Portman Ridge Finance Corporation (NASDAQ:PTMN) Q1 2023 Earnings Call Transcript

Portman Ridge Finance Corporation (NASDAQ:PTMN) Q1 2023 Earnings Call Transcript May 11, 2023

Operator: Welcome to Portman Ridge Finance Corporation’s First Quarter 2023 Earnings Conference Call. An earnings press release was distributed yesterday, May 10, after market close. A copy of the release, along with an earnings presentation is available on the company’s website at www.portmanridge.com in the Investor Relations section and should be reviewed in conjunction with the company’s Form 10-Q filed yesterday with the SEC. As a reminder, this conference call is being recorded for replay purposes. Please note that today’s conference call may contain forward-looking statements, which are not guarantees of future performance or results and involve a number of risks and uncertainties. Actual results may differ materially from those in the forward-looking statements as a result of a number of factors, including those described in the company’s filings with the SEC.

Portman Ridge Finance Corporation assumes no obligation to update any such forward-looking statements unless required by law. Speaking on today’s call will be Ted Goldthorpe, Chief Executive Officer, President and Director of Portman Ridge Finance Corporation. Jason Roos, Chief Financial Officer; and Patrick Schafer, Chief Investment Officer. With that, I would now like to turn the call over to Ted Goldthorpe, Chief Executive Officer of Portman Ridge.

Ted Goldthorpe: Good morning. Thanks, everyone, for joining our first quarter 2023 earnings call. I’m joined today, as previously mentioned by our Chief Financial Officer, Jason Roos, and our Chief Investment Officer, Patrick Schafer. I’ll provide brief highlights on the company’s performance and activities for the quarter. Patrick will provide commentary on our investment portfolio and our markets. And Jason will discuss our operating results and financial condition in greater detail. Yesterday, Portman Ridge announced its first quarter 2023 results. And continuing off the back of strong earnings momentum seen in fiscal year 2022, we’re pleased to report yet another strong quarter of financial performance in the first quarter of 2023.

Our total investment income, core investment income and net investment income for the first quarter of 2023, all increased in comparison with the fourth quarter of 2022 as we continue to see the impact that rising rates have in generating incremental revenues from our debt portfolio investments. Our core investment income for the first quarter of 2023 was $19.3 million, an increase of $1.6 million as compared to $17.7 million for the fourth quarter of 2022 and an increase of $4.2 million as compared to $15.1 million for the first quarter of 2022. Our strong performance this past quarter has allowed us to raise our dividend for the third consecutive quarter to $0.69 per share. This increase to our shareholder distribution also represents the fifth overall increase in — over the past 7 quarters.

Regarding our primary market as a whole, the bank failures of Silicon Valley Bank, Signature Bank and First Republic during March and April have further perpetrated the volatility and uncertainty — perpetuated the volatility and uncertainty in the syndicated markets that we have noted in our early March earnings call, which historically is favorable to private credit businesses such as Portman Ridge. We remain bullish on new investment opportunities and the ability to rotate our portfolio at reduced risk and incremental returns. For new opportunities, spreads remain approximately 150 basis points wide as compared to the beginning of 2022, and upfront fees are up an incremental 100 to 200 basis points. Additionally, we continue to see strong equity contributions from sponsors and reduced leverage levels on new opportunities.

Turning the focus back to the company. We continue to believe in the valuation of Portman Ridge as we continued repurchasing shares under the renewed stock purchase program. In the first quarter, we repurchased an incremental 35,613 shares following on the trend seen throughout 2022, where we repurchased a total of 167,017 shares at an approximate cost of $3.8 million. We expect this trend of repurchasing Portman shares to continue throughout 2023 as we’re able to do so. On this call, Patrick will also walk through the portfolio upside cases for our net asset value. Our portfolio is largely in first lien debt and is now valued at a meaningful discount to par. If we experienced normalized defaults or even elevated default rates versus history, we believe there’s embedded net asset value upside in the portfolio.

This adds to our earnings momentum, driven by wider spreads on new originations and rising short-term interest rates to drive both potential NAV and earnings upside. With that, I will turn the call over to Patrick Schafer, our Chief Investment Officer, for a review of our investment activity.

Patrick Schafer: Thanks, Ted. Turn to Slide 5 of our investment presentation and the sensitivity of our earnings to interest rates. As of March 31, 2023, approximately 89.2% of our debt securities portfolio were either floating rate with a spread to an interest rate index such as LIBOR, SOFR or Prime, with 52% of these still being linked to LIBOR. As you can see from the chart, the underlying benchmark rates on our assets during the quarter lagged the prevailing market rates and still remain significantly below the LIBOR and SOFR rates as of April 24, 2023. We expect this to normalize over time as the underlying one, three, six month contracts reset. For illustrative purposes, if all our assets were to reset to either a three-month LIBOR or SOFR rate, respectively, we would expect to generate an incremental $690,000 of quarterly income.

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Our liability costs would also rise relative to their Q1 levels. We would still expect a net positive benefit of approximately $0.06 per share, assuming all of our assets and liabilities are utilized in the same 3-month benchmark rates for an entire quarter. Skipping down to Slide 11. Both investment activity and originations for the first quarter were lower than the prior quarter, resulting in net repayments and sales of approximately $32.6 million. Net deployment consisted of new fundings of approximately $11.8 million, offset by approximately $44.4 million of repayments and sales. These new investments are expected to yield a spread to SOFR of 625 basis points on par balance and the investments were purchased at a cost of approximately 97% of par, which will generate incremental income to the stated spread.

As mentioned during our last earnings call, it was our expectation that Q1 would generate more repayments than deployments as we intentionally drew up a portion of our revolver in Q4 2022 to invest ahead of several repayments. In February, we repaid $6.9 million of our 2018-2 secured notes. And in May, we expect to make another paydown of approximately $23 million. During the fourth quarter, we funded $5.6 million into our Great Lakes joint venture, which has taken us close to being fully funded under that commitment. Similar to our experience with new assets on the balance sheet, incremental investments in our Great Lakes joint venture have come at increasing spreads and widening OID, which should result in higher returns going forward. Our investment securities portfolio at the end of the first quarter remained highly diversified with investments spread across 28 different industries and 106 different entities, all while maintaining average par balance per entity of approximately $3.3 million.

Turning to Slide 12. We had one incremental investment on nonaccrual as compared to December 31, 2022, which is a subordinated note in Lucky Bucks Holdings, which is valid at 24.75% of par. In aggregate, investments on nonaccrual status remained relatively low at five investments in the first quarter of 2023 as compared to four investments on nonaccrual status as of December 31, 2022. These five investments on nonaccrual status at the end of the first quarter of 2023 represents 0.3% and 1.5% of the company’s investment portfolio at fair value and amortized cost, respectively. On Slide 13, as Ted mentioned in his opening remarks, if we focus on the top three rows of the table and exclude our investment in Pro R Holdings, which we have marked at 0, we have an aggregate debt securities fair value of $442 million — $442.9 million, which represents a blended price of 91.11% of par value and is 85% comprised of first lien loans at par value.

Assuming a par recovery, our March 31, 2023 fair values reflect a potential for $43.2 million of incremental NAV value of $4.52 per share. For illustrative purposes, if you were to assume a 10% default rate and a 70% recovery rate on this debt portfolio, there would still be an incremental $2.99 per share of NAV value over time as the portfolio matures and is repaid. This default rate is above anything the market is expecting or has experienced historically. Turning finally to Slide 14. If you aggregate these three acquired portfolios, over the last three years, we have purchased a combined $434.8 million of investments that have realized over 72% of these investments at a combined realized and unrealized mark of 102% of fair value at the time of closing their respective mergers.

We were able to achieve these results despite the global pandemic in 2020 and most of 2021 and a weak market for almost all asset classes in 2022. In a similar vein as the previous slide, as of March 31, 2023, there remains an incremental $11.8 million of value as compared to par in these portfolios or $8.0 million when applying a similar 10% default rate and 70% recovery rate analysis. I’ll now turn the call over to Jason to further discuss our financial results for the period.

Jason Roos: Thanks, Patrick. As both Ted and Patrick previously mentioned, despite operating under a challenging economic environment, our results for first quarter of 2023 reflect strong financial performance. Our total investment income increased by $1.7 million to $20.3 million in the first quarter of 2023 in comparison to $18.6 million in the fourth quarter of 2022 as we continue to see the impact of rising rates and generating incremental revenue from our investments. The increase was largely due to higher paydown income, servicing fees, dividend income and interest income from rising rates as compared to the prior quarter. This reported total investment income also represents a $3.4 million increase from the $16.9 million of reported total investment income in the first quarter of 2022.

Excluding the impact of purchase price accounting, our core investment income for the first quarter was $19.3 million, an increase of $1.6 million as compared to $17.7 million for the fourth quarter of 2022 and an increase of $4.2 million as compared to $15.1 million for the first quarter of 2022. Our net investment income for the first quarter of 2023 was $8.5 million or $0.89 per share, an increase of $1.4 million as compared to $7.1 million or $0.74 per share for the fourth quarter of 2022 and an increase of $600,000 as compared to $7.9 million or $0.82 per share for the first quarter of 2022. The quarter-over-quarter increase was largely due to the aforementioned impact of increased paydown income, servicing fees, dividend income and interest income from rising rates as compared to the prior quarter.

As of March 31, 2023 and December 31, 2022, the weighted average contractual interest rate on our interest-earning debt securities was approximately 11.7% and 11.1%, respectively. We believe the portfolio remains well positioned in a rising rate environment to generate incremental revenue in future quarters. Total expenses for the quarter ended March 31, 2023, were $11.8 million compared to total expenses of $11.5 million seen in the fourth quarter of 2022. This was predominantly driven by rising costs associated with the interest expense on our debt, offset by reduced expenses related to administrative services, professional fees and other general and administrative costs, areas where we have focused on reducing overall expenses. Our net asset value for the first quarter of 2023 was $225.1 million or $23.56 per share as compared to $232.1 million or $24.23 per share in the fourth quarter of 2022.

The decline due to our debt and equity securities was primarily driven by paydown activity and sales as well as mark-to-market movements within our portfolio. On the liability side of the balance sheet, as of March 31, 2022, we had a total of $358.3 million par value of borrowings outstanding, comprised of $79 million in borrowings under our revolving credit facility, $108 million of 4.875% notes due 2026 and $171.3 million in secured notes due 2029. This balance represents a quarter-over-quarter decrease of $19.9 million, driven by a $13 million repayment on our revolving credit facility and a $6.9 million repayment on the secured notes due 2029. As of the end of the quarter, we had $36 million of available borrowing capacity under the senior secured revolving credit facility and no remaining borrowing capacity under the 2018-2 revolving credit facility as the reinvestment period ended shortly after our draw on November 20, 2022.

As of March 31, 2023, our debt-to-equity ratio was 1.6x on a gross basis and 1.4x on a net basis. From a regulatory perspective, our asset coverage ratio at quarter end was 162%. This is at the high end of our target range, driven by the drawing of the remaining capacity under the 2018-2 revolver in advance of its expiration in the fourth quarter of 2022. Lastly, and as announced yesterday, a quarterly distribution of $0.69 per share was approved by the Board and declared payable on May 31, 2023, to stockholders of record at the close of business on May 22, 2023. This is a $0.01 per share distribution increase as compared to the prior quarter and a $0.06 per share distribution increase as compared to the second quarter of 2022. This also marks the third consecutive quarter of a stockholder distribution increase and the fifth stockholder distribution increase over the last seven quarters.

With that, I will turn the call back over to Ted.

Ted Goldthorpe: Thank you, Jason. Ahead of questions, I’d like to reemphasize that we believe we are well positioned to take advantage of opportunities that arise from the current market environment by continuing to be selective and resourceful in our investment decision-making. Overall, we believe we remain situated to continue to deliver attractive returns to our shareholders throughout 2023. Thank you once again to all our shareholders for ongoing support. This concludes our prepared remarks, and we will now turn it over to the operator for any questions.

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Q&A Session

Operator: And your first question come from the line of Christopher Nolan of Ladenburg Thalmann. Your line is open.

Christopher Nolan: Hi, guys. Jason, I missed it, the unrealized depreciation, was that from mark-to-market? Or is there a particular…

Jason Roos: Yes, the movement in the unrealized is largely mark-to-market. There’s also some of that as it relates to the accretion as your cost basis creeps up, but largely mark-to-market. And then the realized, the bulk of that, I guess, two-thirds of that — more over two-thirds of that was related to a flip between unrealized and realized. Predominantly driven by –

Christopher Nolan: Yes. And then generally, the leverage ratio is quite high. What’s the thoughts in terms of dialing that back given the

Patrick Schafer: Yes. Chris, it’s Patrick Schafer. So I think a couple of things, which is we tend to focus more, at least internally on net leverage because we are sitting on cash that at any given point, we could choose to repay down various different facilities or invest, so we’d like to kind of keep flexibility depending on market conditions and being able to react quickly. I would say that with that said that we saw a small paydown of the 2018-2 facility in Q1, and we have a larger one that’s kind of expected to be about $23 million in this quarter to pay down. So a decent amount of the cash that was sitting on the balance sheet as of March 31, was effectively earmarked for a paydown that because of the 2018-2 facility structured like a CLO, whereby you kind of have one paydown per quarter.

So we sort of — we’re sitting on the cash to then make the paydown in sort of where we are now kind of mid-May. So again, I think our general expectation is that as repayments come in, we will naturally sort of close the gap between gross and net leverage, and that is sort of our plan in going forward. So again, it was kind of an intentional strategy at Q4 that we anticipate kind of continued paydowns over the course of this year.

Christopher Nolan: Final question. In your conversations with portfolio companies, how is the conversation going in terms of mitigating their financial risk to banks or whatever. I think you — get away from this bank or that bank or lower your leverage? Or — how is the general conversations going on that front?

Ted Goldthorpe: I mean I think every company is doing a full analysis of where they hold cash and what their cash is invested in. Also managing cash has become much more important because when rates have gone from 0% to 5%, obviously, cash management becomes more important. We thankfully had no material impact or exposure to any of the banks that have failed. And so I think generally speaking, people are getting much more conscious of where they have their money. And so we get frequent updates from our companies about how they’re dealing with the situation, and we feel very comfortable about cash management across the portfolio. I think we can have a much longer conversation about this at some point.

Patrick Schafer: I think, by and large, the biggest take away that we’ve seen in our portfolio companies is they’re no longer having sort of one bank, one solution for all their treasury work. They always have a kind of a secondary bank account with a different bank just in kind of an event of an emergency or kind of if you need to move money or keeping a little bit of, let’s say, dry powder for a couple of payroll period, just something in a separate bank account. So I think it’s just a little bit more prudent in terms of having multiple kind of treasury functions and treasury relationships as opposed to wholesale changes.

Christopher Nolan: That’s it for me. Thanks guys.

Ted Goldthorpe: Thank you.