position to convey that equity into SBIC III? Is that the plan? I know it probably has to go through the BDC, but is that how you...

Yes, yes, yes. We're going to -- again, with our planned liquidity, we've -- that will go into SBIC III if and when we get it.

Okay. And in terms of the credit facility, is there some sort of minimum borrowing requirement? Or why wasn't that paid down completely, at least as of March, instead of holding the cash?

Yes. So we use the credit facility in some ways to do hedging for our non-U. S. investments. So we have a couple of European investments. I think we have an Australian investment or 2. And what we do is we borrow in those currencies as a way to hedge those assets, which are in foreign currency. So that's why there's a 4-year $2 million balance in the credit facility.

Okay, I understand. And I think I've asked that question before, my apologies. And just my last question. On the stock repurchase, is that a 10b5-1 plan? And what parameters are you looking to use? And in other words, is there some sort of minimum discount to NAV that you're going to employ to help you move the needle? Or just some color on that would be really helpful.

Yes. Look, we've done stock buyback before, and our intention is the same thing. It's -- if right now, it's not a 10b, because we just want to kind of get a sense of what the market is. But our intention is, over the next 4 quarters, to methodically put that money to work, call it, 25% per quarter, which is kind of what we did last time. If the market spasms and the stock goes down more, well, obviously, if we can get the stock cheaper, we'll dive in and get it cheaper.

Okay. And finally, and I'll get off the queue here. The way -- your portfolio way went down in a period where LIBOR increased. I know there was a lower allocation to sub-debt. Was there anything else in the portfolio that caused the weighted average yield to go down?

Look, it was just kind of -- it's going to ebb and flow, sometimes will have a little higher yields, sometimes a little lower. I think that will just depend on the deals that come in, in the quarter. I think we've been guiding people over time that, today, a portfolio has a yield of like mid-11s. Over time, given our strategy, if that's going to go down into the 11% to -- 10% to 11% zone as we continue to move up capital structure, derisk the portfolio. Although we are starting to get some benefit from LIBOR, which is nice. So that will mitigate some of that.

And we'll take our next question from Jonathan Bock with Wells Fargo Securities.

Thank you for taking my questions here. There certainly were quite a few. So I'll come and hone in on a few other points. Art, the first is trying to understand the value of the investment grade rating today. And understandably, one can imagine that there were some folks that invested according to an investment grade rating in the past. But given that the duration or, more importantly, the expected payouts are so short, it's not as if a downgrade in the investment grade credit rating is going to really be that much of an issue. So is it because you're trying to effectively issue new investment grade debt to pay that off, and then you'll do it? I'm trying to understand really the net value proposition for having it if one could make an NPV proposition for increased leverage and all that optionality that comes with that choice.

Yes, it's a great question, and this is something we've been talking about for a while. Part of it is, of course, in the investor relationships. We value our investor relationships, whether they're equity investors or debt investors. To us, reputation is highly meaningful. Our reputation -- we issue these bonds as investment-grade bonds. We have dialogue with those bondholders all the time, and we value our reputation. And we have 16 more months left, and then we will assess different options and different leverage points and different portfolio construction. And an investment-grade rate, or at least living up to what we said to those bondholders, we think, has some value because character is weak -- and if we invested it in -- we say it's a 3-season credit cash full of collateral and character, with character ultimately being the most important thing. That's how we think. We strive to have the highest character ourselves. So -- and look, the portfolio is still one that needs some work. We're not sitting here and saying, the portfolio is perfect right now. We're saying we've got to put our head down and work this portfolio. And then hopefully, we'll come up for air, I don't know, a year from now, and the portfolio will be in even better shape. We'll be closer to reassessing our overall strategy, our overall leverage, and we will hopefully have very good relationships with bondholders and our shareholders as we execute that plan.

Yes. Got it. That is a very honest and forthright response. And no one can argue with that, and both bondholders and equity holders agree with it. Then that kind of brings the second derivative, that if new investment-grade debt is effectively issued, one could surmise that perhaps 2:1 would not be something that you're going to consider if S&P still holds the line on where things are. That being said, I mean, there's no answer to that question, it's just a -- it's a declarative statement. But your points about character matter the most, and folks greatly appreciate it. Now maybe moving to the next item on the portfolio. So you had a $40 million convertible note ETX, and you converted to equity. And clearly, that's your option. Walk us through the value proposition of the conversion versus actually holding the debt and collecting what is likely a coupon and cash flow at this point, when cash flow, particularly high spread, it's really hard to find in the middle market and in new investments.

Yes, and it's a good question. So the way ETX converts is arcane. The way it worked, we got PIK income, which is positive, and we can all debate the value of PIK income at the same time the way that convert -- if you go back to the last Q, the safe value was higher than the cost. So it's what happened during the restructuring. The face value was higher than the cost. So you basically had a -- at the reverse of OID, it was something like the face value was $38 million and the cost was $25 million. So you are accreting down. So net, net, net, the amount of income that was coming from the ETX convert was de minimis, even -- plus, it was PIK. So for us, this management team is excited about the opportunity. They've got a couple of acquisitions in their sight. They think those could grow equity value significantly. We are a minority shareholder. The 2 bigger shareholders were supportive. We could have been obstructionist, not our style typically. And since the net income that was actually coming was de minimis, we went along with it.

Got it, got it. And so it isn't as if this conversion was the means to relieve that individual company of -- well, because, I guess, it was all PIK, but some form of interest or cash burden at all. This was really just an option to exercise additional value?

Yes. And then because they have acquisitions in their sights, they want to get these reserve base loans. And the RBL lenders, when you've got another piece of debt in there, are going to be less aggressive or not aggressive at all in terms of supporting that. So basically, another version of what's going on in Ram. Ram, a few quarters ago, we converted a big chunk of debt to equity. Same thing. RBL lenders want to see less debt. These companies want to go hunt in this environment. Again, and from an overall standpoint, you now have energy companies wanting to hunt, which is both good from an offensive standpoint as well as, at some point, as we ascertain value hopefully and exit these equity investments, the M&A environment's starting to bubble up.

Got it. And then this is a conceptual question, Art, just because, clearly, as one of the clear leaders since the beginning, this space was, prior to the recession, one of the very few that not only survived, but thrived. Now with the 2:1 leverage constraint or a 2 -- with the 1:1 leverage constraint being lifted, questions ensue in the mind of shareholders, right? Is this going to be beneficial, particularly on the incremental capital that's being charged? And so can you give us your views as to how you look at leverage today and, more importantly, whether you believe that additional leverage needs to come at a -- with a net win-win for both shareholders as well as the external manager in the form of both increasing ROE as well as increasing fees to the external manager?

Yes. Look, we agree that it should be a win-win. So everyone should benefit, shareholders, managers, etc. So look, we'll see. In this particular company, we've got to put our head down and execute the plan. And -- but look, we'll have a debate and discussion with our stakeholders as well as our board. And as we come out of this 15 months from now, what's our strategy? Do we keep the same strategy? Do we do a lower-risk, lower-reward strategy with perhaps higher leverage and fees that make sense relative to those assets? So we're happy to have those discussions. And part of it will be, what's the market environment at that time? What assets are good risk-rewards at that time? What mix do you want to have? We like to go on the market with our middle-market financial sponsors being able to give them a variety of solutions. Whether it be classic first-lien spread sheet or second-lien mezz, that helps our team originate deal flow because we can give people a menu of different options. That said, depending on the environment, you may want to skew higher in the capital structure. You may feel more comfortable skewing it in the middle of the capital structure. So that will all play into the ultimate mix.

I appreciate the thoughts. And again, thank you for the net improvement as it relates to ROEs because of the fee, and I appreciate your thoughts on the win-win.

(Operator Instructions) And we'll take our next question from David Miyazaki with Confluence.

First of all, I guess, Art, you and I have talked at great length over the years about the absence of the share repurchase programs. So first, I wanted to say, thank you for putting that in place. And it's nice to be on the same page with you in that regard. And I was also glad to hear that it sounds like you're actually committed to doing it. There's quite a pantheon of repurchase programs in this industry that don't really get effected. So my question for you on that front is, what happened in your discussions with the rating agencies? Because obviously, you've had since some monetizations here with your equity, but I presume you're going to have to satisfy some thoughts from the rating agencies as far as how you're going to manage the leverage versus buying back stock that will increase the balance sheet leverage.

So it's a good question. Look, there the agencies are focused on their specific guidelines. Each have their own Fitchiness and they have their own specific guidelines. And with the gusher of cash that we were able to generate this past quarter, particularly the $46 million of equity, we could meet -- we could both meet their guidelines for staying investment grade and do what we've been hoping to do for the last few quarters, which is initiate a stock buyback. So it was just due to the circumstances of the monetizations, particularly the equity monetizations that we were able to generate this quarter.

Okay, that's good to hear. And just to clarify again that, obviously, your price will change, and your stock and your investment opportunities will change. But all things being the same that, from here, you would be committed to actually executing that repurchase program?

We are nothing if not predictable, I hope. I hope we're predictable. That's our goal, is to be predictable. Back to that character thing. So we did a stock buyback program a few years ago. We were predictable. We put it to work over 4 quarters. This is our intention today. If the stock market has a big spasm, and we can buy the stock cheaper, we'll put it to work quicker. But our intention is roughly 25% a quarter.

Okay, great. That's very good to hear. I wanted to also dial back a little bit to some conversations that we've had in the past regarding your portfolio of energy companies. And I think back when oil was in the 40s that you had -- you were in the midst of restructuring a lot of the investments. And your comment was that a lot of these companies had long-term value in the mid- to high 40s that could survive on a restructured basis, but you would reach profitability kind of in the mid-60s to $70 range. And it would appear, based upon the way that you're talking about M&A activity for Ram, for ETX, the opportunity to monetize American Gilsonite, is that still the case for these companies?

Yes, we're feeling much better. Here we are around $70. We're feeling much better. 70's new in the last few days, essentially. Say it's at $70, we hope we're going to ascertain real value here. Nothing's ever for sure. All these companies have moved around a little bit, and they've added assets here and subtracted assets there since oil was in the 40s a year or 2 ago. But we're hopeful that we can get good value and, over time, exit these equity securities at good values and go back to doing our middle-market lending to middle-market financial sponsors and avoid the equity patch forevermore.

So one of the thing -- I mean, there is a big difference between making new investments and holding an existing one, and I can understand that. But your decision to hold the equity going forward at the same time when you are saying that you're very unlikely to do any more energy debt in the future is somewhat inconsistent with each other, right? Because you're optimistic about the opportunities in the industry and the opportunity for the equity to earn -- to have good returns. Can you reconcile that a little?

I'm smiling, because you and I one day should have a drink about how we deal with some of our bad investments. Not that you've ever made a bad investment, David, but...

I'll take you up on that, Art.

We had a little style shift. We've paid for it. We're sorry. We've had an excellent track record in basic middle market, sponsor-driven lending, I think, for these BDC portfolios. That's where we should be. And not to say in other types of portfolios we can't use our expertise, and that we've learned to make money. But, yes, you're right. There's a basic inconsistency between holding onto equity investments that you think and hope will generate good returns because the wind's finally at our back in energy after several years versus doing new loans. And we debate this. And perhaps down the road, we may -- after we've licked our wounds for a little while, we may get back into it. But for now, I think with a chunk of this portfolio in energy, we're full up in energy, and then hoping to exit well with good values over time.

Well, certainly, having good outcomes on your remaining equity would bolster the credibility you would have in making those kinds of loans. But I would just say that you paid the tuition for the lessons. If you learned how to be a better energy lender, it might make sense in the future to apply those lessons. The last thing I would say is that, back when your dividend was in the high-20s, I think you and I talked a little bit about where you're going to set it based upon the fact that equity had risen as a proportion of your portfolio. And it seemed like -- my recollection from those conversations was that you thought that the normalized earning power of the balance sheet was probably able to create an NII in the mid-20s. And so as you're working through this, and some of the equity is now coming back and you're able to deploy it, understanding that the ROE environment in the middle market has changed, do you still see that that's the earnings power of the balance sheet over time? Not for this quarter, obviously, or next quarter or this year, but as you move forward and deploy that capital, is that still the pathway that you think that you're going to be able to hit?

I mean, it's certainly a goal that we aspire to. Certainly, using SBIC financing can be powerful. Certainly, recycling the equity exits as we get them can be powerful. And certainly, as LIBOR hopefully continues to go up, and perhaps we could catch a break and spreads increase over time, it's certainly an aspiration. I think we're more focused on the here and now and executing our game plan and all of those levers. And we'll get back in the mid-20s, for sure.

Okay, great. Well, I appreciate the progress on the multiplicity of different funds, and I look forward to watching you progress.

Thank you very much, David.

So we'll take our next question from Mickey Schleien with Ladenburg.

Yes. Art, just one quick follow-up. Apart from the reversals, what else drove the unrealized depreciation for the quarter?

I mean, the biggest mover was ETX in this conversion from convertible debt to equity and the value that was determined by the majority shareholders, which was roughly cost. That was the biggest driver of the move.

And we'll take our next question from Michael Cohen with Opportunistic Research.

A quick question on both sort of Ram and ETX. Is the strategy similar to what you guys have articulated in the past, which is they're trying to find adjacent properties and wells of it, by definition, kind of improve their operating leverage, which kind of improves their EBITDA, which makes them more attractive for exit?

That's correct, and the idea is to cluster and get critical mass in certain geographies that then create the best value for exit or over the long term.

And how far along do you think they are in that process? What do you think is a realistic time horizon in the past where you've said anywhere from 12 to 24 months on sort of a rolling basis. How do you think about that today?

I think it's still probably the same, 12 to 24 months. These management teams have very specific priorities of focus and plans that they want to pursue, which is why these capital structures have morphed around a little bit in the last 6 to 9 months. And I think our call is to give them time. If the animal spirits pick up again in the energy markets and there's a great value on exit, of course, we'll look at taking it.

And just out of curiosity. When they're sort of layering on adjacencies, how do you guys think about the risk? Obviously, they're now buying with oil at $70, not $40. So there's -- presumably, what they're paying for is higher valuation, which kind of introduces some risk. But can you just kind of talk us through how you think about that?

That's right. It's a good news and a bad news at the same time, right? So clearly, we and those management companies want these add-on acquisitions to be creative, such that when we go ascertain value, the overall value will be better. And certainly, at $70 versus $50, it is more expensive. So if there's no good deals to do, that tells you that maybe you should be selling, right? So I think we've just got to play along for a little while.

Okay, understood. And then not to beat a dead horse on the SBIC, let me ask a question slightly differently. Recognizing, obviously, your unwavering commitment to bondholders, which makes complete sense to me, how much of your thinking is impacted just simply based on sort of timing of the economic cycle, timing of the commercial lending cycle, and wanting to have a greater reserve or greater purchasing power, for lack of a better way of saying it, at the bottom of the cycle? Meaning if you held your dry powder until the time period in which credit perhaps genuflects, and you can then use that additional purchasing power, how do you think about that? Is that a consideration?

Certainly, it is, and as well as what our -- what's the underlying collateral relative to the debt. So we've all -- we've said that this legislation's been bandied about for, I don't know, 6, 7, 8 years or whatever it is. We've said there's -- that there are certain assets, like classic first-lien debt, where you can prudently leverage them more than 1:1 and you should feel fine. And we've also said there's assets, such a second lien or mezzanine, that even if you couldn't leverage them more than 1:1, you should. So it's all kind of -- in some ways, it's based on the underlying portfolio that you have. PFLT, which is a sister, but you see that's mostly first lien, has a joint venture where that joint venture on first-lien assets gets up to 2:1 leverage. We think for that collateral, that's absolutely prudent and makes sense. PNNT today is kind of 40% second lien in mezz and 17% equity. Thank you very much. Even if we can leverage them more than 1:1, we're fine for now. And part and parcel, it is, yes, we want to maintain our rating for a number of reasons. But look, as these bonds roll off in 15 months, we can look up and say, "What's the opportunity to market on the asset side? What's the opportunity on the financing side? What are our stakeholders saying, both debt and equity stakeholders? And do we shift the mix around a little bit?" So that's a discussion we'll be having over the coming year.

At this time, I'd like to turn the call back to Mr. Art Penn for any additional or closing remarks.

I just want to thank everybody for being on the call today. Lots of great questions. We remain excited about our company and about the investment opportunity. So thank you for your interest, and we'll be talking to you in early August. Thank you very much.

And that concludes today's presentation. We thank you for your participation. You may now disconnect.