PennantPark Floating Rate Capital Ltd.

Good morning and welcome to Pennant Park Floating Rate Capital's fourth fiscal quarter 2024 earnings conference call. Today's conference is being recorded. At this time, all participants have been placed in a listen-only mode. The call will be open for 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'd like to withdraw your question, 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.

Thank you, and good morning, everyone. I'd like to welcome you to Pennant Park Floating Rate Capital's fourth fiscal quarter 2024 earnings conference call. I'm joined today by Rick Olordo, our Chief Financial Officer. Rick, 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 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 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 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.

Thanks, Rick. We're going to spend a few minutes discussing the current market environment for private 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, and then open it up for Q&A. For the quarter ended September 30th, core net investment income was $0.32 per share. As of September 30th, our portfolio grew to $2 billion, or 20% from the prior quarter. During the quarter, we continued to originate attractive investment opportunities and invested $446 million in 10 new and 50 existing portfolio companies at a weighted average yield of 11%. we continue to see an attractive vintage in the core middle market. For investments in new portfolio companies, the weighted average debt to EBITDA was 3.4 times, the weighted average interest coverage was 2.5 times, and the weighted average alone, the value was 38%. Subsequent to quarter end, we remained active and invested over $330 million at a weighted average yield of 10.2%. Investment volume is increasing, we have a robust pipeline, and we expect the remainder of 2024 to be active. During 2024, the market yield on first lean term loans has tightened 50 to 75 basis points. As the credit statistics just highlighted indicate, we continue to believe that the current vintage of core middle market directly originated loans is excellent, and the core middle market leverages lower, spreads are higher, and covenants are tighter than in the upper middle market. Despite covenant erosion in the upper middle market, In the core middle market, we are still getting meaningful covenant protections. As of September 30th, our debt-to-equity ratio was 1.35 times to 1. With a target ratio of 1.5 times to 1, we believe that we are positioned to drive additional growth in net investment income going forward. Securitization financing continues to be a good match for our lower-risk first lien assets. During the quarter, PFLT closed the refinancing and upsize of a $351 million term debt securitization transaction with a weighted average spread of 1.89%, a four-year reinvestment period, and a 12-year final maturity. The weighted average spread of 1.89% is a meaningful decrease of 50 basis points from the prior level of 2.39%. The main contributor to this decrease was a favorable market environment in which the AAA portion of the structure priced at an attractive weighted average spread of 1.75%. The ratio of external debt to PFLT's junior capital was 3.1 times to 1, which creates plenty of liquidity for the company. Additionally, during the quarter, we closed on an amendment and extension of the truest revolving credit facility. The highlights of the amendment are an increase in total commitments to $636 million, a reduction in the rate to SOFR plus $225 million, which is down from SOFR plus 236, and an extension in the revolving period to 2027. We expect continued stability in NII in part due to our investment in the joint venture. As of September 30th, the JV portfolio totaled $913 million, and the JV remained active during the quarter and invested $46 million in five new and seven existing portfolio companies at a weighted average yield of 11.3%, including 45 million of assets purchased from PFLT. GAAP and adjusted NAV decreased to 0.3 percent to $11.31 per share from $11.34 per share. The decrease in NAV for the quarter was due primarily to the write-off of fees and expenses associated with the previously noted securitization refinancing and revolving facility amendment and extension. Credit quality of the portfolio has remained strong. We didn't add any new investments to non-accrual status, and non-accruals represent only 0.4% of the portfolio cost and 0.2% at market value. As of September 30th, the portfolio's weighted average leverage ratio through our debt security was 4.1 times, and the portfolio's weighted average interest coverage was 2.3 times. We believe this is one of the most conservatively structured portfolios in the direct lending industry, and it's a testament to our focus on the core middle markets. We like being positioned for capital preservation as a senior secured first lien lender focused on the United States. 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. 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 spreads, and an 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 upper middle market state that those bigger companies are less risky. That may make some intuitive sense, but the reality is different. According to S&P, loans to companies with less than $50 million of EBITDA have a lower default rate and higher recovery rate and 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 13 years ago has been excellent. PFLT has invested $6.7 billion in over 500 companies, and we have experienced only 20 non-accruals. Since inception, PFLT's loss ratio on invested capital is only 10 basis points annually. As a provider of strategic capital, it 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 have invested over $540 million in equity co-investments, have generated an IRR of 26% and a multiple uninvested capital of two times. Our experienced and talented team and our 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 the 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 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.

Thank you, Art. For the quarter ended September 30th, GAAP net investment income was $0.24 per share, and core net investment income was $0.32 per share. Core net investment income includes the add-back of $0.08 per share of one-time financing costs that were expensed during the quarter, net of the impact on incentive fees. Operating expenses for the quarter were as follows. Interest and expense on debt were 19.3 million. Base management and performance-based incentive fees were 7.8 million. General and administrative expenses were 1.7 million. And provision for taxes were 0.2 million. For the quarter ended September 30th, Net realized and unrealized change on investments, including provision for taxes, was a gain of $3.4 million. As of September 30th, our GAAP NAV was $11.31, which is down 0.3% from $11.34 per share last quarter. Adjusted NAV, excluding the mark-to-market of our liabilities, was $11.31 per share, down 0.3% from 1134 per share last quarter. As of September 30th, our debt to equity ratio was 1.35 times, and our capital structure is diversified across multiple funding sources, including both secured and unsecured debt. As of September 30th, our key portfolio statistics were as follows. The portfolio remains highly diversified with 158 companies across 46 different industries. The weighted average yield on our debt investments was 11.5% and approximately 100% of the debt portfolio is floating rate. PIC income equaled only 2.9% of total interest income during the quarter. We had two non-accruals, which represent .4% of the portfolio at cost and .2% at market value. The portfolio is comprised of 88% first lien senior secured debt, less than 1% in second lien debt, 3% in the equity of PSSL, and 9% in other equity. Our debt to EBITDA on the portfolio is 4.1 times, and interest coverage was 2.3 times. Now let me turn the call back to Art.

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.

Thank you. If you would like to ask a question, you may signal by pressing star 1 on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. We'll take our first question from Paul Johnson with KBW.

Yeah, good morning. Thanks for taking my question. Congrats on the big deployment. We're very active here for the firm. My only question, I guess, would be kind of, you know, what do you see, you know, in the current vintage that, you know, you currently find that's very attractive? And also, I know, what are your kind of thoughts about the upcoming vintage in terms of kind of next year with the administration changeover and declining rate environment?

Thanks, Paul, and good morning. Look, when you can originate loans that have an average debt to EBITDA of 3.4 times, average interest coverage of 2.5 times, a loan the value of 38% and get kind of 550 over the risk-free rate on average, our viewers are supposed to be doing that all day long. So as you know, we opt for safety and security over yield at PFLT. So, you know, we've had some yield compression over the last year. It seems to have plateaued for now. But, you know, I think the credit quality that we get has been very, very high here in the core middle market where there's a lot less competition. All the big players have moved up, and it just doesn't make sense for their business models to be lending to $10 million, $20 million, even $30 million EBITDA companies. So, you know, we've been taking advantage of that opportunity. And think it's a really good one i think in terms of the outlook as you can tell it's been busy from an m a standpoint in the core middle market hopefully that means we can rotate some of these equity positions you know we've had a very good track record with these equity combats as we've said the two times moic over you know 18 years now um so hopefully we can get liquid on some of these rotate that capital into you know cash paying yield And then with the activity, the question will be with the supply-demand curve in the core middle market, can spreads widen again because of the supply? That would be our hope. Even if they don't, we're very pleased with the vintage given the credits that I just outlined. But we would hope that perhaps with more supply, spreads widen. In terms of the risk-free rate, you know, that's way above our pay grade. Certainly the market believes it's going to go down. the question will be how much. So did that answer your question, Paul?

Yeah, yeah, yeah, thanks for that, Art. That's a good color there. You know, but in this year, kind of talking about the current year and the current vintage, I mean, you know, you say you're getting still meaningful covenants, but it's definitely been, you know, a tighter spread environment. So I would just, you know, just ask you kind of where has the deterioration occurred in terms of the terms that you're getting? Has it just been a little bit of spread pressure on pricing that you've seen, or how has documentation held up? Are you getting the same covenants that you were getting versus last year? Is it less fees or less equity? Where has, if any, the deterioration or the pressure, I would say, on terms occurred?

Yeah, that's a good question. Certainly in the bad old, good old days of rising interest rates and fear, and we were getting, you know, 575 or 600, even 625 over, you know, the covenant cushions were, you know, closer to 25%. That's where you negotiate your cushion to the base gate. Today they're 30 or 35%. So they're certainly wider than they were. But they're still there and they're still protective. I mean, if you just want to go back to a dramatic example, you can go back to COVID. And the fact that there were quarterly maintenance tests that these companies had to live up to, as well as the fact that we were getting monthly financial statements along the way, really brought people to the table quickly to discuss and figure out how we were going to solve problems together. And we've seen a lot of the same phenomenon here well past COVID. It's really due to the loan value that we're seeing because these sponsors have so much private equity capital beneath the debt. And the vast majority of the cases, if there's a problem with a covenant or any kind of liquidity problem, they're generally willing to put more equity in to solve that problem. And, you know, our non-accrual rate, you know, has remained really low here and we're very thankful for that and we're protective of that. But one of the reasons is they've got so much capital beneath us that if it takes a little bit more capital to solve a problem, they're by and large willing to do that.

Thanks for that, Howard. And then just for anyone on the team, I guess with the decline in non-cools this quarter, could you just walk us through the driver But that was their restructure written off in the quarter.

Yeah. So we had three non-accruals last quarter. Dynata, Pragmatic, and Walker Edison. Dynata restructured. Walker Edison and Pragmatic are still a non-accrual. So, you know, same two out of three. Got it.

Okay, and then last question, Rick. What, could you tell us the impact just on a book value per share basis of the issuance from the ATM this quarter, if there was any?

No impact on NAV. We're issuing under the ATM either at or above NAV. Impact has been, you know, immaterial.

Got it. Thank you. That's all for me.

Thank you. We'll take our next question from Mark Hughes with Truist.

Yeah, thank you. Good morning. Anything with the doge and the offing and the potential pressure on government spending? Anything in your portfolio that you have your eyes on that could be impacted by that?

It's a great question, Mark, and we all wish we knew what those will mean from an impact. As you know, defense government services have been a nice piece of this portfolio, steady and stable. You know, most of those businesses are service businesses where people walk into offices and do some form of cybersecurity work. Uh, technology, you know, intelligence, it's not really, you know, building, you know, bombs and, and, and guns and bullets. So, um, but it's been steady and stable. It may, maybe there's cross currents here. Certainly the world from a geopolitical standpoint is, uh, is, uh, is a little messy right now. Um, and of course as taxpayers, we all want an efficient government. So we all want our tax dollars to be used efficiently. So we'll see how it all plays through in terms of the government services and defense. Healthcare is a big piece of what we do. We've had a very good healthcare track record, much better than our peers. We know some of our peers have stumbled in healthcare. I think it's just we keep our leverage pretty reasonable and low. Like if you're leveraging a healthcare company four, four and a half times on a senior basis, You could get hurt, of course, but it's a lot less risky than the six times or seven times that maybe some of our peers have done. So our healthcare track record's been good. We've selected the right companies in the right sectors. And we, like all taxpayers, want an efficient healthcare system. So we'll see. We're going to keep being conservative. If you keep leverage low, it can kind of solve for a lot of ills. Not to say there won't be impacts to be seen, but You know, we're just going to stick to that.

Yeah. Okay. Appreciate that. How about your origination activity so far in the fourth quarter has been quite strong. How about repayments? How are you looking on a net basis?

Yeah. You know, we are getting repayments. It happens. And that's good. You know, when people pay us back, we say thank you. Sometimes, as you know, they don't. So we're getting repayments regularly. And that's all due to a more active M&A environment, which by and large is good for us. The equity co-invest should churn a little bit more, turn those to cash. We'll get repayments. That's fine. We'll hopefully deploy capital sensibly and conservatively. So it's probably, at least recently, I'll estimate... You know, given the opportunity, we've been probably making new investments $2 out to $1 getting repaid. That's just an off-the-cuff estimate. But that will have an ebb and flow.

And then the equity co-invest, are you seeing in these new originations kind of similar opportunity? Is that going to be a relatively stable part of the strategy? Yeah. both in terms of opportunity and then your appetite or your approach to those co-invests?

Yeah, it's a good question. You know, having now done this, you know, 18 years at Penn and Park and before that elsewhere, that opportunity is always there. It's a question of do we take that opportunity? Sometimes we will graciously decline the opportunity depending on the situation. Sometimes we'll work hard to invest more because we like the equity. Over a long period of time, over many deals, it's worked out by and large. There's some big winners and there's some losers. But that's kind of the equity co-invest business. We've invested $540 million in the 18 years and had a 26% IRR and a two times MOIC, multiple invested capital. So it's generally worked. We've certainly had some zeros in there. We've certainly had some that have been a lot more than 2X.

Appreciate that. Thank you.

Thank you. We'll take our next question from Doug Harder with EUBS.

Thanks. Can you give us updated thoughts as to you know, kind of how you're thinking about the dividend and maybe some of the puts and takes on earnings power in the coming year?

Sure. It's a great question. You think about it all the time, as you might imagine. Because we're credit guys, we're going to hit the downside first. That's how we think. What's the downside? Downside, of course, are interest rates, right? Are interest rates going to continue to come down? And then credit quality. You know, we think credit quality will remain strong. Of course, there's never any guarantee. And the title of this vehicle is Pennapark Floating Rate Capital, which would imply that, you know, as interest rates rise and fall, you know, this floating rate portfolio will take its cue from that to some extent. So certainly potentially lowering rates, credit quality, and just highlighting that in the title of this vehicle, Floating Rate Capital. So that's the downside. On the upside, you have several different elements. We're not at target leverage yet. We're kind of at 1.3, 1.35. Our target leverage is one and a half times. A, B, equity co-invest rotation. As you go through our equity co-invest portfolio, you'll see some that are marked up substantially. Those are always ripe. Those are kind of leading indicators of companies that are going to be sold. So, you know, we hope to get some decent equity rotation here in this more robust M&A environment. And then we have this, you know, JV opportunity, you know, which gives us a very nice historically been a mid-teens return on capital. So, you know, we're looking at that and saying, should we upsize the existing JV? Should we do a new JV? These JVs have been very successful both for PFLT and PNNT. It's a nice way to take lower risk senior assets, leverage them up a little bit more than we would on the balance sheet of the BDC, still safely though, and generate a mid to upper teens return on capital. And for the shareholder, we're managing more capital and our management company's not charging a management fee on that. So those pure returns go to the bottom line So that's got some puts and takes. You know, we'll see where we go. And hopefully I answered your question.

I appreciate that, Art. Thank you.

Thank you. With no additional questions in queue, I would like to turn the call back over to Mr. Penn for any additional or closing remarks.

Just want to thank everybody for being on this call today and the Thanksgiving week, and I want to let everyone know we are certainly grateful and thankful for the interest you show in PFLT and investing in the company. So wishing everybody a great holiday season, and we'll talk to you in February.

That will conclude today's call. We appreciate your participation.