PennantPark Investment Corporation

Good afternoon and welcome to the Penn at Park Investment Corporation's second fiscal quarter 2023 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 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, 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 Investment Corporation. Mr. Penn, you may begin your conference.

Good afternoon, everyone. I'd like to welcome you to Pennant Park Investment Corporation's second fiscal quarter 2023 earnings conference call. I'm joined today by Rick Elorder, 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 Investment Corporation 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 and comment on our target market environment, provide a brief summary of how we fared in the quarter ended March 31st, how the portfolio is positioned for the upcoming quarters, a detailed review of the financials, and open it up for Q&A. For the quarter ended March 31st, our net investment income was 26 cents per share. Core NII was 21 cents per share and excluded 5 cents of one-time interest and dividend income. GAAP NAV decreased slightly to $7.60 per share from $7.71 per share, or 1.4%. This decrease was driven largely by valuation adjustments on our equity co-investments, partially offset by net investment income in excess of the dividend. Our debt portfolio continues to benefit from rising base rates. As of March 31st, our weighted average yield to maturity was 12.1%, which is up from 11.9% last quarter and 8.4% last year. As a result of a stable debt portfolio and growing net investment income, the Board of Directors has approved another increase in the quarterly dividend to 20 cents per share. This is an 8% increase from the prior quarter and a 38% increase from a year ago. The dividend will be paid on July 3rd to Sheryl Rose of Record as of June 15th. We are confident that with the continued strong credit performance, the increased dividend will be more than fully covered by net investment income. For the quarter ended March 31st, we invested $58 million in new and existing portfolio companies had a weighted average yield of 11.8%, and had sales and repayments of $114 million. For the investments in new portfolio companies, the weighted average debt to EBITDA was 4.3 times. The weighted average interest coverage was two times, and the weighted average loan-to-value was 49%. On March 31st, the JV portfolio equaled $748 million, and together with our JV partner, we continued to execute on the plan to grow the JV portfolio to $1 billion of assets. We believe that the increase in scale and the JV's attractive double-digit ROE will also enhance P&NT's earnings momentum. We continue to believe that the current vintage of middle market directly originated loans should be excellent. Leverage is lower, spreads and upfront fees are higher, and covenants are tighter. The credit quality of the portfolio continues to perform well. As of March 31st, we had one non-accrual out of 135 different names at PNNT. This represents 1.1% of the portfolio cost and 0% on market value. Our investment in Walker Edison has returned to accrual status after completing a balance sheet restructuring. PNNT has an equity ownership in Dominion Voting, which subsequent to quarter end settled their lawsuit with Fox News for $787 million. Dominion has communicated their intention to distribute the net settlement proceeds and P&NT shares estimated to be approximately $12 million. Now let me turn to the current market environment. From an overall perspective in this market environment of inflation, rising interest rates, geopolitical risk, and a potentially weakening economy, we are well positioned as a lender focused on capital preservation in the United States, where the floating interest rates on our loans can protect 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 are an important strategic capital to our borrowers. We have a long-term track record of generating value by successfully financing high-growth 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 technology. These sectors have also been recession resilient and tend to generate strong free cash flow. In our software vertical, we do not have any exposure to ARR loans. In many cases, we are typically part of the first institutional capital into a company, and the loans that we provide are important strategic capital that fuel the growth and help that $10 to $20 million EBITDA company grow to $30, $40, $50 million of EBITDA or more. We typically participate in the upside by making an equity co-investment. Our returns on these equity co-investments have been excellent over time. Overall, for the platform, from inception through March 31st, we've invested over $394 million in equity co-investments and have generated an IRR of 26% and a multiple uninvested capital of 2.2 times. 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 fees and 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, virtually all of our originated first lien loans have meaningful covenants which help protect our capital. This is one reason why our default rate in performance during COVID was so strong and why we believe we are well positioned in this environment. This sector of the market, companies with 10 to 50 million of EBITDA, is the core middle market. The core middle market is below the threshold and does not compete with the broadly syndicated loan or high yield markets. Many of our peers who focus on the upper middle market state that those bigger companies are less risky. That is a perception and 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 a higher recovery rate than loans to companies with higher EBITDA. We believe that the meaningful covenant protections of the core middle market, more careful diligence, and tighter monitoring have been an important part of this differentiated performance. Since inception, PNNT has invested $7.4 billion with an average yield of 12%. This compares to a loss ratio of approximately 22 basis points annually. This strong track record includes our energy investments, primarily subordinated debt investments made prior to the financial crisis, and recently, the pandemic. With regard to the outlook, new loans in our target market are attractive, and this vintage should be particularly attractive. 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. We want to reiterate our goal is to generate attractive risk-adjusted returns through income, coupled with a long-term preservation of capital. 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 through debt 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.

Thank you, Art. For the quarter ended March 31st, net investment income was 26 cents per share and core net investment income was 21 cents per share. Core net investment income excludes approximately 5 cents per share of one-time income related primarily to the acceleration of OID amortization in connection with the early repayment of our loan to PRA. Operating expenses for the quarter were as follows. Interest and credit facility expenses were $10.6 million. Base management and incentive fees were $7.6 million. General and administrative expenses were $1.1 million. And provision for excise tax was $450,000. For the quarter ended March 31st, net realized and unrealized change on investments and debt, including provision for taxes, was a loss of 11.8 million or 18 cents per share. The change in the fair value of our credit facility increased our GAAP NAV by two cents per share. As of March 31st, our NAV per share was $7.60, which is down 1.4% from 771 per share from the prior quarter. As of March 31st, our debt to equity ratio was 1.43 times, and our capital structure is diversified across multiple funding sources, including both secured and unsecured debt. As of March 31st, our key portfolio statistics were as follows. The portfolio remains highly diversified with 135 companies across 30 different industries. The weighted average yield on debt investments was 12.1%. The portfolio was invested in 57% first lien secured debt, 10% in second lien secured debt, 8% in subordinated notes to PSLF, 5% in other subordinated debt, 5% in PSLF equity, and 15% in other preferred and common equity. 96% of the debt portfolio is floating rate with an average LIBOR floor of 1%. Debt to EBITDA on the portfolio is 4.6 times, and LTM interest coverage ratio is 2.8 times. The portfolio as a whole has a meaningful cushion with regard to interest coverage. On a sensitivity basis, for overall interest coverage to decrease to 1.25 times, base rates would need to go up 150 basis points, and EBITDA would need to decrease by 35%. 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 P&NT and its shareholders. 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.

Thank you. If you would like to ask a question, please 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. Once again, press star 1 to ask a question. We'll take our first question from Paul Johnson with KBW.

Hey, good afternoon, guys. Thanks for taking my question. I just want to make sure I understand this right, but the settlement that you guys announced in the press release last night, the $12 million, so are we looking at potentially like an 18 cent sort of one-time settlement? payment in, you know, a future quarter at some point. Is that the correct number?

Correct?

Yes, that's correct, Paul. That'll come through as a dividend income.

Okay. Is that reflected in any way in the 331 mark, or is that marked pretty much, I guess?

No, it is not reflected in the 331 mark.

Got it. Okay. I guess just kind of higher level questions.

You know, I guess in terms of like the opportunity set that you guys see today, You know, in the past, you know, obviously, you know, subordinated, you know, secondly type of opportunities, junior capital opportunities have been, you know, part of the strategy in P&T. I know for a long time, you know, the strategy has been moving away from that. In today's world, I'm just curious, you know, are you starting to see any sort of attractive opportunities in that part of the market? Or, you know, at this point, is there just not enough of a differentiation, you know, between the, I guess maybe the first loan type of opportunities that you're seeing really stretch for a junior capital?

Yeah, it's a great question. Um, you know, I think we've always, even recently been open to second lien MES. Uh, the bar is high, you know, the lesson we've learned is you gotta be right and you gotta be right quick because if you're a MES or second lien four years down the road, Something didn't go right. So we're still up in the MES and second lien. Some of the MES today has a big PIC portion because so much cash pay EBITDA is going towards paying the first lien. We're not a lover of PIC. So our funnel for MES and second is going to be a little bit more selective. That said, the subordinated debt and equity that we buy in our joint venture This PSLF joint venture, where it's mostly first lien collateral underlying the portfolio, and we leverage it up a little bit more than what's in the BDC, is a very attractive return on invested capital backed by cash pay, conservatively structured senior debt. So that's kind of been where we've been getting the incremental juice in this portfolio is kind of building that JV. I think as of quarter end, it was about $750 million of assets. For us, it was about a $150 million investment, and continuing to grow that is, we think, a very nice way to get some incremental yield on the portfolio in a safe way.

That makes sense.

That's helpful color there. on the opportunity set. Last question, you know, just on kind of broadly on your equity co-investments. I guess, you know, are those investments, you know, over time, are they pretty much entirely dependent on some sort of M&A event from the sponsor, you know, basically a sale of the business, you a realization of that equity co-investment, or are there other ways that can be constructed over time, I guess, for you guys to potentially cash out on some of those investments?

Yeah, so good question. We're going in kind of heads up with the sponsor. We've had a very good long-term 2.2 times MOIC over 17 years on that capital, so it's been very accretive. And just like the sponsor, there's an M&A exit, there's a potential IPO exit, and then there's certainly dividends that can come out of that, the Dominion voting situation. That'll be a dividend coming at us out of the company because we're an equity shareholder. So really aligning ourselves, I guess we could sell our equity to the sponsor if we need or want liquidity. We haven't needed it, and you generally don't like being on the opposite side of someone who may have slightly more information than you have. So we haven't elected that route, but we could, if we needed or wanted liquidity, sell these stakes back to the sponsor.

That makes sense. And one last question, if I may, just going back real quick to the settlement payment in future quarter. Do you guys have any thoughts in terms of how you guys are going to treat that income, you know, special, maybe like a special one-time dividend and retain part of it? Any sort of thoughts there on how you're going to treat it?

Yeah, so, you know, look, we always evaluate. I don't think we have any predisposition. We're building some nice spillover, and that'll go into kind of our dividend policy over the next year, year and a half. You saw a very nice bump in the dividend this quarter. We think it's sustainable based on ongoing NII, and we have this nice kind of, you know, spillover that you know, can potentially go into protecting that dividend over time.

Thank you. We'll take our next question from Robert Dodd with Raymond James.

Hi, guys. A quick question on any visibility into mining. I mean, obviously, it will be a fairly significant project. benefit when it does occur to shareholders. So is it likely to occur in the June quarter or later, just for a modern purpose?

Yeah, we've been led to believe that'll happen in this quarter that we're in right now, the quarter ended June 30th. Got it.

Thank you. Then on to the equity, you've been, obviously, it's been declining as a portion of the portfolio. If we take out the January... coming in a mid teens the target is lower than that Francis but I mean obviously you know to your point that yes you skip and you can potentially liquidate it but that's not necessarily how to do so but how how fast do you think how fast you would you expect that to come down towards you at your

It's a great question. Yeah, look, it's tied to M&A deal flow. M&A deal flow, as we all know, has been slow year to date. So what normally, when you make a private equity investment, people normally say it's a three to five year life and maybe things have been extended a year due to the market environment. So look, I think we hope that over the next year or two, we're going to be able to get some you know, reasonable exits and bring it down. I mean, back to the last question about Dominion, it wasn't even included in the NAV for the March quarter because we did not know it was an event as of March 31st. You could have put that $12 million into the mix and said, gee, your equity percentage is higher, you know, than 15%. And that would have been right, although this was kind of a positive surprise out of the blue. So I don't know. You know, I can't really give you an answer. We're doing our best. We're not in control of much of this. But, you know, kind of knowing that over time we've had well in excess of a two times MOIC on this capital, you just got to kind of wait till it happens. Got it.

I appreciate that. Thank you.

We'll take our next question from Kyle Joseph with Jeffries.

Hey, good morning. Thanks for taking my questions. Just want to talk about the originations environment and kind of walk us through the cadence in the quarter. Obviously, you know, deal flow is light. I get M&A's light out there. But, you know, in terms of timing, were January and February fairly kind of consistent? And did you see a big fall off kind of in March post all the regional bank volatility? And how has deal flow been kind of quarter to date?

Yeah, so Q1, calendar Q1 was slow as it normally is slow. Seasonally, it's normally a slow quarter. Made slower this year by the turmoil and the capital markets and the rising interest rates. Made even slower, you know, since the banking situation, the banking, you know, kind of issues that we've had. So what's going on is buyers and sellers, to a large extent, are still trying to figure out where they meet. Sellers still are hoping for a value like it was a year or two ago, and buyers are baking in higher interest rates and a potentially softening economy. So until there's equilibrium between buyers and sellers, there's not going to be a lot of deal flow. That's statement one. Statement two is we are starting to see more deal flow. So we are starting to see buyers and sellers get together and our deal flow is picking up. No guarantees as to what's going to close between now and June 30th and what's going to close after June 30th, but it does feel like the second half of 2023 will certainly be busier than the first half.

All right, got it. And then on the repayments, we're a little bit elevated in the quarter. Just wondering, you know, is that RAM? Is that some other... one-time things in there. Obviously, it's never bad to get paid back, and never bad to get paid back when it really boosts your other income, but just kind of wondering if that's a one-off or a trend.

You know, look, RAM, by definition, is one-off, and that happened that past quarter, and PRA, APRA, which is this corporate events company that we invested in that was exited, and that's where that one-time non-core positive fee came in you know from that exit it was a company that you know it's a corporate events company so by definition in the middle of COVID it was struggling and as you can probably sense uh people are getting out and about and traveling and corporate events have blossomed post COVID so that company really paid us back well and early and we had a very nice exit fee as part of the redo of the capital structure in the middle of COVID which generated the one-time fee income. So really, those are the two primary drivers. I mean, are they one-time or ongoing? We'll see. We certainly, you know, you're going to have certainly the companies that are tied to events and tied to travel. You know, we have some trade show businesses, for instance, that were getting hurt in COVID. Those companies are now obviously doing very well. So there might be more of that, and that is a a piece of the portfolio. It's not an oversized piece, but it's a piece of the portfolio, and those companies are doing well.

Got it. Thanks very much for answering my questions. Thanks, Kyle.

We'll take our next question from Mickey Schlian with Leidenberg.

Yes, good afternoon, everyone. Art, a lot of discussion about how folks are so excited about the current vintage of deals. And, you know, I would definitely agree. I'm curious, you know, whether you're being able to structure terms in these deals that will allow them to stay on the books, you know, as long as you would like, given how attractive they are. whether it's the tenor or the prepayment penalties that you're building in or anything else that you're able to do to try to ensure that, you know, this will show up in the income statement a couple years from now?

Yeah, it's a good question, and, you know, kind of the average investment in this last quarter, debt to EBITDA 4.3 times, very attractive, interest coverage two times, and LTV about, you know, 50%. So this is an attractive vintage, and I guess that's the blessing of of the equity co-invest. That's our tail. You know, when companies do well, we have that tail and we participate in the companies doing well. You know, we've had deals in the last six months where even post-banking situation, the company deleveraged to two or three times debt. Diva Donna Commercial Bank took us out. That's great. If we're in the equity, we are participating in the lower cost of capital. By definition, it means the company is a good free cash flow generator. And at some point, that equity value will be ascertained in some way, shape, or form. Dominion Voting paid off the debt, I don't know, two years ago. So we still have this residual equity co-investment, which is paying off.

Thank you for that, Art. I appreciate your time. Thank you.

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

Yeah, thank you. Good afternoon. Is there any potential variability in that Dominion payout, or is that pretty well set? Any final wrangling on the numbers?

No, we were, you know, that's why I say approximately, you know, $12 million. You know, there's still legal fees and taxes that, you know, kind of come off the top, but it's kind of pretty in that zone, pretty much in that zone.

Yeah. What is your opinion on the credit environment here? We've been kind of tipping into recession for two years now. I'm just sort of curious how you think the economy is shaping up. You've got a unique view from where you sit. What's your sense?

It's a mixed economy. Certainly not what it was coming out of COVID, which everything was going gangbusters. The consumer is particularly mixed because the consumer, on one hand, is happy to go take trips and go take cruises and hop on planes and stay in hotels. On the other hand, when it comes to goods, has been more cautious buying furniture. Walker Edison, a prior non-accrual, was a furniture company. So Walker Edison did great during COVID and is doing much softer now. It's a bifurcated consumer. You've got to be careful in the consumer space. So it's much more kind of mixed. I think, obviously, when we underwrite credit here, we assume there's a recession. There may not be one. We may be able to skate by, which would be nice. But we assume there's a recession. And when we do our credit underwriting, we're putting that in the model to see how these companies would perform in a recessionary situation. That's our assumption as prudent credit underwriters. Our house view is probably there might be a light recession, but that doesn't impact how we underwrite. We underwrite for a recession.

Yeah. How bad would the recession have to be for it to be material to the portfolio?

You know, hard to say. I mean, I think Rick and his numbers gave this sensitivity around, you know, EBITDA would have to go down something like 35%. And at the same time, which is contradictory, base rates would have to go up 150 basis points, and you're down to one and a quarter times EBITDA to interest coverage. Obviously, if the economy's soft, the Fed's probably not raising rates. So that's kind of an interesting thing to think about, which is if the economy's soft, the Fed's probably reducing rates, which will increase interest coverage. the yields will go down. We, of course, have floors, but the yields would go down. But, you know, I think you can do the work as much as I can. I think in an environment where yields are going down, investors may flock to yield vehicles like BDCs to take advantage of high yields. So, you know, we can look at all kinds of scenarios.

Thank you for that. Appreciate it. Thanks.

We'll take our next question from Melissa Weddle with JP Morgan.

Good afternoon. Thanks for taking my questions. Wanted to touch on the dividend increase in the June quarter. I think it's like the sixth quarter that you've done an increase to the dividend. Just thinking ahead, are you thinking about this dividend increase a little bit differently than the rest? Does this feel like maybe with... where the forward curve is projecting rates to go, that this might be a good place to pause? Or will you keep reevaluating?

I want to sound a lot like the Fed with my answer, Melissa, which is we're going to let the facts and circumstances dictate how we go. I mean, the various facts and circumstances would be kind of how's our JV expansion going and is that going to continue to be able to generate more ROE? How's our rotation of equity going? Obviously, equity rotation and even things like Dominion where we have, you know, fresh equity powder. How's that looking to be able to rotate that into yield? How's our spillover looking? You know, we have substantial spillover. That's on the positive side. And then on the potential issue side is where our defaults and non-accruals, where our long-term rates and our cost of financing. So I think, you know, Every quarter, we do our best. We look at the facts and circumstances and do our best. We're very pleased that we've taken a dividend up from $0.12 to $0.20 in a relatively short period of time, which does, in fact, mimic the NII and earnings of the company. And we'll see where we go from here.

All right, fair enough. Thinking about portfolio leverage and where you guys are at now, you know, certainly there's been rotation in the portfolios, but leverage is still fairly high. It doesn't sound like you're particularly pessimistic from a macro perspective, but how are you thinking about portfolio leverage and where would you like to run that in an environment with the opportunities that you're seeing today?

Yeah, and we did, you know, I think we mentioned in our remarks, you know, we're targeting, you know, we target one and a quarter times. So we're a little over levered At this point, we're confident that with, you know, some repayments and some, you know, equity rotations, we can easily glide down to that. We are conscious of our credit rating. It's important for us to, you know, for attractive debt capital to keep a strong credit rating. So, you know, we'll gradually let it grind down to one and a quarter-ish, one and a quarter area, you know, over the coming time period at the same time as we try to optimize the joint venture and the financing and the JV and the ROE from the joint venture at the same time as we try to, you know, rotate equity.

That's helpful. Thanks, Art. Thank you.

We'll take our next question from Casey Alexander with Compass Point.

Hi. Good afternoon. I have two questions. First of all, in relation to Dominion, I'm going to ask you to put my hat on for a second and ask, would you model it in? And if you modeled it in, what quarter would you model it into?

Again, we've been told that it's this quarter, end of June. Never any guarantees, but that's what we've been told. I'm just giving it to you straight. And to us, you can't say it's recurring. I mean, it's kind of like sometimes when you get – your equity co-invest really blossoms into something great. You can't really model it. It's just like nice upside to offset the inevitable downside you have as a lender from time to time. So, you know, when we think about kind of what it means to an IIN dividend, it's obviously not recurring. Next quarter, hopefully it'll be in there and we'll say it's non-recurring. It does build spillover though, right? So, you know, as we think about long-term dividend policy, it does impact that.

Yeah, and it adds to NAV. And I believe a previous question said 18 cents a share. I think when you net it out versus incentive fees, it's more like 14 or 15 cents a share, I think is the real impact. My second question is... You know, I realize it's a small position, but the restructured loan of Walker Edison, my understanding is that it's 100% pick. Did you consider leaving it on non-accrual for the time being until such a point in time as the company is able to turn that into more of a cash pay instrument?

Yeah, it's a good question. I think the independent valuation firms are marking that instrument at par. It's a good question. By the way, it's not really material in PNNT at this point anyway. But it's a good question. I think our valuation firm said, hey, it's a par instrument. Granted, if in a couple quarters the company doesn't perform well and it starts to get marked down, I think we'll take another look at that. Again, thankfully, it's not that big of an investment for us at this point. It's underperformed. We're certainly hopeful that the company will find its footing and People will buy furniture from this company, and it will have a steady EBITDA. At some point, we certainly hope our debt is paid off and our equity has value, but it's early days.

All right. Well, and I'm fully cognizant that in your – actually, your original investment in Walker Edison, you guys took a very attractive gain. So, you know, there is two sides to this story. All right. Thanks for taking my questions.

Thanks, Casey. That will conclude our question and answer session. At this time, I'd like to turn the call back over to Mr. Penn for any additional or closing remarks.

I just want to thank everybody for being on the call today. We'll talk to you next time in early August for our June 30th numbers. Thank you very much.

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