Palmer Square Capital BDC Inc. (NYSE:PSBD) Q2 2024 Earnings Call Transcript

Palmer Square Capital BDC Inc. (NYSE:PSBD) Q2 2024 Earnings Call Transcript August 11, 2024

Operator: Welcome to today’s Palmer Square Capital’s BDC Second Quarter 2024 Earnings Call. [Operator Instructions] And as a reminder, this conference call is being recorded. At this time, I would like to turn the call over to Andrew Wedderburn-Maxwell, Investor Relations. Andrew, you may begin.

Andrew Wedderburn-Maxwell: Welcome to Palmer Square Capital BDC’s second quarter 2024 earnings call. Joining me this afternoon are Chris Long, Chairman and Chief Executive Officer; Angie Long, Chief Investment Officer; Matt Bloomfield, President; and Jeff Fox, Chief Financial Officer and Director. Palmer Square Capital BDC second quarter 2024 financial results were released earlier today and can be accessed on Palmer Square’s Investor Relations website at palmersquarebdc.com. We have also arranged for a replay of today’s event that can be accessed on our website for the next 6 months. During this call, I want to remind you that the forward-looking statements we make are based on current expectations. The statements on this call that are not purely historical are forward-looking statements.

These forward-looking statements are not a guarantee of future performance and are subject to uncertainties and other factors that could cause actual results to differ materially from those expressed in the forward-looking statement, including and without limitation, market conditions caused by uncertainty surrounding interest rates, changing economic conditions and other factors we identified in our filings with the SEC. Although, we believe that the assumptions on which these forward-looking statements are based on are reasonable. Any of those assumptions can prove to be inaccurate. And as a result, the forward-looking statements based on those assumptions can be incorrect. You should not place undue reliance on these forward-looking statements.

The forward-looking statements made during this call are made as of the date hereof and Palmer Square Capital BDC assumes no obligation to update the forward-looking statement unless required by law. To obtain copies of SEC related filings, please visit our website at palmersquarebdc.com. With that, I will now turn the call over to Chris Long.

Chris Long: Good afternoon, everyone. Thank you for joining us today for Palmer Square Capital BDC’s second quarter 2024 conference call. Today, I will begin by providing an overview of the quarterly highlights, then turn the call to the team to discuss our market outlook, portfolio and financial performance. I am pleased to report another quarter of strong earnings results, driven by solid credit performance and continued portfolio expansion. During the second quarter, our team deployed $189 million of capital and generated total and net investment income of $36.5 million and $15.8 million marking 33% and 11% year-over-year growth respectively. We delivered net investment income of $0.48 per share and paid a $0.47 per share second quarter total dividend, including a $0.05 supplemental distribution.

As a reminder, PSBD is the only publicly traded BDC that discloses monthly NAV to the investment community, providing real-time visibility into the health and value of the portfolio. In line with our commitment to industry leading transparency, we recently announced our June 30 NAV per share of $16.85. Our operating results for the second quarter demonstrate PSBD’s focus for 2024 to deliver shareholder value, while maintaining the exceptional credit quality of the portfolio that we established before entering the public market. At the core of Palmer Square Capital BDC is our opportunistic credit investment strategy, which allows our team to invest and react swiftly across market cycles and volatile periods, maximizing upside while minimizing downside scenarios.

Our opportunistic credit investment strategy, which invests across liquid and private markets, is a key differentiator that we believe will separate PSBD from other managers due to most being limited to liquid assets, which maybe a headwind as idiosyncratic credit issues arise and as opportunities to buy high-quality loans at a discount present themselves. The trend of tighter spreads and low dispersion that emerged at the end of last year has accelerated into the first half of 2024. It is important to remember that in a tight spread and low dispersion environment, we are rewarded for avoiding losing investments versus trying to time the market and pick winners. Our conservative positioning and prudent relative value framework leave us well prepared to capitalize on opportunities when they inevitably arrive.

Palmer Square Capital Management, which just celebrated its 15th anniversary, was purposely constructed to deliver superior relative value opportunities across corporate and structured credit. Notably, Palmer Square has established its reputation in the global corporate and structured credit market as the top ranked CLO issuer by deal volume. Year-to-date, Palmer Square issued approximately $7.7 billion in CLOs, including nine new issue CLOs, four reset CLOs and one refinanced CLO. As of July 31, 2024 has been a banner year for the CLO market, with $243 billion issued in the U.S. and $41 billion issued in Europe. For comparison, this year-to-date, figures already exceed the yearly total amount issued in each year since 2021. In May, PSBD, along with Bank of America as a ranging partner, closed its inaugural $400 million CLO.

This is the first CLO transaction to be issued out of PSBD, and it provides an attractive form of term based financing to accelerate our strong growth trajectory. The CLO has a reinvestment period through 2029 and does not mature until 2037 with additional flexibility to refinance its spreads continue to tighten in the future. We remain confident that Palmer Square Capital BDC is well positioned for upside in this current dynamic operating environment, and we are excited to demonstrate the true power of PSBDs liquid strategy to the investment community over the years to come. I will now hand the call over to Angie to discuss our outlook for the year.

Angie Long: Thank you, Chris. The U.S. economy has slowed modestly off the highs. The labor market has recently begun showing signs of fatigue and post the recent Federal Reserve meeting, a lot of these factors have led to a few days of macro and interest rate volatility. It’s hard to predict where markets will go from here. There’s certainly been a big move in equities, albeit off all time highs, meaningful volatility in Japan, around yen and carry trades and large moves in treasuries. So far, we’re not seeing much movement in credit companies are still on the market, borrowing, loan creation has for the most part, continued, although opportunistic repricing transactions are not getting done. The benefit of our more liquid and opportunistic strategy is that we can move around positions.

We’re not beholden to the liquid ones. We’ve been positioned toward higher quality as of late. As credit spreads have been tightening this year, up until this past week. Perhaps this will cause new issue loan terms and spreads to improve, or at least stabilize, as we’ve really been in a borrower friendly environment the past several quarters, times of volatility tend to instill a bit more discipline in the market, and we’re hopeful we’ll be seeing those signs. Bank loans performed well in the second quarter, despite some moderate pressure in June, returning 1.7% during the quarter and bringing the year-to-date return up to 4.1% both of which compare very favorably to other areas of corporate credit. By way of comparison, PSBD returned approximately 7.5% year-to-date through July, since our IPO.

Loans continue to offer attractive current income with base rates still above 5% and spreads at attractive levels despite the repricings and refinancings that dominate the market in the second quarter. It’s possible the recent move in rates might reverse retail demand that has seen such strong inflows in the first half of this year, but that could provide interesting opportunities for PSBD. Importantly, borrower level fundamentals have remained strong over the last few quarters. We remain keenly focused on issuer credit quality and selecting issuers in the defensive sectors with the ability to maintain adequate credit quality. Although, fundamentals look healthy at the market level, there remains an elevated number of stressed issuers on the lower end of the credit spectrum.

Given the high level of yield and current income provided by higher quality issuers, we don’t feel compelled to reach for incremental yield from lower quality issuers. This is especially true following the significant amount of repricing activity that occurred during the quarter. Some of which we use to exit positions but no longer offered yields can measure it with their risks. In markets where spreads tighten and capital markets activity picks up, we believe it’s critical to maintain discipline and avoid the traps that can come with those types of environments. The primary market remains very active and is currently on track to reach all time high for gross issuance. However, new money transactions have been somewhat limited, which has created a favorable environment for issuers and requires investors to maintain discipline when participating in primary market transactions.

On the positive side, the accommodating primary market has helped to meaningfully reduce the loan maturity wall through 2026 which is now down over 55% since the end of 2022. Our objective for the remainder of 2024 is to maintain the strong credit quality of the portfolio. We do not plan to add meaningful risk, especially at these levels, and will continue to look for opportunities in the primary market and in the secondary market, when opportunities present themselves. These recent macro trends could make for a compelling entry point for investors in the public market. We believe the PSBD portfolio offers competitive yield with meaningful risk mitigation compared to the majority of the middle market, BDC landscape. With that, I’d like to hand the call over to Matt, who will discuss our portfolio and investment activity.

Matt Bloomfield: Thank you, Angie. Turning to our portfolio and investment activity for the second quarter, our total investment portfolio as of June 30, 2024 had a fair value of approximately $1.43 billion across 39 industries that demonstrate both strong credit quality and a diverse mix of core service offerings. This compares to a fair value of $1.39 billion at the end of the first quarter of 2024 reflecting sequential growth of approximately 3%. In the second quarter, we invested $189 million of capital, which included 24 new investment commitments at an average value of approximately $5.6 million. During the same period, we realized approximately $140 million through repayments and sales. This speed of deployment can be attributed to PSBDs differentiation in the marketplace.

Our strategy focuses on large companies with stable recurring revenue streams, while underweighting cyclical industries. As a reminder, our team is organized by industry, which is intentional, due to our core belief that trends come by sector and not credit ratings. Because of this deliberate strategy, we have a large pool of accessible loans that have been proactively evaluated by our Investment Committee, and the liquid nature of our portfolio allows us to deploy capital with extraordinary efficiency rather than waiting to source and originate new deals. We believe our ability to execute with speed, while remaining disciplined and mitigating risk offers our shareholders meaningful upside compared to the broader direct lending universe. Looking back at the second quarter, I wanted to highlight key portfolio statistics, which underscore our belief that PSBD represents one of the most compelling investment opportunities in the sector.

As of June 30, PSBD shares offered an annualized dividend yield based on NAV of 11.2% on a portfolio focused on first lien, predominantly floating rate, liquid loans. In our opinion, this provides investors access to a flexible investment strategy with more upside through NAV appreciation and total return. At the end of the second quarter, our weighted average total yield to maturity of debt and income producing securities at fair value was 9.8% and our weighted average total yield to maturity of debt and income producing securities at amortized cost was 8.8%. Our investors benefit from our highly diverse portfolio high-quality sectors and borrowers based on industry, our largest portfolio exposure at the end of the second quarter of 2024 included software, healthcare, professional services and insurance, which is mostly brokerage or services, not balance sheet risk, all industries that we believe offer highly stable and growing income profiles.

Furthermore, the 10 largest investments only account for 11.2% of the overall portfolio. We believe these factors point to industry leading diversification, which will continue to drive strong credit performance across market cycles. Our portfolio is 96% Senior Secured with an average hold size of approximately $6 million. On a fair value weighted basis, our first lien borrowers have a weighted average EBITDA of $451 million Senior Secured leverage of 5.3x and interest coverage of 2.1x. We believe these metrics compare favorably with the best-in-class portfolios trading at a premium in the public markets. As mentioned on last quarter’s call, we had one loan to non-accrual status in April, converged one and subsequently worked through the restructuring of the businesses’ capital structure before quarter end.

As part of the process, we reinstated a lower quantum of debt and also took an equity possession in the company, which we believe gives them an appropriate capital structure to return to growth. This process resulted in booking a realized loss on the previous loan, which was reflected in this quarter. In addition, we had several positions that were marked above par given their strong underlying performance and wider spreads, and several of those companies prepaid portions of their debt at par during June, thus leading to a reversal of those unrealized gains. However, we view that as a good problem, given the strong performance of those loans and outsized income generated relative to the risk profiles. This dynamic, coupled with some price depreciation on a portion of the portfolio in June comprised the movement in NAV, when adjusted for the dividend payment.

Finally, we would highlight that our PIK income as a percentage of overall net investment income remains very low relative to the industry at approximately 0.5%. The overwhelming majority of this PIK income is to companies with strong underlying performance, but that have used the strength of the market to afford themselves the opportunity to pick a certain portion of their interest expense at their discretion. Our focus on liquid loans to larger companies with strong fundamentals, senior in the capital structure continues to produce attractive risk adjusted returns. This is represented by an average internal rating of 3.7 on a fair value weighted basis for all loan investments, all debt and short-term investments were income producing, and there were no loans on non-accrual status as of June 30, 2024.

As a reminder, we have a unique relative value based scoring system that allows our team to ascertain where we believe the best relative value resides and reflect that in the portfolio. It’s a dynamic system that is updated quarterly, but given the size of the markets we participate in, the scores are updated in real time when warranted. Now, I would like to turn the call over to Jeff, who will review our second quarter 2024 financial results.

Jeff Fox: Thank you, Matt. We were very pleased with our second quarter results. Total investment income was $36.5 million for the second quarter of 2024, up 33% from $27.4 million for the prior year period. The increase was primarily driven by the growth in our portfolio, as well as interest income from our investments. Total net expenses for the second quarter were $20.8 million compared to $13.2 million in the prior year period. The increase in expenses compared to the prior year was driven by the higher interest expense in line with our portfolio expansion, as well as the implementation of our management incentive fee at the time of the IPO. Net investment income for the second quarter of 2024 was $15.8 million or $0.48 per share, compared to $14.2 million or $0.56 per share for the comparable period last year.

During the second quarter of 2024, the company had total net realized and unrealized losses of $10.4 million compared to net realized and unrealized gains of $9.7 million in the second quarter of 2023. For the first three months ended June 30, 2024, this consisted of net unrealized depreciation of $8.1 million related to existing portfolio investments and net unrealized appreciation of $7.1 million related to exited portfolio investments, a portion of which has been reclassified to realized losses. At the end of the second quarter, NAV per share was $16.85 compared to $17.16 at the end of the first quarter of 2024. As a reminder, the June NAV also reflects the payment of a $0.47 quarterly distribution comprised of a base dividend of $0.42 and a supplemental dividend of $0.05 per share.

Moving to our balance sheet as of June 30, 2024, total assets were $1.5 billion and total net assets were $549 million. At the end of Q2, our debt-to-equity ratio was 1.49x, compared with 1.42x at the end of Q1. Available liquidity consisting of cash and undrawn capacity on our credit facilities was approximately $192 million this compares to $30 million of undrawn investment commitments. As a reminder, our Board of Directors approved a stock repurchase purchase plan to acquire up to $20 million of PSBD common stock. The program expires on January 17, 2025. In the second quarter, we repurchased 21,352 shares at an average price of $16.22 for a total purchase cost of $346,000. On August 8th, the Board of Directors declared a third quarter 2024 base dividend of $0.42 per share, in line with our formalized dividend policy.

Given the liquid nature of the portfolio, we plan to announce the supplemental dividend in September, which allows for repayments to settle. The supplemental distribution will be paid out to the excess of PSBD quarterly undistributed net investment income above the base quarterly distribution. With that, I would like to open the call up for questions.

Operator: [Operator Instructions] And it looks like our first question today comes from the line of Kenneth Lee with RBC Capital Markets. Kenneth, please go ahead.

Q&A Session

Kenneth Lee: Hey. Good afternoon and thanks for taking my question. In terms of the investments you sold within the portfolio in the quarter, and I think you briefly mentioned that they were not meeting the risk adjusted returns, or at least you didn’t find them attractive. Wonder if you could just talk a little bit more about the thought process, what exactly triggered the sales, and then realize that your investment strategy allows you to be more nimble. So, just want to get a little bit more of an explanation on that. Thanks.

Matt Bloomfield: Hey. Thanks again. This is Matt, yes. So, I would say the vast majority of that was in situations where refinancings were coming to market or re-pricings. And as we mentioned in the prepared remarks, there was a fair amount of spread tightening in the quarter. And so some of those loans, while we might have liked, from a credit standpoint, just from an overall yield standpoint, just didn’t really, kind of meet the hurdles of what we are trying to achieve in the BDC. In a couple of other cases, loans were able to fully refinance into new 7-year term loans. And just from a risk reward or concerns about longer term, business fundamentals in those situations, we chose to just take our par payoff and, move along. So, it was a mix, but I would say the overall preponderance was just from the – from some of the spread tightening and the refinancing, because it just didn’t make sense to stay involved in the BDC.

Kenneth Lee: Got it. Very helpful there. And just one follow-up if I may, wonder if you could just share your latest thoughts around the relative attractiveness between the primary and secondary broadly syndicated loan markets right now at this point. Thanks.

Matt Bloomfield: Yes, you bet. I mean I think what we have done in second quarter from a new investment standpoint, the vast majority of those were, new transactions, or refinancing transactions for existing borrowers. Nearly all of those, quite frankly, versus on your pure new bars to our portfolio, I think that’s still a function of, while the capital markets have been, I would say, vastly more open than they have been for the past couple of years. The preponderance of those transactions has been refinancings for the most part. I would say, new issue, M&A volumes have picked up incrementally, over the past couple of quarters. But I still don’t think they are, really to the – to the amount of volume that we would have expected, a couple of quarters ago, quite frankly.

From conversations with the private equity sponsors and a lot of their capital markets groups, it does seem like just really in the past month or so, conversations are heating up. There is a lot more of, kind of early look transactions going on. So, I think we are cautiously optimistic that the back half of the year we will actually see some new, new borrowers to the market, but it’s still been slower than we would have anticipated.

Kenneth Lee: Got it. Very helpful there. Thanks again.

Operator: Alright. Thanks Ken. [Operator Instructions] And our next question comes from the line of Doug Harter with UBS. Doug, please go ahead.

Doug Harter: Thanks and good afternoon. I was hoping you could talk about how you are seeing the relative attractiveness of kind of more liquid markets where you participate versus kind of direct lending?

Chris Long: Yes. Hi Doug. Thanks for the question. I would say both, quite frankly, have been pretty interesting for us over the past couple of quarters. Certainly, the syndicated market has been more active than we have seen for quite some time, but still seeing a fair amount of activity on the larger end of the private credit market, right where we focus on not necessarily pure middle market or lower middle market. So, we had a couple of new investments this quarter that wore those kind of larger private credit transactions, one of which actually was in our portfolio as a broadly syndicated loan that refinanced themselves into the private credit market. Spreads, I would say both markets have certainly tightened. I would say on the larger end of the private credit spectrum, what we are seeing is probably a bit more spread tightening versus what we have seen on the syndicated market, at least from a pure new issue standpoint.

But a lot of those, large private credit unit tranches that were coming at, SOFR 600 plus over the past couple of years, or more in the SOFR 475 to 500 range. So, a fair amount of spread tightening there. But I would say both markets are still fairly attractive in our opinion. But again, we are continuing to focus on the larger end and larger borrowers, and that’s kind of reflected again, in our statistics and weighted average EBITDA of over $450 million. So, nothing in our view has changed to make us want to go down in borrower size by any stretch of the imagination. But I think both markets continue to offer some pretty interesting relative value.

Doug Harter: And can you talk about on recent transactions, how kind of covenant and collateral packages and things like that have been trending?

Chris Long: Yes, great question. I know very topical with some of the things that have gone on and in the private credit markets of recently. I would say not too dissimilar from what we have seen, quite frankly, now there has obviously been a lot of volatility in the past week or so, and in a lot of cases, that volatility does lead to, I would say, more lender friendly terms. But it’s probably a little too early to make a call on how that’s going to play out given, the market falls really just been, over this last week or so. So, from our vantage point of what we saw in the second quarter, which was undoubtedly a pretty borrower friendly market, I wouldn’t say things are too dissimilar from how they have been.

Doug Harter: Appreciate it. Thank you.

Operator: Alright. Thanks Doug. [Operator Instructions] And our next question comes from the line of Melissa Wedel with JPMorgan. Melissa, please go ahead.

Melissa Wedel: Thank you. Good afternoon. Appreciate you taking my question. I really wanted to go back to a comment made earlier on the call. Just want to clarify. You were talking about some realized gains in the portfolio this quarter. I think you said there were a few investments where they had been marked up given fundamental performance, and so there was an unrealized gain. I got the impression those were marked up above par. I am wondering, did you say that when they were repaid, they were repaid at par. So, the reversal of the unrealized gain was actually larger than the realized gain, might did I hear that right?

Matt Bloomfield: Hey Melissa. Yes, this is Matt. So, yes, so there was a portion of the portfolio that, were wider spread, loans from the past couple of years that performance had been quite strong and were trading well above par. And so those had had unrealized gains that have been associated with them, and with some free cash flow pay-downs in the quarter, those were those were able to pay down a par and so those were reversals of that which had a negative impact of approximately $3 million during the quarter. So, bit of a unique situation, given where some of those were trading. But from an underlying credit performance, they have been performing quite well. Hence, the marks above par that had to be reversed.

Melissa Wedel: Got it. And is this something that you would that you see recurring, or has happened before? I would think that given your relative value approach that you often will be rotating out of things that are trading particularly well and above par, especially if you think there is an opportunity that they might refinance those.

Matt Bloomfield: Yes, I would say it’s a bit unusual. A few of those specific loans, in our opinion, have pretty wide spreads relative to their risk. So, from investment income standpoint, they are quite attractive given the current yield they are paying, and some of them still have hard call protection. So, they can’t refinance those without having to pay us that premium, but they can pay with cash flow at par. So, I wouldn’t expect it to have a lot of that type of activity in most markets. I would say it’s a bit of a unique situation, just given the timing from when those were issued in more volatile markets versus the underlying risk characteristics, so a bit of a unique situation. I don’t think something that would be a consistent theme across the portfolio.

Melissa Wedel: Okay. Thanks so much.

Operator: Thank you, Melissa. And it appears there are no further questions, so I will now turn the call back over to Chris Long for closing remarks. Chris?

Chris Long: Thank you so much. On behalf of the entire management team, we appreciate you joining us today and your support of Palmer Square Capital BDC. As Angie said in her remarks, we are confident in our positioning today, and believe we are driving value for our current shareholders while also presenting a compelling opportunity for prospective investors in the market. I remain pleased with the team’s ability to execute on our differentiated large liquid loan strategy focused on high-quality broadly syndicated loans and large private credit loans. Due to our new portfolio and track record of capitalizing on market dislocations, we believe we have the ability to provide attractive risk adjusted returns for shareholders, while also of course, mitigating risk for the foreseeable future. We look forward to updating you on our third quarter 2024 earnings call during November. Thank you so much. Have a great rest of your day.

Operator: Thanks Chris and ladies and gentlemen, that does conclude today’s call. Thanks for joining and you may now disconnect.