PennantPark Investment Corporation

Good afternoon, and welcome to the Pennant Park Investment Corporation'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 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 two on your telephone keypad. It is now my pleasure to turn the call over to Mr. Art Pinn, Chairman and Chief Executive Officer of Penn and Park Investment Corporation. Mr. Pinn, you may begin your conference.

Good afternoon, everyone. I'd like to welcome you to Penn and Park Investment Corporation'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 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 September 30th, how the portfolio is positioned for the upcoming quarters, a detailed review of the financials, then open it up for Q&A. For the quarter ended September 30th, our GAAP and core net investment income was 22 cents per share. GAAP and adjusted NAV increased 0.5% to $7.56 per share from $7.52. The increase in NAV for the quarter was due primarily to net positive valuation adjustments in the investment portfolio. As of September 30th, our portfolio totaled $1.3 billion, and during the quarter, we continued to originate attractive investment opportunities and invested $192 million in 12 new and 44 existing portfolio companies at a weighted average yield of 11.4%. 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 3.6 times the weighted average interest coverage was 2.4 times, and the weighted average loan-to-value was 36%. As of September 30th, the portfolio's weighted average leverage ratio through our debt security was 4.5 times, and the portfolio's weighted average interest coverage ratio was 2.0 times. These attractive credit statistics are 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 highlighted 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, in the core middle market, we are still getting meaningful Covenant protections. During the quarter, PNNT's joint venture, PSLF, accepted $127 million of additional capital commitments from PNNT and its JV partner. PNNT committed $52.5 million, and the JV partner committed $75 million. In addition, the JV increased its senior secured credit facility from $325 million to $400 million. This additional capital will allow the JV to scale its investment portfolio to over $1.5 billion, representing a nearly $500 million increase in the JV's investment capacity. At September 30th, the JV portfolio equaled $1 billion, and during the quarter, the JV invested $146 million, including $105 million of purchases from PNNT. Over the last 12 months, PNNT earned a 19.2% return on invested capital in the JV. We expect that with continued growth in the JV portfolio, the JV investment will enhance P&NT's earnings momentum in future quarters. The credit quality of P&NT's investment portfolio remains strong. We had only two non-accruals as of September 30th. Non-accruals represented 4.1% of the portfolio cost and 2.3% 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 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, companies with 10 to 50 million of EBITDA, is below the threshold and does not compete with the broadly syndicated loan market or the 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 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 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 the core middle market, 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 participate in the upside of the company by making an equity co-investment. Our returns on these equity call investments have been excellent over time. Overall for our platform from inception through September 30th, we invested over $540 million in equity call investments and have generated an IRR of 26% and a multiple on invested capital of two times. Since inception nearly 17 years ago, PNNT has invested $8.3 billion at an average yield of 11.3% and has experienced a loss ratio on invested capital of approximately 20 basis points annually. This strong track record includes investments of primarily subordinated and debt investments made prior to the global financial crisis, legacy energy investments, and more 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 are producing attractive 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 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 September 30th, gap and coordinate investment income was 22 cents per share. Operating expenses for the quarter were as follows. Interest and credit facility expenses were 12.3 million. Base management and incentive fees were 7.4 million. General and administrative expenses were 1.75 million. And provision for excise taxes were 0.7 million. For the quarter ended September 30th, net realized and unrealized change on investments and debt, including provision for taxes, was a gain of 4 million. As of September 30th, our gap and adjusted NAV was $7.56 per share, which is up 0.5% from $7.52 per share in the prior quarter. As of September 30th, our debt to equity ratio was 1.57 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 152 companies across 33 different industries. The weighted average yield on our debt investments was 12.3%. We had two non-accruals, which represent 4.1% of the portfolio at cost and 2.3% at market value. The portfolio is comprised of 55% first lien secured debt, 5% second lien secured debt, 9% subordinated notes to PSLF, 5% other subordinated debt, 6% equity in PSLF, and 20% in other preferred and common equity. 94% of the debt portfolio is floating rate, and the debt to EBITDA on the portfolio is 4.5 times, and interest coverage is two 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 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 signal with questions, please press star 1 on your touchtone telephone. If you're joining us today using a speakerphone, please make sure your mute function is is turned off to allow your signal to reach our equipment. Again, that is star 1 if you would like to signal with questions, star 1. And the first question will come from Mark Hughes with Truist.

Thank you. Good afternoon. The investment activities so far in the fourth quarter, I'm not sure if you gave any specifics on that, but what have you seen so far?

Yeah, thanks, Mark. You know, we've been active, you know, kind of with PNNT's current situation. You know, PNNT's kind of pretty fully leveraged here at about one and a half times. Our long-term target leverage is targeting about 1.25 to 1.3 times. So what PNNT does is it basically, you know, buys deals and seasons them and then, you know, at some point to JV. will then purchase those deals. So the growth of the portfolio in PNNT is really going to come through the JV at this point. So it's kind of been more of a steady state at PNNT, and the new deals, the new opportunities, given the leverage, are going to be shifted over to the JV when appropriate. So kind of ins and outs are monitored very closely, and we've been active, but we're also getting repayments.

Yeah. Okay. And then you described kind of high-teens returns on the JV. Anything structurally that should influence that? Is that kind of sustainable? Is there decent visibility for those sort of returns? Are there any market factors that maybe influence that?

Sure. It's a lot of the first lean deals that we originate across our platform, lower leverage lower risk type deals and then as they go into the JV they get levered up a little bit more than they would on a BDC balance sheet, you know, kind of two to one kind of debt to equity ratio range. And we use credit facilities, we use CLO technology to finance those loans. So certainly the same thing as a BDC balance sheet, if interest rates come down, The returns on that JV will come down. These are mostly or virtually all floating rate loans. You know, granted, the cost of the live bills will come down as well. And then credit performance. You know, we've had excellent credit performance in the JV. Hopefully, we continue to have excellent credit performance. But a combination of interest rates and credit performance would be the key areas that you'd watch for that 19% return coming down.

Very good. And then thinking about the credit stats this quarter, I think 3.6 times debt to EBITDA, and then it seems like the loan-to-value also pretty attractive. At the same time, you're getting a little bit of spread compression. What are you seeing just in terms of those leverage numbers? They seem pretty good. Is that sustainable, or you might see those move up a bit?

Yeah, look, they're really good, you know, from an overall standpoint. We end up being in the mid-fours over a long-run basis. And as we say, you know, typically we'll start out with a company that's, you know, a platform for growth or acquisition. So we'll finance a $10 or $15 or $20 million EBITDA company. Once it's a little smaller, we might keep leverage a little tighter. As the company grows to $20, $30, $40 of EBITDA, it gets a little bit bigger. Maybe the leverage will go up a little bit as it does add on acquisitions and draws down the delayed draw facilities. So that's the typical life cycle of one of our deals. We'll start out smaller EBITDA, keep leverage tight, give them a DDTL to grow, co-invest in the equity to participate in that growth. Company gets bigger, you know, ends up at four, four and a half times leverage. And then as it gets to 40 or 50 of EBITDA or greater, it moves off to the upper middle market.

Appreciate that. Thank you.

And the next question will come from Robert Dodd with Raymond James.

Morning. Hi, guys. On the outlook in terms of sectors, you mentioned five key sectors. When I look at the ads this quarter, I think three or four of them were healthcare mostly and then business services. Only one government slash defense Um, what, what are the ones that, that look appealing to you going forward in the 2025? Maybe we're taking into account, obviously change in administration coming, et cetera. I mean, which, which areas do you expect to remain attractive?

Yeah, look, I think there are two biggest sectors and some of those business services might, as you look under the cover, a little bit more government services or defense. Look, healthcare has been a good sector for us. Some of our peers have stumbled a little bit in that space. I think we generally tend to keep leverage lower than some of our peers. You know, maybe we're financing smaller companies at lower leverage with tighter covenants. Don't know. But, you know, we've selected areas in healthcare where the tailwinds are behind us. The reimbursement risk may be a little lower. And importantly, we keep leverage lower. And demographically, healthcare is just going to continue to be a big portion of our economy. You almost can't avoid it, the aging of our population. So we're going to continue to do a bunch in healthcare, you know, be very selective about which pieces of the industry and then keep leverage low. Government services and defense continue to be, you know, an important part of the economy. The geopolitical outlook remains uncertain. Certainly, you know, with DOGE coming in and taking a look at all government expenses, That's, you know, we'll see how that plays out. As taxpayers, we of course want our tax dollars to be spent efficiently. But typically in defense government services, we're financing service businesses where human beings walk into an office building and sit behind computers, whether that be cyber security, intelligence, you know, other kind of, you know, non-heavy asset areas. that we think will continue to be really important given the geopolitical risk that's in the market. But it's really hard to, you know, handicap what the Doge effort's going to mean. And, you know, kind of, again, we just try to keep leverage low. I don't know how many of our peers have a portfolio that has a debt tibetan kind of in the mid-fours and has new loans in the mid-threes debt tibetan. I don't think there's very many. So for us, that's been our tactic or strategy and we're okay. You know, we're okay. Keeping, uh, keeping, uh, lower, lower leverage and accepting a lower yield. And, you know, with the advent of being able to officially finance those loans, either on the balance sheet of the BDC or in a JV or leverage can be optimized a little bit more and we can, um, we can manage more assets on behalf of the shareholder and not charge a management fee for managing those assets and be able to punch out amid the opportunities in return. We think that's a very good model for PNNT.

Got it. Thank you. On that, you know, the spread question, I mean, they have come down. You mentioned in your prepared remarks. I mean, where do you think it's at a bottom, you know, that spread compression is kind of leveled out given, you know, or do you think there's, You know, the returns on first lean are still really, really attractive. I mean, double-digit yields on first lean, even with spreads where they are right now. So, I mean, do you think there's room for them to come down further, or is this the bottom?

Yeah, great question. We think they've plateaued here. You know, our deals are typically right now on the senior side, 5 to 550 spread over the risk-free rate. Seems to have plateaued. If deal supply gets even heavier, perhaps we have a chance as an industry or in the core middle market to be able to increase spread a little bit. If there's heavy supply, that wouldn't be so bad. Again, credit, credit, credit, that's got to be most important. If we can reduce mistakes, the rest of it will take care of itself. So we're not modeling an increase in spread, and right now we don't think there will be any tightening. And on a relative value, if you look at the BSL market, you know, BSL market's kind of 350, you know, spread. So if we're 550, BSL is 350. From a relative value standpoint, we still think it's attractive.

Got it. Thank you.

Thank you.

And moving on to Paul Johnson with KBW.

Good morning. Good afternoon. Thanks for taking my questions. So on the JV, very strong return once again this quarter. It's been a great asset for the BDC, a 19% annualized distribution rate from the JV this quarter. Portfolio yield close to 11% inside of the JV. Can you kind of give your thoughts around just sustainability, you know, that current distribution rate? I mean, you know, some sort of any sort of sensitivity around, you know, interest rates and what would happen with net interest income in the JV?

Yeah, you know, it's a great question. And certainly our track record in the JV to date is really good. We've had very minimal non-accruals. Look, you have to kind of say, let's build in some cushion in that. If you were to kind of say, okay, long run, we're four or maybe five years into that, JV, can we sustain that? I certainly hope so, but certainly over time we have non-accruals, and we should model those in. For P&NT over many years, it's been a 20 basis point annualized diminution of return due to non-accruals. The PFLT and the JV portfolio is a little bit closer to the PFLT first lean portfolio has been 10 basis points annualized. Certainly as interest rates come down, it's going to be sensitive to that. So those are the two things you'd model in. Is 19% going to come to 17% or 15% at some point? It's quite possible. It's hard to guarantee 19% forever. I mean, I certainly hope we can achieve that, but it's really hard to say it's absolutely sustainable and pound the table. But certainly the way we've been investing in senior debt and then how we've been using leverage at the JV level, including securitization, CLO leverage, we should still be able to get an opportunity to return on that capital.

And what is the idea around leverage? I think last quarter was around 2.1 times or so in the JV. Is the idea to continue to increase that as rates decline? Is that kind of near its sort of max target leverage? What's the idea?

Yeah, I think two to one, two and a quarter to one is probably the relevant zone at this point. Again, these are the same exact assets that we use across our platform, PFLT, and it's JV gets these first lien assets. It's important to note that we have a CLO business A third-party CLO business in these same assets are in middle-market CLOs where the equity gets levered three or four to one, and those are very strong, good structures. We are going to price our CLO 10 shortly in the coming days, and if you look at third-party research on middle-market CLOs, thankfully Penn and Park is one of the top top three quarter after quarter in terms of performance in the middle market CLOs. It's because the performance of the underlying assets so far has been very good in the same assets that are in our JVs and in PFLTs. So these assets could be safely levered three or four to one. In the JV right now, we're focused on two, two and a quarter to one.

Thanks for that. I mean, can I just ask about the amendment this quarter in the JV? It looks like you made an amendment that allows parties to potentially redeem their interests. What's the idea with that? Is that to potentially create some sort of opportunity to maybe bring new partners in, you know, in the future somehow or, you know, to sell stakes? But what was the purpose of that amendment?

Yeah, that was just kind of – in line with the updated agreement we have with our JV partner. They were bringing more capital in as part of that. They just wanted to clarify entry and exit mechanics. So there's a potential that this really could just be an evergreen vehicle. And their limited partners can come in and exit on an early basis if they want to continue to be in this vehicle.

Thanks for that. And then on the non-accruals in the filing, you know, it says there's two companies on non-accrual. However, you know, if I pull up the number of companies on partial non-accruals, there's a few more. Can I just ask, you know, why would a company be placed on partial non-accrual versus just full non-accrual? Was there any specific situations this quarter or? for a reason for that.

Rick, do you want to handle that one?

Thanks, Paul. There's one company, it's called Pragmatic, that's on partial non-accrual. Based upon the valuation, which is in the low 60s, it is currently paying pick interest. So we're accruing to that mark of 60 because the enterprise value of the company is not, you know, it's It's basically at 100% loan-to-value, so we're reserving for that portion that exceeds the enterprise value and then, therefore, collectability.

Appreciate that. And then just a few more, if you may. Within the portfolio, you know, what would you say, I guess, is the refinancing opportunity that's still – left in the portfolio at this point? I mean, what would you see as kind of like the balance between, you know, activity that can be derived from the existing book versus new activity, kind of given that leverage is obviously kind of getting close to being maxed out, you know, within the BDC?

Yeah. We're getting repayments. You know, middle market M&A is getting active again. You know, I think you were on the PFLT call earlier. It's an active environment for middle market M&A. We hope to be getting some realizations on our equity co-invest portfolio as part of that. Certainly, we're going to get repayments on loans as part of that. And the idea is to, you know, optimize that portfolio, optimize the JV portfolio, and manage it, you know, manage it sensibly and tightly. But, you know, the the wheels of commerce and the wheels of M&A are picking up again. And hopefully that'll provide us an ability to get some equity realizations and make the equity piece of the book, smaller piece of the book.

Thanks for that. I mean, would you say that any of your larger equity co-investments are getting any closer to that point of exit if we do see a material pickup in M&A activity next year?

Sure. I mean, you can, it's a simple review of the equity co-investment, look at fair market value relative to cost. And if there's, the fair market value is a lot higher than cost, and typically we're a co-investor with a private equity sponsor, typically it's just a matter of time, right? So we're hoping to get some nice realizations in the not too distant future.

Appreciate it. Thank you very much, Art. That's all for me.

Thank you.

And our next question will come from Melissa Waddell with JP Morgan.

Good afternoon. Thanks for taking my question. Most of mine have already been asked, but I thought I'd follow up on the JV in particular. As you mentioned that the growth in the portfolio is likely to come through that JV. It certainly makes sense with the recent upsize. When you think about the investment in the JV, both in the sub-debt, but also the equity investment. How do you think about position sizing of that JV investment within the total portfolio context? Do you think of, is there some constraints in terms of position size that you would be targeting or not be comfortable exceeding in a portfolio? Thank you.

Yeah, definitely. That's a great question. So the JV itself with about a billion and a half of availability for that particular bucket, let's just say average position should be 2%. So that's up to 30 million. And I think reality, the average position there will be about 25 million. If we were to do, you know, a new loan that JV would take 20, 25 million, you know, in and of itself. So very diversified portfolio. And the JV, and then the question is, what's too big for PNNT in terms of its position in that JV? You know, look, we're getting pretty full. Just to be quite honest, we're getting pretty full. It is part of our 30% bucket, which is getting pretty full. So we're getting there, not to say we're there there, but it's getting to be a pretty full position. And you saw that we, prior to this investment, we, PNNT on 60% of the JV, our partner on 40%. We did not take 60% of this upsize. We took less. You know, they took more. So I think we're probably about 55%, 45% now. So something we evaluate. That said, when you look at the underlying portfolio, the underlying portfolio obviously is very, very diversified.

Understood. Thanks, Art.

And the next question will come from Casey Alexander with Compass Points. Yeah, I've got a few. One in particular, J&F equity position that was marked up $9 million this quarter. That was a pretty extreme mark-to-market quarter-over-quarter on an equity position. It was one of the few equity positions that really is large enough that if it got monetized, it could really help your income-producing position. your income generating in terms of switching it to stuff that does generate income, does that one in particular appear to have some sort of a path towards monetization? Because all of a sudden, because usually when we see a large quarter-over-quarter markup like that, it may mean that, you know, something is more current.

Yeah, you know, that's, you know, we just said that, hey, when there's a big markup of the equity, hopefully it's just a matter of time. although we never want to over-promise and under-deliver, and occasionally we've under-delivered on that score, Casey, so do not want to over-promise and under-deliver, but that deal has been marked up and the company's performing well.

All right. But secondly, and as you say, you're the 45% in the JV, right?

in this last iteration, but overall, no, overall today we're about 55%.

Oh, P&NT is 55%, okay. Yeah. Because it could be the first JV I've ever seen where the balance sheet is going to be larger than the on-company balance sheet. But let me ask, you know, the balance sheet on Pennant's balance sheet, as well as the debt that it has also has $100 million payable for investment purchased. And so, you know, that would make the effective leverage around 1.7 times. You know, so obviously you're warehousing a little bit for the JV, you know, and when you bring that down, when you move those over to the JV, the appropriate investments to get it to where you want to be, and bring your leverage ratio back down to your target leverage ratio, I'm struggling a little to figure out how that is going to be accretive to earnings if 100% of the income is on balance sheet shifting to 50% of the income going off balance sheet. Is it just because you have so much additional leverage in the JV that you're able to squeeze out some accretion to earnings from that?

Yeah, so it's a great question. You know, every dollar we invest in the JV, whether it's earning a 19%, which is terrific, or something a little bit less, is obviously accretive to NII. So that's very helpful. And we're earning some income along the way. But your question is, like, hey, when the dust settles, you know, once the JV is fully optimized, it's a billion and a half, and this incremental capital we're putting in, what do those economics look like? And we can work through that model with you, Casey, on the incremental capital, putting in the JV and how that works its way back to PNNT. And then, yes, we are looking forward to some equity rotation in this M&A world that seems to finally have revived after a couple years of being sleepy. And I think those are the two drivers for optimizing You know, NII is the JV and the equity rotation.

Okay. My next question is, you know, you have 152 companies in the portfolio, 12 of which were new this quarter, which means that 140 are legacy companies, and you did add-on investments to 44 companies, which is over 30% of the portfolio. You know, it's hard to imagine that over 30% of your portfolio is you know, was getting bolt-on growth capital. It feels like there may be some maintenance capital that's helping these companies pay the coupon on their debt. And pick income is already 13% of the total portfolio. Can you talk to those 44 and, you know, how many of them are kind of maintenance capital versus ones that are really requiring additional bolt-on growth capital?

I'll kick it over to Rick in a minute because some of this might just be revolver draws. So I don't know, Rick, how much of that's revolver. We do have a very active portfolio. Again, most of the deals we're doing, you're taking a $10 or $15 or $20 million bid-out company and there's a real game plan to grow it to $40, $50 and greater. So the DDTLs are an important piece of the add-on loans we're making. Rick, are revolvers included in some of those numbers Casey was referring to?

Yes, the 44 add-on does include revolver draws, and I would guesstimate that that's probably about 85% is related to revolver draws as opposed to add-on acquisitions and DDTL funds.

Okay, great. Thank you for taking my questions.

Thanks, Casey.

And that does conclude the question and answer session. I'll now turn the conference back over to Mr. Art Pinn.

I just want to thank everybody for being on the call today and this season of Thanksgiving. I want to express gratefulness and thankfulness to everybody who's on the call and your interest in PNNT. Wishing everybody a terrific holiday season and we'll talk to you in February.

Thank you. That does conclude today's conference. We do thank you for your participation. Have an excellent day.