PennantPark Floating Rate Capital (NYSE:PFLT) Q3 2019 Earnings Conference Call August 8, 2019 10:00 AM ET
Art Penn - Chairman and Chief Executive Officer
Aviv Efrat - Chief Financial Officer
Conference Call Participants
Michael Ramirez - SunTrust
Chris York - JMP Securities
Mickey Schleien - Ladenburg
Ray Cheesman - Anfield Capital
Good morning and welcome to the PennantPark Floating Rate Capital’s Third Fiscal Quarter 2019 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 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.
Thank you, and good morning, everyone. I'd like to welcome you to PennantPark Floating Rate Capital's third fiscal quarter 2019 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 PennantPark Floating Rate 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, Art Penn.
Thanks, Aviv. I'm going to spend a few minutes discussing financial highlights, followed by a discussion of the portfolio, investment activity, the financials, and then open it up for Q&A. For the quarter ended June 30, we invested $183 million in primarily first lien senior secured assets at an average yield of 9.3%. PennantPark Senior Secured Loan Fund or PSSL continued to perform well.
As of June 30, PSSL owned a $470 million diversified pool of 43 names, with an average yield of 7.9%. Credit quality has improved since last quarter. The number of non-accruals on our books today is two, down from four as of March 31. The two non-accruals represent only 1.4% of cost and 0.5% of the market value of the portfolio.
Over the last several years, we’ve substantially grown our platform by adding senior and mid-level investment professionals in regional offices, as well as New York. The additional people in offices combined with additional equity and debt capital we’ve raised, has significantly enhanced our deal flow. This puts us in a position to be both active and selective.
Net investment income was $0.29 per share. Due to our activity level and the maturation of PSSL, we are pleased that our current run rate net investment income covers our dividend. Our earnings stream should have a nice tailwind based on gradual increase in our debt to equity ratio, while still maintaining a prudent debt profile.
As of September 30, our spillover was $0.31 per share. With regard to the Small Business Credit Availability Act, a reminder that our board approved and modified the asset coverage that was included in the law, reducing asset coverage from 200% to 150% effective April 5, 2019.
Over time, we are targeting a debt to equity ratio 1.4 to 1.7 times. We will not reach this target overnight. We will continue to carefully invest and it may take us several quarters to reach the new target. Given the seniority of our assets, in the near-term we're actively considering utilizing CLO financing to help achieve the target.
A careful and prudent increase in leverage against a primarily first lien portfolio should lead to higher earnings. Our primary business of financing middle-market financial sponsors has remained robust. We have relationships with about 400 private equity sponsors across the country and elsewhere that we managed from our offices in New York, Los Angeles, Chicago, and Houston.
We’ve done business with about 180 sponsors to date. Due to the wide funnel of deal flow that we receive, relative to the size of our vehicles, we can be extremely selective with our investments. We remain primarily focused on long-term value, and making investments that will perform well over several years and can withstand changing business cycles.
Our focus continues to be on companies and structures that are more defensive, have low leverage, strong covenants and high returns. We continue to be a first call for middle market financial sponsors, management teams and intermediaries, the one consistent credible capital. As an independent provider free of conflicts or affiliations, we are a trusted financing partner for our clients.
As a result of our focus on high quality companies' seniority and the capital structure, floating rate assets and continuing diversification, our portfolio was constructed to withstand market and economic volatility. The cash interest coverage ratio, the amount by which EBITDA or cash flow exceeds cash interest expense continue to be healthy 2.8 times. This provides significant cushion to support stable investment income.
Additionally, at cost, the ratio of debt-to-EBITDA on the overall portfolio was 4.8 times, another indication of prudent risk. In our core market of companies with 15 million to 50 million of EBITDA, our capital is generally important to the borrowers and sponsors. We are still seeing attractive risk reward, and we are receiving covenants, which help protect our capital.
Credit quality has improved since last quarter. Today, we only have two non-accruals on the books, representing only 1.4% of the portfolio at cost, and 0.5% end market. As of June 30, we had three non-accruals, which represented about 2.3% of our overall portfolio cost and 0.8% at market. We are pleased with the progress we are making on this front.
Our credit quality since inception eight years ago has been excellent. Out of 357 companies in which we have invested since inception, we've experienced only nine non-accruals. Since inception, PFLT has made investments totaling about $3 billion at an average yield of 8.1%. This compares with an annualized loss ratio, including both realized and unrealized losses of only about 8 basis points annually.
With regard to the economy and credit cycle, at this point, our underlying portfolio indicates a strong U.S. economy and no sign of a recession. From an experience standpoint, we're one of the few middle market direct lenders who was 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, and at that time focused primarily on investing in subordinated and mezzanine debt. Prior to the onset of the global financial crisis in September 2008, we initiated investments, which ultimately aggregated $480 million, again primarily in subordinated debt.
During the recession, the weighted average EBITDA of those underlying portfolio companies, declined by 7.2% at the trough of the recession. This compares to the average EBITDA decline of the Bloomberg North American High Yield Index of 42%.
As a result, the IRR of those underlying investments was 8% even though they were made prior to the financial crisis and recession. We are proud of this downside case track record on primarily subordinated debt.
In terms of new investments, we’ve had another active quarter investing in attractive risk-adjusted returns. Our activity was driven by a mixture of M&A deals, growth financings, and re-financings. And virtually all these investments, we've known these particular companies for a while have studied the industries or have a strong relationship with the sponsor.
Let's walk through some of the highlights. We purchased 35 million of the first lien term-loan, 4.5 million of revolver, and 1 million of preferred and common equity of MeritDirect. The company is a provider of B2B database products. Mountaingate Capital is the sponsor.
We purchased 5 million of the first lien term loan and 1 million of the revolver of River Point Medical. The company is a future manufacturer for the veterinary, dental and sports medicine markets. Arlington Capital is the sponsor. Signature Systems, it is a designer manufacturer of ground protection products. We purchased 13 million of our first lien term loan, 1.7 million of our revolver and 1.2 million of preferred and common equity. Center Rock Capital is the sponsor.
We purchased 13.8 million of our first lien term loan and 2.6 million of the revolver of TWS Acquisition Corp. TWS is a for profit provider of plus secondary education focused on technical carriers and skill to trades. Halifax Group is the sponsor.
Turning to the outlook, we believe that the rest of 2019 will be active, due to both growth and M&A driven financings. Due to our strong sourcing network and client relationships, we're seeing active deal flow.
Let me now turn the call over to Aviv, our CFO to take us through the financial results.
Thank you, Art. For the quarter ended June 30, 2019, net investment income was $0.29 per share. Looking at some of the expense categories, management fees totaled about $4.9 million. General and administrative expenses totaled about $1 million. And interest expense totaled about $5.7 million.
During the quarter ended June 30, net unrealized appreciation among investments was about $12 million or $0.30 per share. Net realized losses was about $18 million or $0.47 per share. Net unrealized appreciation on our credit facility and notes was $0.01 per share. Net investment income exceeded the dividends by about $0.01 per share.
Consequently, NAV went from $13.24 to $13.07 per share. Our entire portfolio, our credit facility and notes are mark-to-market by our board of directors each quarter using the exit price provided by an independent valuation firms, exchanges or independent broker-dealer quotations when active markets are available under ASC 820 and 825.
In cases where broker-dealer quotes are inactive, we use independent valuation firms to value the investments. Our portfolio remains highly diversified with 93 companies across 36 different industries. 88% is invested in first lien senior secured debt, including 11% in PSSL, 3% in second lien debt, and 9% in equity, including 5% in PSSL. Our overall debt portfolio has a weighted average yield of 8.9%. 99% of the portfolio is floating rate.
Now, let me turn the call back to Art.
Thanks, Aviv. 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 to that goal.
We try to find less risky middle-market companies that have high free cash 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.
In closing, I 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 to questions.
Thank you. [Operator Instructions] We will take our first question from Michael Ramirez of SunTrust. Please go ahead. Your line open.
Hi, good morning, guys. Thanks for taking our questions.
Sorry. It seems that the growth in the PSSL has slowed, but the contribution to, I guess your NII has remained strong. Could you please get us a sense of where do you think you are with the JV, I guess prospects for continued growth and if you are at a steady state with the NII contribution or is there some other upside remaining?
It’s a great question Michael. We just had some repayments in PSSL. So, it’s a temporary slight reduction. Our goal is to continue to ramp it and upsize it over the coming quarter. So, again, hard to complain when you get repayments and we did. So, it’s temporarily a little lower than our expectation of how we expect to ramp it. And it is a – kind of we say it is a maturing portfolio because it is kind of almost fully ramped and it’s performing well and is generating a nice dividend for PFLT.
Okay, that’s helpful. Appreciate that. I guess maybe one other one here, I guess we’ve already seen some spread compression in the space. Is there any opportunity on liability side of the ledger to either reduce cost? In your prepared remarks, you mentioned CLO, can you maybe just dive a little bit deeper into how that would impact your P&L?
Yes. Look, you know, as we said, we’re actively considering CLO financing. The vast majority of that is floating. There are, you know, some pieces of CLO tranches that do get fixed. You know, we will assess as we do this fixed versus floating options along the way. Cost of capital is not going to be that dramatically different than our existing revolver, which is a very attractive and low-cost revolver, but it is a differentiated financing source, new set of debt investors for us, and is a very nice long-term financing.
You know CLO financing, you know, has a nice long term and longer than our credit facility. So, we’re actively assessing that option, and as we, you know, think about gradually and prudently increasing leverage of that, that could be a key element of doing that really doing CLO financing, contributing assets to that, and then fraying up the revolver to finance future growth.
Okay. That's really helpful. And I guess just on return on equity, you guys have done a nice job over the prior year improving that along with your strategy, and, you know, it seems like it has picked up quite a bit. Can you maybe detail spell out for us like any opportunity to enhance this going forward?
Yes. It’s really going to be through the gradual increase in leverage. Really obviously, the G&A costs are fixed, so as the portfolio growth, the G&A costs are relatively fixed, and actually G&A costs are coming down over time as we grow the rest of our platform, and as we get more and more efficient on the G&A side, so a combination of growth of the portfolio, G&A gradually working down and then the leverage gradually working up, you know, we hope to, you know, have the very nice ROE.
Okay, perfect. And one last housekeeping one, in your prepared remarks you had spoke about the non-accruals, compared to your companies since inception, can you just update us on the recovery rate? I believe last quarter you had said it was $0.98 per dollar.
Yes. It’s now down into the 80s as of the last mark-to-market. Of course, some of these, you know, we end up getting equity pieces, which we hope will have value, but it’s not as high as it was due to this last – you know these last couple of non-accruals. We’re hopeful that we’re going to get some good recoveries. We also look at it on a – what’s the annualized basis points per year, lost, realized and unrealized, and as we said, it's only about 8 basis points realized and unrealized since inception now. You know over eight years ago; you know on our $3 billion or so of capital. So, you know, that’s kind of another way that we look at it. That includes both realized and unrealized.
Okay, great. Thanks for taking our questions.
We will now take our next question from Chris York of JMP Securities. Please go ahead, your line is open.
Good morning, guys, and thanks for taking my questions. Art, could you help us understand what drove the increase in the weighted average debt-to-EBITDA ratio, and then, the decline in the debt service coverage ratios in the quarter?
You know, we think this is temporary. It's just, you know, some of the – the underperforming deals dragged it up a little bit and as we work through that I think we’re going to end up back into the mid-4s debt-to-EBITDA. If look at the new originations that we've been putting on, they’re kind of between 4 times and 4.5 times debt-to-EDBITDA, but we think that’s going to end up, you know, coming down a little bit over time and kind of to a more normalized mid-4s kind of range.
Very helpful. So, it's more a product of underperformers then new originations?
That’s right. The new originations as I said were doing, you know highly selective. Right now, as we should and we’re getting really good lucks. I mean we’re getting some nice looks and some of the deal I highlighted in the comments are from newer relationships that have come out of some of the regional offices that we've opened in Chicago, and Texas, and on the West Coast, as well as some senior folks we’ve hired here in New York.
So, we’re getting more and more looks from – the investment we made in our team, you know, about four years ago, into some very senior people and that allows us to be highly selective. So, the new deals that are coming on are kind of in the mid-4s on a blended basis, very nice equity cushions in this market. You know, we’re trying to be very, very, disciplined. So, we think [4.8] is a temporary phenomenon, and then, over time it’s going to get back down into the mid-4s.
Okay. And then, just maybe a little bit more detail there, you talked a little bit about the equity cushion. Are LTVs maybe 50%? Or, you know, where are you seeing LTVs today?
Yes. You know it’s – you know I think – the higher end of the LTV range is kind of 65%-ish these days where we’re seeing a 35% equity cushion. Sometimes we’re looking at deals where it's a 70% in equity cushion and we’re evaluating one later this afternoon, where, you know, it's a 75% equity cushion. So, I take 50, you know, if I had to kind of pick a – you know at average.
You know middle of the [indiscernible] that might be hit in this market. So, you know so there's a lots of equity coming underneath us by in large now, you know, that's comforting on one hand, and then, we see this play out when sponsors pull a lot of equity, and if there's a problem, they are, in many cases, more likely to add to that equity to solve the problem. But, you know, we have to be prudent underwriters and careful and skeptical, and sometimes just because there’s 50% or 70% equity beneath us, it doesn't necessarily mean it’s a money good loan.
So, we have to be very clear either these companies, you know, in the long run may or may not be worth what the sponsors are paying them and we need to be careful about where we are in the capital structure and our way to good spot to recover capital.
Makes a lot of sense in that color. I appreciate it. And then, could you just remind us what your loss assumptions are on maybe a yearly basis, and then, like a peak severity basis?
These are great questions. You know the – you know people would say that in the market you're going to the market for first lien loans as you’re going to have a 2% default rate and an 80% recovery rate. That's what the market is. We think we’re going to do better than that. We’re obviously, since inception, you know, eight years ago, which does not include the financial crisis. We could talk what we did in financial crisis at PNNT. You know we’ve had an 8 basis points annualized loss.
PNNT on sub-debt has had a 30 basis points or so annualized loss ratio, and that’s on a portfolio that over time yielded 12%, you know, including the global financial crisis. So – I mean that gives you some sense of our historical track record on both senior debt, sub-debt. You know, there are [track record] now over 12 years as an institution. You know, but we – you know past performance is never a guarantee of future performance as they say, so we have to remain very vigilant and focused right now.
Okay. So, I mean – yes, so I know you quote 8% realized and unrealized loss rate, and then, that kind of compares to the market expectation of a 160 basis points, so I was just curious in kind of how you guys were thinking about this for your models going forward, so just to re-examine that. The color is very helpful. I just wanted to revisit it with you. That's it from me. So, thanks for taking my questions.
We will take our next question from Mickey Schleien of Ladenburg. Please go ahead, your line is open.
Good morning, Art. It’s always entertaining to hear how people pronounce my name. Regardless, I have a couple of questions. I haven't had a chance, frankly, to thoroughly scrub the Q, it looks like New Trident was one of the main drivers of your realized and unrealized gains and losses, what were the other drivers?
New Trident was certainly, you know, a big driver. The other ones were [Hollander], which remains a problem, that was one of the non-accruals; and Country Fresh, which got restructured into our quarter. Those were the negative drivers. A positive driver was By Light equity co-invest, [indiscernible] nicely, and I do want to, you know, we tend to on these calls focus as we should on the non-accruals, but we do have some very nice co-invest like By Light, DecoPac, Cano Health and Walker Edison, which, you know, have been performing well, which, you know, the theme here of course is we are going to make mistakes from time to time; we are going to have non-accruals; and these equity co-invest investments are meant to have some upside that could, you know, in part or in full, you know, fill some of those gaps. So, New Trident certainly was a negative outcome for sure.
Art, do you have any visibility on monetizing some of those equity co-invests this year?
Yes. We’ll see. It's hard to say, but you can – you know, look, you can rest assure that when a private-equity sponsor has a nice gain, the wheels are turning in terms of right now [is that] in the next six months, in the next 18 months who knows, but the wheels are turning.
Fair enough. One more question, I know it’s not a large position for you, but another BDC exchange, its Unitech cumulative prefers for [pick preferred] and they booked a large pick dividend income, which as we know, can cause stress on cash flow. I noticed you didn't do that and I think it would be interesting to understand your thoughts about a situation like that. Does it relate to your, you know, overall portfolio management process?
Yes, certainly, So, yes, we’ve chosen not to do it because, you know, you are looking to underlying performance of the company and say, do they have enough earnings and profits to support that income, and we decided the answer is no. So, we stayed as is; we did not to convert. I know some of the peers did convert. We think it might be aggressive, but for us, we stayed as a regular – you know, regular equity position, which does not accrue income. You know, at the end of the day, you need to look at the facts and circumstances. It might be – the underlying company does declare dividends, and then, it’s great to book that income that they declared, but you also need to look do they have enough earnings to support that dividend.
And so BDCs, you know, this is what makes the market. Sometimes you’ll see, you know, different BDCs on a mark-to-market basis, mark different assets to market, but these are judgment calls and, you know, our judgment on Unitech was not convert it to in a picking instrument at this point in time.
I understand. So, the cumulative dividends are booked to fair value, right, of the investment over time and eventually you’ll realize that, is that correct?
That is correct. So, we do obviously compute what is the cumulative preferred, but we market in the mark-to-market, which you should see growing, but not in income.
Okay, that's really helpful. That’s it for me. I very much appreciate your time. Thank you.
We will take our next question from Ray Cheesman of Anfield Capital. Please go ahead, your line is open.
I believe on the last call you mentioned activity from the sponsor up at Montreign, the casino in the Catskills, and with the announcement over the last few days about the sponsor possibly taking out the minority shareholders, I’m wondering how does that all flows through to your holding in it and the value you assign to that holding?
So, it’s a great question. It’s very topical, Ray, thank you. Montreign is – the equity there is controlled by an entrepreneur, and KT Lim, is well-known in the gaming sector. He controls Genting, which is a large gaming company. Montreign is owned in a public company called the New York-New York, NYNY is the ticker. KT Lim has made an announcement that he wants to take NYNY private. He already owns 80% plus of it. At the enterprise value that he's proposed to take the company private; it values the equity around $300 million. That $300 million of equity of course is junior to $500 million of debt.
Montreign – we own a piece of the Montreign debt, which, you know, today is marked in the mid-80s or so. We still think this is par. Obviously, if the entrepreneur behind it is valuing the equity of $300 million beneath the debt, we think the debt is par, the entrepreneur is indicating that he thinks the debt is par, you know, we’ll see. You know, we think we have a fairly full position right now in PFLT, so we’re not going to add any more debt, but for all those of you in the market who want to buy what we think is very attractive piece of paper, that is broker dealer quoted in the mid-80s, Montreign first lien debt is and we think it's going to end up being a par piece of paper.
Thanks, and that’s a very positive story.
Thank you, Ray.
I would now like to turn the call back over to Art for any final remarks.
I want to thank everybody for being on the call today, and their interest in PFLT, and we look forward to speaking to you next in November. Reminder that November is our 10-K, which means our call will be slightly later than it normally is after quarter and because it takes a little while to get – a while longer to get the 10-K done versus 10-Q, so kind of mind-November time frame for our next conference call. Thank you very much and have a great end of August everybody.
This concludes today’s call. Thank you for your participation. You may now disconnect.