Portman Ridge Finance Corporation

Welcome to Portman Ridge Finance Corporation's fourth quarter and full year 2022 earnings conference call. An earnings press release was distributed yesterday, March 9th, after market closed. A copy of the release, along with an earnings presentation, is available on the company's website at www.portmanridge.com in the investor relations section and should be reviewed in conjunction with the company's Form 10-K filed with the SEC. As a reminder, this conference call is being recorded for replay purposes. Please note that today's conference call may contain forward-looking statements which are not guarantees of future performance or results and involve a number of risks and uncertainties. Actual results may differ materially from those in the forward-looking statements as a result of a number of factors, including those described in the company's filings with the SEC. Portman Ridge Finance Corporation assumes no obligation to update any such forward-looking statements unless required by law. Speaking on today's call will be Ted Goldthorpe, Chief Executive Officer, President and Director of Portman Ridge Finance Corporation, Jason Ruse, Chief Financial Officer, and Patrick Schaefer, Chief Investment Officer. With that, I would now like to turn the call over to Ted Goldthorpe, Chief Executive Officer of Portman Ridge. Good morning.

Good morning. Thanks, everyone, for joining our fourth quarter and full year 2022 earnings call. I'm joined today by our Chief Financial Officer, Jason Ruse, and our Chief Investment Officer, Patrick Schaefer. I'll provide brief highlights on the company's performance and activities for full year 2022. Patrick will provide commentary on our investment portfolio and our markets, and Jason will discuss our operating results and financial condition in greater detail. Yesterday, Portman Ridge announced its fourth quarter and full year 2022 results, and we are pleased with the solid earnings power of the company, despite operating under difficult market conditions, a challenging economic environment, rising interest rates, and market volatility. Our core investment income in 2022 increased by $800,000 to $64.2 million in comparison to $63.4 million seen in 2021 as we continue to see the impact that rising rates have in generating incremental revenue from our sourced investments. Additionally, our amended and extended credit facility with JPMorgan Chase has reduced our cost of capital, helping further reduce our expenses relative to our asset base. Overall, our performance both this quarter and earnings momentum from a timing lag and a realization of rising benchmarks has allowed us to raise our dividend for the second straight quarter to 68 cents per share, and we believe that we are situated to continuing delivering attractive returns to our shareholders in 2023. Regarding our primary market as a whole, despite the continued volatility in the syndicated markets and an uncertain macro backdrop, we remain bullish on new investment opportunities and the ability to rotate our portfolio at reduced risk and incremental returns. For new opportunities, spreads have widened by approximately 150 to 200 basis points as compared to the beginning of the year, and upfront fees are an incremental 100 to 200 basis points. Additionally, we continue to see strong equity contributions from sponsors and reduced leverage levels. To illustrate this, the weighted average total leverage of deals we completed in the fourth quarter was 4.8 times as compared to five times in Q3 and and 5.5 times for all of 2022. Turning the focus back to the company, we continue to believe in the valuation of Portman Ridge as we continued repurchasing shares under a renewed stock repurchase program. In 2022 alone, we repurchased a total of 167,017 shares at an approximate cost of approximately 3.8 million, more than double the amount of shares we repurchased in 2021 at 75,377 shares. We expect this trend of repurchasing Portman shares to continue into 2023 as we're able to do so. On this call, Patrick will also walk through the potential upside cases for an asset value. Our portfolio is largely in first lien debt and is now valued at a significant discount to par. If you experience normalized defaults or even elevated default rates versus history, we believe there is embedded net asset value upside in the portfolio. So this adds to our earnings momentum, driven by wider spreads on new originations and rising short-term interest rates, to drive both potential NAV and earnings upside. With that, I will turn the call over to Patrick Schaefer, our Chief Investment Officer, for a review of our investment activity.

Thanks, Ted. Turning to slide five of our presentation and the sensitivity of our earnings to interest rates, As of December 31st, 2022, approximately 90% of our debt securities portfolio were either floating rate with a spread to an interest index such as LIBOR, SOFR, or PRIME, with 67% of these still being linked to LIBOR. As you can see from the chart, the underlying benchmark rate of our assets during the quarter lagged the prevailing market rates and still remains significantly below the LIBOR and SOFR rates as of February 28th, 2023. We would expect this to normalize over time as the underlying one, three, and six-month contracts reset. For lesser purposes, if all our assets were to reset to either a three-month LIBOR or SOFR rate, respectively, we would expect to generate an incremental $2 million of quarterly income. While our liability costs will also rise relative to their Q4 levels, we still expect a net positive benefit of approximately 10 cents per share assuming all of our assets and liabilities are utilizing the same three-month benchmark rates for an entire quarter. Skipping down to slide 11, both investment activity and originations for the fourth quarter were lower than the prior quarter, resulting in net deployments of approximately $6.3 million, excluding regularly scheduled quarterly amortization payments and fundings under previously committed facilities, including our Great Lakes joint venture. Net deployment consisted of new fundings of approximately $23.8 million, offset by approximately $16.5 million of repayments. These new investments are expected to yield a spread to SOFR of 704 basis points on the par balance. And the investments were purchased at a cost of approximately 95.5 percent of par, which will generate incremental income in addition to the stated spread. As mentioned in our press release, We drew $14.3 million under our 2018-2 secured notes at a rate of LIBOR plus 158 basis points to fund these assets yielding SOFR plus 704 basis points, resulting in a very attractive return on equity. Additionally, during the quarter we funded $13.7 million into our Great Lakes joint venture and have had additional funding so far this year that have in aggregate taken us close to being fully funded under that commitment. Similar to our experience with new assets on the balance sheet, incremental investments in our Great Lakes Joint Venture have come at increasing spreads and widening OID, which should result in higher returns going forward. Our investment securities portfolio at the end of the fourth quarter remained highly diversified, with investments spread across 31 different industries and 119 different entities, all while maintaining an average par balance per entity of approximately $3.3 million. Turning to slide 12, We had one incremental investment on non-recrual as compared to September 30, 2022, which is a subordinated note in pro-error holdings, which is valued at zero. In aggregate, investments on non-recrual status remained relatively low at four investments in the fourth quarter of 2022 as compared to seven investments on non-recrual status as of December 31, 2021. These four investments on non-accrual at the end of 2022 represent 0.0 and 0.6 percent of the company's investment portfolio at fair value and amortized cost, respectively. On slide 13, as Ted mentioned in his opening remarks, if we focus on the top three rows of the table, we have an aggregate debt securities fair value of $475.3 million, which represents a blended price of 91.66 percent of par value and is 84% comprised of first lien loans at par value. Assuming a par recovery, our December 31, 2022 fair values reflect a potential of $43.2 million of incremental NAV value, or $4.51 per share. For illustrative purposes, if you were to assume a 10% default rate and a 70% recovery rate on this debt portfolio, there would still be an incremental $2.89 per share of NAV value over time as the portfolio matures and is repaid. This default rate is above anything the market is expecting or has experienced historically. Turning finally to slide 14, if you aggregate these three portfolios, over the last three years, we have purchased a combined $434.8 million of investments. have realized over two-thirds of these positions at a combined realized and unrealized mark of 103% of fair value at the time of closing the respective mergers. We're able to achieve those results despite the global pandemic in 2020 and most of 2021 and a weak market for almost all asset classes in 2022. In a similar vein as the previous slide, as of December 31st, 2022, There remains an incremental $13.7 million of value as compared to the par in these portfolios, or $9.3 million when applying a similar 10% default rate and 70% recovery rate analysis. And I'll turn the call over to Jason to further discuss our financial results for the period.

Thanks, Patrick. As both Ted and Patrick previously mentioned, despite operating under a challenging economic environment, Our results for both the fourth quarter and for the full year 2022 reflect strong financial performance. Total investment income for the full year 2022 was 69.6 million, of which 55.8 million was attributable to interest income from the debt securities portfolio. This compares to total investment income for the full year 2021 of 80.1 million, of which 65 million was attributable to interest income from the debt securities portfolio. The decrease was largely due to lower purchase price accretion reflected in 2022, as well as reduced repayments along with lower fee income. Excluding the impact of purchase price accounting, our core investment income for the year was $64.2 million, an increase of $800,000 as compared to core investment income of $63.4 million in 2021. Our net investment income for the full year 2022 was $28.9 million, or $3 per share, which compares to $42 million or $4.92 per share for the full year 2021. The year-over-year decrease was largely due to the aforementioned impact of reduced purchase accretion, lower repayment activity, and reduced fee income. As of December 31st, 2022 and December 31st, 2021, the weighted average contractual interest rate on our interest-earning debt securities was approximately 11.1% and 8.1% respectively. We believe the portfolio remains well positioned in a rising rate environment to generate incremental revenue in future quarters. Total expenses for the year ended December 31, 2022 were $40.7 million compared to total expenses of $38.1 million seen in the full year 2021. This was predominantly driven by rising costs associated with the interest expense on our debt. One item to note is that we continue to see reduced expenses related to administrative services and other general and administrative costs. a trend we are looking to maintain in 2023. Our net asset value for the fourth quarter of 2022 was $232.1 million, or $24.23 per share, as compared to $251.6 million, or $26.18 per share, in the third quarter of 2022. The decline due to our debt and equity securities was driven primarily by mark-to-market movements within our portfolio. On the liability side of the balance sheet, as of December 31, 2022, We had a total of $378.2 million par value of borrowings outstanding, comprised of $92 million in borrowings under our revolving credit facility, $108 million of 4.78% notes due 2026, and $178.2 million in secured notes due 2029. This balance represents a quarter-over-quarter increase of $9.2 million relating to a draw in our secured notes of $14.3 million, offset by a $5.1 million repayment on our revolving credit facility. As of the end of the quarter, we had $28.9 million of available borrowing capacity under the Senior Secured Revolving Facility and no remaining borrowing capacity under the 2018-2 Revolving Credit Facility as the reinvestment period ended shortly after our draw on November 20, 2022. Additionally, and as pointed out in our previous earnings calls, we successfully refinanced our Senior Secured Revolving Credit Facility in April which changed the benchmark interest rate to three-month SOFR, reduced the rate of interest margin to 2.8% per annum from 2.85% per annum, and extended the maturity of the facility to April 29, 2026. As of December 31, 2022, our debt-to-equity ratio was 1.6 times on a gross basis and 1.5 times on a net basis. From a regulatory perspective, our asset coverage ratio at quarter end was 160%. This is at the high end of our target range, driven by the drawing of the remaining capacity under the 2018-2 revolver in advance of its expiration in the fourth quarter of 2022. Lastly, and as announced yesterday, a quarterly distribution of 68 cents per share, which represents an increase of one cent from prior quarter levels and an increase of five cents from levels seen in the first quarter of 2022, was approved by the Board and declared payable on March 31st, 2023. To stockholders of record, at the close of business on March 20, 2023. The latest increase of 68 cents also represents two consecutive quarters of stockholder distribution increases and the fourth stockholder distribution increase over the last six quarters. This increased quarterly distribution is supported by the fourth quarter's strong financial performance and our expectations for similar financial performance to continue in future quarters. With that, I will turn the call back over to Ted.

Thank you. Ahead of questions, I'd like to reemphasize that we believe we are well positioned to take advantage of the current market. Through our prudent yet selective investment strategy, coupled with our emphasis on cost management, we anticipate that we will be able to generate strong returns for our shareholders in 2023. Thank you once again to all our shareholders for your ongoing support. This concludes our prepared remarks, and I'll now turn the call over to the operator with any questions.

At this time, if you'd like to ask a question, simply press star 1 on your telephone keypad. Our first question will come from the line of Christopher Nolan with Lindenberg Thelman. Please go ahead.

Hey, guys. The leverage ratio is high. What's the anticipation going forward in terms of maintaining that level or bringing it down? And what's the current target leverage range?

Yeah, I think our – hey, Chris, it's Patrick Schaefer. So I think our target leverage range kind of remains – what we stated before, which is 125 to 1.4. So we're a little bit above that at 1.5. I think, again, as mentioned, we intentionally drew up our revolver, which brought us a little bit above our leverage range, given that it was terming out and it's a particularly attractive financing at LIBOR plus 158. But we would expect over the course of this year to have leverage decline back into kind of what we would think of our target range is, kind of something below 1.4 times net.

Okay, thanks, Patrick. As a follow-up question, Silicon Valley Bank is in the news today. And I know it's a quickly evolving situation, but are you guys trying to figure out in terms of any of your portfolio companies or their sponsors may have exposure to Silicon Valley in terms of significant deposits there? And I know it's early days and it's a fast-moving situation, but any perspective would be welcome to.

Yeah, anytime something like this happens, you know, we're always very focused on the knock-on effects. You know, we called and spoke to a number of our portfolio companies both last night and this morning, and I think it's a little too early to assess, but obviously, you know, there will be some flow-through effects on certain tech businesses, given they're a big lender there, as well as a whole lot of cash. And then we're looking at other knock-on effects, too, in terms of, you know, if they're having to sell securities at big discounts, you know, how does that ripple through the rest of the financial markets? I would say if you look at our portfolio, we think, again, we don't think this is going to, as of right now, we don't think this is going to have really any material impact on our portfolio unless there's, you know, other unforeseen things that happen because of it.

Okay. That's it for me. Thanks, guys.

Again, for any questions, please press star one. Your next question will come from the line of Ryan Lynch with KBW. Please go ahead.

Hey, good morning. First, I just wanted to hop into kind of what happened quarter over quarter regarding interest income as well as, or investment income as well as interest expense. So if I look at core investment income, it only increased about $100,000 from 2017 point six million to 17.7 million. Meanwhile, and also looking at your slide as far as like accelerated fees, I know those were a little bit lower in the quarter, but I think that was only maybe a couple hundred thousand dollars lower versus Q3. So that was only a few hundred thousand dollar headwind. But meanwhile, interest expense went up by over a million dollars. So I was just wondering, it was I understand that there's a lag. from the positive impact of rising rates, but that same lag impacted third quarter numbers. And so effectively where we are, we're always in a lag, but quarter over quarter, it feels like we should be moving up generally the same amount. So I was just curious on why the lack of movement in investment income this quarter relative to where rates went. where rates really moved in the third quarter, which would have then mostly impacted your fourth quarter numbers.

Yeah. Hey, Ron, let me just start quick. This is Patrick. Let me start quickly on the timing. So particularly for Portman, our CLO, which is the bulk – not the bulk, but it is over 50% of our floating rate liabilities, resets in the middle of the quarter, specifically reset at the end of November. So we are on a bit of a different cadence where the – the majority of our liabilities on the floating rate reset during the quarter. So depending on when the actual Fed rate hikes are over the course of a period of time, we can get a bit of a mismatch there because of the timing of that reset. So again, when you kind of roll it forward and we discussed and we show in our presentation kind of the 10 cents on a run rate basis, there's not a significant amount of further increase in our liabilities because of where they were reset to during the fourth quarter. So that's why we specifically highlighted some of the timing differences, but I'll turn it over to Jason to kind of go through some of the income numbers themselves. But I just wanted to throw that out there on the timing. We have a bit of a unique situation because of when a big chunk of our floating rate liabilities reset. Okay. Yeah.

Yeah. And there's some netting netting impacts happening there. So if you look at quarter over quarter, you see purchase accretion kind of running off at a clip of about $500,000. So that's a piece of income that has to be offset with the interest raise throughout the quarter. If you look at pure interest, we're up well over $1.2 to plus million quarter over quarter on the interest alone. That's offset a little bit by that accretion I was mentioning. Fees quarter over quarter slightly down, call it $200,000 closer to $270,000 for the quarter. CLO income was down, and we can talk more about that, but those are some of the drivers really just offsetting to get to a net increase quarter over quarter on that investment income.

Yeah, why was CLO income down so much quarter over quarter? And is that a good quarter run rate? Is that a good run rate going forward?

Yeah, the CLOs are on a The accounting model for that is the beneficial interest method. And as you reset your basis in the assets and you calculate your IRR over the life of the future cash flows, and as those cash flows move around, your IRR will change, which drives your yield. And that's what drives your interest income on those CLOs. As a result of the embedded cash flows, that future cash flow expected stream decreasing, just given the market environment we're in, that yield is coming down, which is what's driving the reduction in that yield.

Yeah, so the shorthand there is the actual price of the CLOs that are marked at has an impact on what we recognize from a revenue perspective. So the marks on CLOs being down quarter over quarter lead to less revenue being recognized. It's not necessarily a cash flow from the securities being down necessarily. So in theory, if we were to mark up the CLOs next quarter, you would see a increase in the revenue, roughly speaking, because of that. But it's a little bit more of a revenue recognition as opposed to underlying cash flows of the CLOs.

Yeah, I think it's fair to say, and the same thing happened in 2020 and other periods of time, but I think the third-party valuation firms changed their methodology around how they account for CLOs in terms of how they view defaults and future defaults. And so that they made a change in the fourth quarter, which obviously had an impact not only on income, but also on valuations.

Okay. Gotcha. And the other question comes to, and you talked a little bit about in your prepared remarks, but just the net portfolio losses that were recorded in this quarter and really the last couple quarters, you know, driving kind of the decline in NAVs. I know last quarter you talked about it. It sounds like a lot of it is mark-to-market, but they've certainly been outsized relative to other BDC marks. Now, I know you can't comment on how other BDCs are marking their portfolios, and I also can understand that. When I look at non-accrual specifically, they haven't increased significantly, so that is one indicator that credit, you know, at least from a non-accrual default standpoint, hasn't increased meaningfully, but still, The declines in your portfolio, the markdowns have been well outside the normal range for what we've seen in BDC. So it feels like there's something more going on besides mark-to-market. Can you talk about that and why have those markdowns been so large and what are you expecting? I mean, if it is just mark-to-market, those will eventually theoretically recover, but depending on how market conditions play out over time. But it's just they're really outsized relative to other BDCs.

Yeah, I mean, it's obviously something that we, you know, if you think of it, just take a huge step back, right? If you think about what happened with markets last year and where comparable indices were last year and were levered, you know, we're not really a big outlier vis-a-vis the overall markets. We are an outlier vis-a-vis the BDC sector. And I can't speak to other people's policies, but, you know, 84% – we are not seeing a market increase or decrease in credit quality. And our average, you know, as Patrick mentioned in his remarks, you know, 84% of our debt is first-lane debt. And our average debt mark is at 91, 91.6. So, you know, we – you know, I hear what you're saying. And, by the way, we obviously look in the mirror every single day. And, by the way, we look at our peers' earnings as well. But, again, if you look at where our valuations are vis-a-vis market indices, I would say, you know, we feel that, like, you can shock our portfolio in lots of different ways, and you can add a very elevated default rate to this, and there still should be a pretty big upside to our NAV. And so, again, I'm not going to comment on broad valuation policies, but I would say our, we believe our NAV declines are largely temporary and mark-to-market in nature. I mean, obviously there's always credit-specific stuff, but are non-accruals today at fair value or zero? So I would say I hear what you're saying, actually, and it's something that obviously we talk a lot about internally here, but obviously we always want to be conservative on valuations and adhere to our valuation policies.

Yeah, and Ryan, the two other minor small points I would add is Perhaps unlike some other BDCs, we do have a little bit of a chunk of a liquid portfolio that has a lot more true kind of mark-to-market as opposed to like third-party valuation type of marks. So obviously the volatility in the syndicated markets and kind of where that market is has had perhaps a slightly disproportionate impact on kind of our fair value relative to perhaps another BDC that really doesn't have any level two assets. And then the second thing I would say is, again, not to get into general people's valuation policies, you know, we do have a decent reliance on the actual liquid benchmarks and the yields of those benchmarks. So that does ultimately, again, perhaps that does lead to a little bit more volatility on our mark-to-market perhaps relative to others if they're not using kind of, you know, CS lever loan indices from a yield perspective.

Yeah, I mean, I guess I'm just looking at, you know, versus the Credit Suisse, I'm looking at, you know, LCDs and, you know, the average flow name bid is at 97. And so, you know, I certainly appreciate the potential conservatism in your book if you guys have your first link marked at 91. But I would also ask, I guess... why is it marked down that low to that level of conservatism when I don't see that in broad liquid indices and leveraged loan indices, and I don't see other BDCs marking it down to that level? What drives that level of potential? We'll find out over time if that's just conservatism and that overall mark.

I think that 97 number is a today figure, and again, these are 1231 marks. So when you look at our liquid indices benchmarks, and again, post SVB, we'll see if this changes, but obviously we've had a pretty big rally in credit for the first three months of this year. So if you look at the benchmarks we use to value our portfolio, they're tighter today, meaning the spreads are tighter, meaning prices are higher than they were at 1231. So you've had a pretty big rally in credit, and you've definitely had a big rally in floating rate debt, because obviously This hire for longer has put a real floor under loan valuations. And obviously, you know, the vast majority of our portfolio is floating rate loans. So the number you're using, again, like if we were going to value our book today and use the indices today, you know, obviously the NAV would look different.

Yeah, and Ryan, the only thing I'd say, again, I'm happy to follow up offline. I mean, we use a, again, part of what we use is a broad Credit Suisse levered loan index that I'm literally pulled up and looking at right now. And as of year end, the average price in that index was 91.9, not 97. So like I said, I'm happy to sync up afterwards. It's a publicly available entity that is part of what makes up our valuation process. But the 97, again, I'm not sure that's apples to apples.

And the last thing I'd say, we don't want to get all high and mighty about our valuation policies because everybody can speak for themselves. But the other back testing we do for our board is is we look at every single realization and where it was valued beforehand and where it was realized. And I think across, it's basically like 100% hit rate for the last couple quarters on our realizations are higher, at higher values than where we were valued. So, I mean, it just shows, it's for us to provide comfort to the board that our valuations are, generally speaking, conservative.

Yeah. I guess, you know, What we're trying to do with outsiders looking in is just figure out, you know, and if something is just conservative, then that's fine. But I guess, you know, from an outsider looking in, we're trying to figure out these outsized moves in your portfolio's NAV, you know, and the portfolio decline as well as the NAV decline. Is that right? credit or is that mark to market and there's probably a combination of both of them uh given what's going on in the market today with just broadly deteriorating credit quality across the but i think that's the biggest i think focus right now for investors particularly the sort of these outside movement apps is trying to navigate that so i appreciate you know i i honestly i agree with everything you're saying i read your note last night too like i i agree with all that um

And so, us, it's frustrating because we feel like our business is doing really well, and we feel like we're really not seeing – I mean, we will have credit issues, as will everybody, but we have an incredibly diverse portfolio. You know, we've got – like, so there's not, like, one name that can really have a huge impact on our business. You know, again, non-accruals are basically zero. And, you know, I just look at the broad loan indices last year and see BDCs reporting flat NAV, and I just – to me – I mean, I won't comment on others, but I just say – I don't think our numbers are wildly off where benchmarks are. But what you're saying is the same question we ask ourselves as well. Because if I was a shareholder, I'd be asking the same question. I mean, the counter to all that is, obviously, we're buying back our stock. We raised our dividend for the fourth time. My guess is we'll have continuing dividend increases as this timing and lag issues normalize. And so, you know, again, we're pretty optimistic for earnings this year.

Okay. I got you. Thanks for the dialogue. That's all for me today. I'll thank you.

Once again, for any questions, press star 1 on your telephone keypad. We have no further questions at this time. I'll hand the conference back over to management.

Great. Thank you, everybody, for joining us today. And we look forward to speaking to you all in early May when we'll be announcing our first quarter 2023 results. Thank you very much.

Ladies and gentlemen, that will conclude today's meeting. Thank you all for joining. You may now disconnect.