Pennantpark Investment Corp
NASDAQ:PNNT
Earnings Call Analysis
Q1-2024 Analysis
Pennantpark Investment Corp
PennantPark Investment Corporation reported a consistent quarter with net investment income at $0.24 per share. However, there was a minor dip in the adjusted Net Asset Value (NAV) by 0.6% to $7.65 per share from $7.70 in the previous quarter.
The company was very active this quarter, directing $231 million into 44 new and existing portfolio companies, securing an impressive weighted average yield of 11.9%. This reflects PennantPark's ability to identify and invest in promising opportunities even in a challenging economic climate.
Portfolio credit quality remained stable, with no new nonaccruals reported. Even with rising base rates in 2023, the weighted average interest coverage ratio stood firm at 2.2x. This indicates that the portfolio companies can handle their debt obligations despite the increasing cost of borrowing.
There was a positive shift in first lien spreads tightening by 25 basis points. The loan characteristics in the core middle market—where PennantPark focuses—are superior to those in the upper middle market, with beneficial terms such as higher leverage and stricter covenants. The joint venture (JV) portfolio reflected growth and contributed a 19% return on invested capital over the previous year, bolstering expectations for future earning enhancements.
PennantPark is strategically focused on the core middle market sector, a segment known for resilience during economic downturns and strong free cash flow generation. Their tailored approach in this sector enables them to serve as a key lending partner to their portfolio companies, offering a package combined with diligent monitoring and substantial covenant protections.
Since its inception around 17 years ago, PennantPark has invested $7.8 billion with a compelling average yield of 11.3%, and has maintained an impressively low annual loss ratio of only 18 basis points on invested capital. Additionally, the company has seen strong returns from its equity co-investments, with an internal rate of return (IRR) of 26% and a 2.1x multiple on invested capital.
The company's outlook remains positive, with expectations for attractive new loan opportunities. PennantPark emphasizes preserving capital and patient investment strategies aiming to achieve risk-adjusted returns that support both income generation and capital conservation.
For the first fiscal quarter of 2024, PennantPark reported a net loss on investments and debt of $5 million, which resulted in an $0.08 decrease per share. The company maintains a diversified portfolio spanning 139 companies across 30 industries, with the weighted average yield on debt investments at 12.6%. Additionally, the debt-to-equity ratio was at a prudent level of 1.4x.
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Good afternoon, and welcome to the PennantPark Investment Corporation's First Quarter 2024 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.
Good afternoon, everyone. I'd like to welcome you to PennantPark Investment Corporation's First Fiscal Quarter 2024 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 include a discussion about forward-looking statements.
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 our latest 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.
Thank you, Rick. We're going to spend a few minutes and comment on the current market environment for private credit, provide a summary of how we fared in the quarter ended December 31, how the portfolio is positioned for upcoming quarters, a detailed review of the financials and then open it up for Q&A.
For the quarter ended December 31, our GAAP and core net investment income was $0.24 per share. GAAP and adjusted NAV decreased 0.6% to $7.65 per share from $7.70 per share. As of December 31, our portfolio grew to $1.2 billion or 16% from the prior quarter.
During the quarter, we continued to originate attractive investment opportunities and invested $231 million and 12 new and 32 existing portfolio companies at a weighted average yield of 11.9%. For the investments in new portfolio companies, the weighted average debt to EBITDA was 3.7x. The weighted average interest coverage was 2.4x, and the weighted average loan-to-value was 55%.
Credit quality of the portfolio is stable. We had no new nonaccruals in the quarter ended December 31. As of December 31, the portfolio's weighted average leverage ratio through our debt security was 4.9x. And despite the increase in base rates through 2023, the portfolio's weighted average interest coverage ratio was 2.2x.
On average, we have seen a 25 basis point tightening of first lien spreads. However, we continue to believe that the current vintage of core middle market directly originated loans is excellent. Leverage is lower, spreads and upfront OID are higher and covenants are tighter than in the upper middle market. Despite covenant erosion in the upper middle market, in the core middle market, we are still getting meaningful covenant protections. At December 31, the JV portfolio equaled $858 million. And during the quarter, the JV invested $81 million, including $8 million of purchases from PNNT.
Over the last 12 months, PNNT earned a 19% return on invested capital into the JV. We expect that with continued growth in the JV portfolio, the JV investment will continue to enhance PNNT's earnings momentum in future quarters.
Now let me turn to the current market environment. In an uncertain market environment, we are well positioned as a lender focused on capital preservation in the United States. We continue to believe that our focus on the core middle market provides the company with attractive investment opportunities where we provide important strategic capital for our borrowers. We have a long-term track record of generating value by successfully financing growing middle market companies in 5 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 and defense, health care and software and technology.
These sectors have also been recession resilient and tend to generate strong free cash flow. The core middle market, which is -- which are companies with $10 million to $50 million of EBITDA, is below the threshold and does not compete with the broadly syndicated loan or high-yield markets unlike our peers in the upper middle market.
In the core middle market, because we are an important strategic lending partner, the process and package 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 spreads, upfront OID and 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, unlike the erosion in the upper middle market, virtually all of our originated first lien loans have meaningful covenants, which help protect our capital. This is a significant reason why we believe we are well positioned in this environment. Many of our peers who focus on the upper middle market state that those bigger companies are less risky. That is a perception that may make some intuitive sense, but the reality is different.
According to S&P, loans to companies with less than $50 million of EBITDA had a lower default rate and higher recovery rate than loans to companies with higher EBITDA. We believe that the meaningful covenant protections of core middle market loans, more careful diligence and tighter monitoring have been an important part of this differentiated performance. As a provider of strategic capital that fuels the growth of our portfolio companies, in many cases, we participate in the upside of the company by making an equity co-investment. Our returns on these equity co-investments have been excellent over time.
Overall for our platform, from inception through December 31, we've invested over $448 million in equity co-investments and have generated an IRR of 26% and a multiple on invested capital of 2.1x. Since inception nearly 17 years ago, PNNT has invested $7.8 billion at an average yield of 11.3% and has experienced a loss ratio on invested capital of approximately 18 basis points annually. This strong track record includes investments of primarily subordinated debt made prior to the global financial crisis, legacy energy investments and recently, the pandemic.
With regard to the outlook, new loans in our target markets are attractive. Our experienced and talented team and our wide origination funnel is producing active deal flow. Our continued focus remains on capital preservation and being patient investors. We want to reiterate our goal to generate attractive risk-adjusted returns through income, coupled with 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.
Thank you, Art. For the quarter ended December 31, GAAP and core net investment income was $0.24 per share. Operating expenses for the quarter were as follows: interest and credit facility expenses were $9.6 million, base management and incentive fees were $7.3 million, general and administrative expenses were $1.4 million, and provision for excise taxes were $0.4 million. For the quarter ended December 31, net realized and unrealized change on investments and debt, including provision for taxes, was a loss of $5 million or $0.08 per share. As of December 31, our GAAP and adjusted NAV was $7.65 per share which is down 0.6% from $7.70 per share in the prior quarter.
As of December 31, our debt-to-equity ratio was 1.4x, and our capital structure is diversified across multiple funding sources, including both secured and unsecured debt. As of December 31, our key portfolio statistics were as follows: our portfolio remains highly diversified with 139 companies across 30 different industries, the weighted average yield on our debt investments was 12.6%, PIK income equaled only 3% of total investment income.
We had one nonaccrual, which represents 1% of the portfolio at cost and 0% at market value. The portfolio is comprised of 58% first lien secured debt, 7% second lien secured debt, 9% subordinated notes to PSLF, 4% other subordinated debt, 5% equity in PSLF, and 16% in other preferred and common equity. 96% of the debt portfolio is floating rate. And debt to EBITDA on the portfolio is 4.8x, and interest coverage is 2.2x.
Now let me turn the call back to Art.
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 our remarks.
At this time, I would like to open up the call to questions.
[Operator Instructions] And our first question comes from Mark Hughes of KBW ( sic ) [ Truist Securities ].
I'll go with the Mark Hughes part of that. Rick, what did you say the EBITDA coverage was on the overall portfolio?
So EBITDA was 4.8x and the interest coverage was 2.2x.
Yes. And then any nuance now about the attractiveness of either subordinated debt or the preferred or common? The first lien is -- has obviously been attractive. But anything about the dynamic where you might see a little bit more of a preference for some of those other categories?
Yes. Thanks, Mark. And by the way, just to clarify, Mark Hughes is with Truist. And look, we do invest across the capital structure. Obviously, it's been really good to do first lien in this higher yield environment with the vintage and the good credit stats as well as classically, we'll do equity co-invest to participate in some of the upside.
There are interesting second lien, sub-debt and pref deals to look at. They just haven't been that interesting relative to first lien recently. But we will continue to look. And if we have real conviction, we'll potentially kind of take a look at adding some of that to the portfolio judiciously and carefully.
Next, we go to the line of Robert Dodd with Raymond James.
Congratulations on the quarter. Just on the activity in the quarter, I didn't catch this, if you said it, Mark. Can you give us an idea how much of that origination was really late in the quarter? Because it certainly looks like you it. You originated it a lot. Interest income didn't move that much and lates did move, right? So I presume a considerable portion of that was very late, but like just how much?
Yes. Thank you, Robert. So about 40% of the origination was done in the month of December.
Got it. Thank you. I mean as you said -- some of my questions have already been answered on a previous call. So some of the key sectors that you look at like business, there's consumer, government, et cetera, any change in relative attractiveness there? I mean in kind of the activity, the initial preliminary pipeline may be for the next -- for the rest of the year. Is it concentrated in those sectors, i.e., does it really mesh with your preferences? Or is -- how is that looking in terms of your potential opportunities by interest area?
So in general, look, we've been very active in defense and government services. We're one of the leading lenders in that space. Given what's going on geopolitically, we feel like there's really nice tailwinds to that space. So we've been very active there. And for us, we've had a really good track record. It's very stable, steady and now potentially growing. Health care continues to be active for us. Now some of our peers have stumbled a little bit in health care. We've thankfully avoided some mistakes and our way of looking at it and avoiding reimbursement risk, keeping leverage low, trying to get behind companies that are helping bring high-quality care at a low cost has generally performed well from a credit standpoint. And then business services, which is a big catch all. Business services can mean a lot of things. We're active there. We've been less active in tech/software. It's always been one of our smaller verticals. We're -- we lend against cash flow. We don't lend against revenue, and we lend reasonable levels of cash flow. So we've -- it's a sector for us. It's not one of our bigger sectors. And then consumer remains a sector for us. We've been a little bit more cautious there given some of the volatility around -- potential volatility around the consumer.
We've done better there when we've had brands that have some meaning. And we haven't done a lot there recently. But if you look at kind of what's worked for us and what hasn't worked, brand that had meaning have worked. So it's really been government services, defense, health care and business services is kind of the big 3 for us.
Perfect. And on that point, I mean you'd like to say business services is little white bucket, so is health care. And to your point, you didn't do a lot of site position [ office ] roll-up, so things like that. So reimbursement risk, et cetera. I mean -- so is the interest there? Is it the intersection between health care and government? Is it health care? I mean just -- you have had some successes in that area. So I mean, what's looking particularly -- maybe you don't want to say on a public call, but what's looking narrower areas in within that are looking good right now?
Yes. I mean there's a number of different niches. It's such a vast industry. It's about 20% of the GDP of the United States. There's so many different niches of care and services and synergies to be had among small or medium-sized providers and putting them together and then dealing with payers who want to get synergies around who they're paying as well.
So we can -- offline, we can go through some of the names in the portfolio, but it's a wide variety of different kinds of ways to articulate, hopefully, stable or growing health care niches with high free cash flow where you're providing care at a reasonable cost that payers view as a reasonable cost. So it's enormous. We can certainly go to -- going it off-line, but it's all in there in the SOI statement of investments and people can look and see. Go in and do the interpolation to the websites of these companies and see kind of the stuff we're doing.
Got it. Got it. One last one, if I can, on credit. Obviously, interest coverage, et cetera, that looks good. Obviously, there's always going to be some marginal companies in the portfolio, but that's always the case anyway. I mean in terms of trends, are you seeing any emerging signs of weakness, maybe not even in the portfolio, but across businesses that are coming to market now? I mean it just seems everything is hanging in on a credit front-wise, broadly much better than I would have thought if you'd ask me certainly like 2 years ago. So is anything catching up to anybody yet? Or is it just everything fits along and everything is doing relatively fine?
Yes. We agree. It's -- as lenders, we're skeptics by nature. We presume and we underwrite assuming a recession, which is how we underwrite. And if you rewind the tape to some of these calls a year or 2 ago, we were saying very clearly, we're underwriting and assuming a recession. That has not appeared. So again, our credits generally perform very well because we underwrote assuming a recession. Now we did not assume that base rates -- going way back, we did not assume base rates would be where they are today. So that's been the -- that has been the surprise. For us, it's been, by and large, good because the yields we're getting are excellent. If these base rates continue to persist, of course, in a portfolio of 100 or 150 names, there's going to be some companies that are, over time, just -- it's just too expensive for and where there'll be amendments and things of that nature as this higher for longer trend continues. If when the Fed starts easing, that will give some of these companies a little bit of a break and a breather. But by definition, if these base rates persist for a while in any portfolio of this magnitude and the magnitude of our peers, there's going to be companies peeling off and needing amendments and extensions and needing some relief because you can't have 100, 150 companies all going up to the right all together no matter how good you are.
And then we think we're pretty good. We think some of our peers are pretty good. And by and large, EBITDAs are growing 5% to 10%, and we're really thrilled with that. But by definition, there's always a handful of companies that are going to need some help.
Next, we go to the line of Casey Alexander with Compass Point.
And pretty simple stuff here. This one is just first maintenance. The weighted average yield dropped, if I'm correct, about 40 bps quarter-over-quarter, which is actually a fair amount in this environment. Is that new weighted average impacted by the fact that you're now carrying the government securities in the portfolio as opposed to categorizing them as cash and cash equivalents?
Well, I'll take the first crack and kick it over to Rick. I mean, for sure, we've seen, as we said, spread compression. So the new deals are coming in, call it, 25 bps tighter from a spread compression standpoint since we have been very active, the weighted average certainly has come down. Rick, I don't know if you have any other commentary other than that.
I'll just confirm that the government securities are not included in the calculation of the weighted average yield, so they are not impacting the outcome.
Okay. All right. Then secondly, I noticed in the SOI that you made a new loan of $50 million to Mid-Ocean. And if I'm not -- and maybe I'm not correct, maybe -- but I think you've been sort of in and out and around that name for quite a while. Could you kind of walk us through your history with Mid-Ocean and what you found attractive to put a new $50 million in, in this quarter?
It's a great question and you're very astute at highlighting this. This is a company called JF Petroleum, which we've had for a while. It was originally a mezz deal, then it was a restructured deal where we owned a chunk of equity and was restructured once again where we basically just became an equity holder. The company has seen a resurgence. There's been some very smart add-on acquisitions that have been made. The company has come back very, very strongly, and you could track the value of the equity. There's an equity piece that's been marked up. It's coming back strong. And the company, we'll see. I've learned not to overpromise, Casey, and you can appreciate that. The company is coming back strong. Let's just put it at that, and we'll see where we go.
Next, we go to the line of Paul Johnson with KBW.
I was just hoping to get a little bit more color maybe on just what kind of what drove the depreciation this quarter. Was it just sort of broad across book? Or were there any loans in particular that were -- that mainly drove that?
Yes. So picking up to Casey's last point, JF was up substantially. The 3 loans that have been marked down are Flock Financial, Walker Edison, which was a restructuring, which remains challenged and a company called Atlas Purchaser. So those were the big 3, the 3 biggest declines in loans that got marked down during the quarter.
Got it. Yes. I did notice Flock Financial. I did notice that was a bigger loan in your portfolio that was marked down this quarter. I was just curious if you could just kind of -- maybe just tell us what that business is and kind of what drove the weaker mark this quarter?
Yes. It's a specialty finance company. They are focused on busted credit card receivables, auto receivables. And they've had some recent stumbles. We are in there working with them to help solve the problem. It could be a really good sector. They've made some mistakes. And we're in there working with the company and trying to help them grow, solve their problem and build back up.
Got it. I appreciate the color there. Two more. Just on the equity co-investment, it sounds like there could be some possible rotation there this year, which would be great. I was wondering if it's at all possible to quantify that in any way, maybe without names or if there's even just any particular industry that maybe you would expect that is kind of ripe for deals. Just any sort of clues there would be helpful.
Yes. So we had -- in the quarter ended December, we had a company called TBC get sold, and we had some equity in that. This quarter, so far, year-to-date, we just had an exit company got sold. I can't tell you the name, but obviously, it will be public in May when we talk in May. So we're starting to see as M&A kind of hopefully gets back going again, good news and bad news, kind of we will inevitably get repayments of some of our better deals. That's both -- that is good news and bad news at the same time.
And then as we've said, equity co-investment is typically part of the package in many of these. We will get liquid on some equity pieces. Nothing that major or material but 2s and 3s and 5s can all add up over time and they're very helpful. And as we've said, our MOICs have been multiple and invested capital been north of 2x historically. And both TBC and the one I'm referring to were kind of in the 3 to 4x MOIC zone. So kind of we'll see. It's -- you can't count on it, but as deal flow grows, we hope to see some more equity rotation.
Got it. And last one, I'm just wondering if you guys have any sort of idea within the portfolio? I mean, if you've seen trends of higher PIK utilization from your sponsors or even if you have any idea? If that's the case, if you're seeing higher PIK utilization, what sort of percent of your loans might be on PIK at the moment? I would just assume, obviously, with base rates where they're at, expect it to stay high for -- even for -- into the rest of the year, that could be something we would see. But just curious to get your thoughts on that.
Rick, do you want to talk about PIK income?
Yes. Paul, for the quarter, PIK income was about 3% of total income. So currently, it's at a relatively low percentage.
Outlook -- from an outlook standpoint, Paul, look, as we said, if this higher for a longer trend continues, inevitably, some companies are going to need some relief. And part of amendment structures could be PIK. So 3% feels really good now, and we're very proud of that. But we'll just see how long this higher for longer trend continues and quite possibly, it could go higher than 3%.
We go next to Brian McKenna with Citizens JMP.
Okay. Great. Most of my questions have been asked, but I just had one question for you. So we've seen some consolidation in the public BDC universe. And I think really what some of these consolidation announcements are getting at are greater scale and bigger kind of public vehicles. So would you ever look to merge PNNT with PFLT just to kind of create a bigger publicly traded vehicle? And if that's something you would look at, I mean, what would kind of have to take place or align for that to take place?
Yes. Thank you. So look, we -- all things are always on the table. So let me just state that. We're always looking for ways to enhance shareholder value. Over time, PNNT has had a different investment orientation, a little bit lower in the capital stack, a little bit higher return. In addition, PNNT, as we know, has had a chunkier, lumpier performance and NAV. So -- and it's not traded as well, quite frankly, as PFLT. PFLT has had, what we think, is a fairly pristine track record. So it's something we look at from time to time. We are always looking to say, hey, does it make sense to have 2 different strategies. Does it make sense to have 2 different strategies? As PNNT hopefully gets less lumpy and hopefully trades better, then that discussion might be something kind of more current. But it's something we look at, something we evaluate and it's a good question.
We go next to Melissa Wedel with JPMorgan.
Mine have also been mostly asked already, but I thought I'd touch on portfolio leverage. Certainly, with a really productive December quarter in terms of originations, it seems like portfolio leverage has risen above where you identified your target as being. Is this -- are you comfortable at current levels? Or would you consider sort of rotating out of the government securities and take a [ march ] down a bit towards your target?
Yes. So there's a couple of different things in your question. First, the JV, kind of the way the JV works is we usually season assets at the BDC level at PNNT. And then after the season, they may move on to the JV. So December 31 was a moment in time. It was a moment in time. So our goal is really to kind of get down to kind of our core target, which is around the zone of 1.25x. So 1.4x we're a little higher than that. So we're going to look to get back down to our target as assets move from the BDC level to the JV over time.
Rick, do you want to cover the treasuries, the government securities and what we do and how we do it, so just to clarify?
Sure. So at quarter end, we are executing and putting on balance sheet, some U.S. treasuries just from a perspective of kind of balance sheet optimization in terms of kind of how we think about utilizing kind of that 30% bad asset bucket.
We don't call the bad asset bucket. We say it's a good asset bucket, but it's the 30% asset bucket, opportunistic bucket. So our JV -- just to be clear, our JV has been really successful. It's been really accretive for PNNT shareholders. And we like -- that's part of our 30% bucket. And we like having room in that. We might grow the JV, we might do another JV. Keeps a very good option for the company open to optimize that 30% bucket.
Okay. That's helpful. I appreciate it. Separate question. it seemed like there was a lot of activity both to new companies and existing companies in the December quarter. I was just curious if you're -- what you're seeing in terms of sort of existing companies and how they're using proceeds of incremental borrowings. Any trends -- anything worth noting?
Yes. Look, it's -- a lot of what we do is start off with companies as a platform in a particular sector where the private equity sponsor says, hey, this is our platform company. We're going to go execute a strategy of doing add-on acquisitions. And we finance them either with delayed draws or just add-ons and incrementals. And it's part of our normal flow. Again, this is where our equity co-invest can be helpful where we're helping them grow the platform, and we can participate in the upside. So nothing really dramatic. It just we were active in that calendar Q4, and that activity included existing portfolio of companies.
Okay. So that was companies drawing down on existing facilities or you're seeing some incremental add-on acquisition?
Well, in most cases, there's a delayed draw term loan that's structured at the beginning of a deal. And that delay draw is meant to be relatively easy for the borrower to access to do add-on acquisitions or grow subject to certain thresholds. So much of that is delay draw term loan facilities being drawn. Occasionally, it's an incremental. That's not a delay draw, but much of it is a delay draw that's being drawn.
We have no further questions. I'd like to turn the floor back to Mr. Art Penn for any additional or closing remarks.
Thanks, everybody, for being on the call today. We look forward to speaking to you next in May. Have a great day.
This concludes today's conference. We thank you for your participation. You may disconnect your lines at this time.