PennantPark Investment Corporation

Good afternoon and welcome to the Penn Up Park Investment Corporation's third fiscal quarter 2024 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 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 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 third fiscal quarter 2024 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 your 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 the current market environment for private middle market credit, how we fared in the quarter ended June 30th, how the portfolio is positioned for the upcoming quarters, detailed review of the financials, and then open it up for Q&A. For the quarter ended June 30th, our GAAP net investment income was $0.24 per share, and our core net investment income was $0.21 per share. GAAP and adjusted NAV decreased 2.2% to $7.52 per share from $7.69 per share. The decrease in NAV for the quarter was due primarily to valuation adjustments on the non-accrual loans, partially offset by increases in several equity investments. As of June 30th, our portfolio totaled $1.2 billion. And during the quarter, we continued to originate attractive investment opportunities and invested $163 million in 11 new and 42 existing portfolio companies at a weighted average yield of 12%. 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 1.9 times. and the weighted average loan to value was 50%. As of June 30th, the portfolio's weighted average leverage ratio to our debt security was 4.3 times, and the portfolio's weighted average interest coverage was two times. These attractive credit statistics are a testament to our selectivity, conservative orientation, and our focus on the core middle market. During 2024, the market yield on first lien term loans has tightened 50 to 75 basis points. As the credit statistics just highlight indicate, we continue to believe that the current vintage of core middle market directly originated loans is excellent. In the core middle market, leverage is lower, spreads are higher, and covenants are tighter than in the upper middle market. Despite covenant erosion in the upper middle market and the core middle market, we're still getting meaningful covenant protections. At June 30th, the JV portfolio equaled $926 million. During the quarter, the JV invested $56 million, including 38 million of purchases from PNNT. During the quarter, the JV made a special dividend of $4.2 million, and PNNT's share was $2.5 million. The dividend was a distribution of the JV's cumulative, undistributed net investment income. The special dividend is another indicator of the earnings power of the JV. With its current capital base, the JV portfolio can grow to $1.1 billion. We're having discussions with our JV partner to potentially grow the JV. Over the last 12 months, P&NT earned a 19.5% return on invested capital in the joint venture. We expect that with continued growth in the JV portfolio, the JV investment will enhance P&NT's earnings momentum in future quarters. Credit quality remains strong. We had three non-accruals as of June 30th. Non-accruals represented 4.2% of the portfolio costs and 2.5% at market value. Now let me turn to the current 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 to our borrowers. We have a long-term track record of generating value by successfully financing growing companies, growing middle market companies in five key sectors. These are sectors where we have substantial domain expertise and other right questions to ask and have an excellent track record. There 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 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 questions to protect our capital, attractive spreads, 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 to 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 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 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 who fuels the growth of our portfolio companies, in many cases, we've participated 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 June 30th, we have invested over $511 million in equity co-investments, have generated an IRR of 26%, and have generated a multiple uninvested capital of two times. Since inception nearly 17 years ago, PNNT has invested $8.2 billion, has an average yield of 11.3%, and has experienced a loss ratio uninvested capital of about 20 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 on our target market are attractive. Our experienced and talented team in 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 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 in 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 June 30th, GAAP net investment income was $0.24 per share and core net investment income was $0.21 per share. During the quarter, we received a special dividend of $2.5 million or $0.03 per share from the JV, which consisted of cumulative undistributed net investment income from prior periods. Given the non-recurring nature of this dividend, we have excluded it from our core net investment income. Operating expenses for the quarter were as follows. Interest and credit facility expenses were $11.5 million. Base management and incentive fees were $7.5 million. General and administrative expenses were $1.5 million. And provision for excise taxes was $0.7 million. For the quarter ended June 30th, net realized and unrealized change on investments and debt including provision for taxes, was a loss of 12 million. As of June 30th, our gap and adjusted NAV was $7.52 per share, which is down 2.2% from $7.69 per share in the prior quarter. As of June 30th, our debt to equity ratio was 1.5 times, and our capital structure is diversified across multiple funding sources, including both secured and unsecured debt. As of June 30th, our key portfolio statistics were as follows. Our portfolio remains highly diversified with 144 companies across 30 different industries. The weighted average yield on our debt investments was 12.7%. We had three non-accruals, which represent 4.2% of the portfolio at cost. and 2.5% at market value. The portfolio is comprised of 56% first lien secured debt, 5% second lien secured debt, 10% subordinated notes to PSLF, 4% other subordinated debt, 6% equity in PSLF, and 19% in other preferred and common equity. 96% of the debt portfolio is floating rate. Debt EBITDA on the portfolio is 4.3 times and interest coverage ratio is 2.0 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 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'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. We'll take our first question from Mark Hughes with Truist.

Yeah, thank you. Good morning, good afternoon. The return potential, you know, you described very good the 19.5% return on invested capital in the JV. If you increase the size of that as apparently you're discussing, what's the, how does that change the return profile and is that level of return sustainable?

Hey, Mark. Good afternoon. It's Art. Good question. Look, certainly the returns of these vehicles, the BDC itself or the JV, are high now. We've been in a high interest rate environment. So I would say to the extent that interest rates start to come down, you know, yields will come down across the platform in the BDC as well as the JV. Today we've had really good credit performance in that JV. There's never an assurance that we'll continue that. But we're very pleased with the upper teens. I think, you know, if you want to model it, you can certainly be modeling it into the upper teens. And, you know, to the extent we finalize the arrangement to upsize the JV, whatever capital PNNT puts in, you know, you can certainly model it at an attractive, you know, return on that capital, which should certainly be accretive to PNNT. Okay.

And then the dividend trajectory, you had a special dividend this quarter, obviously. Refresh me on how that has trended over time, what the usual pacing has been on those sorts of dividends.

Yeah, I mean, Rick's going to get you the historical. I mean, usually we take whatever the NII for the JV is. We pay out the majority of it, and we leave a little cushion, and that cushion accumulates over time. We paid out this amount, which is about $0.03 a share, because we wanted to pay out all the undistributed income as we look to potentially upsize the GAV, so everyone kind of come in kind of with a fresh slate. Rick, you know, historically.

Yeah, so, Mark, I'll say kind of the regular, you know, kind of core dividend from the JV is about $4.8 million a quarter.

Yeah, yeah. And then the equity co-invest, is that something where you might think about either increasing or decreasing, you know, the pacing of Has your experience recently been, you know, kind of more or less favorable in historical terms, and does that influence your appetite on a go-forward basis?

That's a great question. You know, for us, it's usually less macro and more micro. We're looking at the particular companies, the investments, the entry multiples, you know, the growth parameters, you know, prototypical deals for us, We're starting out with a company that's doing 10 to 20 of EBITDA. The sponsor has a growth trajectory in mind. There's a delayed draw term loan. We're helping fuel that growth. So the goal is to take that 10 to 20 million dollar EBITDA company, grow it to 30, 40, 50 and above with our debt capital being a driver of that. So in many cases, it makes some sense for us to participate in some of that equity by co-investing side by side with the sponsor. These are not intended to be large equity bets. It's intended to just be a kind of relatively small amount, but over the course of time, you know, 5 to 10 to maybe 15% of the portfolio.

Appreciate it. Thank you. Thank you.

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

Hi, guys. First one, I may have missed this. There's been a lot of calls this morning. On the JVR, you just told Martin that you paid out the excess so that as it gets upside, everybody would come in on the same amount. uh, kind of, uh, level, right? Um, so can I read into that? There's the intent to maybe not just upsize it with the existing partner, but is there an intent to, to, to maybe expand the number of partners that were involved in, in that JV?

Yeah, that's a good question. Uh, you know, it's working really well with our existing, uh, JV partner. It's been great simpatico. Uh, we started with them kind of right after COVID. So, uh, kind of, you know, it's been, we're kind of three, four years old. I think if we had another third party, we'd probably just set up a separate JV. Just, you know, you start to get more different deciders around the table, make it more complex, and each JV partner has their own way of thinking about things, et cetera. So I think we're open to another JV over time if we can find the right partner who sees credit the way that we see it and It sees the world the way that we see it. So I think that's something that's certainly potentially on the table for PNNT.

Got it. Thank you. Just on the market outlook, right? I mean, in terms of pipeline demand, do you expect the recent volatility in the market, very short term, so who knows how long it's going to last, to affect... demand in your area of the market? I mean, yeah, there's been some BSLs pulled in the very large market, but that's not the area you're typically competing in. And so do you expect if the volatility does persist that it would affect sponsor activity in your segment or any thoughts on how all that's going to happen?

Yeah, you know, when you look going back over many years, and we've been at Penn and Park now 17 years of business, you know, when you have market shocks, it takes a little while for the core middle market to impact. First, obviously, the broadly syndicated loan market has an impact fairly immediately, which then gets articulated to the upper middle market, which then gets articulated to the core middle market where we sit. So typically it takes up to six months of a choppy market before it starts to impact our market. What are we supposed to do in the meantime? We could wait. We're never in a rush to invest. We've learned lessons over the years. You never should be in a rush to invest, so we're never in a rush to invest. On the other side, when you find great companies and great capital stacks, it's always a good time to invest because we feel like great companies, great situations end up working out no matter what the scenario is. I think if this choppiness continues, we certainly are going to be thinking about the macro and seeing what's going on, but we're also going to be, as always, looking at the micro and trying to find excellent companies that we can back and support excellent sponsors and try to work both sides against the middle. I don't know if that makes sense or that you understand what I'm saying.

Yeah, I think I get the general idea. Again, one more on the non-accruals or the new non-accrual. But there was a new non-accrual last quarter flop. It's been restructured. The debt's back on accrual in one quarter. You had another new non-accrual this quarter. I mean, is this a similar kind of thing where it's going to be very short-term and a quick restructuring, or can you give us any color on what you expect kind of the timeline this time? That's what it was. Yeah. Yeah.

Yeah, Flock, you know, that was a restructuring. We converted debt to equity. We put more money into it. We now control the company. This company is the new non-accrual. It's called Pragmatic. They provide corporate training solutions to product managers, in many cases technology and other industries. The sponsor injected equity underneath us. So this is a little bit different. The sponsor injected equity underneath us. We are not in control at this point. The valuation came in in the low 60s, and it's a PIC instrument. So given the valuation came in in the low 60s and it's PIC, we decided ourselves to to put it on non-accrual.

Got it. Thank you.

We'll take our next question from Paul Johnson with KBW.

Yes. Good morning or good afternoon. Thanks for taking my questions. You guys seem to be approaching kind of max leverage on the balance. sheet and on the BDC and also the JV, at least kind of the, you know, informal sort of target size, I think you had mentioned on previous calls for the GV. I know you're obviously potentially in discussions to expand that as well, but can you just kind of talk about your investment capacity here, you know, as we sit at kind of one 0.5 times leverage. Should we kind of be expecting to kind of pull back here a little bit and, you know, focus on just recycling capital at this point?

Yeah, Paul, that's a great question. I think that's a fair statement, which is we're full leverage now. We're going to use the JV to deleverage. That's the first thing we're going to do. And then Over time, we do expect and hope to get some rotation on the equity portfolio. You know, M&A is starting to pick up again. There are some really interesting equity positions in there. So, you know, we're very hopeful that we can rotate some of the equity, which will create dry powder to invest in cash-paying debt securities.

Appreciate that. And then... realizing the portfolio overall has an experience of spread compression, but within the JV, have you seen any spread compression there? Should we be kind of tempering expectations for these additional special dividends and maybe the overall return on JVs due to spread compression at all?

Yeah, I mean, look, it's been a great time to be in the lending business, particularly if you could select good companies that pay you back, right? So we've got a really good track record in general. We've got a really good track record in the JV. Obviously, when you have assets that are primarily floating rate and they're spread compression and yields start coming down, for sure, you know, yields and returns are going to come down, you know, in the space. What I can tell you is on the liability side, We've seen spread compression also. If you were on the call or listened in to our earlier call on PFLT, PFLT just recently did a securitization CLO financing, and we got 50 basis points of compression on the liability side in that recent securitization. So, if you see it on the asset side, in some way, shape, or form, you're going to see it on the liability side, sometimes sooner, sometimes later. You know, our credit facility, we also redid in PFLT. Again, we did it as a tighter spread. So it may take a little while for it to, you know, you're never fully 100% matched, but if asset spreads are coming down, liability spreads are coming down, you know, as well.

Thanks for that. And then one more on the JV. What level, or if any, Do you have PIC loans within the JV? Does the structure allow PIC? And then kind of what percent of, if any, is in the JV?

Yeah, it's very small. We don't have it. I think we have it at hand here. We can certainly call you back. But our level of PIC is very low in the JV. You know, we've had in the nearly four years, we've had one non-accrual in the JV to date, Dynata Research now. So it's been, you know, I think it's very, very clean. But we can call you back. Rick can call you back later. But it's a very low number in terms of PIC.

That'd be great. Well, Paul, for me, thanks for taking my question.

Thanks, Paul.

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

Good afternoon. Thanks for taking my questions today. Art, you touched on my first one. I know that equity rotation has been, you know, a long-term goal, at least for part of the allocation there. You mentioned it just now, that remains part of the strategy. Given the sort of general sentiment around expecting a pickup and deal activity in the second half and its rates come down, You didn't mention it earlier, but I'm wondering if you feel like part of the portfolio is particularly well-positioned for that. Is there anything that we should be thinking about in terms of, you know, sort of modeling and timing and rotating part of that?

You know, it's a great question, and the last thing we want to do is over-promise and under-deliver, Melissa, right? So... Look, you're right. You know, we believe deal activity is going to pick up. You know, we believe interest rates are coming down. We certainly hope and want and believe that a portion of that equity portfolio is going to rotate. Hard for us to put out an estimate or guidance on the amount and the timing other than that continues to be a goal of ours. And as you know, Much of it is not in our control. Much of it is with the equity co-investments in particular. We're riding side by side with the private equity firm.

Yep. Okay. Understood. And then a follow-up question. I just wanted to revisit the dividend and the decision to take that up a quarter or two ago. You know, given... sort of the earnings power of the portfolio right now, given sort of the tail end that came from the one-time dividend from PSLF this quarter, which sort of met the dividend level on a quarterly basis. How are you thinking about dividend coverage and feeling just generally about the earnings power of the portfolio, given the potential for, you know, really a lower rate environment as we go forward? And I keep in mind everything you just said about expanding the JVC.

Michael Nutterman, Yeah, look, it's a great question. We're trying to, you know, kind of balance earnings power of the portfolio, the JV, the potential upsizing of the JV, and equity rotation. And we do have about a buck a share of spillover, you know, so, you know, we got to pay that out, you know, and we want to kind of pay it out judiciously over time in a careful fashion, knowing that we're fairly fully levered at this point. So, we're balancing all these different competing interests or different interests, I should say, you know, in terms of paying out the spillover, in terms of looking at the earnings power of the company, you know, and all the different elements of that. So, you know, kind of that really led to our decision to boost the dividend last quarter to $0.08 per month, in large part due to all these different, you know, elements, including the very large spillover.

Okay, that's helpful. Thanks, Art.

And at this time, there are no further questions. I'll turn the call back to Art for any additional or closing remarks.

Thank you, everybody, for participating today. We really appreciate your interest in the company. A reminder that next quarter is our 10K, so the quarterly call will be a little bit later than our normal. We're going to be targeting mid-November for the quarterly earnings release and the quarterly call. In the meantime, Wishing everybody a terrific end of summer and fall. Speak to you next quarter.

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