PennantPark Investment Corporation

Good afternoon and welcome to the Pennant Park Investment Corporation's first quarter 2024 earnings conference call. Today's conference is being recorded. At this time, all participants have been placed in a listen-only mode. This call will be open for a question and answer session following the speaker's remarks. If you'd 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 two 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. Pennant, you may begin your conference.

Good afternoon, everyone. I'd like to welcome you to Pennant Park Investment Corporation's first fiscal quarter 2024 earnings conference call. I'm joined today by Rick Aloro, 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 would 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.

Thank you, Rick. We're going to spend a few minutes and comment on the current market environment for private credit. To write a summary of how we fared in the quarter ended December 31st. how the portfolio is positioned for upcoming quarters, a detailed review of the financials, and then open it up for Q&A. For the quarter ended December 31st, our GAAP and coordinated investment income was 24 cents per share. GAAP and adjusted NAV decreased 0.6% to $7.65 per share from $7.70 per share. As of December 31st, our portfolio grew to $1.2 billion, or 16% from the prior quarter. During the quarter, we continued to originate attractive investment opportunities and invested $231 million in 12 new and 32 existing portfolio companies at a weighted average yield of 11.9%. For the investments in new portfolio companies, the weighted average debt to EBITDA was 3.7 times, the weighted average interest coverage was 2.4 times, and the weighted average loan-to-value was 55%. Credit quality of the portfolio is stable. We had no new non-accruals, and the quarter ended December 31st. As of December 31st, the portfolio's weighted average leverage ratio through our debt security was 4.9 times, and despite the increase in base rates through 2023, the portfolio's weighted average interest coverage ratio was 2.2 times. On average, we have seen a 25 basis point tightening of first lien spreads, However, we continue to believe that the current vintage of core middle market directly originated loans is excellent. The leverage is lower, spreads and upfront OID 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. At December 31st, the JV portfolio equaled $858 million, and during the quarter, the JV invested $81 million including 8 million of purchases from PNNT. Over the last 12 months, PNNT earned a 19% return on invested capital into the JV. We expect that with continued growth in the JV portfolio, the JV investment will continue to enhance PNNT's earnings momentum in future quarters. Now let me turn to the current market environment. In an uncertain market environment, we are well positioned as a lender focused on capital preservation in 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 for 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 recession resilient and tend to generate strong free cash flow. The core middle market, which are 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, 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're 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 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 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. 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 December 31st, we've invested over $448 million in equity co-investments, and have generated an IRR of 26% and a multiple on invested capital of 2.1 times. Since inception nearly 17 years ago, PNNT has invested $7.8 billion at an average yield of 11.3% and has experienced a loss ratio on invested capital of approximately 18 basis points annually. This strong track record includes investments of primarily subordinated debt made prior to the global financial crisis, legacy energy investments, and recently, the pandemic. With regard to the outlook, new loans in our target market are 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 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 December 31st, GAAP and core net investment income was 24 cents per share. Operating expenses for the quarter were as follows. Interest and credit facility expenses were $9.6 million. Base management and incentive fees were $7.3 million. General and administrative expenses were $1.4 million. And provision for excise taxes were $0.4 million. For the quarter ended December 31st, net realized and unrealized change on investments and debt, including provision for taxes, was a loss of $5 million or $0.08 per share. As of December 31st, our gap and adjusted NAV was $7.65 per share, which is down 0.6% from $7.70 per share in the prior quarter. As of December 31st, our debt-to-equity ratio was 1.4 times, and our capital structure is diversified across multiple funding sources, including both secured and unsecured debt. As of December 31st, our key portfolio statistics were as follows. Our portfolio remains highly diversified with 139 companies across 30 different industries. The weighted average yield on our debt investments was 12.6%. Pick income equaled only 3% of total investment income. We had one non-accrual, which represents 1% of the portfolio at cost. and 0% at market value. The portfolio is comprised of 58% first lien secured debt, 7% second lien secured debt, 9% subordinated notes to PSLF, 4% other subordinated debt, 5% equity in PSLF, and 16% in other preferred and common equity. 96% of the debt portfolio is floating rate and debt to EBITDA on the portfolio is 4.8 times and interest coverage is 2.2 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 PNNT and the 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'd 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.

Again, press star 1 to ask a question, and we'll pause just briefly to assemble our queue. And our first question comes from Mark Hughes of KBW. Please go ahead.

I'll go with the Mark Hughes part of that. Good afternoon. Rick, what did you say the EBITDA coverage was on the overall portfolio?

So EBITDA was 4.8 times and the interest coverage was 2.2 times.

Yeah, thank you. And then any nuance now about the attractiveness of either subordinated debt or the preferred or common? The first lane has obviously been attractive, but anything about the dynamic where you might see a little bit more of a preference for some of those other categories?

Yeah, thanks, Mark. And by the way, just to clarify, Mark Hughes is with Truist. And look, we do invest across the capital structure. Obviously, it's been really good to do first lien in this higher yield environment with the vintage and the goods credit stats as well as, you know, classically we'll do equity co-invest to participate in some of the upside. There are interesting second lien, sub-debt, and PREF deals to look at. They just haven't been that interesting relative to first lien deals. recently um um but we will continue to look and if we have real conviction we'll we'll uh we'll potentially you know kind of kind of take a look at adding some of that to the portfolio judiciously and carefully thank you next we go to the line of robert dodd with raymond james please go ahead

Hi, guys, and congratulations on the quarter. Just on the activity in the quarter, I didn't catch this. Can you give us an idea how much of that origination was really late in the quarter? Because it certainly looks like it originated a lot. Interest income didn't move that much, and lates didn't move. So I presume a considerable portion of that was very late, but, like, just how much?

Yes, thank you, Robert. About 40% of the origination was done in the month of December.

Got it. Thank you. And then looking, I mean, as you said, some of my questions have already been answered on a previous call. So, you know, some of the key sectors that you look at, like business services, you know, consumer news, government, et cetera, anything change in relative attractiveness there? I mean, in kind of the activity, the initial preliminary pipeline, maybe for the next, for the rest of the year, is it concentrated in those sectors? Does it really mesh with your preferences? Or, you know, is, you know, how's that looking in terms of potential opportunities by interested?

So so so in general, look, we've been very active in defense and government services, we're one of the leading lenders in that space, given what's going on geopolitically, we feel like there's really nice tailwinds to that space. So we've been very active there. And for us, we've had a really good track record. It's very stable, steady, and now potentially growing. Healthcare continues to be active for us. Now, you know, some of our peers have stumbled a little bit in healthcare, we've thankfully, you know, avoided some mistakes. And, you know, our way of looking at it and avoiding reimbursement risk, keeping leverage low, trying to get behind companies that are helping bring high-quality care at a low cost has generally performed well from a credit standpoint. And then business services, which is a big catch-all. Business services can mean a lot of things. We're active there. We've been less active in tech slash software. It's always been one of our smaller verticals. We lend against cash flow. We don't lend against revenue. And we lend at reasonable levels of cash flow. So it's a sector for us. It's not one of our bigger sectors. And then consumer remains a sector for us. We've been a little bit more cautious there given some of the volatility around, potential volatility around the consumer. We've done better there when we've had brands that have some meaning. And we haven't done a lot there recently, but if you look at kind of what's worked for us and what hasn't worked, brands that have meaning have worked. So it's really, you know, it's really been government services, defense, healthcare, and business services is kind of you know, the big three for us.

Perfect. Thank you. And on that point, I mean, you'd like to say business services is a really wide bucket, so is healthcare. And to your point, yeah, you didn't do a lot of, say, physician office roll-ups or things like that. So, you know, all the reimbursement risk, et cetera. I mean, so, you know, is the interest there, is it, you know, the intersection between healthcare and government? Is it healthcare and tech? I mean, just... you know, you have had some successes in that area. So, I mean, what's looking particularly, maybe you don't want to say on a public call, but what's looking narrow areas within that are looking good right now?

Yeah, I mean, there's a number of different niches. It's such a vast industry. It's about 20% of the GDP of the United States. There's so many different niches of care and services and synergies to be had among small or medium sized providers and putting them together and then dealing with payers who want to get synergies around who they're paying as well. Offline, we can go through some of the names in the portfolio, but it's a wide variety of different kinds of ways to articulate hopefully stable or growing healthcare niches with high free cash flow where you're providing care at a reasonable cost that payers view as a reasonable cost. It's enormous. We can certainly go into it offline, but You know, it's all in there in the SOI, the Statement of Investments, and people can look and see, you know, go and do the interpolation to the websites of these companies and see kind of the stuff we're doing.

Got it, got it. Thank you. One last one, if I can, on credit. Obviously, interest coverage, et cetera, that looks good. Obviously, there's always going to be some marginal companies in the portfolio, but that's always the case for anybody. I mean, in terms of Are you seeing any emerging signs of weakness, maybe not even in the portfolio, but across businesses that are coming to market now? I mean, it just seems everything's hanging in on a credit front-wise broadly much better than I would have thought if you'd asked me, certainly, you know, like two years ago. So, is anything catching up to anybody yet or is it just, you know, everything takes long and everything's, you know, doing relatively fine?

Yeah, we agree. It's, you know, as lenders, we're skeptics by nature. We presume and we underwrite assuming a recession, which is how we underwrite. And if you rewind the tape to some of these calls a year or two ago, we were saying very clearly we're underwriting and assuming a recession. that has not appeared. So again, our credits generally performed very well because we underwrote assuming a recession. Now, we did not assume that base rates going way back. We did not assume base rates would be where they are today. So that's been the, that's been, that has been the surprise for us. It's been by and large good because the yields we're getting are excellent. If these base rates continue to persist, of course, in a portfolio of 100 or 150 names, there's going to be some companies that over time You know, just, you know, it's just too expensive for and where there'll be amendments and things of that nature as this higher for longer trend continues. If when the Fed starts easing, that will give some of these companies a little bit of a break and a breather. But by definition, you know, if these base rates persist for a while in any portfolio of this magnitude and the magnitude ever appears, there's going to be companies peeling off and needing amendments and extensions and, you know, needing some relief because you can't have 100, 150 companies all going up to the right altogether no matter how good you are. And we think we're pretty good. We think some of our peers are pretty good and By and large, cheaper dollars are growing 5% to 10%, and we're really thrilled with that. But by definition, there's always a handful of companies that are going to need some help.

Got it. Thank you.

Next, we go to the line of Casey Alexander with CompassPoint.

Please go ahead.

Hi. Good afternoon. Thanks for taking my questions. Pretty simple stuff here. This one is just first maintenance. The weighted average yield dropped, if I'm correct, about 40 bps quarter over quarter, which is actually a fair amount in this environment. Is that new weighted average impacted by the fact that you're now carrying the government securities in the portfolio as opposed to categorizing them as cash and cash equivalents?

Well, I'll take the first crack and kick it over to Rick. I mean, for sure we've seen, as we said, spread compression. So the new deals that are coming in call it 25 beeps tighter from a spread compression standpoint. Since we have been very active, you know, the weighted average certainly has come down. Rick, I don't know if you have any other commentary other than that.

I'll just confirm that the government securities are not included in the calculation of the weighted average yield, so they are not impacting anything.

the outcome. Okay. All right. Secondly, I noticed in the SOI that you made a new loan of $50 million to MidOcean. And if I'm not correct, and maybe I'm not correct, but I think you've been sort of in and out and around that name for quite a while. Did you kind of walk us through your history with MidOcean and what you found attractive to put a new $50 million in this quarter?

It's a great question, and you're very astute at highlighting this. This is a company called JF Petroleum, which we've had for a while. It was originally a MES deal. Then it was a restructured deal where we owned a chunk of equity, and it was restructured once again where we basically just became an equity holder. The company has seen a resurgence. There's been some very smart add-on acquisitions that have been made The company's come back very, very strongly, and you can track the value of the equity. You know, there's an equity piece that's been marked up. It's coming back strong. And the company, you know, we'll see. I've learned not to overpromise, Casey, and you can appreciate that. The company's coming back strong. Let's just put it at that, and we'll see where we go.

All right. Thank you for taking my questions.

Next, we go to the line of Paul Johnson with KBW.

Please go ahead.

Good morning. Thanks for taking my questions. I was just hoping to get a little bit more color maybe on just kind of what drove the depreciation this quarter. Was it just sort of broad across the book, or were there any loans in particular that mainly drove that?

Yeah, so, so picking up to the Casey's last point, JNF was up substantially, the three loans that have been marked down are Flock Financial, Walker Edison, which was a restructuring, which remains challenged, and a company called Atlas purchaser, Atlas purchaser. So those are the big three, the three biggest declines in loans that got marked down, you know, during the quarter.

Got it. Yeah, thanks for that. I did notice flocked financial. I did notice that was a bigger loan in your portfolio that was marked down this quarter. I was just curious if you could just kind of maybe just tell us what that business is and kind of what drove the weaker mark this quarter.

Yeah, it's a specialty finance company. They are focused on busted credit card receivables, auto receivables, and they've had some recent stumbles. We are in there working with them to help solve the problem. It could be a really good sector. They've made some mistakes, and we're in there working with the company and trying to help them grow, solve their problem, and build back up.

Got it. Appreciate the color there. Two more. Just on the equity co-investment, it sounds like there could be some possible rotation there this year, which would be great. I was wondering if it's at all possible to quantify that in any way, maybe without, you know, names or if there's even just, you know, any particular industry that maybe you'd expect that, you know, is kind of ripe for deals. Just any sort of clues there would be helpful. Yeah.

Yeah, so we had in the quarter end of December, we had a company called TBC get sold. And we had we had some equity in that this quarter. So far, here today, we just had a an exit company got sold, I can't tell you the name, but obviously, it'll be public, you know, in May, when we talk in May. So we're starting to see starting to see as M&A, you know, kind of hopefully gets back going again. Good news and bad news, we will inevitably get repayments of some of our better deals. That is good news and bad news at the same time. And then as we've said, equity column investment is typically part of the package in many of these. We will get liquid on some equity pieces. Nothing that major or material, but twos and threes and fives can all add up over time and they're very helpful. And as we've said, You know, our MOICs have been multiple invested capital, been north of two times historically, and both TVC and the one I'm referring to were kind of in the three to four times MOIC zone. So, you know, kind of, you know, we'll see. You can't count on it, but as deal flow grows, we hope to see some more, you know, equity rotation.

Got it. Thanks for that, Art. And last one, I'm just wondering, you know, if you guys have any sort of idea within the portfolio. I mean, if you've seen trends of higher PIC utilization from your sponsors, or even if you have any idea if that's the case, you know, if you're seeing higher PIC utilization, you know, what sort of percent of your loans might be on PIC at the moment. I would just assume obviously with, you know, base rates where they're at, you know, expect it to stay high for, you know, even for into the rest of the year. you know, that could be something we would see. But I'm just curious to get your thoughts on that.

Rick, you want to talk about PIC income?

Yeah, Paul, for the quarter, PIC income was about 3% of total income. So currently it's at a relatively low percentage.

You know, outlook, you know, from an outlook standpoint, Paul, look, as we said, if this higher for longer, trend continues inevitably, some companies are going to need some relief. And, you know, part of amendment structures could be pegged. So 3% feels really good now. We're very proud of that. But, you know, we'll just see how long this hire for longer trend continues and quite possibly could go higher than 3%. Thanks.

That's all for me. Appreciate the answers today. Thank you.

We go next to Brian McKenna with Citizens JMP. Please go ahead.

Okay, great. Most of my questions have been asked, but I just had one question for you. So we've seen some consolidation in the public BDC universe, and I think really what some of these, you know, consolidation announcements are getting at are greater scale and bigger kind of public vehicles. So would you ever look to merge PNNT with PFLT just to kind of create a bigger publicly traded vehicle? And if that's something you would look at, I mean, what would kind of have to take place or align for that to take place?

Yeah, thank you. So, look, all things are always on the table. So let me just state that. We're always looking for ways to enhance shareholder value. Over time, PNNT has had a different investment orientation, a little bit lower in the capital stack, a little bit higher return. In addition, PNNT, as we know, has had a chunkier, lumpier performance and NAV. And has not traded as well, quite frankly, as PFLT. PFLT has had what we think is a fairly pristine track record. So, It's something we look at from time to time. You know, we are always looking to say, hey, does it make sense to have two different strategies? You know, does it make sense to have two different strategies? You know, as P&NT hopefully gets less lumpy and hopefully trades better, then, you know, that discussion might be something, you know, kind of more current. But it's something we look at, something we evaluate, and – You know, and it's a good question.

Helpful. Thank you.

We go next to Melissa Wedel with JP Morgan. Please go ahead.

Good afternoon. Thanks for taking my question. Mine have also been mostly asked already, but I thought I'd touch on portfolio leverage, certainly with a really productive December quarter in terms of originations. It seems like portfolio leverage has risen above where you identified your target as being – is this – are you comfortable at current levels, or would you consider sort of rotating out of the government securities and taking large down a bit towards your targets?

Yeah, so there's a couple different things in your question. First, the JV, you know, kind of the way the JV works is we usually season assets at the BDC level at P&NT, and then after the season, they move on to the JV. So, December 31st was a moment in time. It was a moment in time, so, you know, our goal is really to kind of get down to kind of our core target, which is around the zone of 1.25 times. So 1.4 times, we're a little higher than that. So, you know, we're going to look to get back down to our target as assets move from the BDC level to the JV over time. Rick, do you want to cover the treasuries, the government securities, and what we do and how we do it, just to clarify? Okay. Sure.

So at quarter end, we're executing and putting on balance sheets some U.S. treasuries just from a perspective of kind of balance sheet optimization in terms of kind of how we think about utilizing kind of that 30% bad asset bucket.

We don't call it the bad asset bucket. We say it's a good asset bucket, but it's the 30% asset bucket. So our JV, just to be clear, our JV has been really successful. It's been really accretive for PNNT shareholders, and that's a part of our 30% bucket, and we like having room in that. We might grow the JV. We might do another JV. It keeps a very good option for the company open to optimize that 30% bucket.

Okay, that's helpful. I appreciate it. Separate question. It seemed like there was a lot of activity both to new companies and existing companies in the December quarter. I was just curious what you're seeing in terms of sort of existing companies and how they're using proceeds of incremental borrowing. Any trends? Anything worth noting?

Yeah, look, it's a lot of what we do is start off with companies as a platform in a particular sector where the private equity sponsor, you know, says, hey, this is our platform company. We're going to go execute a strategy of doing add-on acquisitions. And we, you know, finance them either with delayed draws or just add-ons and incrementals. And it's part of our normal flow. Again, this is where our equity co-invest can be helpful, where we're helping them grow the platform, and we can participate in the upside. So nothing really dramatic. It's just we were active in that calendar Q4, and that activity included existing portfolio companies.

Okay. So that was companies drawing down on existing facilities, or you're seeing some incremental add-ons in position? Yes.

Well, in most cases, there's a delayed draw term loan that's structured at the beginning of a deal. And that delayed draw is meant to be relatively easy for the borrower to access to do add-on acquisitions or grow subject to certain thresholds. So, much of that is delayed draw, you know, delayed draw term loan facilities being drawn. Occasionally, it's an incremental that's not a delay draw, but much of it is a delay draw that's being drawn.

Got it.

Thanks, Art.

And we now have no further questions. I'd like to turn the floor back to Mr. Art Pinn for any additional or closing remarks.

Thanks, everybody, for being on the call today. We look forward to speaking to you next in May. Have a great day.

This concludes today's conference. We thank you for your participation.

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