Portman Ridge Finance Corporation (NASDAQ:PTMN) Q3 2023 Earnings Call Transcript

Portman Ridge Finance Corporation (NASDAQ:PTMN) Q3 2023 Earnings Call Transcript November 9, 2023

Operator: Welcome to Portman Ridge Finance Corporation’s Third Quarter 2023 Earnings Conference Call. An earnings press release was distributed yesterday, November 8, 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 afternoon, and thanks, everyone, for joining our third quarter 2023 earnings call. I’m joined today 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 third quarter 2023 results, and we are pleased with the solid earnings power of the portfolio despite operating in a somewhat challenging market conditions. Our core investment income was up year-over-year, increasing by $700,000 as we continue to see the impact that rising rates have on our debt portfolio.

Additionally, our net asset value per share increased from $22.54 per share to $22.65 per share. We continued our accretive repurchase program, purchasing over 60,000 shares at an average cost of approximately $1.2 million during the third quarter. Due to the continued strong performance this past quarter, the Board of Directors was able to approve a dividend of $0.69 per share, a level that represents a 12.2% annualized return on net asset value. On a year-to-date basis, total dividends to be distributed to shareholders amount to $2.75 per share, representing a 7.4% increase as compared to the dividend distributed in 2022. As we have discussed in previous quarters, M&A deal flow continues to be at depressed levels year-to-date, but we remain optimistic on the overall outlook.

On the sponsor finance front, we are starting to see the early innings of deal activity pick up through a combination of valuation expectations being more reasonable and acceptance that interest rates will remain elevated for an extended period of time significant dry powder on the sidelines and private equity LPs encouraging the return of capital from their fund managers. Sponsors are looking to put less total leverage on their companies, which lowers our detachment point. We’ll remain cautious on the ultimate execution rate of these M&A processes, the recipe for increased activity levels appear to be in place. Both the sponsor and non-sponsor activity — we continue to find the investment opportunities to be very attractive given the combination of higher benchmark rates, lower leverage on new deals, higher equity contributions from sponsors and better documentation.

Given the continued macro uncertainty around inflation, consumer sentiment and ongoing conflict in Ukraine and Israel, we continue to be very selective on new investment opportunities and have overall found investments in existing portfolio companies more attractive than those in new borrowers. Refocusing on Portman Ridge, we continue to believe our stock remains undervalued. Thus, as previously mentioned, we continued repurchasing shares under our renewed stock purchase program. In the third quarter, we repurchased an incremental 6,559 shares for an aggregate cost of approximately $1.2 million. This follows the trend set throughout 2022 and the first half of 2023 and expect this trend to continue through the final quarter of the year as we are able to do so.

Following my remarks, Patrick will also walk through the potential upside cases for net asset value. But in addition to the market trading discount of our stock price, we continue to believe that there is significant embedded value to NAV even when overlaying conservative default and recovery rates. With that, I will turn over the call to Patrick Schafer, our Chief Investment Officer, for a review of our investment activity.

Patrick Schafer: Thanks, Ted. Turning now to Slide 5 of our presentation and the sensitivity of our earnings to interest rates. As of December — as of September 30, 2023, approximately 90.5% of our debt securities portfolio were either floating rate with a spread to an interest rate index such as LIBOR, SOFR or Prime Rate, with 98% of these being linked to SOFR. As you can see from the chart, the underlying benchmark rate of our assets during the quarter lagged prevailing market rates and still remain below the SOFR rates as of October 30, 2023, and but the gap is the narrowest it has been since the onset of the Fed rate hike cycle. For lesser purposes, if all our assets were to reset to either a 3-month LIBOR or SOFR rate, respectively, we would expect to generate an incremental $75,000 of quarterly income.

Having said that, Slide 7 shows a slight decline in NII per share on a run rate basis driven largely by a slightly lower asset balance as of September 30, 2023, and our simple methodology of not assuming any changes to the portfolio. Skipping down to Slide 11. Originations for the third quarter were slightly higher than the prior quarter but still remained below repayment levels, resulting in net repayments and sales of approximately $11.6 million. Some of this was driven by late repayments during the quarter and 2 transactions expected to close in Q3 that were pushed into early Q4. Our new investments made during the quarter are expected to yield a spread to SOFR of 917 basis points on par value, and the investments were purchased at a cost of approximately 99% of par.

Our investment securities portfolio at the end of the third quarter remained highly diversified with investment spread across 26 different industries and 101 different entities. All while maintaining an average par balance per entity of approximately $3.3 million. Turning to Slide 12. We had 1 new portfolio company go on nonaccrual as of — as compared to June 30, 2023, and 1 come off nonaccrual due to the completion of a restructuring. In aggregate, securities on nonaccrual stats remain relatively low at 8 investments in the third quarter of 2023 as compared to 7 investments on nonaccrual status as of June 30, 2023. These 8 investments on nonaccrual status at the end of the third quarter of 2023 represent 1.6% and 3.6% of the company’s investment portfolio at fair value and amortized cost, respectively.

On Slide 13, excluding our nonaccrual investments, we have an aggregate debt securities fair value of $427 million, which represents a blended price of 93.4% of par value and is 88% comprised of first lien loans at par value. Assuming a par recovery, our September 30, 2023 fair values reflect a potential of $28 million of incremental NAV value, a 13.1% increase or $2.94 per share, excluding any recovery on the nonaccrual investments. For illustrative purposes, if you would assume a 10% default rate and a 70% recovery rate on this debt portfolio, there would still be an incremental $1.60 per share of NAV value or a 7.1% increase over time as the portfolio matures and is repaid. Again, this is excluding any recovery on the nonaccrual investments.

This indicative default rate is above anything the market is expecting or has experienced historically. Finally, turning to Slide 14. If you aggregate the 3 portfolios acquired over the last 3 years, we have purchased a combined $435 million of investments, have realized over 78% of these positions at a combined realized and unrealized mark of 103% of fair value at the time of closing the respective mergers. This is an indication of our ability to effectively realize the value of legacy portfolios acquired, while rotating into BC Partners sourced assets. More importantly, we’re able to achieve those results despite the global pandemic in 2020 and most 2021 and a weak market for almost all asset classes in 2022 and the first half of 2023. 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 the third quarter of 2023 reflect strong financial performance. Our total investment income decreased slightly by $400,000 to $18.6 million in the third quarter of 2023 in comparison to $19 million in the third quarter of 2022. This reported total investment income represents a $1 million decrease from the $19.6 million of reported total investment income in the second quarter of 2023. The quarter-over-quarter decrease was largely due to reduced fee income and dividend income compared to the second quarter of 2023. Excluding the impact of purchase price accounting, our core investment income for the third quarter of 2023 was $18.3 million, an increase of $700,000 as compared to $17.6 million for the third quarter of 2022, a decrease of $900,000 as compared to $19.2 million for the second quarter of 2023.

Our net investment income for the third quarter of 2023 was $7.2 million or $0.75 per share, a decrease of $1.2 million as compared to $8.4 million or $0.87 per share for the third quarter of 2022 and a decrease of $700,000 as compared to $7.9 million or $0.83 per share for the second quarter of 2023. The quarter-over-quarter decrease was largely due to the aforementioned decreases unit fee and dividend income. As of September 30, 2023 and June 30, 2023, the weighted average contractual interest rate on our interest-earning debt securities was approximately 12.3% and 12.1%, respectively. We continue to believe the portfolio remains well positioned to generate incremental revenue in future quarters due to the current rate environment. Total expenses decreased quarter-over-quarter from $11.7 million for the second quarter of 2023 to $11.4 million in the third quarter of 2023.

This decrease was due to reduced expenses and predominantly all expense categories, a result of our efforts to reduce overall expenses. Our net asset value for the third quarter of 2023 was $214.8 million or $22.65 per share as compared to $215 million or $22.54 per share in the second quarter of 2023. Turning to the liability side of the balance sheet. As of September 30, 2023, we had a total of $321.5 million par value of borrowings outstanding at a current weighted average interest rate of 6.9%. This balance was comprised of $74 million in borrowings under our revolving credit facility, $108 million of 4 7/8% notes due 2026 and $139.5 million in secured notes due 2029. The quarter-over-quarter decrease of $12.2 million was primarily driven by an $8.2 million repayment on the secured notes due 2029 and a net $4 million repayment on the revolving credit facility.

As of the end of the quarter, we had $41 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 September 30, 2023, our debt-to-equity ratio was 1.5x on a gross basis and 1.34x on a net basis. From a regulatory perspective, our asset coverage ratio at quarter end was 166%. Finally, and as announced November 8, 2023, a quarterly distribution of $0.69 per share was approved by the Board and declared payable on November 30, 2023, to stockholders of record at the close of business on November 20, 2023. This is a $0.02 per share distribution increase as compared to the fourth quarter of 2022, including the distribution subsequent to the announcement of full year 2022 earnings results total stockholder distributions for 2023 amount to $2.75 per share.

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 the current market environment as we have shown throughout the year so far. Through our prudent investment strategy, we believe we will be able to deliver strong returns to our shareholders in the final quarter of the year and into 2024. Thank you once again to all of our shareholders for ongoing support. This concludes our prepared remarks, and I will turn the call over for any questions.

Operator: [Operator Instructions] Our first question will come from the line of Paul Johnson with KBW.

See also 30 Best Whiskeys Under $30 and 20 States With the Highest Gas Prices in the US.

Q&A Session

Paul Johnson: The first is just kind of just maybe kind of giving your overall thoughts on leverage post gross leverage the and kind of where you see going into next year, if there’s focus on reducing that or rotating out certain investments that are just basically just redeploying what’s coming in terms of the payment across there [Indiscernible]

Ted Goldthorpe: Yes, it’s a great question. I think the answer is, again, we have a stated target leverage range, which we’re close to the high end of. And so again, I don’t feel like our — of anything our leverage will go down. I don’t feel like our leverage will go up going into next year. I mean there’s a lot of uncertainty going into next year. We’re earning very strong ROEs, and we don’t need leverage to earn dividend nor our earnings. So we — if you recall, we took up leverage for a temporary period of time, which is now coming down because we had a use it or lose it facility that was very accretive for shareholders. But yes, we expect leverage to come down or at least stay within the range that we’ve kind of outlined to people.

Paul Johnson: And then is that kind of I guess, your impede your ability to kind of continue buying back shares? How do you see that kind of any of your thoughts around share repurchases?

Ted Goldthorpe: I mean, I think, listen, we’ve done it for a bunch of years in a row, like we’re very committed to buying back stock. And again, given where ROEs are and given where new investment rates are, it’s also very accretive for us to invest. But given where our stock trades and given where our yield is at market, we just think it makes a lot of sense for us to buy back stock.

Paul Johnson: And then my other question is just on interest income. If I’m calculating it right, approximately about 16% or so of total interest income was PIK income this quarter. I just want to make sure I’m looking at that correctly. And then also, how does that compare, I guess, historically to the portfolio.

Jason Roos: Yes, I would say we did have more PIK income this quarter relative to prior quarters. That’s a function of some of our — we look at interest income and PIK income as kind of 1 and the same as a conglomerate source of income. But you’re right. This quarter, we had a larger amount of our investment income being made up of PIK income, which is a function of some of the assets that were previously, cash paying are now picking due to some of the optionality that they have in the agreements themselves.

Patrick Schafer: Yes. And there was one — there was also one specific name that moved from cash to pick this in Q3, but then was exited in where we sit today on the phone in Q4. So all equal, you expect that to go down a little bit next quarter just because of the exit of one of the assets that had a little bit of PIK for one particular quarter.

Operator: Your next question will come from the line of Christopher Nolan with Ladenburg Thalmann.

Christopher Nolan: For your portfolio companies, are you seeing sponsors step up and put in more equity or not really?

Ted Goldthorpe: Why don’t I go first and then Patrick can respond. I think we’re seeing like — this is just my own opinion, like I think you’re seeing a bifurcation in the market between size of sponsor, meaning, I think we’re seeing pretty constructive behavior on behalf of middle-market sponsors, and we’re seeing more economic decision-making on behalf of larger sponsors. And again, that more affects the larger players in the BDC space the syndicated markets. But yes, we’re in constant dialogue with our sponsor counterparts. And I think like they’ve been very, very constructive so far.

Patrick Schafer: Yes. Matt, I don’t have much to add Ted hit the nail there. The only thing in some instances, if sponsors are looking at some sort of amend and extend for a kind of multiyear period the thing that ourselves as well as just lenders in the market are focused on is interest coverage at this point as opposed to leverage. And so there’s oftentimes where there needs to be a little bit of incremental equity coming into the structure to bring you down to a coverage perspective that makes sense. So those are obviously all kind of one-off conversations. But as Ted said, kind of usually in those discussions, the bifurcation is really on size of sponsor and what they’re comfortable doing.

Christopher Nolan: And I guess a follow-up question would be what sort of EBITDA multiples are you seeing given the change in rates? I mean, obviously [Technical Difficulty]

Ted Goldthorpe: Yes. So I think there’s a push pull, but everyone is on the same page, which is sponsors are back-solving for their interest coverage ratios, basically to Patrick’s point, but we’re not being asked to max lever companies. So we’ve seen leverage come down anywhere from 1 to 2 turns pretty consistently, and that just ties back into interest coverage ratios. I mean there’s a recent large private equity deal that was done with no debt. And the sponsor is just of the view that they’re going to be able to finance it later, cheaper, which I don’t know, I’m not sure I would make that bad. But yes, we’re definitely been asked for lower leverage levels. So it’s not the intention of like we’re being asked for max leverage we don’t want to do it.

Operator: [Operator Instructions] Our next question will come from the line of Steven Martin with Slater.

Steven Martin: A couple of questions. You said that on the non-accruals that 1 went on and 1 went off, but the total went from 7 to 8. Am I missing something?

Patrick Schafer: No. I mean, technically, one, the new nonaccrual has just two different securities as we evolve in our term loan and they’re par with each other. So we have both of them on nonaccrual. It’s 1 borrower, but 2 different securities. So that table is security count and not borrower count.

Steven Martin: Can you — would you care to elaborate on what that 1 security was or I know what it is, but what the story is behind it?

Patrick Schafer: The security that came back of this period that went on.

Steven Martin: The 1 that came back, we were less concerned with went on.

Patrick Schafer: On the legal entity name is HDC [Indiscernible] way, there’s a term loan and revolver HDC HW Intermediate Holdings, LLC is the legal name. It’s a company that we’ve had sort of marked below par for a period of time they have sort of 1 business that has been struggling and 1 side of the house, it has been growing pretty well, but the side of the house, it’s growing is a little bit smaller in the side of house that is declining. We’ve been working with the other lenders on a potential restructuring pathway for the company and kind of in light of the — what we hope is a relatively short pathway to restructuring, we felt it prudent to put it on nonaccrual in the quarter with the hope that it’s a relatively short-lived candidate within there.

Steven Martin: Is it a sponsor-backed deal?

Patrick Schafer: It was a sponsor a deal. The sponsor is not very involved at this stage.

Steven Martin: And was it a BC source deal? Or was it 1 you inherited?

Patrick Schafer: It was not. It was inherited from the Garrison portfolio.

Steven Martin: Can you talk about quarter-to-date events vis-a-vis repayments and sales, et cetera, and/or share repurchase?

Jason Roos: I can give you some high-level numbers on the purchases, we had about 18 — a little over $18 million of purchases, offset by approximately $30 million of sales and pay-downs. If you’re doing the role, then you have about a $1.7 million of unrealized gain offset by a realized loss of about $1.6 million. And then with accretion and some others, you get the delta in the investment portfolio.

Ted Goldthorpe: You’re asking about — you’re asking about quarter-to-date, right? I mean are you talking about activity through or quarter-end. Yes. I mean I would say there’s nothing — I mean, Patrick can speak up to you. But I think nothing outside of normal course. Like I don’t think there’s anything particularly different about the market today than we experienced in the third quarter.

Patrick Schafer: No, that’s right. We had one or two handful of portfolio companies repay. We’ve invested in one or two new portfolio companies. Again, as Ted said, I don’t think there’s anything particularly outside of the ordinary course that’s kind of gone on so far quarter-to-date.

Steven Martin: And share repurchase quarter-to-date?

Jason Roos: I’d have to get back to you on that number, Steve. But as you know, the program is — it’s an ongoing program. And when that turns out, we’ll set it up as we normally do.

Steven Martin: Can you comment on the CLO market? And given you’re over-earning the dividend, and your view on dividends going into the end of the year?

Patrick Schafer: Yes. I’ll take the CLO market and Ted can talk about dividends. I’d say, in general, the CLO market is — has been a little bit healthier, particularly sort of back half of Q3 and maybe a touch into the first bit of Q4 here that has led overall to a little bit better bids and pricing in the syndicated loan market in general as some of that CLO formation has driven the need to buy some assets. So I’d say kind of generally speaking, the CLO market is like a little bit healthier this quarter or where we sit today relative to perhaps sometimes in the last couple of quarters. Having said that, our — the CLOs that we are invested in, generally speaking, are out of their investment periods. So by and large, the CLO managers there are kind of making decisions around what they might expect in terms of repayments on their various portfolios, the relative OC tests and things like that around distributions, et cetera.

So our particular portfolio is a little bit separate from the CLO market broadly, but I’d say, generally speaking, the market has had some improvement over the last, call it, 6 to 8 weeks or so.

Steven Martin: So given your specific portfolios, the CLO — your CLO portfolio is a source of funds rather than a use of funds.

Ted Goldthorpe: It’s always a source of funds. It’s just — it’s always a different amount of source of funds, but it’s not a use of funds.

Steven Martin: Yes. I mean you’re asking…

Ted Goldthorpe: I think you’re asking about total return versus income return. And again, we’re getting positive income off our portfolio. And I think — I mean, look, it’s only a couple of weeks into the quarter. I don’t think we really know in terms of valuation. It’s small. And again, it’s 2% of our portfolio.

Steven Martin: And Ted, your comment about year-end dividends?

Ted Goldthorpe: In terms of a special dividend, is that what you’re asking about?

Steven Martin: Something along those lines.

Ted Goldthorpe: I mean, listen, we obviously benefited greatly from some of this M&A, which created some advantages for our shareholders around spillover income. I would say we feel really good about our dividend. Even if the Fed cuts rates which we don’t obviously speculate on because that’s not our thing. The dividend is pretty protected down to a pretty big reduction in short-term rates. So again, we assess every quarter — obviously, we’re comfortably over earning our dividend in a period of time where we’re getting — So I think we feel good about where our dividend is. And I don’t — again, we’ll assess it at year-end and see if there’s — see where we are in terms of spillover income.

Operator: Our next question comes from the line of James Power.

Unidentified Analyst: I was wondering about this — I don’t know whether I’m pronouncing it correctly. Repertoire partners — but anyway, they’ve made a filing in the last quarter and had quite a bit of stock. I was wondering if you would talk to them about their intentions and what they — are they going to be sellers of this block? And how did they get that bigger block?

Ted Goldthorpe: Yes, I don’t think we comment on individual shareholders and individual shareholders’ intentions. So I’m not sure we want to really make a comment on that.

Operator: We have no further questions at this time. I’ll hand the call back over to Ted Goldthorpe for any closing remarks.

Ted Goldthorpe: Great. Well, thank you all for attending our call. As per always, please reach out to us with any questions, which we’re happy to discuss. And I hope everybody has a great Thanksgiving. And we look forward to speaking to you again on our next call. Thank you.

Operator: Ladies and gentlemen, thank you all for joining today’s meeting. That will conclude our call. You may now disconnect.