PennantPark Investment - Earnings Call - Q1 2025
February 11, 2025
Executive Summary
- NII per share was $0.20, under-earning the $0.24 quarterly dividend by $0.04; GAAP NAV/share rose 0.1% to $7.57 as credit performance remained stable.
- Investment income was $34.2M, modestly lower year over year due to portfolio mix and yields; realized loss of $(2.6)M was offset by $5.7M net unrealized gains, driving $0.25 net increase in net assets per share.
- PSLF JV scaled rapidly to $1.3B (capacity expected to $1.6B) and delivered strong returns; credit facility upsized to $500M in Feb 2025, adding funding flexibility.
- Management reiterated a long-term leverage target of 1.25x–1.3x and indicated potential equity monetizations in 2025 to reduce equity exposure and enhance NII.
- Wall Street S&P Global consensus estimates were unavailable due to rate limits; beat/miss vs estimates cannot be assessed for this quarter [GetEstimates error].
What Went Well and What Went Wrong
What Went Well
- “We are pleased to announce another quarter of solid NAV and credit performance,” supported by strong PSLF JV returns and spillover income supporting dividends.
- Origination quality remained high: new loans carried weighted average debt-to-EBITDA of 4x, interest coverage 2.2x, and LTV 62%, with spreads stabilized at SOFR +500–550 bps in core middle market.
- JV momentum: portfolio reached ~$1.3B; ROIC of 18.4% over last 12 months; capacity expected to increase to ~$1.6B, enhancing forward earnings power.
What Went Wrong
- NII fell to $13.0M ($0.20/share) from $15.7M ($0.24/share) YoY, primarily on higher interest expense; realized losses of $(2.6)M, and full nonaccrual of Pragmatic Institute reduced NII by ~$0.012/share in the quarter.
- Investment income of $34.2M was flat-to-down YoY as dividend/other income shifted; weighted average yield on debt investments edged down to 12.0% vs 12.3% prior quarter.
- Ongoing equity overhang and under-earning the dividend: equity remains >20% of portfolio ex-JV; management aims to halve it over time but timing depends on M&A markets.
Transcript
Arthur H. Penn (Founder and Managing Partner)
Opportunities and invested $296 million in 12 new and 61 existing portfolio companies at a weighted average yield of 10.6%. 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 4x, the weighted average interest coverage was 2.2x, and the weighted average loan-to-value was 62%. As of December 31st, the portfolio's weighted average leverage ratio through our debt security was 4.9x, and the portfolio's weighted average interest coverage was 1.9x. These attractive credit statistics are a testament to our selectivity, conservative orientation, and our focus on the core middle market. In the core middle market, the market yield on first lien term loans appears to have stabilized in the SOFR plus 500-550 range.
As the credit statistics just highlighted indicate, we continue to believe that the current vintage of core middle market loans is excellent, and the core middle market leverage is lower, spreads are higher, and covenants are tighter than the upper middle market, and we are still getting meaningful covenant protections. Our JV portfolio continues to grow and be a significant contributor to our NII. At December 31st, the JV portfolio grew to $1.3 billion, and during the quarter, the JV invested $354 million, including $286 million of purchases from PNNT. Over the last 12 months, PNNT earned an 18.4% return on invested capital in the JV. The JV has the capacity to increase its portfolio to $1.6 billion, and we expect that with the continued growth in this portfolio, the JV investment will enhance PNNT's earnings momentum in future quarters. The credit quality of our investment portfolio remains strong.
We had two non-accruals as of December 31st, which represented 4.3% of the portfolio cost and 1.5% of market value. Now let me turn to the current market environment. We're 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 technology. These sectors have been recession resilient and tend to generate strong free cash flow.
In the core middle market, companies with 10-50 million of EBITDA are below the threshold and do 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 stats, meaningful covenants, substantial equity cushions to protect our capital, attractive spreads, and equity and co-investments. 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 a higher recovery rate than loans to companies with higher EBITDA. We believe that the meaningful covenant protections of the core middle market, where there's 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 co-investments have been excellent over time.
Overall, for our platform, from inception through December 31st, we've invested over $563 million in equity co-investments and have generated an IRR of 26% and a multiple on invested capital of two times. Since inception nearly 18 years ago, PNNT has invested $8.6 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 the investments of primarily subordinated debt that we 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 long-term preservation of capital.
We seek to find out 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 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.
Richard T. Allorto Jr. (CFO)
Thank you, Art. For the quarter ended December 31st, GAAP and core net investment income was $0.20 per share. For the quarter, NII was negatively impacted by $0.012 per share as a result of placing our investment in Pragmatic Institute on full non-accrual. Operating expenses for the quarter were as follows. Interest and credit facility expenses were $11.7 million. Base management and incentive fees were $7 million. General and administrative expenses were $1.75 million, and provision for excise taxes was $0.7 million. For the quarter ended December 31st, net realized and unrealized change on investments and debt, including provision for taxes, was a gain of $3.1 million. As of December 31st, our GAAP and adjusted NAV was $7.57 per share, which is up 0.1% from $7.56 per share in the prior quarter.
As of December 31st, our debt-to-equity ratio was 1.57x, 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 158 companies across 35 different industries. The weighted average yield on our debt investments was 12%. We had two non-accruals, which represent 4.3% of the portfolio at cost and 1.5% at market value. The portfolio is comprised of 50% first lien secured debt, 4% second lien secured debt, 11% subordinated notes to PSLF, 6% other subordinated debt, 6% equity in PSLF, and 23% other preferred and common equity. 94% of the debt portfolio is floating rate. Debt-to-EBITDA on the portfolio is 4.9x, and interest coverage is 1.9x. Now let me turn the call back to Art.
Arthur H. Penn (Founder and Managing Partner)
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.
Operator (participant)
And as a reminder, that is Star One. If you would like to ask a question, we'll now take our first question from Mark Hughes with Truist.
Mark Hughes (Analyst)
Yeah, thank you. Art, I'm just sort of curious. Any commentary about the level of capacity or competition in the core middle market? I think you described spreads as relatively stable, so that's one meaningful indicator. But I'm just curious whether you've seen more folks in the market pursuing these types of loans.
Arthur H. Penn (Founder and Managing Partner)
Good question, Mark. We have not. We have not seen new players. The larger players have not chosen to come down into this kind of space. We've seen them exit and go up market. So there's really just a handful of players that we view as kind of peers in this market. And frankly, there's not many of those peers who kind of have our game plan of being willing and able to finance a $10 million EBITDA company, for instance, and then have a game plan to finance the growth of that company up to 30, 40, 50 million of EBITDA. So we're one of the only couple of players, I think, that can kind of are willing, able, and would like to do that kind of growth financing.
In many cases, we'll make an initial loan to the platform, and we will structure a delayed draw term loan to fuel the growth of that company. So no new competitors of meaning. Spreads have kind of stabilized at 500-550 in general, and it's been a pretty good environment to be a lender.
Mark Hughes (Analyst)
How about your appetite or the companies or private equity, the appetite for the equity co-investments? Is that something you're pursuing more or less? Is that going to be a stable part of the investment portfolio?
Arthur H. Penn (Founder and Managing Partner)
Yeah. I don't think we do it more or less. They're each individual investment decisions. We first try to figure out if we can make a good and safe loan, and then separately, as a separate investment, we evaluate the equity co-invest. In those prototypical deals where we're fueling the growth and we're helping these companies and private equity sponsors grow, we think it makes a lot of sense to be participating in that upside to some extent that we're helping to create with our loans. So in many of those cases, we will ask for and receive some form of upside equity co-invest instrument to capture some of that growth.
And we think it makes a lot of sense as a portfolio matter because even though we're highly diversified and we're very selective and we try to keep leverage low, we like having something in our portfolio that's got a little bit of lift. And on those co-invest over time, as we've said, we've had a 26% IRR and two times MOIC. So that's helped to solidify NAV over time.
Mark Hughes (Analyst)
Yeah. And then when we think about net investment activity for PNNT, obviously the JV took down a lot of the investments. How do you think that'll trend in kind of the first half of the year? Would we expect PNNT to be a net investor, net positive investment activity?
Arthur H. Penn (Founder and Managing Partner)
At this point, PNNT is optimized. I still think we believe PNNT long-term should be leveraged in the 1.25-1.3x debt-to-equity range. So PNNT is a little bit higher than that right now, really just as a holding pen for assets that are going to end up in that growing joint venture. So long-term, we're still anticipating PNNT's leverage back down to that 1.25-1.3x zone, but a little bit more leverage than that for now temporarily as it holds assets that will ultimately end up in that joint venture.
Mark Hughes (Analyst)
Thank you.
Arthur H. Penn (Founder and Managing Partner)
Thank you.
Operator (participant)
We'll now take our next question from Robert Dodd with Raymond James.
Robert Dodd (Director)
Morning. How are you doing? On the spillover income question, I mean, you've got, to your point, in the PFLT $0.99, I mean, that's basically your dividend run rate, which means functionally you can't cut the dividend until that's worked down, not without paying corporate tax at least. So where would you like to work that spillover income down to in terms of how many quarters of dividend or a dollar number? Because to your point, it's going to take a long time at the rate it's getting eaten into. But just give us any color on what your target kind of level would be for that.
Arthur H. Penn (Founder and Managing Partner)
It's a great question. And part of it is, what's the market opportunity? Where's the yield in the market? What's our equity rotation looking like? At this point, we're kind of steady as she goes. We think we should be earning more than 20 on a core basis. As we said, 21-22, we should be. We're hoping that 2025 will give us an opportunity to rotate equity. And you see some of the names that have been marked up. We would hope we can turn some of those into cash. So I don't necessarily know that we have a target. We know that our shareholders like a steady, stable dividend stream, and we think we've got plenty of runway to do that under the current construct.
But we'll kind of grind through 2025, see where we end up, and continuously speak to our board about it and try to understand where the market is and how the overall platform is doing in terms of kind of getting rotation on the equity. And I don't really have an exact answer for you. It's kind of like we take it as it goes. This year, the game plan is clear for 2025. Steady as she goes, grind our way through it, try to rotate some equity, come up for air in a year. And we are committed to keeping the dividend where it is.
Robert Dodd (Director)
Got it. Got it. Thank you. Moving on to the other on Pragmatic, obviously, full non-accrual now. What are the prospects for a restructuring there, maybe some of that equitization and some of the debt or something like that where the remainder of the debt comes back onto accrual? I mean, is that a likely or potential outcome in the near medium term for that asset?
Arthur H. Penn (Founder and Managing Partner)
Yeah, it's a good question. And we're figuring out as we speak. Our current assumption is that during this quarter, the quarter ended March, there will be some form of restructuring there. Some debt will be converted, and there'll be a yield instrument coming out of that.
Robert Dodd (Director)
Got it. Got it. Thank you. And then just to kind of follow on from Mark's questions, in terms of the environment, I mean, you are very active. What areas do you and you've talked about some really attractive vintage, but I mean, are there areas in particular that you'd like to ramp up exposure more in the portfolio? Obviously, there's even within the JV as well, right? I mean, there's industry concentrations you're trying to manage and things like that. So I mean, are you seeing the right kind of industries in terms of being attractive also to manage your concentrations in that vehicle and directly on balance sheet as well?
Arthur H. Penn (Founder and Managing Partner)
Yeah. So as you know, we kind of respond to what's being shown us in the marketplace and where the middle market private equity community finds value. So certainly, we can de-emphasize certain areas, and we can emphasize others. Healthcare is the biggest portion of the economy. It's the biggest portion of our portfolio. And we try to, in healthcare, particularly with reimbursement risk, try to find areas that are on the right side of cost containment, try to find providers, service providers, and other types of companies that can provide healthcare at a lower cost and still maintain high quality. So that's something that's probably just a big part of the portfolio. I think our performance in healthcare has probably been better than some of our peers.
I think some of our peers have gotten caught in it, whether it's just not picking the right credits that are on the right side of cost containment or just having higher leverage. As you've heard, our incoming debt-to-EBITDA for new loans is under four times or four times exactly here in this vehicle. So when you structure deals with more reasonable leverage, you can deal with a curveball or two. So healthcare will remain. Government services, again, that's topical given what's going on with the government. We believe we're on the right side of financing companies that are driving cost containment for the government and are aligned with government payment. Again, we're responding to what our sponsors are showing us. And there's a whole proliferation of other types of industries, business services, consumer, and others that were shown.
But we can kind of dial things up or dial things down. For us, it always begins with, is it a steady, stable cash flow stream that is protected? Is anyone really going to care if this company goes away or not? And trying to keep leverage as low as we possibly can. And then, of course, alignment with the sponsors putting in a lot of equity beneath us.
Robert Dodd (Director)
Got it. Thank you. Appreciate it.
Arthur H. Penn (Founder and Managing Partner)
Thank you.
Operator (participant)
We'll now take our next question from Brian McKenna with Citizens JMP.
Brian McKenna (Director and Equity Research)
Great. Thanks. So just on the portfolio rotation opportunity, is there any way to think about the timing and magnitude of monetizing some of your equity investments and then redeploying this capital into loans? And I guess ultimately, where does the percent of equity investments within the portfolio settle in at longer term?
Arthur H. Penn (Founder and Managing Partner)
Yeah, so I'll try to deal with the last question first, which is, what are we targeting? We're certainly targeting less equity. Certainly, you can look at the equity book and see where there's been markups, and the goal would be that's kind of a leading indicator for where there might be some monetization opportunities, but in terms of the equity book, I mean, let's exclude the JV equity, which is about 6% of the portfolio, and that's just part of this JV that's generating a very healthy 18% return in cash, and there's over 20% in other equity. Some of it's co-invested. I think about half of it's kind of from co-invest where we've co-invested, and the other half is restructured equity where we converted debt to equity. Some of that, some of both of those has been marked up.
So we hope that 2025 is the year where we're going to see more M&A activity in this core middle market where we can monetize some of those names and convert that equity to cash and ultimately yield. Look, we'd like to get that 20% number down in half if we can. That's our goal. Try to cut that in half over time. We have not met that goal. It's taken us too long, to be honest with you. And some of it we kind of control, some of it we don't. But that's got to be our target, and that's what we're going to try to do.
Brian McKenna (Director and Equity Research)
Okay. Great. That's helpful and then, all right, I've mentioned this in the past, but assuming you are successful kind of rotating out of the equity and into loans and that kind of ratio looks similar and the percent looks similar to PFLT, I mean, do you ultimately maybe potentially look to merge the two so you have one publicly traded BDC. I'd just love to get your updated thoughts there.
Arthur H. Penn (Founder and Managing Partner)
Yeah. Look, there's nothing more updated than what we've talked, which is we've got a little bit of a cleanup scenario here. We've got to focus on it. Then we'll lift our head up and kind of look at the options. There's certainly arguments to do something and certainly arguments not to do something. All options are always on the table. There has been historically differentiated portfolio, difference in yields, difference in underlying portfolio. We got a little bit of a job to do first, and then we'll come up and try to assess what's best for shareholders.
Brian McKenna (Director and Equity Research)
Okay. Great. That's helpful. I'll leave it there.
Arthur H. Penn (Founder and Managing Partner)
Thank you.
Operator (participant)
We'll now move to Paul Johnson with KBW.
Paul Johnson (Equity Research Analyst)
Yeah. Good afternoon. Thanks for taking my questions. On some of those investments that were marked higher, I noticed By Light was marked higher again this quarter. That's a mark that's been moving up over the past few quarters. I mean, should we take that as an indication of interest that you might think the company's been receiving, or has that just been more of a result of just performance?
Arthur H. Penn (Founder and Managing Partner)
Yeah. Look, it's hard for me to. I can't comment on M&A and all that. I can comment that the company has performed well, and you've seen that in the markups, and most of these companies are owned by private equity firms who ultimately try to sell. Can't comment on a specific name, but the company's been performing well.
Paul Johnson (Equity Research Analyst)
Got it. Thanks, Art. And then last question was, I noticed that PNNT participated in the Marketplace Events loan that PennantPark reinvested with the company following the sale of the business. Just given that I don't believe PNNT participated in the previous investment, and it's just a slightly lower yield, I was just curious as to why PNNT participated this time.
Arthur H. Penn (Founder and Managing Partner)
I'm going to defer to Rick. I don't think that PNNT was involved in the marketplace. Rick, any color?
Richard T. Allorto Jr. (CFO)
You're correct in terms of the realization, but PNNT did participate in the new loan. And the thought there overall is, again, that that loan will ultimately live at the joint venture.
Arthur H. Penn (Founder and Managing Partner)
Oh, yes. The new loan, yes.
Richard T. Allorto Jr. (CFO)
That's the new.
Arthur H. Penn (Founder and Managing Partner)
Right, so there was a new buyer that came in and bought Marketplace Events. PFLT and a group of other lenders were the shareholders, and PFLT was the lead equity investor. A new private equity sponsor came in, bought the company at an attractive price, and as part of that, there was an attractive loan to be made in a company that we obviously knew very well, so we did buy that loan across the platform, PFLT, PNNT, and ultimately the joint venture as well will own a piece of that Marketplace Events loan.
Paul Johnson (Equity Research Analyst)
Got it. And when you made that loan, was that a loan that you chose to reinvest in the company, or was that a loan that was essentially carried over to enact the deal?
Arthur H. Penn (Founder and Managing Partner)
Yeah. It was a separate transaction. So the funds that were in the old Marketplace Events got cash. And then we evaluated where the new loan and a new equity co-invest would make sense. And then across the platform, PennantPark platform bought new senior debt and new equity co-invest in the new Marketplace Events where another sponsor came in and bought the company. And that's been allocated across the platform.
Richard T. Allorto Jr. (CFO)
Okay. Thank you, Art. That's all for me.
Arthur H. Penn (Founder and Managing Partner)
Thank you.
Operator (participant)
We'll now move to Mickey Schleien with Ladenburg.
Mickey Schleien (Managing Director and Equity Research)
Yeah. Art, just a couple of questions from me. What did you assume in terms of the fund's balance sheet leverage and equity rotation in your core NII guidance?
Arthur H. Penn (Founder and Managing Partner)
Core NII was actual NII. There's no, this is kind of actual for the quarter ended December 31st. In terms of the guidance going forward, oh, your question is about the guidance going forward. We just said that's kind of just assuming continued growth of the joint venture.
Mickey Schleien (Managing Director and Equity Research)
Okay. And the balance sheet leverage remaining where it is?
Arthur H. Penn (Founder and Managing Partner)
Yeah. Yes. And over time, kind of getting back down to 1.3 after we fill up that joint venture. We could work away that joint venture. We could do another joint venture. We hope to be able to get some equity realizations here in the next number of quarters, which will certainly be helpful.
Mickey Schleien (Managing Director and Equity Research)
For sure. And just a housekeeping question maybe for Rick. What were the main drivers of the realized loss and the unrealized gains?
Richard T. Allorto Jr. (CFO)
Sure. Let's see. The main drivers for the unrealized, there was a write-up in JF Intermediate and a write-up in Federal Advisory Partners. Those are the two larger write-ups. On the write-downs that netted that down, the equity investment in Cascade Environmental and additional write-down on Pragmatic were the two main large drivers on the write-down side. In terms of realized gain or, sorry, realized loss for PNNT, that was a restructuring for STG, also goes by Reception Purchaser. That was the main driver for the realized loss during the quarter.
Mickey Schleien (Managing Director and Equity Research)
I understand. That's it for me this afternoon. Thank you.
Arthur H. Penn (Founder and Managing Partner)
Thanks, Mickey.
Operator (participant)
We'll now move to Melissa Wedel with J.P. Morgan.
Melissa Wedel (VP and Equities Research)
Good afternoon. Thanks for taking my questions. Most of mine have been asked, but I thought I would follow up and clarify a couple of things. Firstly, on the growth of the JV, when we look at the dividend income to the BDC from that JV, it looks like that was pretty flat quarter over quarter, except that the portfolio assets at the JV had grown pretty decently even since September 30th. How should we think about the growth in the dividend to the BDC from PSLF and the cadence of that going forward?
Arthur H. Penn (Founder and Managing Partner)
Yeah. It's a great question, and the growth in the underlying JV portfolio should match what comes over to PNNT, but we don't book income unless it's actually distributed, so there's a bit of a reserve that we create at the joint venture, and there's no particular reason we're creating a reserve there other than just to have excess cash so that we have a bit of a reserve, but you would imagine, and it would certainly normalize over time where growth in the joint venture and growth in the investment in that joint venture will yield the dividends. Rick, I don't know if you have any particular explanation for why the phenomenon Melissa's talking about in this particular quarter.
Richard T. Allorto Jr. (CFO)
Yeah. Sure. Melissa, last quarter, the JV did distribute some of that reserve Art just mentioned. And I believe we detailed that out last quarter as kind of a core NII adjustment because that portion was, I'll say, less recurring. Additionally, we fund the JV through both debt and equity. So as we fund additional capital to fuel the growth of that JV portfolio, the economics back to us, a portion is in that debt instrument, so you just don't see it in that dividend line item on the income statement.
Melissa Wedel (VP and Equities Research)
Okay.
Arthur H. Penn (Founder and Managing Partner)
All right, so yeah, one way to look at it is comprehensively between the debt instrument and the equity instrument, right?
Melissa Wedel (VP and Equities Research)
Yes. And then just to clarify, I wasn't quite sure I fully followed your comments on the exposure to government services and defense companies. How much exposure is there in the portfolio to any potential sort of reimbursement risk, whether that's in the government segment and defense segment or even in the healthcare segment of the portfolio? Have you taken a more critical look at that?
Arthur H. Penn (Founder and Managing Partner)
Yeah. [Crosstalk] No, we're looking at it.
Melissa Wedel (VP and Equities Research)
Tariff exposure? Sorry. Same question for any tariff exposure as well.
Arthur H. Penn (Founder and Managing Partner)
Tariffs, yeah. Yeah. We have limited tariff exposure. Most of the companies that would be impacted by tariffs were not really involved in, and the ones that we are kind of had a dry run of tariff exposure during the last Trump administration. So the tariff exposure is very, very limited. Biggest part of the U.S. economy and biggest part of our portfolio is healthcare. So for sure, there is government reimbursement risk in healthcare. The way we comport ourselves in that is we try to focus on healthcare companies that are driving lower costs with reasonable quality. So if we're on the right side of that, which is lower cost, reasonable quality in any environment, we're likely to be okay. And then we layer on the fact that we keep leverage lower.
The average new loan is four times debt-to-EBITDA in this portfolio with at least 50% equity beneath us. So where some of our peers may have stumbled occasionally in healthcare, to date, we're relatively clean because of those two facts. So same applies on the government services and defense side. When you look at that portfolio, we're not doing tanks. We're not doing missiles. We are focused typically on service companies where you have individuals, people walking into offices and sitting behind computers doing things like cybersecurity, intelligence, maneuvering satellites, doing technology updates. Those, again, typically are what we would call on the right side of cost, on the right side of being very efficient with taxpayer dollars going into government contracting and defense. And then when you drill down one layer deeper in those companies, they typically get paid in two ways.
One is cost-plus, where they provide the cost and they create a margin above that. And on those companies, those companies by and large are making single-digit EBITDA margins. They're not making excess margins on cost-plus. If they were making excess margins on cost-plus, they would be more at risk. And then the other way companies get paid is through fixed price, where they take risk. They essentially go long providing a service for a fixed price, in which case the government's dishing the risk off to the provider. The provider's taking risk. In those cases, those companies could earn higher margins, and they could also earn lower margins depending on how they've priced their service relative to their cost. Again, if you look at that piece of that portfolio, we seem to have very good operators who are generating fair margins, not exorbitant, but fair margins.
And they're taking risk off the government, and they're going long a service. So we think we're relatively well-insulated, but every day is a new day, as you know. We don't know, but kind of we've comported ourselves in those two industries which have government exposure to be focused on the right side of cost containment and then add on the layer of keeping debt-to-EBITDA four times or below so that if there are curveballs, they could be dealt with appropriately.
Melissa Wedel (VP and Equities Research)
Art, I appreciate all the detail there. Actually, one final question for you. I take your point on hoping for some equity rotation in the coming quarters, as you said. It occurs to me, though, that you also have a pretty elevated balance in Treasuries. Is that something that could be a source of funds to deploy into something higher yielding until you get that equity rotation?
Arthur H. Penn (Founder and Managing Partner)
Yes.
Melissa Wedel (VP and Equities Research)
Thanks very much.
Arthur H. Penn (Founder and Managing Partner)
Yeah. Thank you. Good question. The Treasuries are balance sheet management that we do at quarter end typically. That's temporary to optimize our 30% bucket. We want to optimize our 30% bucket for the JV and for other 30%-type assets. So that is a technique we use to optimize that bucket.
Melissa Wedel (VP and Equities Research)
Thank you.
Operator (participant)
We'll now move to Casey Alexander with Compass Point.
Casey Alexander (Managing Director and Senior Equity Research)
Hi. Good afternoon. Art, I've got a few questions for you. First of all, we know that base rates have gone down 100 basis points, but there's a delay in the way in which they flow through your balance sheet. What percentage of that 100 basis points would you suggest has already flowed through?
Arthur H. Penn (Founder and Managing Partner)
Oh, that's a really good question. Rick, I'll defer to Rick. I don't know if you have an estimate, Rick, or off the cuff, or we can certainly get back to you, Casey, later on, but any sense?
Richard T. Allorto Jr. (CFO)
It isn't off the cuff. I would say the majority of the borrowers are electing three-month LIBOR contracts, so they are flowing through on kind of a three-month basis. Quarter ends, there's a higher volume, a higher number of borrowers that kind of roll their contracts towards the quarter end, but they do roll all throughout the period. Off the cuff, I would say it's in that 50%-75% is already in the numbers.
Casey Alexander (Managing Director and Senior Equity Research)
So you're halfway through flowing through to maybe three-quarters of the way flowing through?
Richard T. Allorto Jr. (CFO)
Correct.
Casey Alexander (Managing Director and Senior Equity Research)
That would be your guess.
Arthur H. Penn (Founder and Managing Partner)
Yeah. Right. And we also have liabilities, obviously, that are floating as well. So we have some fixed, and we have some floating liabilities. So there's some matching going on.
Casey Alexander (Managing Director and Senior Equity Research)
Yeah. I'm aware. I'm aware. Thanks. Based upon the amount that you shipped down to the JV this quarter, another quarter like that, and you're basically going to be at capacity, do you think that you'll be at or near that capacity by the end of the first calendar quarter?
Arthur H. Penn (Founder and Managing Partner)
I'd say for the next it probably takes us two to three quarters to get that JV more fully ramped and optimized. It gives us time to evaluate financing options. It gives us time to evaluate equity rotation options. And then once we're optimized, we're optimized, and we'll do everything we can to add value thereafter. But kind of we're expecting and hoping for some kind of equity rotation between now and then.
Casey Alexander (Managing Director and Senior Equity Research)
So we should be thinking about a little bit slower pace going down to the JV over the next couple of quarters if we compared it relative to this last quarter.
Arthur H. Penn (Founder and Managing Partner)
Yeah. Yeah. And then part of it is just the activity levels. We're seeing what I'll call normal quarterly flow. The December quarter was very busy, as you saw. The March quarter that we're in today is a little bit slower. That's a normal seasonal activity. We still think 2025 can be a very active year, but this quarter that we're in right now is a little bit slower.
Casey Alexander (Managing Director and Senior Equity Research)
Right. Okay. So let's have a conversation about the dividend distribution. I'm just curious, have you guys considered switching off to a year-end special distribution to clear up some of the spillover and right-sizing the dividend? Because it's pretty common knowledge that when you appear as though you're chronically under-earning your dividend, the market tends to impact your valuation in a negative way because you're doing that. And if you switch to a year-end special distribution, you could right-size the dividend relative to your current earnings power, and perhaps the market would treat your valuation better. Have you considered that as an option?
Arthur H. Penn (Founder and Managing Partner)
Casey, we're happy to consider it and happy to talk to you anytime you like about dividend policy and try to figure out the optimal way to get our stock trading even better. So we can talk about that and talk about different things and what our shareholders would prefer. I don't know. You have institutional shareholders. You have retail shareholders. What's the preference? What do people want? What's the reaction going to be? So we don't have to have the call here, have that discussion in front of the community, but we're always happy to talk about it and talk about it with our board as to what's going to help our stock trade better. And if there's other methodologies or other ways to do it, we are all ears.
Casey Alexander (Managing Director and Senior Equity Research)
I would be more than happy to have that conversation with you.
Arthur H. Penn (Founder and Managing Partner)
Great.
Casey Alexander (Managing Director and Senior Equity Research)
You mentioned that the JV, when it reaches its capacity, that you might enact another JV. Is there any technical limitations given that when this JV has completed its capacity, it's going to be larger than the on-balance sheet BDC itself? And so I'm just wondering if there's any practical limitations to how much you can take off balance sheet relative to the size of the on-balance sheet BDC itself.
Arthur H. Penn (Founder and Managing Partner)
Yeah. It's a great question. And certainly, there's a couple of limitations. A, it's part of the 30% bucket, right? So no more than 30% of our overall balance sheet at PNNT can be in one of these vehicles. And you're correct that the JV itself can get quite large, but PNNT's ownership of it can be a different number, right? PNNT is a little bit more than 50% owners of it. The JV can continue to grow, and PNNT can own less than 50%. I mean, there's some of our peers who have the BDC owning 10%, 12%, 15%, or 20% of a JV that can be very large with third-party investor capital. So the relevant thing is, what's the 30% bucket, and how much of that is in a JV-type structure? The JVs have been very accretive.
For us here, it's been generating 18%, which is accretive to PNNT. And when you think about it, kind of our investment management company is managing all these assets, and we're not charging our shareholders an incremental management fee for it. It's just showing up in the form of incremental ROE. So we think it has some benefits. It's been a good thing for PNNT, and we've seen it be a good thing for other BDCs. So we'll continue to look at it. We'll continue to look at our 30% bucket and continue to figure out if we can add value through using the JV mechanism to do so.
Casey Alexander (Managing Director and Senior Equity Research)
Lastly, have there been any notable credit events that have taken place in the portfolio since the end of the quarter?
Arthur H. Penn (Founder and Managing Partner)
There's a company called Zips Car Wash, which has filed a prepackaged bankruptcy. It's not particularly big in our portfolio here, but it is out there. It's public information. It's not that material. It was appropriately marked, we believe, as of 12/31 and is in the marks. If you were to flow through the potential income impact, it might be $0.005 a share.
Casey Alexander (Managing Director and Senior Equity Research)
That includes the amount of Zips that is located within the JV?
Arthur H. Penn (Founder and Managing Partner)
Yep. Yep. JV and on-balance sheet.
Casey Alexander (Managing Director and Senior Equity Research)
All right. Great. Thank you for taking my questions. I appreciate it.
Arthur H. Penn (Founder and Managing Partner)
Thank you.
Operator (participant)
We'll now take a follow-up from Robert Dodd with Raymond James.
Robert Dodd (Director)
Hi, guys. Yeah. Just a quick follow-up from Melissa's question, actually. I mean, there is a visible gap, to your point, in terms of stocking a reserve, so to speak. And there was an extra couple of million that paid out in June. So, I mean, is there going to be a true-up distribution from the JV? Kind of, is it going to be once a year, or is it going to be once in a while? I mean, should we expect an annual distribution from that vehicle that kind of captures that, or is it just a true-up whenever you and the partner decide it's appropriate?
Arthur H. Penn (Founder and Managing Partner)
More of the latter. Kind of, we try really to distribute the vast majority of NII out on a quarterly basis every so often because the credit performance has been good there. We just have a little bit of excess, and we'll distribute it when appropriate.
Robert Dodd (Director)
Got it. Thank you.
Operator (participant)
We'll now take a follow-up from Melissa Wedel with J.P. Morgan.
Melissa Wedel (VP and Equities Research)
Thanks. One more follow-up, actually, to Brian's question about whether PNNT and PFLT would ever make more sense in a combined vehicle. You mentioned that there's a little bit of cleanup work to do, and I just wanted to better understand what that means to you. Is that a function of non-accruals, equity exposure, something else? And I ask that because in the past, I know you've probably gotten that question a number of times over the years. In the past, you had referenced the multiple and the disparity between multiples on the two vehicles, and that seems to be less of an issue now. So appreciate any clarifying thoughts you have on that.
Arthur H. Penn (Founder and Managing Partner)
Yeah. And that could be it's all kind of maybe the same thing, Melissa, which is, I believe if we can get some reasonable equity rotation, which will de-risk the portfolio, de-risk the NII, that will be cleanup, right? That'll be the cleanup I'm referring to. And then we can take a look and evaluate different options.
Melissa Wedel (VP and Equities Research)
Thank you.
Operator (participant)
That does conclude today's question and answer session. I'd like to turn the conference back over to Mr. Penn for any additional or closing comments.
Arthur H. Penn (Founder and Managing Partner)
Just really want to thank everybody for their participation. I want to thank the research community for your excellent questions. It's good that there's engagement and some interest. And we look forward to speaking with you all again next in early May as we discuss the March numbers. Thank you very much. Have a good rest of the winter.
Operator (participant)
Once again, that does conclude today's conference. We thank you all for your participation. You may now disconnect.