PennantPark Floating Rate Capital Ltd. (NYSE:PFLT) Q2 2024 Earnings Call Transcript May 9, 2024
PennantPark Floating Rate Capital Ltd. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good morning and welcome to the PennantPark Floating Rate Capital’s Second 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 question-and-answer session following the speakers’ remarks. [Operator Instructions] It is now my pleasure to turn the call over to Mr. Art Penn, Chairman and Chief Executive Officer of PennantPark Floating Rate Capital. Mr. Penn, you may begin your conference.
Arthur Penn: Thank you and good morning, everyone. I’d like to welcome you to PennantPark Floating Rate Capital’s second fiscal quarter 2024 earnings conference call. I’m joined today by Rick Allorto, our Chief Financial Officer. Rick, please start off by disclosing some general conference call information and include a discussion about forward-looking statements.
Richard Allorto: 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 PennantPark Floating Rate Capital 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 those 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, Art Penn.
Arthur Penn: Thanks Rick. We’re going to spend a few minutes discussing current market — the current market environment for middle market lending, how we fared in the quarter ended March 31st, how the portfolio is positioned for the upcoming quarters, a detailed review of the financials, and then open it up for Q&A. For the quarter ended March 31st, GAAP and core net investment income was $0.31 per share. GAAP and adjusted NAV increased 1.8% to $11.40 per share from $11.20 per share. The increase in NAV for the quarter was due primarily to positive valuation adjustments on both debt and equity investments. As of March 31st, our portfolio grew to $1.5 billion or up 16% from the prior quarter. During the quarter, we continue to originate attractive investment opportunities and invested $338 million in 11 new and 48 existing portfolio companies at a weighted average yield of 11.6%.
For the investments in new portfolio companies, the weighted average debt-to-EBITDA was 4.2 times, the weighted average interest coverage was 2.1 times, and the weighted average loan to value was 42%. On average, we have seen a 50 basis point tightening on first lien spreads over the last six months. However, 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 and upfront OID are higher, 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. As of March 31st, our debt-to-equity ratio was 1.2:1. With a target ratio of 1.5:1, we believe that we are well-positioned to drive additional growth in net investment income going forward.
Securitization financing continues to be a good match for our lower-risk first lien assets. During the quarter, PFLT closed a $351 million term debt securitization transaction with a weighted average spread of 2.79%, a four-year reinvestment period and a 12-year final maturity. The AAA portion of the structure priced at a weighted average spread of 2.3%. The ratio of external debt to PFLT’s junior capital was 4.5:1, which creates plenty of liquidity for the company. The proceeds were used to repay a portion of our senior secured revolving facility, which will be available to reborrow and invest in new originations as we continue to grow the PFLT portfolio. We expect additional growth in NII in part driven by our investment in the joint venture.
As of March 31st, the JV portfolio totaled $870 million and together with our JV partner, we continue to execute on the plan to grow the JV portfolio to approximately $1 billion of assets. During the quarter, the JV invested $80 million in six new and four existing portfolio companies had a weighted average yield of 11.6%, including $77 million of assets purchased from PFLT. We believe that the increase in scale of the JV’s balance sheet will continue to drive an attractive mid-teens return on invested capital and enhance PFLT’s earnings momentum. Credit quality of the portfolio has remained strong. We added one new investment to non-accrual status and removed one investment. Non-accruals represent only 0.4% of the portfolio at cost and 0.3% at market value.
For the quarter ended March 31st, PIK income remained low at only 1.7% of total investment income, which we believe is among the lowest in the BDC sector. As of March 31st, the portfolio’s weighted average leverage ratio through our debt security was 4.4 times, and the portfolio’s weighted average interest coverage was 2.2 times. We believe that this is one of the most conservatively structured portfolios in the direct lending industry and is a testament to our focus on the core middle market. We like being positioned for capital preservation as a senior secured first lien lender focused on 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. We know the right questions to ask and have an excellent track record. They are business services, consumer, government services and defense, health care, and software and technology. These sectors have also been resilient and tend to generate strong free cash flow. Approximately 19% of our portfolio is in government services and defense, which is a sector with strong tailwinds in this geopolitical environment. In our software vertical, we don’t have any exposure to ARR loans. In the core middle market, which we define as companies with $10 million to $50 million of EBITDA, that is below the threshold and does not compete with a 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 structured transactions with sensible credit statistics, meaningful covenants, substantial equity cushions to protect our capital, attractive spreads, attractive upfront OID, and equity co-investment. Additionally, from a monitoring perspective, we received 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 had 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 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 core middle market loans, more careful diligence, and tighter monitoring have been an important part of this differentiated performance. Our credit quality since inception over 13 years ago has been excellent. PFLT has invested $5.9 billion and 492 companies, and we have experienced only 18 non-accruals. Since inception, PFLT’s loss ratio on invested capital is only 12 basis points annually.
As a provider of strategic capital that fuels the growth of our portfolio companies, in many cases, we participate in the upside of the company by making an equity co-investment. Our returns on these equity co-investments have been excellent over time. Overall, for our platform from inception through March 31st, we have invested over $469 million in equity co-investments and have generated an IRR of 26% and a multiple on invested capital of 2.1 times. Our experienced and talented team and our wide origination funnel is producing active deal flow. Our continued focus remains on capital preservation in being patient investors. Our mission and goal are a steady, stable and protected dividend stream, coupled with the preservation of capital. Everything we do is aligned to that goal.
We seek to find investment opportunities in growing middle market companies that have high free cash flow conversion. We capture that free cash flow primarily in first lien senior secured 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 in more detail.
Richard Allorto: Thank you, Art. For the quarter ended March 31st, GAAP and core net investment income was $0.31 per share. Operating expenses for the quarter were as follows; interest and expenses on debt were $14.7 million; base management and performance-based incentive fees were $8.2 million; general and administrative expenses were $1.8 million; and provision for taxes were $0.5 million. For the quarter ended March 31st, net realized and unrealized change on investments, including provision for taxes, was a gain of $12 million or $0.20 per share. As of March 31st, our GAAP NAV was $11.40, which is up 1.8% from $11.20 per share last quarter. Adjusted NAV, excluding the mark-to-market of our liabilities was $11.40 per share, up 1.8% and from $11.20 per share last quarter.
As of March 31st, our debt-to-equity ratio was 1.2 times, and our capital structure is diversified across multiple funding sources including both secured and unsecured debt. As of March 31st, our key portfolio statistics were as follows; our portfolio remains highly diversified with 146 companies across 44 different industries. The weighted average yield on our debt investments was 12.3% and approximately 100% of the debt portfolio is floating rate. PIK income equaled only 1.7% of total investment income. We had one non-accrual, which represents 0.4% of the portfolio at cost and 0.3% at market value. The portfolio is comprised of 87% first lien senior secured debt, less than 1% in second lien and subordinated debt, 6% in equity of PSSL, and 7% in other equity.
Debt to EBITDA on the portfolio is 4.4 times and interest coverage was 2.2 times. Now, let me turn the call back to Art. .
Arthur Penn: Thanks Rick. In closing, I’d like to thank our dedicated and talented team of professionals for their continued commitment to PFLT and its shareholders. 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 to questions.
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