PennantPark Investment Corporation (NYSE:PNNT) Q2 2023 Earnings Call Transcript May 11, 2023

Operator: Good afternoon and welcome to the PennantPark Investment Corporation’s Second Fiscal Quarter 2023 Earnings Conference Call. Today’s conference is being recorded. [Operator Instructions] It is now my pleasure to turn the call over to Mr. Art Penn Chairman and Chief Executive Officer of PennantPark Investment Corporation. Mr. Penn, you may begin your conference.

Art Penn: Good afternoon, everyone. I’d like to welcome you to PennantPark Investment Corporation’s second fiscal quarter 2023 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 included discussion about forward looking statements.

Rick 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 Investment Corporation. 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 these projections. We do not undertake to update our forward-looking statements unless required by law.

To obtain copies of related 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.

Art Penn: Thanks, Rick. We’re going to spend a few minutes and comment on our target market environment provide a brief summary of 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 open it up for Q&A. For the quarter ended March 31st. Our net investment income was $0.26 per share. Core NII was $0.21 per share, and excluded $0.05 of one-time interest and dividend income. GAAP NAV decreased slightly to $7.60 per share from $7.71 per share, or 1.4%. This decrease was driven largely by valuation adjustments on equity call investments partially offset by net investment income in excess of the dividend. Our debt portfolio continues to benefit from rising base rates, as of March 31st, our weighted average yield to maturity was 12.1%, which is up from 11.9% last quarter and 8.4% last year.

As a result of a stable debt portfolio and growing net investment income. The board of directors has approved another increase in the quarterly dividend to $0.20 per share. This is an 8% increase from the prior quarter and the 38% increase from a year ago. The dividend will be paid on July 3rd to shareholders of record as of June 15th. We are confident that with the continued strong credit performance, the increased dividend will be more than fully covered by net investment income. For the quarter ended March 31st, we invested 58 million in new and existing portfolio companies at a weighted average yield of 11.8% and at sales and repayments of 114 million. For the investment to new portfolio companies, the weighted average debt-to-EBITDA was 4.3 times.

The weighted average interest coverage was two times and the weighted average loan-to-value was 49%. On March 31st, the JV portfolio equals 748 million and together with our JV partner we continue to execute on the plan to grow the JV portfolio to $1 billion of assets. We believe that the increase in scale and the JV is attractive double-digit ROE will also enhance PNNT’s earnings momentum. We continue to believe that the current vintage of middle market directly originated loans should be excellent leverages lower spreads and upfront fees are higher and covenants are tighter. The credit quality of the portfolio continues to perform well as of March 31st. we had one non-accrual out of 135 different names a PNNT. This represents 1.1% of the portfolio cost and 0% at market value.

Our investment of Walker Edison has returned to accrual status after completing a balance sheet restructuring. PNNT has an equity ownership and Dominion voting, which subsequent to quarter end settled their lawsuit with Fox News for $787 million. Dominion has communicated their intention to distribute the net settlement proceeds, and PNNT share is estimated to be approximately $12 million. Now, let me turn to the current market environment. From an overall perspective in this market environment of inflation, rising interest rates, geopolitical risk, and a potentially weakening economy. We are well positioned as a lender focused on capital preservation in the United States, where the floating interest rates on our loans can protect against rising interest rates and inflation.

We continue to believe that our focus on the core middle market provides the company with attractive investment opportunities where we are an important strategic capital to our borrowers. We have a long-term track record of generating value by successfully financing high growth middle market companies in five key sectors. These are sectors where we have substantial domain expertise, know the right questions to ask and have an excellent track record. They are business services, consumer, government services in defense, health care, and software technology. These sectors have also been recession resilient, and tend to generate strong free cash flow. And our software vertical, we do not have any exposure to ARR loans. In many cases were typically part of the first institutional capital into a company and the loans that we provide are important strategic capital that fuel the growth.

And of that $10 million to $20 million EBITDA company grow to 30 million, 40 million, 50 million of EBITDA or more. We typically participate in the upside by making an equity co-investment. High returns on these equity call investments have been excellent over time. Overall, for the platform from inception through March 31st. We’ve invested over $394 million in equity co-investments, have generated an IRR of 26% and a multiple on invested capital of 2.2 times. Because we are an important strategic lending partner. The process impact of terms we receive is attractive. We have many weeks to do our diligence with care. We thoughtfully structure transactions with sensible credit statistics, meaningful covenants, substantial equity cushions to protect our capital, attractive upfront fees, and spreads and an 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, virtually all of our originated personal loans have meaningful covenants, which help protect our capital. This is one reason why our default rate and performance during COVID was so strong, and why we believe we’re well positioned in this environment. The sector of the market companies with 10 million to 50 million of EBITDA is the core middle market. The core middle market is below the threshold, and does not compete with a broadly syndicated loan or high yield markets. Many of our peers who focus on the upper middle market state that those bigger companies are less risky. That is a perception and may make some intuitive sense.

But the reality is different. According to S&P, loans to companies, with less than 50 million of EBITDA have a lower default rate and a higher recovery rate, than loans to company’s with higher EBITDA, we believe that the meaningful covenant protections of the core middle market, more careful diligence and tighter monitoring have been an important part of this differentiated performance. Since inception, PNNT has invested $7.4 billion, with an average yield of 12%. This compares to a loss ratio of approximately 22 basis points annually. The strong track record includes our energy investments, primarily subordinated debt investments made prior to the financial crisis, and recently the pandemic. With regard to the Outlook, new loans in our target market are attractive and this vintage should be particularly attractive.

Our experienced and talented team and our wide origination funnel is producing active deal flow, a continued focus remains on capital preservation and being patient investors. We want to reiterate our goal is to generate attractive risk adjusted returns through income coupled with a long-term preservation of capital. 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 through debt 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.

Rick Allorto: Thank you, Art for the quarter ended March 31st, net investment income was $0.26 per share, and core net investment income was $0.21 per share. Core net investment income excludes approximately $0.05 per share of one-time income related primarily to the acceleration of OID amortization in connection with the early repayment of our loan to PRA. Operating expenses for the quarter were as follows. Interest and credit facility expenses were 10.6 million. Base management and incentive fees were 7.6 million general and administrative expenses were 1.1 million and provision for excise tax was 450,000. For the quarter ended March 31st, net realized and unrealized change on investments and debt, including provision for taxes was a loss of 11.8 million or $0.18 per share.

The change in the fair value of our credit facility increased our GAAP NAV by $0.02 per share. As of March 31st, our NAV per share was $7.60, which is down 1.4% from 771 per share from the prior quarter. As of March 31st, our debt-to-equity ratio was 1.43 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. The portfolio remains highly diversified, with 135 companies across 30 different industries, the weighted average yield on debt investments was 12.1%. The portfolio was invested in 57% firstly, secured debt, 10% in secondly unsecured debt. 8% in subordinated notes to PSLF. 5% in other subordinated debt, 5% in PSLF equity and 15% in preferred and common equity.

96% of the debt portfolio is floating rate with an average LIBOR floor of 1%. Debt-to-EBITDA on the portfolio is 4.6 times and LTM interest coverage ratio is 2.8 times. The portfolio as a whole as a meaningful cushion with regard to interest coverage. On a sensitivity basis for overall interest coverage to decrease to 1.25 times, base rates would need to go up 150 basis points and EBITDA would need to decrease by 35%. Now, let me turn the call back to Art.

Art Penn: Thanks, Rick. In closing, I’d like to thank our dedicated and talented team of professionals for their continued commitment to PNNT and its shareholders. Thank you all for your time today and for your continued investment and confidence in us. That concludes my remarks. At this time, I would like to open up the call to questions.

Q&A Session

Operator: Thank you. [Operator Instructions] We’ll take our first question from Paul Johnson with KBW.

Operator: Thank you. We’ll take our next question from Robert Dodd with Raymond James.

Operator: We’ll take our next question from Kyle Joseph with Jefferies.

Operator: We’ll take our next question from Mickey Schleien with Ladenburg.

Operator: We’ll take our next question from Mark Hughes with Truist.

Operator: We’ll take our next question from Melissa Wedel with JP Morgan.

Operator: We’ll take our next question from Casey Alexander with Compass Point.

Operator: That will conclude our question-and-answer session. At this time, I’d like to turn the call back over to Mr. Penn for any additional or closing remarks.

Art Penn: Want to thank everybody for being on the call today? We’ll talk to you next time in early August for June 30th numbers. Thank you very much.

Operator: Thank you. That will conclude today’s call. We appreciate your participation.