Pennantpark Floating Rate Capital - Earnings Call - Q1 2021

Transcript

Speaker 0

Good morning, and welcome to the PennantPark Floating Rate Capital's First Fiscal Quarter twenty twenty one 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 opened for a question and answer session following the speakers' remarks. It is now my pleasure to turn the call over to Mr.

Arch Penn, Chairman and Chief Executive Officer of PennantPark Floating Rate Capital. Mr. Penn, you may begin your conference.

Speaker 1

Thank you, and good morning, everyone. I'd like to welcome you to PennantPark floating rate capital's first fiscal quarter twenty twenty one earnings conference call. I'm joined today by Aviv Efrat, our Chief Financial Officer. Aviv, 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 a property of Penny Park Floating Rates Capital and that any unauthorized broadcast of this call in any form is strictly prohibited. Audio replay of the call will be available by using the telephone numbers and PIN provided in our earnings press release as well as 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 pennantpark.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, Bart Nen. Thanks, Aviv. First, we hope that you, your families and those you work with are staying healthy.

I'm going to spend a few minutes discussing how we fared in the quarter ended December 31, how the portfolio is positioned for the upcoming quarters, our capital structure and liquidity, the financials and then open it up for Q and A. Despite the challenging economic conditions brought on by the pandemic, we are pleased with our performance this past quarter. We achieved another substantial increase in NAV during the quarter. Adjusted NAV increased 4.3% from $11.81 to $12.32 as our portfolio continued to improve during the quarter. We have several portfolio companies in which our equity co investments have materially appreciated in value and we are benefiting from the K shaped recovery.

This is solidifying and bolstering our NAV. Over time, rotation of that equity into debt instruments should outgrow PFLT's income. We will highlight those companies in a few minutes. As part of our business model, alongside the debt investments we make, we selectively choose to co invest in the equity side by side with the financial sponsor. Our returns on these equity co investments have been excellent over time.

Overall for our platform from inception through December 31, our $217,000,000 of equity co investments have generated an IRR of 28% and a multiple on invested capital of 2.9 times. In a world where investors may want to understand differentiation among middle market lenders, our long term returns on our equity co investment program are a clear differentiator. Additionally, in late December, we priced a CLO financing in our PSSL JV, which closed in late January. We've been pleased with the stable performance of PFLT's long term low cost securitization CLO financing through COVID. We said the financing is well matched to finance our senior debt positions, which we believe are among the lowest risk in the industry.

As a result of the completion of this CLO financing of PSSL, we can efficiently grow the venture, which generate additional income from PFLT. The combination of potential income growth from equity rotation, a larger and more efficiently financed PSO sale and a growing more optimized PFLT balance sheet should help grow the company's net investment income relative to its dividend over time. Those factors combined with strong portfolio performance through COVID and our $0.22 spillover as of September 30 have led us to conclude that we will be keeping our dividend steady at this point. Although we never predicted a global pandemic, as you may know, we have been preparing for an eventual recession for some time. Prior to the COVID-nineteen crisis, we proactively positioned the portfolio as defensively as possible.

Since inception, we have had a portfolio that is among the lowest risk in the direct lending industry. As of December 31, average debt to EBITDA in the portfolio was four times and the average interest coverage ratio, the amount by which cash income exceeds cash interest expense was 2.9 times. This provides significant cushion to support stable investment income. These statistics are among the most conservative in the direct lending industry. We have only two non accruals out of 105 different names in PFLT and PSSL.

This represents only 2.3 of the portfolio at cost and 1.9% at market value. We have largely avoided some of the sectors that have been hurt the most by the pandemic, such as retail, restaurants, health clubs, apparel and airlines. PFLT also has no exposure to oil and gas. The portfolio is highly diversified with 100 companies in 42 different industries. Our credit quality since inception over nine years ago has been excellent.

Out of three eighty seven companies in which we have invested since inception, we have experienced only 13 non accruals. Since inception, PFLT has invested over $3,700,000,000 at an average yield of 8.1%. This compares to an annualized realized loss ratio of only 10 basis points annually. If we include both realized and unrealized losses, the annualized loss ratio is only 12 basis points annually. We are one of the few middle market direct line issuers in business prior to the global financial crisis and have a strong underwriting track record during that time.

Although PFLT was not in existence back then, PennantPark as an organization was investing at that time. During that recession, weighted average EBITDA of our underlying portfolio companies declined by 7.2% at the bottom of the recession. This compares to the average EBITDA decline of the Bloomberg North America high yield index of negative 42%. We are proud of this downside case track record in the prior recession. Based on tracking EBITDA of our underlying company through COVID so far, we believe that our EBITDA decline will be substantially less than it was during the global financial crisis.

Looking forward to 2021, where we can expand today, our analysis suggests that the vast majority of the companies in our portfolio are in a strong position to perform well in the coming quarters. Many of our portfolio companies are in industries such as government services, defense, healthcare, technology, software, business services and select consumer companies that are less impacted by COVID and where we have meaningful domain expertise. We believe that we are experiencing K shape recovery with some companies and industries being large beneficiaries of the environment. We are pleased that we have significant equity investments in three of these companies, which can substantially move the needle in both NAV and over time net investment income. I would like to highlight those three companies.

The two companies are Cano, Walker Edison and Bylight. Cano Health is a national leader in primary health care and is leading the way in transforming health care to provide high quality care at a reasonable cost to a large population. Our equity position has a cost and fair market value on December 31 of 400 and $31,000 and $9,100,000 respectively. Canna has been experiencing rapid growth with revenues nearly quintupling and EBITDA more than tripling over the last three years. We believe that there is a massive market opportunity for Canada to grow in the years ahead with the Medicare Advantage program.

During the quarter ended December 31, we received $200,000 of cash as a return of capital. The merger with Charles acquisition is scheduled to close at the March or early April. At that time, we will receive another 800,000 of cash and own 825,274 shares of Cano Health in a limited partnership controlled by a financial sponsor where the sponsor will earn 20 percent of the exit proceeds. The shares will be locked up for six months. From a valuation perspective, due to the lockup, the independent valuation firm values the position with a 7% illiquidity discount to the traded values on December 31.

Walker Edison is a leading e commerce platform focused on selling furniture exclusively online through top e commerce companies. Since our investment was made in 2018, sales have more than tripled and EBITDA is up almost four times. Our position has a cost of $1,400,000 and a fair market value of $11,100,000 as of December 31. MiWay is a leading software, hardware and engineering solutions company focused on national security challenges across MiWay and simulation, cyber and global defense networks. Since our initial investment was made nearly four years ago, sales have gone up 1.5 times and EBITDA has more than doubled.

Our position has a cost of $2,200,000 and a fair market value of $10,800,000 as of December 31. All three of these companies have gained financial momentum in this environment, and our NAV should be solidified and bolstered from these substantial equity investments as their momentum continues. Over time, we expect to exit these positions and rotate those proceeds into debt instruments to increase income at PFLT. We were active this past quarter making new loans. I'll walk through some of the highlights.

We purchased $15,000,000 of the first lien term loan of the Aegis Technologies Group. The company is a government contractor providing differentiated solutions across space superiority, directed energy and missile defense. Arlington Capital Partners is the sponsor. Applied Technical Services is a provider of nondestructive testing, calibration lab and consulting engineering services. We purchased $9,500,000 of first lien term loans and co invested $504,000 of common equity.

IFree Investment Partners is the sponsor. Hancock Claims Consultant is a leading insurance claims services company focused on the residential roofing market on behalf of carriers. We purchased 6,000,000 of the term loan and 450,000 of equity. Century Equity Partners is the sponsor. Rancho Health is a primary care provider in Southern California that has focused on offering value based primary care.

We purchased $3,700,000 in first lien term loan and co invested $1,100,000 in common equity. Light Day Capital is the sponsor. Sigma Defense Systems is a leading IT services provider and systems integrator of satellite communication equipment for mission critical airborne surveillance programs. We purchased $7,500,000 of first lien term loan and purchased 6 and $42,000 common equity for Cigna Defense Systems. SageOne Capital is the sponsor.

The outlook for new loans is attractive. We believe that middle market lending is a vintage business. This upcoming vintage loan is likely to be the most attractive we've seen since the 02/2012 time period. The leverage levels are lower, equity cushion is higher, yields are higher and the package of protections, including covenants, are tighter. After enduring about five years in the late cycle market in the middle market lending, it is refreshing to have attractive risk reward available to us.

Let me now turn the call over to Aviv, our CFO, to take us through the financial results in more detail. Thank you, Art. For the quarter ended December 31, net income was 0.26 per share. Looking at some of the expense categories, management fees totaled about $4,500,000 taxes, general and administrative expenses totaled about $800,000 and interest expense totaled $5,300,000 During the quarter ended December 31, net unrealized appreciation on investment was $23,000,000 or $0.58 per share. Net realized losses was about $2,700,000 or $07 per share.

Net unrealized depreciation on our core facility and notes was $0.10 per share. Net investment income was lower than the dividend by $02 per share. Consequently, GAAP NAV went from $12.31 to $12.7 per share. Adjusted NAV, excluding the mark to market of our liability, was $12.32 per share, up 4.3 percent from $11.81 per share. Our entire portfolio, our credit facility and notes are mark to market by our Board of Directors each quarter using the equity price provided by an independent valuation firm, exchanges or independent broker dealer codes when active markets are available under ASC eight twenty and eight twenty five.

In case of where broker dealer codes are inactive, we use independent valuation firms to value the investments. Our spillover as of September 30 was $0.22 per share. We have ample liquidity and are prudently levered. Our GAAP debt to equity ratio was 1.2 times, down from 1.4 times last quarter, while GAAP net debt to equity after subtracting cash was 1.1x, down from 1.3x last quarter. Regulatory debt to equity ratio was 1.3x, down from 1.5x last quarter and our regulatory net debt to equity ratio after subtracting cash was 1.2x, down from 1.4x last quarter.

With regard to leverage, we have been targeting a debt to equity ratio of 1.4 times to 1.6 times. Our net of cash regulatory asset coverage ratio of 1.2x was well below the low end of our range this past quarter. We had ample liquidity to fund revolver draws and were in compliance with all of our facilities at December 31. We have readily available borrowing capacity and cash liquidity to support our commitments. We have a strong capital structure with diversified funding sources and no near term maturity.

We have EUR 400,000,000,000 revolving credit facility maturing in 2023 with a syndicate of 11 banks with $257,000,000 drawn as of December 31, 119,000,000 of unsecured senior secured notes maturing in twenty three and two twenty eight million of asset backed debt associated with Payment Part C level one due 02/1931. Our portfolio remains highly diversified with 100 companies across 42 different industries. 87% is invested in first lien senior secured debt, including 12 in PSFL, 3% in second lien debt and 10% in equity, including 4% in PSFL. Our overall debt portfolio has a weighted average yield of 7.5%. 98% of the portfolio is floating rates and 86% of the portfolio has a LIBOR floor.

The average LIBOR floor is 1%. Now let me turn the call back to Art. Thanks, Yves. To conclude, we want to reiterate our mission. Our goal is a steady, stable and protected dividend stream, coupled with the preservation of capital.

Everything we do is aligned with our goal. We try to find less risky middle market companies that have high free cash flow conversion. We capture our free cash flow primarily in the first lien senior secured instruments and we pay out those contractual cash flows in the form of dividends to our shareholders. In closing, I'd like to thank our extremely talented team of professionals for their commitment and dedication. Thank you all for your time today and for your investment and confidence in us.

That concludes our remarks at this time. I would like to open up the call for questions.

Speaker 0

Thank We can go ahead and take our first question from Kevin Fultz with JMP Securities.

Speaker 1

First, sure, looking at non accruals, the nail stopped second lien and PRA ventures have been removed from non accrual during the quarter. Can you provide some color around why those investments were removed from non accrual by the amendments look like? Sure. Thanks, Kevin. PRA, the sponsor put in injected more equity.

So we agreed to as part of that deal, we agreed to a formula where the sponsor put in more equity and put them on back to non accrual, and the company is moving forward with a much better liquidity position. MSpark or MailSouth, we go through a full restructuring, where our original second lien was converted to equity. We and, the other, second lien holders put in an additional second lien, and, and we have an agreement with the first lien, player to give the company, you know, a couple of years of room to rebound. The company has done quite nicely since the restructuring. It seems to be rebounding quite nicely.

Okay. Appreciate that color. And then now that PSSL has completed the CLO financing, can you discuss the level of growth we can expect in the JV moving forward? Sure. So PSSL can, with leverage, get up to, I don't know, $550,000,000 of total assets or so.

So that's something we look to achieve, follow along carefully in all the coming quarters. Okay. And then lastly, just touching on prepayments. What visibility do you have around that point of prepayments? And then just the level of prepayments quarter to date so far?

Yeah. Yes, it's a good question. I've got what level of transparency we have around prepayments. Usually, we have pretty good transparency. You know, we have, we typically are getting nothing financial statements.

We're typically talking to the management sponsor, you know, at all times. So far, prepayments have been somewhat muted so far this quarter. But, you know, frankly, with the portfolio performing so well, which ultimately is, for us, the most important thing, you know, we could have more prepayments. So I'd say we're going back into a more normalized environment. You know, a more normalized environment for us is where a new portfolio, rotates 25% to 33% a year on the debt side, and we need to replace it.

And as we said in the prepared remarks, potentially grow. So I'd say we're back to a more normalized environment. Okay. That's it for me. I appreciate you taking my questions.

Thanks, Kevin.

Speaker 0

All right. We'll go ahead and take our next question from Ryan Lynch with KBW. Ryan, please go ahead.

Speaker 2

Hey, good morning. Thanks for taking my questions. First one, Art, you mentioned that looks for new loans being pretty attractive as far

Speaker 1

as lower leverage levels, higher protections and some higher yields. I'm just

Speaker 2

wondering, have you been seeing though that the quality and some of the benefits of those deals? Are you seeing those start to shrink and return to sort of pre COVID levels? Certainly, we've

Speaker 1

seen the liquid

Speaker 2

markets, terms and structures have kind of reverted pretty close, if not all the way back to kind of pre COVID level. So in the market that you're playing in, are you starting to see those sort of revert back to those levels? And if so, do you how long do you expect it to be still seeing better deals versus pre COVID levels?

Speaker 1

That's a terrific question, Ryan. And first, it's a definitional question, which is what market do we play in and what are we playing, where are some of our peers playing. We focus on what we call the core middle market, the core middle market, which is companies with 15,000,000 50,000,000 of EBITDA, which is kind of below the fray of competing with the broadly syndicated loan market or the high end market. Many of our very, very large peers who manage 10s and 20s and $30,000,000,000 of assets really do compete on a day in and day out basis with the broadly syndicated loan market, in business of writing big checks to big companies. And we have to make quick decisions.

Deal flow is quick. They're only getting financial statements, you know, every three months. It's covenant light or covenant covenant wide. And, there's a lot of velocity in that space because they're they're, you know, less of an opportunity for due diligence. We compete in the 15,000,000 to $50,000,000 space, what we call the core middle market.

New deals take longer, suggesting we are doing many, many weeks of due diligence. We are negotiating multiple covenants. It's a much more labor intensive and slower process. As part of this, we also get the lift in Convest, which we've had a very nice track record on with the 2.9x MOIC track record. So it's a different world.

It's a slower moving world. And as a result, it's taken longer for the bounce back. We were competing with the broadly syndicated loan market or the high yield market, which is back to where it was pre COVID. We basically have to move to that level. In our world, it certainly is has bounced back somewhat since the bottom of COVID, but certainly nowhere, you know, all the way back.

So we kinda like where we're, you know, positioned. We like this 15,000,000 to $60,000,000 in our core middle market. We think we can get really attractive risk adjusted returns. You know, I think we've come through COVID, and I think it's kind of improved the true COVID. You know, we've had very minimal defaults in the equity fund that's about it, you know, a lot of return.

If you look at our our senior private credit vehicle, which is a private version of PFLT, we had kind of a net return of 18% for 2020, which is kind of, ridiculous when you think about COVID-nineteen in 2020, and we had an 18% net return for a vehicle that the vehicle looks a lot like PFLP. And our credit ops vehicle, which looks a lot like PNNT, we had a 2829% net return 2020. So a combination of low defaults, the equity column, that's really going to position us well during 2020.

Speaker 2

Okay. That's helpful and good color on the market. I know in the past, prior to COVID, you as well as a lot of other director lenders talked about late cycle investing. And of course, PFLP targets that in general as far as being high up the capital structure and more recession resistant businesses. I'm just wondering, though, now that we're coming out of a downturn or a pandemic, do you intend or do you have any appetite to shift the investment focus of PFLT and all maybe taking on more risk since we just kind of ramp it down scenario?

Or is it going to be kind of steady as you all kind of invested in kind of your target markets, whether that's where you are in the capital structure or where you are as far as industry exposure?

Speaker 1

Yes. So look, PFLT has always been positioned from day one as what the open think has been, your grandmother's BDC with a lower risk, lower reward, lower expense structure. So our yields are among the lowest in the industry. Our leverage at four times is among the lowest in the industry. Our expenses are among the low the industry.

So for PFLT, we're not, you know, we're not intending to veer off that. I think one of our key focuses going forward though is, you know, we have these kind of five key sectors where we've developed really meaningful domain expertise where we can be among the smartest, you know, people in the room when deals come in. And I think that's where we're digging, you know, digging deeper, and that's kind of government services, defense, health care, technology and software, business services, and and consumer, you know, where when a deal comes in and we know the right questions to ask, we're we're really prepared and and, you know, the areas where we have where we think we have real domain expertise, we're we're gonna play.

Speaker 2

Okay. And then I just had one last one. In January, PennantPark has a platform. You closed PennantPark Credit Opportunity Fund III. I'm just curious, is the investment strategy of that fund similar to PFLTs?

Or is it more similar to PN and Ps? And is there any ability to co invest PFLT to co invest across that fund? Or does that have any sort of impact on PNNT or PennantPark as a platform's ability to further speak them out? Can you just talk a little about that? That would be helpful.

Speaker 1

Yes. Yes. No, we have a growing private business. Overall, at Santa Park, we have two separate strategies. We have opportunistic, which is a blend of highly yielding first lien, second lien, mezz and equity convest, and we have senior debt.

Basically senior and stretch senior as well as equity co invest. PFLT is a senior debt vehicle, and we have private vehicles that look a lot like PFLP but are private. So as I said, that that, you know, those vehicles had a 18% net return in 2020 due to very minimal non accruals and the strong equity common best track record. And then the other side of the equation is our opportunistic strategy, which looks a lot like PNNT, excluding the energy. As you know, PNNT, we have to call here, energy has been a challenge for PNNT.

But our credit ops business, which looks a lot like PNNT without the energy, with that focus, and that's the fund that we closed. And again, had a 29% net return in 2020 due to very minimal defaults and these equity call invests, which have been doing so well. So PennantPark, real large, two strategies, opportunistic and senior debt, and our BDC has kind

Speaker 2

of mimic that, although PNNT. Hoping to get

Speaker 1

a lot of energy at some point and move in strength going forward, and I think we're making good progress,

Speaker 2

and we'll talk about that later. Okay. Got it. That's helpful clarification on that private fund strategy and work ethics. Those are all

Speaker 1

my questions. I really appreciate the time today. Thank you.

Speaker 0

All right. We'll go ahead and take our next question from Mickey Schoen with Ladenburg. Mickey, please go ahead.

Speaker 3

Thank you. Good morning, Art and Lavie. Hope you're well. Art, I wanted to ask about a little bit of query on the pandemic. When we think about the pace of vaccinations and the virus' mutations, it certainly looks like the pandemic will go on longer than we had hoped.

And that will obviously continue to stress some companies and some industries like event planning where I see that you injected additional capital in one of your borrowers. My question is how significant do you think the need is to continue to inject capital in these sort of specific situations? And how willing are your private equity partners to write additional checks to support those borrowers and get them through to the other side?

Speaker 1

That's a great question. It's one we've grappled with with some of these companies. I mean, I think, first, all of these companies have done a really good job maintaining liquidity, and they're all in a very liquid position. And we feel good about their liquidity. However long this takes, You know, our underwriting case did not assume a bounce back, in the spring or the summer.

Our underwriting case assumes, you know, bounces back later later in 2021 and 2022. So, you know, we, you know, we weren't counting on any kind of bounce back in the spring or summer. And we may or may not have any bounce back in the spring or summer, but we we do not underwrite that way. And, and, and we've been counting on it, and we've made sure all these companies are are very liquid, which they are. So really good management teams.

These are, you know, what you would have called and which we do call big companies, which just happen to, you know, be hit by COVID. But really solid management teams and done the right the right things where the management team and the sponsors, and we feel they're as well positioned as they can be to deal with an elongated vaccination schedule, which we may be at.

Speaker 3

Thank you for that, Art. Looking at the portfolios in the fourth quarter and fourth calendar quarter were strong for middle market M and A, but I noticed that both PFLT's on balance sheet and the senior loan funds portfolio both shrank and fee income was up particularly high for the company. Could you just discuss the backdrop for that trend in terms of, you know, the market opportunity and your pipeline and, you know, were prepayments higher than you had expected? Just some background on that would be helpful.

Speaker 1

Yeah. It's a great question. And I think a lot of the repayments were earlier in the quarter, including Canna. We had a big position in Canna, which which got repaid and taken out of the public syndicated loan that was done by a large investment bank. And then we got really busy towards the back end of the quarter, but we had a bunch of deals closing between Christmas and New Year's.

And I do think, you know, seem to be very, very busy. So we think we're, you know, motoring along again, you know, in this core middle market, these deals are more handcrafted and more tailored. They take longer to negotiate. We think the package of risk adjusted return, including the co investors, is really attractive. In some cases, the better.

But it takes it takes a while to get the engines going again. Like I said, the engines are busy, and and I'm looking at a lot of deals. And, you know, we've learned the hard way. Sometimes you shouldn't rush it. You know, sometimes you shouldn't rush it.

We do believe that this vintage is a really great percentage for some really nice companies by and large, but we wanna be very thoughtful and methodical and careful about what we put in these portfolios. And and we will ramp in, you know, appropriate, judicious fashion we always have. And we've never had a problem ramping. I mean, if you look at our history in the news, either our BDC or our current funds, we've never had a problem ramping. It's a question of, you know, what exactly is the timing, how many quarters, and just making sure that the deals that we put in vehicles are really strong deals.

Speaker 3

Yes, I understand. Just a couple of more sort of housekeeping questions. Was the Marketplace Events restructuring the main driver of the realized loss? Or was there something else causing that result?

Speaker 1

Yes. Now that as well as MassHealth and Spark, the two you realize you the gains or losses when there's the losses, in this case, when there's a restructuring. When this restructuring is completed, you realize the loss.

Speaker 3

Okay. And lastly, administrative expenses continued to decline. Was that due to some sort of change in the agreement with the adviser? Or was it due to the relative size of PFLP to the overall platform or something else?

Speaker 1

The main driver is our growing private fund business. So when we do we have a finance and ops team and we have fixed G and A, and that gets allocated pro rata around our platform. So to the extent that our private fund business is growing, which it is, and if it returns, it will continue to grow. It really helps the BDCs and lowers the G and A.

Speaker 3

Okay. So it was a relative side. That's it for me. Thank you for your time. Take care.

Speaker 1

Thank you.

Speaker 0

All right. It appears there are no further questions. I'd like to turn the conference back to the speakers for any additional or closing remarks.

Speaker 1

Thanks, everybody, for your interest in PFLT. We look forward to speaking with you in early May as we review the March results. Thank you. Stay safe and healthy. Have a good day.

Speaker 0

This concludes today's call. Thank you for your participation. You may now disconnect.