PennantPark Floating Rate Capital (PFLT) CEO Art Penn on Q4 2020 Results - Earnings Call Transcript
PennantPark Floating Rate Capital (NASDAQ:PFLT) Q4 2020 Earnings Conference Call November 19, 2020 10:00 AM ET
Company Participants
Art Penn - Chairman and Chief Executive Officer
Aviv Efrat - Chief Financial Officer and Treasurer
Conference Call Participants
Paul Johnson - KBW
Mickey Schleien - Ladenburg
Devin Ryan - JMP Securities
Operator
Good morning and welcome to the PennantPark Floating Rate Capital Fourth Quarter 2020 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.
Art Penn
Thank you, and good morning, everyone. I'd like to welcome you to PennantPark Floating Rate Capital's Fourth Fiscal Quarter 2020 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.
Aviv Efrat
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 www.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.
Art Penn
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 September 30. How the portfolio is positioned for the upcoming quarters, our capital structure and liquidity, the financials. Then open it up for Q&A.
Despite the challenging economic conditions brought on by the pandemic, we are pleased with our performance this past quarter. We achieved a 3.2% increase in adjusted NAV as our portfolio continued to improve during the quarter. We have several portfolio companies in which we have substantial equity positions who are benefiting from the K shaped recovery. This is solidifying and bolstering NAV. Over time rotation of debt equity into debt instruments should help grow PFLT's income. We will highlight those companies in a few minutes. Additionally, we've been pleased with the stable performance of our long-term securitization CLO financing through COVID. Debt financing has continued to perform well and is well matched to finance our senior debt positions, which we believe are among the lowest risk in the industry.
As a result, we are exploring using the same type of financing to grow and efficiently finance PSSL JV, which should generate additional income for PFLT. The combination of potential income growth from equity rotation, and the larger more efficiently financed PSSL should help grow PFLT's net investment income relative to dividend over time. Those factors combined with strong portfolio performance through COVID and $0.22 spillover had 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-19 crisis, we practically positioned the portfolio as defensively as possible. Since inception, we've had a portfolio that was among the lowest risk in the direct lending industry.
As of September 30, average debt to EBITDA in the portfolio was 4.2x and average interest coverage ratio, the amount by which cash interest exceed cash interest expense was 2.9x. This provides significant cushion to support stable investment income. These statistics are among the most conservative in our industry. We have only three non-accruals out of 105 different names and PFLT and PSSL. This represents only 2.1% of the portfolio at cost, and 1.8% at market value. We've largely avoided some of the sectors that have been hurt the most by the pandemic, such as retail, restaurant, health clubs, apparel and airlines. PFLT also has no exposure to oil and gas. The portfolio is highly diversified with 102 companies in 44 different industries.
Our credit quality since inception over nine years ago has been excellent. Out of 382 companies, and which we have invested since inception, we've only experienced 12 non-accruals. Since inception PFLT has invested over $3.7 billion at an average yield of 8.1%. This compares to an annualized realized loss ratio of only 10 basis points annually. And if we include both realized and unrealized losses, the annualized loss ratio is only 19 basis points annually.
We are one of the few middle market direct lenders who were 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, the 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 down 42%. We are proud of this downside case track record in the prior recession. Based on tracking EBITDA for our underlying companies through COVID so far, we believe that our EBITDA decline will be substantially less than it was during the global financial crisis.
Now let's turn to the outlook ahead in the coming quarters and how our portfolio is positioned. As mentioned previously, we are gratified that our historical investment focus has protected us from some of the worst hit areas of the economy, such as retail, restaurants, health clubs, apparel, airlines and energy. We've been pleased with the way our portfolio companies have moved to rapidly adjust cost, and it focused on shoring up liquidity. Looking forward to the quarter ended December 30 and beyond where things stand today, our analysis suggests that the vast majority of the companies in our portfolio are in a strong position to perform well in the company quarters. Many of our portfolio companies are in businesses such as government services, health care, software, communications and cybersecurity, which collectively comprise a substantial portion of our portfolio and are less impacted by COVID.
Additionally, alongside the debt investments we make in many companies, we invest in the equity, usually as a co-investor with the financial sponsor. Our returns on these equity call investments have been excellent over time. Overall, for our platform from inception through September 30, our $209 million of equity co-invest have generated an IRR of 25.3% and the multiple on invested capital of 2.3x. We believe that we are experiencing a K-shape recovery with some companies and industries being large beneficiaries of the environment. We are pleased that we have attractive debt and significant equity investments in three of these companies, which can substantially move the needle on both NAV and over time net investment income. I would like to highlight those three companies. The three companies are Cano, Walker Edison, and By Light.
Cano Health is a national leader in primary healthcare who is leading the way in transforming healthcare to provide high quality care at a reasonable cost to a large population. Our equity position has a cost and fair market value on September 30 of $766,000 and $2.3 million respectively. Cano has been experiencing rapid growth, with revenues quintupling and EBITDA more than tripling over the last three years. We believe there is a massive market opportunity for Cano to grow in the years ahead with a Medicare Advantage program. Based on the recently announced transaction with Jaws Acquisition and where Jaws is trading, that position would be valued at approximately $9 million. About 12% of that value is in cash, and then we will receive before and at consummation of the deal in early 2021. And the rest is in shares of Jaws Acquisition.
Our shares are locked up in a limited partnership controlled by the financial sponsor, and will likely be valued by the independent valuation firm at a discount to the traded value. 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 4x. Our position has a cost of $1.4 million and the fair market value of $8.7 million as of September 30.
By Light is a leading software, hardware and engineering solutions company focused on national security challenges across modeling and simulation, cyber and global defense networks. Since our initial investment was made nearly four years ago, sales have gone up 1.5x, and EBITDA has more than doubled. Our position has cost of $2.2 million and a fair market value of $7.6 million as of September 30. All three of these companies are gaining 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 would expect to exit these positions and rotate those proceeds into debt instruments to increase income at PFLT.
As we discussed earlier, our securitization financing has performed well during COVID. We think this type of financing is well matched to our lower risk assets. As a result, we are exploring using the same type of financing at PSSL to help grow and efficiently finance the vehicle. We would hope that doing so would increase NII of PFLT. With regard to our gaming portfolio, is proving to be extremely resilient and continues to perform well. With the repayment of Peninsula Pacific, Colonial Downs since quarter end, our gaming exposure is now 4.2% of our portfolio, down from 5.1% as of September 30. We exited Peninsula Pacific, Colonial Downs with an 11% IRR. Our regional properties such as Fantasy Springs and Kentucky Downs have experienced strong performance since reopening, after periods of closure due to COVID.
We expect the strong performance to continue. The outlook for new financings is attractive. We believe that middle market lending is a vintage business. This upcoming vintage loans is likely to be the most attractive we've seen since the 2009 to 2012 time period. Leverage levels are lower, equity cushion is higher, yields are higher, and the packages of protections including covenants are tighter. After enduring about five years of late cycle market for middle market lending, it's refreshing to have an attractive risk reward available to us.
Let me now turn the call over to Aviv, our CFO to take you through the financial results in more detail.
Aviv Efrat
Thank you, Art. For the quarter ended September 30, net investment income was $0.27 per share. Looking at some of the expense categories, management fees totaled about $4.8 million. Taxes and general and administrative expenses totaled about $1.1 million and interest expense totaled about $5.5 million. During the quarter ended September 30, net unrealized appreciation on investments; we had about $20 million or $0.51 per share. Net realized losses were about $4.7 million or $0.12 per share.
Net unrealized depreciation on our credit facility and notes was $0.22 per share. Net investment income was lower than the dividend by $0.02 per share. Consequently, GAAP NAV went from $12.16 to $12.31 per share. Adjusted NAV excluding the mark-to-market of our liabilities was $11.81 per share up to 3.2% from $11.44 cents per share last quarter. Our entire portfolio, our credit facility and notes are mark-to-market by our Board of Directors each quarter using the exit price divided by any independent valuation firm 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 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 1.4x down from 1.5x last quarter, while GAAP mix debt-to-equity after subtracting cash was 1.2x down from 1.3x last quarter. Regulatory debt-to-equity ratio was 1.5x down from 1.6x last quarter. And our regulatory net debt-to-equity ratio after subtracting cash was 1.4x down from 1.5x last quarter.
With regard to our leverage, we have been targeting a debt-to-equity ratio of 1.4x to 1.7x. Our net of cash regulatory assets coverage ratio of 1.4x was at the low end of our range this past quarter. This was primarily due to pay down from borrowers, selected asset sales and an increase in the mark-to-market of our portfolio. We have ample of liquidity to fund revolver draws and we're in compliance with all of our facilities as of September 30. We have readily available borrowing capacity and cash liquidity to support our commitments. We're looking to carefully manage our leverage over time. We expect to stay in compliance with both regulatory requirements and covenants under our credit facilities. We have a strong capital structure with diversified funding sources and no near-term maturities.
We have $520 million revolving credit facility maturing in 2023, with a syndicate of 11 banks with $309 million drawn as of September 30. $139 million of unsecured senior notes maturing in 2023 and $228 million of asset backed debt associated with PennantPark CLO 1 due 2031. We have been in consistent dialogue with our lenders and are thankful for their support. Our portfolio remains highly diversified, with 102 companies across 44 different industries. 89% invested in first lien senior secured debt, including 11% in PSSL, 40% in second lien debt, and 8% in equity, including 4% in PSSL.
Our overall debt portfolio has a weighted average yield of 7.3%. 99% of the portfolio is floating rate, and 86% of the portfolio has a LIBOR floor. The average LIBOR floor is 1%.
Now, let me turn the call back to Art.
Art Penn
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 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.
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 my remarks. At this time, I would like to open up the call to questions.
Question-and-Answer Session
Operator
[Operator Instructions]
We take our first question from Paul Johnson at KBW.
PaulJohnson
Hey, good morning, guys. Thanks for taking my questions. Congratulations on the Cano Health acquisition. It's obviously very positive news yesterday. But I just kind of I have few question here today. And over the last few quarters no investments have obviously been fairly new investments originations have been fairly muted, understandably so. I'm just kind of curious so now you're back sort of within the leverage range target? What is sort of your outlook for new investments going forward? Can we expect to see maybe more active origination and then also on that, for any sort of new investments that you are looking at today? What is the environment that you're seeing? Are you still able to extract the same sort of covenants that you were -- in terms that you were before? Has that diminished? But, yes, any commentary on that would be very helpful.
Art Penn
Perfect, thanks. Thanks, Paul. Yes, look, we -- for last couple quarters, we've been evaluating the economy and our portfolio, and we are indeed back actively originating deals for both PFLT and PSSL, we also are getting repayments, of course, as part of that so the wheels of commerce are starting to move again. And we're out there actively looking and doing deals. So target leverage is still kind of in that 1.5x zone debt-to-equity as we say, we think our portfolio is among the lowest risk in the industry. You could see it in the yields kind of our first lien typically is a lower yielding first lien, maybe more of a classic first lien and then some of the others, which means we believe that we can comfortably be in that 1.5x levered zone and feel very safe and feel like it's prudently capitalized and judicious in terms of the debt-to-equity ratio, because the risk we're taking is lower than most and is lower than the industry.
In terms of kind of the risk reward we're seeing, again, remember another definitional thing. We tend to focus on companies with between 15 and 50 EBITDA average, EBITDA of $20 million to $30 million in this portfolio, we like staying away from the fray of the broadly syndicated loan market, which has bounced back very dramatically, where it's all covenant lie where yields are low, or EBITDA adjustments are back and where leverage is high. And some of our bigger brethren who have to write bigger checks and the bigger companies are up competing against the broadly syndicated loan market and accepting lower covenants, lower yields, more EBITDA adjustments and et cetera with us. We always got covenants, even pre-COVID. We're getting tighter covenants now. We're getting fewer EBITDA adjustments, the adjustments, if we accept them are thoroughly diligence, we're seeing more equity from our sponsors, we're seeing more yield.
So the whole package of risk adjusted return that we're seeing today versus pre-COVID is better, and much better, which is why we say we like this vintage. We think this vintage of next year two or three, where we play in the middle market, is we think it's -- it could be similar to 2009 to 2012. I don't think it's going to be as good as 2009, where the average debt-to-EBITDA was 3.3x, our Central Bank and the fiscal authorities reassured that we weren't going to repeat that 2009 again, but we think that this upcoming vintage will look a lot like 2009 to 2012. So we're excited about what we're seeing and we are active.
PaulJohnson
That's good, that's very good to hear. Do you ever see a time where obviously, you guys have built a very high quality, more conservative like you said, traditional first lien portfolio, but in that environment that you sort of described, do you see any opportunity or do you have any thoughts around potentially getting slightly more aggressive to enhance sort of the portfolio yield or top line return? And talking about potentially doing maybe slightly more aggressive deals? Or more second lien? Do you have any thoughts on that?
Art Penn
Yes, look, I think we're going to stay away from second lien in this portfolio. And I think we're going to be cautious about stretch your senior for us, as you could see PFLT itself, we would prefer to have a lower risk, low reward portfolio, and maybe have the leverage a little bit higher, 1x and 1.5x in some of our brethren. So, I think that's the way we think about, every once in a while, of course, we will, if we think we have a real angle, the real edge, or special situation we may do a little bit more to [attract] senior from time to time or unitranche. But I think we're going to specifically stay away from second lien as in this particular portfolio.
PaulJohnson
Okay. And then on the JV, I think quarter-over-quarter, I think you guys have been taking the leverage down actually for the past few quarters in this inside of JV, I noticed that the return this quarter, at least what was paid out to the BDC was relatively stable from last quarter, maybe up slightly. Is that kind of the return that we can expect going forward in terms of where the leverage is at on the JV and what return? It's splitting out? Or do you guys have any other plans as far as the JV goes?
Art Penn
Yes, so and I highlighted this, try to highlight this in the script. So let me be clear, we again, same thing with PFLT, the last x number of quarters, we've been waiting to see how the economy did, wanted to see how our portfolio did. And one of the nice things out of all this is that our securitization, CLO financing in PFLT has been terrific. It's been a great way to finance these lower risk assets. And we're going to explore with PSSL using the same type of financing. And we're going to explore growing PSSL; from where it is today about $400 million to something like $550 million, maybe $600 million with a total portfolio utilizing the securitization style financing that works so well for us over PFLT. So in terms of NII growth at PFLT itself, and PSSL we will hope that growing the portfolio, and using securitization financing can be a big part of that.
PaulJohnson
Got you. And then, finally, I'm just actually very curious as far, I don't know, if you have any commentary around the stock market, obviously, that's becoming very popular this year, it's grown significantly. Do you see that as a potential meaningful driver of more middle market acquisitions such as Cano Health? Or this more of being, I guess, in the middle market may be not as highly prized than an acquisition for like a spec company. But, yes, any sort of thoughts you have on that acquisition? And as it could potentially be a driver of further exits in the portfolio?
Art Penn
Yes. Look, I mean, I think, like our view is the stock market is it's really just another form of an IPO. And the stocks and IPOs that do well they were to go well anyway, or the specs for IPOs, that wouldn't have done well, wouldn't have done so in the case of Cano, it's been such a high growth business and the addressable market for what they do is so enormous, that an IPO of some sort made a lot of sense for the company, because of its growth trajectory, and it's -- the white space that that it has out there. So there's also a comparable out there that Oak Street Health, which is a great company, trades in an $11 billion to $12 billion market cap. And if you line up Cano against Oak Street, and you look at revenues, EBITDA, members, medical loss ratio Cano lined up very favorably to Oak Street Health, which is a terrific company.
So it's quite possible that Cano could over time trade in line even better than Oak Street Health. So to us that makes, we we're not experts in IPOs. You guys may be more experts, but it seems like it's an attractive deal from the get go. But as importantly, or maybe more importantly, there's not -- there's a lot of runway on the upside for Cano; both in this market as well as where it trades versus as comps.
PaulJohnson
Great. And actually, one more if I may, I think I may have mentioned this in your prepared remarks, but I didn't possibly catch it. Do you know the percentage of your portfolio that has LIBOR floor?
Art Penn
Yes, it was in our prepared remarks. It is you want; it's 86% of LIBOR floor, 86%.
Aviv Efrat
That is correct. That's one of the prepared remarks. Yes. LIBOR floor is 1% but about 86, yes.
Operator
We take our next question from Mickey Schleien of Ladenburg.
Mickey Schleien
Good morning Art and Aviv. I just wanted to follow up quickly on the senior loan fund, a calculated blended ROI taking into account the equity and the debt investments of little north of 9%. Are you satisfied with that level of return? Or are you looking for something higher than that with more leverage on that balance sheet?
Art Penn
Hey, it's a great question, Mickey, obviously, over the last few quarters, we've specifically wanted, again, to see our portfolio did, see how the economy went, which is why we are looking to grow PSSL back up again to larger entity and using the securitization financing potentially to finance that. So I think over time, we're going to target 11%, 12% on that vehicle.
Mickey Schleien
That's a blended sort of ROI.
Art Penn
Finding on the, yes, obviously piece of paper, yes.
Mickey Schleien
Okay. And, Art could you be a little more specific about the advantages of the securitization versus the credit facility in that fun? Because I'm no expert like you guys. But I'm curious, what are the features that attracted to that?
Art Penn
It's just very efficient, it's low cost. And it's kind of permanent financing, it's not permanent, but it's long-term financing. And there's a box and there's no individuals you need to talk to, there's no credit guys, you may have a sleepless night or two, and it's just the box. And if we're comfortable in our underwriting, which we are, where we like that box for what we're doing in this portfolio, the lower risk, low reward deals as we looked at kind of the amount of triple C's that we got through this time period with very little very well, I think, if you looked at the equity return on that -- granted the CLO in this case, the equities run by PFLT, I think we had something like a 20% return on the equity, because this transcend the underwriting and the underlying box.
Mickey Schleien
That's a very solid number relative to what I'm seeing elsewhere.
Art Penn
Yes, the Triple C basket kinds of you have up to 17.5% in middle market. I think we're like 8% something like that. So it's for us, because our underwriting works, it's a very good box.
Mickey Schleien
So are the bucket paraphrases and are you suggesting that it's just perhaps an easier piece of capital to manage from your perspective?
Art Penn
Well, that's part of an overall mix as we look up at PSSL, and we'd love to grow PSSL, it could be part of the overall mix of PSSL and PFLT along with credit facilities, and along with bonds occasionally. So we believe in diversified financing tools, we're just saying kind of here we are kind of eight or nine months into COVID. And we did our CLO over PFLT, I guess, last September, and then COVID hit in March. It's performed very, very well. So we're taking that as a data points. And that's really interesting for us; maybe we should use that technology over PSSL.
Mickey Schleien
Understand. And just in terms of the mechanics, I haven't done the math, but I imagine most of the senior loan funds, assets are in the borrowing base for the credit facility, right? So how do you extract those assets? And form the CLO and what is the timing of all of that?
Art Penn
Yes, that's a great question. We're starting to explore now, don't have a firm answer. But obviously the banks who are involved in PSSL are our partners, and we're going to be talking to them about partnering on kind of growing PSSL including the securitization, including a new revised credit facility. So all this is in play, and it's something over the next quarter or two, we're going to hopefully finalize.
Mickey Schleien
Okay, so it sounds like it's sort of mid next year sort of timing to put it all together.
Art Penn
I'm hoping earlier, but that's fine for your expectations and assume mid next year, maybe we have a shot at being better.
Mickey Schleien
And just a couple of sort of more housekeeping questions. Your cash on your balance sheet is built up? Is that to make the principal payment on the CLO notes are due next month?
Art Penn
We have an amortization payment on the Israeli bonds and they are coming up in the next month. So that's what --
Mickey Schleien
Perfect CLO, okay, so that will be paid on cash.
Art Penn
Yes.
Mickey Schleien
Okay. And if I'm not mistaken, last quarter, you said average EBITDA on the portfolio was 35 to 40. And I think you just said 20 to 30 this quarter maybe my previous numbers wrong, but where's the ballpark for the portfolios out there?
Art Penn
We are working, Mickey, we're doing that piece now. The mean is what I gave you last quarter in that 35 to 40. The median is more like 25.
Operator
We'll take our next question from Devin Ryan at JMP Securities.
Devin Ryan
Great. Few of our questions were asked but maybe just ask one here on non-accrual and credit. I am just curious how you guys think about the broader portfolio to the extent we have another shutdown here. COVID related disruption and also to just read in some context on the first lien loans to marketplace advance and I know, a little bit of pressure there in the quarter, and just whether there's been any dialogue with the sponsor and whether they may be adding more support.
Art Penn
Yes, so thank you. Thank you, David, and nice to meet you. I look forward to spending time with you as you take on the BDC and so welcome into the industry. So marketplace event is finalizing its restructuring as we speak. So hopefully, by next quarter, I'm pretty sure by next quarter, that restructuring will be done and that will move off to [Montco]. And that particular name, the lenders are going to be taking control of the company injecting capital to be able to get the company through to the other side. When against inevitably start coming back. Certainly it's about as clear as much today as the one event start coming back. But events will come back and we think that's a really great company in space and more. We're actually happy to make that equity investment in marketplace events. PRA is an event planning company, again, events related. That is in restructuring talks right now as we speak.
Again, that probably comes off non-accrual next quarter looks like the sponsors injecting equity in that one to help that company. So those are -- that's two of the three non-accruals. Both of them are kind of in the event space. In terms of outlook, it's we think it's going to be relatively light, of course, there's going to be non- accruals from time to time that it hit this portfolio. But we don't think there's anything particularly abnormal. We think that the COVID impacts to the extent there were had been identified as I had been or are being dealt with, and or kind of already baked into the pie here.
Operator
It appears there are no further questions at this time. Mr. Penn, I would like to turn the call back to you for any additional or closing remarks.
Art Penn
Just want to thank everybody for being on the call today. We appreciate it. And we will because we had a late reporting period this quarter. And suddenly only a relatively short time until early February when we have our next quarter's number. So looking forward to speaking everybody then. Thank you very much.
Operator
This concludes today's call. Thank you for your participation. You may now disconnect.
