PennantPark Floating Rate Capital Ltd.

Q4 2023 Earnings Conference Call

11/16/2023

spk05: Good morning and welcome to the Pennant Park Floating Rate Capital's fourth fiscal quarter 2023 earnings conference call. Today's conference is being recorded. At this time, all participants have been placed in the listen-only mode. The call will open with a question and answer session following the speaker's remarks. If you would like to ask a question at that time, simply press star 1 on your telephone keypad. If you would like to withdraw your question, please press star 2 on your telephone keypad. It is now my pleasure to turn the call over to Mr. Art Penn, Chairman and Chief Executive Officer of Pennant Park Floating Rate Capital. Mr. Penn, you may begin your conference.
spk04: Thank you, and good morning, everyone. I'd like to welcome you to Pennant Park Floating Rate Capital's fourth fiscal quarter 2023 earnings conference call. I'm joined today by Rick Elordo, our Chief Financial Officer. Rick, please start off by disclosing some general conference call information and include a discussion about forward-looking statements.
spk03: 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 Penn and Park Floating Rate Capital and that any unauthorized broadcast of this call in any form is strictly prohibited. An audio replay of the call will be available on our website. I'd also like to call your attention to the customary Safe Harbor disclosure in our press release regarding forward-looking information. Today's conference call may also include forward-looking statements and projections, and we ask that you refer to our most recent filing 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 pennandpark.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.
spk04: Thanks, Rick. We're going to spend a few minutes discussing the current market environment for middle market lending, how we fared in the quarter ended September 30th, how the portfolio is positioned for the upcoming quarters, a detailed review of the financials, then open it up for Q&A. For the quarter ended September 30th, GAAP and Core Net Investment Income was 32 cents per share. GAAP NAV increased 1.6% to $11.13 per share from $10.96 per share. Adjusted NAV, excluding the mark-to-market adjustments on our liabilities, increased to $11.13 per share or 1.2%. The increase in NAV for the quarter was due primarily to positive valuation adjustments on both debt and equity investments. With a debt portfolio that is 100% floating rate, we continue to benefit from the current base rate environment. As of September 30th, our weighted average yielded maturity was 12.6%, which is up from 12.4% last quarter and 10% last year. During the quarter, we continued to originate attractive investment opportunities and invested $94 million in three new and 31 existing portfolio companies, at a weighted average yield of 12.1%. For the investments in new portfolio companies, the weighted average debt to EBITDA was 3.6 times, the weighted average interest coverage was 2.3 times, and the weighted average loan-to-value was 36%. We continue to believe that the current vintage of core middle market directly originated loans is excellent. Leverages lower, spreads and upfront OID are higher, and covenants are tighter than in the upper middle market. Despite reports of covenant erosion in the upper middle market, in the core middle market, we are still getting meaningful covenant protections. We are seeing an increase in deal flow compared to the first half of 2023 and have a growing pipeline of interesting and attractive investment opportunities. Since quarter end, we have continued to be active from September 30th through November 10th We've invested $76 million into new and existing investments and are continuing to see strong deal flow going into year end. As of September 30th, our debt to EBITDA ratio was 0.76 to 1. With a target ratio of 1.5 to 1, we believe that we are positioned to drive strong growth in net investment income going forward. Additional growth in NII can be driven by our joint venture. As of September 30th, the JV portfolio totaled $786 million, and together with our JV partner, we continue to execute on the plan to grow the JV portfolio to approximately $1 billion of assets. During the quarter, the JV invested $52 million into five new and eight existing portfolio companies at an weighted average yield of 12%, including $37 million of assets purchased from PFLT. We believe that the increase in the scale of the JV's balance sheet will continue to drive attractive mid-teens returns on invested capital and enhance PFLT's earnings momentum. Credit quality of the portfolio is stable. We had no new non-accruals in the quarter ended September 30th. As of September 30th, the portfolio's weighted average leverage ratio to our debt security was 5.1 times, and despite the steep increase in base rates over the last 12 months, the portfolio's weighted average interest coverage ratio at September 30th was 2.1 times. From an overall perspective, in this market environment of elevated inflation, rising interest rates, geopolitical risk, and a potentially weakening economy, we like being positioned for capital preservation as a senior secured first lien lender focused on the United States where the floating rates on our loans can protect us against rising interest rates and inflation. We continue to believe that our focus on the core middle market, provides the company with attractive investment opportunities where we provide important strategic capital to our borrowers. We have a long-term track record of generating value by successfully financing growing middle market companies in five key sectors. These are sectors where we have substantial domain expertise, know the right questions to ask, and have an excellent track record. They are business services, consumer, government services and defense, healthcare, and software and technology. These sectors have also been resilient and tend to generate strong free cash flow. Approximately 12% of our portfolio is in government services and defense, which is a sector with strong tailwinds in this geopolitical environment. In our software vertical, we don't have any exposure to ARR loans. The core middle market, companies with 10 to 50 million of EBITDA, is below the threshold and does not compete with the broadly syndicated loan or high yield markets unlike our peers in the upper middle market. In the core middle market, because we are an important strategic lending partner, the process and package of terms we receive is attractive. We have many weeks to do our diligence with care. We thoughtfully structure transactions with sensible credit statistics, meaningful covenants, substantial equity cushions to protect our capital, attractive upfront OID, and equity co-investment. Additionally, from a monitoring perspective, we receive monthly financial statements to help us stay on top of the companies. With regard to covenants, unlike the erosion in the upper middle market, virtually all of our originated first lien loans have meaningful covenants which help protect our capital. This is a significant reason why we believe we are well positioned in this environment. Many of our peers who focus on the broadly syndicated loan and upper middle market state that those companies are less risky. That might make some intuitive sense, but the reality is different. According to S&P, loans to companies with less than 50 million EBITDA have a lower default rate and higher recovery rate than loans to companies with higher EBITDA. We believe that the meaningful covenant protections of core middle market loans, more careful diligence, and tighter monitoring have been an important part of this differentiated performance. Our credit quality since inception over 10 years ago has been excellent. PFLT has invested $5.3 billion in 468 companies, and we have experienced only 18 non-accruals. Since inception, PFLT's loss ratio is only 15 basis points annually. As a provider of strategic capital that fuels the growth of our portfolio companies, in many cases we participate in the upside of the company by making an equity co-investment. Our returns on these equity co-investments have been excellent over time. Overall, for our platform, from inception through September 30th, We've invested over $410 million in equity co-investments and have generated an IRR of 26% and a multiple on invested capital of 2.2 times. Our experienced and talented team and wide origination funnel is producing active deal flow. Our continued focus remains on capital preservation and being patient investors. Our mission and goal are a steady, stable, and protected dividend stream coupled with preservation of capital. Everything we do is aligned to that goal. We seek to find investment opportunities in growing middle market companies that have high free cash flow conversion. We capture that free cash flow primarily in first lien senior secured instruments, and we pay out those contractual cash flows in the form of dividends to our shareholders. Let me now turn the call over to Rick, our CFO, to take us through the financial results in more detail.
spk03: Thank you, Art. For the quarter ended September 30th, GAAP and core net investment income was $0.32 per share. Operating expenses for the quarter were as follows. Interest and expenses on debt were $8.6 million. Base management and performance-based incentive fees were $7.4 million. General and administrative expenses were $1.1 million. And provision for taxes were $150,000. For the quarter ended September 30, net realized and unrealized change on investments including provision for taxes, was a gain of $9.5 million or $0.16 per share. The unrealized appreciation on our credit facility and notes for the quarter was $2.6 million or $0.04 per share. As of September 30th, our GAAP NAV was $11.13, which is up 1.6% from $10.96 per share last quarter. Adjusted NAV, excluding the mark-to-market of our liabilities, was $11.13 per share, up 1.2% from $11 per share last quarter. As of September 30th, our debt-to-equity ratio was 0.76 times, and our capital structure is diversified across multiple funding sources, including both secured and unsecured debt. We have sufficient liquidity in our revolving credit facility to repay the 76 million of unsecured notes maturing on December 15th. As of September 30th, our key portfolio statistics were as follows. Our portfolio remains highly diversified with 131 companies across 45 different industries. The weighted average yield on our debt investments was 12.6%. and approximately 100% of the debt portfolio is floating rate. We had three non-accruals, which represent 1% of the portfolio at cost and 0% at fair market value. We did not put any new investments on non-accrual during the quarter. The portfolio is comprised of 85% first lien senior secured debt, less than 1% in second lien debt, 5% in equity of PSSL, and 10% in other equity. The debt to EBITDA on the portfolio is 5.1 times, and interest coverage was 2.1 times. The portfolio as a whole has a meaningful cushion with regard to interest coverage. On a sensitivity basis, for the portfolio's overall interest coverage to decrease to 1 times, base rates would need to go up 200 basis points, and EBITDA would need to decrease by 40%. This analysis is based upon current run rate interest coverage, assuming a 5.5% base rate. Now, let me turn the call back to Art.
spk04: Thanks, Rick. In closing, I'd like to thank our dedicated and talented team of professionals for their continued commitment to PFLT and its shareholders. Thank you all for your time today and for your investment and confidence in us. That concludes our remarks. At this time, I would like to open up the call to questions.
spk05: Thank you, Art. Ladies and gentlemen, if you would like to ask a question, please signal by pressing star 1 on your telephone keypads. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. And again, that is star 1. We'll pause for a moment to assemble our queue.
spk06: And we'll take our first question from Ryan Lynch from KBW. Please go ahead.
spk00: Hey, good morning, and thanks for taking my questions. First one I had was just on the level of repayment access you guys have. That's been pretty high the last couple quarters. Can you just talk about – Is there something going on that's really been in the marketplace that's really been driving the higher level of repayments, or has it just been a combination of, you know, kind of normal-sized repayments and your desire to kind of drop down some of those and exit some of those into the JV?
spk04: Thanks, Ryan. Good morning. Yes, certainly some of those deals ended up in the JV for sure. And then I just say it's normal activity. You know, when you pick solid credits and they perform well, and most of our portfolio is performing very well, you get paid off. You know, our origination flow has been a little lighter, you know, up until, you know, through 930. We've been busier since 930. I think we're going to be busier kind of coming into year end and beyond. So deal flow has picked up. You know, none of this was kind of intentional for us. We... We certainly can't manage repayments other than if they fit the JV. And then when we see, you know, attractive new deals come through, we clearly want to select those, and we've been seeing more of those, you know, in the recent weeks.
spk00: Okay. So, I'd love to just touch on that last point a little bit more. Can you just talk about the deal environment? Obviously, the deals that you guys are doing, you mentioned some pretty incredible stats with the leverage, interest coverage, and loan-to-value on new loans as well. The spreads and the absolute yields are pretty high. I know there's certainly in the upper middle market, there's certainly hope that the deal activity is going to pick up as private equity and buyers and sellers start to get a little more clarity with interest rates and pricing. I'd love to just hear kind of your insights on what you're seeing in kind of the core middle market and when do you think that that would translate into a meaningful pickup and deal activity in your world?
spk04: Yeah, so we think that activity is picking up. We've seen it, you know, in lifetime, which is why we've added the recent development subsequent event disclosure to the press release. And our sense is, you know, kind of it's been Sellers have needed some time to adjust to the new environment. The multiples that they could get selling their companies at the end of 21 are no longer generally available to them. So it's taken them a while to adjust to get their mind around it. Clearly, if you're a buyer of one of these companies, you have to absorb higher interest rates by definition. So multiples have come down certainly from where they were in 2021, and that's taken some time to find its equilibrium. So, you know, that's been the biggest part of it. And I think mostly the other big part of it is there's a general sense that we're in kind of the interest rate zone that we're going to be in for a while. Maybe it goes up a little bit. Maybe it goes down a little bit. But in general, you know, kind of people aren't going to be waking up, you know, kind of and seeing, you know, much higher interest rates or much lower interest rates, decisions can be made, you know, kind of where the base rate's at 5.5% or 5.75% or 5.25%. This is the zone people, you know, have accepted, and they can, therefore, price that into the deals that they're trying to do.
spk00: Okay. That's all for me. I appreciate the time today. Thank you.
spk05: Thank you. And next, we'll go to Mickey Schleen from Leidenberg. Please go ahead.
spk01: Yes, good morning, Art and Rick. Art, the portfolio has some exposure to what could be considered cyclical sectors like construction and consumer and auto and hotels and leisure, things like that. Can you describe how those credits are generally doing? and the prospects for those credits going into next year as, you know, the things we've read in the headlines with savings rates going down and credit cards being tapped out and things like that.
spk04: Yeah, no, we, thank you, Mickey. We specifically try to avoid, you know, kind of cyclical names. So if something has the word construction next to it, it'll be some kind of service business, typically something that's architectural or engineering services related. where the underlying market is less cyclical. So if we're in an architectural or engineering services business, it won't really be tied to home building. It might be tied to infrastructure spending, which has been an area of growth. Or it might be tied to a renovation, which goes on whether or not people have capital or not. Consumer is something we're watching. Clearly, when we do consumer, we're very aware of the environment. So we specifically keep leverage lower on our consumer deals than we do on our average deals. And we typically try to find companies that have brands that have value and meaning in their marketplace. So Dr. Scholl's, that's an example. It's a big brand. It's a branded consumer company. leverage is reasonable on it, people are aware of the brand, you know. So, you know, kind of, you know, Arctic, which is, you know, a Yeti comparable. It's a lower cost version of Yeti. It's in our portfolio. When we did the deal, leverage was very low. And because it's a lower cost version, it's actually doing pretty well in this kind of environment. So that's kind of how we think about consumer. That's how we kind of think about construction. I'm happy to to dive deeper if you'd like.
spk01: Well, just in the auto sector, were any of those credits materially impacted by the strikes?
spk04: You know, do you have names specifically on which names specifically?
spk01: You know, sometimes these... No, I just looked at the breakdown of the industries in the last two settlements. Yeah. I mean, if it's auto...
spk04: Yeah, if it's auto, it would be something typically tied to auto aftermarket, you know, which is kind of hopefully a steady stable. We don't have any kind of, you know, exposure to OEM or exposure to stuff that was related to the strike. It will be products that are sold in the aftermarket. You know, we have car wash companies. I don't know whether that's I forget whether that's auto or whether that's consumer or something else, but things like that.
spk01: Okay. Just following up on Ryan's question about terms, in the upper middle market, as you know, we've started to see some spread compression, particularly for higher quality borrowers. Have you seen that starting to trickle down into the middle market at all yet?
spk04: Yeah, I'd say kind of in our core market of 10 to 50 EBITDA, in the upper end of that, if a credit is perceived as really an excellent credit in a space that people love, it may get a little competitive and spreads may tighten a little bit. Again, if it's an excellent credit, we're happy to be competitive. And then there's a piece of the world of as you get to the middle of the 10 to 50 or certainly the lower end where There's a lot less competition. And, you know, we haven't really seen much spread tightening there.
spk01: Okay. My last question. I appreciate the recent developments language in the press release. Can you tell us anything about repayments for this quarter apart from things that you might be transferring to the senior loan fund?
spk04: Repayments have been light quarter today. Okay.
spk01: That's it for me this morning. Thanks for taking my questions and have a nice holiday.
spk03: You too.
spk05: Thank you. And next we're going to go to Maxwell Fritcher from Truist Securities. Please go ahead.
spk02: Hi, good morning. I'm calling in from RQs. So of the companies that have had amendments in fiscal 23, what percent would you judge has received additional capital support from the sponsor?
spk04: I'm going to say certainly the minority. I'm going to guess maybe about a third. Most of these are very minor amendments. In certain cases, the sponsors, we do ask them to put up additional capital. And in all cases so far, that additional capital has been forthcoming. And that's one of the nice things about where we are with the covenants we have, the information rights we have. And they loan the value that we have, you know, for a relatively small check sponsor relative to their initial investment in these companies, the sponsor can solve a problem. So certainly the minority where there's a cash investment, we haven't seen any issues with the sponsors coming forward to date.
spk02: Okay. Thank you. And in regard to the interest coverage, have you seen a meaningful amount of portfolio companies forego CapEx or hiring in order to keep a favorable ratio?
spk04: That's a great question. We certainly sense that with less cushion in the system, I mean, these are very thoughtful companies anyway, the vast majority owned by private equity firms, so they are always looking at their return on capital over their return on equity. So they're always focused on it. I think there's an even higher, you know, higher focus today. But, you know, on average today, our companies are covering their interest two times or something. So it's certainly not the lush times of a year ago when it was kind of three times interest coverage. Now you're down to two times. So we still think there's, you know, reasonable cushion. But, you know, there's certainly heightened awareness of the interest cost that they have to bear and In some ways, that's good. They're focused. They've got a lot of equity beneath us, and they want to make sure that their equity is safe.
spk02: That's helpful. Thank you very much.
spk05: Thank you. I would like to turn the conference back over to our speakers for any closing remarks.
spk04: Thanks, everybody, for being on the call today. We wish everybody a happy Thanksgiving, a Thanksgiving of gratitude. And we look forward to speaking with you in early February at our next earnings release. Thank you very much.
spk05: Thank you. Ladies and gentlemen, that does conclude today's conference. We appreciate your participation. Have a wonderful day.
Disclaimer

This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.

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