PennantPark Floating Rate Capital Ltd

NYSE:PFLT

Q3-2025 Earnings Call

[Operator]

Good morning, and welcome to PennantPark Floating Rate Capital's Third Fiscal Quarter 2025 Earnings Conference Call. [Operator Instructions]

It is now my pleasure to turn the call over to Mr. Art Penn, Chairman and Chief Executive Officer of PennantPark Floating Rate Capital. Mr. Penn, you may begin your conference.

[Arthur Penn, executive]

Thank you, and good morning, everyone. Welcome to PennantPark Floating Rate Capital's Third Fiscal Quarter 2025 Earnings Conference Call. I 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.

[Richard Allorto, executive]

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 Floating Rate Capital 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.

[Arthur Penn, executive]

Thanks, Rick. I'm going to spend a few minutes discussing how we [ fared ] in the quarter ended June 30, highlight the financing activities we executed during the quarter to strengthen the balance sheets of both PFLT and the PSSL joint venture. Then I'll comment on our new joint venture, the current market environment for private middle market lending and how the portfolio is positioned for upcoming quarters.

Rick will conclude with a detailed review of the financials, and then we'll open up the call for Q&A. We are seeing an encouraging recent uptick in deal activity, which we believe will lead to increased loan originations in the second half of 2025. Additionally, we continue to provide additional capital to many of our existing portfolio companies as they execute their respective growth plans. Our platform continues to prove its strength as we support our existing portfolio companies and private equity borrowers with strategic capital solutions to help grow their businesses.

With regard to how we [ fared ] in the quarter ended June 30, core net investment income for the quarter was $0.27 per share. We believe we will achieve net investment income coverage of the dividend as we scale into our target leverage range as the new joint venture becomes operational. As a reminder, prior to Liberation Day, we proactively built a war chest to our ATM program and debt financing activities based on the expectation of sustained deal flow throughout the year.

While market activity slowed the following Liberation Day, we have seen a notable rebound in recent weeks. Looking ahead, we are encouraged by the strong outlook for the remainder of the year and anticipate continued NII growth and full dividend coverage. We are pleased to announce the formation of a new joint venture with our long-term and trusted partner, [ Hamilton Lane ]. The company in [ Hamilton Lane ] have committed to provide $200 million of capital to the joint venture and combined with an expected $300 million financing facility, the total portfolio will be $500 million.

Similar to PSSL, the new joint venture will invest in our core middle market directly originated senior secured loans. We anticipate beginning to invest the capital towards the end of September or the beginning of October. We continue to believe that the current vintage of core middle market directly originated loans is excellent. In the core middle market, leverage is lower and spreads are higher than in the upper middle market.

In the core middle market, the pricing on high-quality first lien term loans is [ over ] plus $475 million to $525 million, we continue to get meaningful covenant protections while the upper middle market is primarily characterized as covenant like. Turning to our current portfolio. We continue to maintain what we believe is one of the most conservatively structured portfolios in the direct lending industry. As of June 30, our portfolio's weighted average leverage ratio through our debt security was 4.3x, and the portfolio's weighted average interest coverage ratio was 2.5x.

Our new platform investments made during the quarter, the weighted average debt-to-EBITDA was 3.8x and the weighted average interest coverage was 2.6x. Weighted average loan to value was 46% and yield of maturity was 10.3%. As of June 30, we had 2 investments on nonaccrual status and total nonaccruals represented only 1% of the portfolio at cost and 0.5% at market value.

These are strong credit metrics, which reflect the rigor of our underwriting process and the discipline of our investment approach. We continue to believe that our focus on core middle market loans provides us with attractive investment opportunities where we provide important strategic capital to our borrowers.

We have a demonstrated track record of value creation through the successful financing of growing middle market companies across 5 key sectors. These are sectors in which we possess deep domain expertise enabling us to ask the right questions and consistently deliver strong investment outcomes. There are business services, consumer, government services and defense, health care and software and technology.

These sectors have been recession-resilient, tend to generate strong free cash flow and have a limited direct impact to the recent tariff increases and uncertainty. Core middle market companies typically [indiscernible] with $10 million to $50 million of EBITDA, operate below the threshold of broadly syndicated loan or high-yield markets. [indiscernible] package of terms we receive is attractive. We have many weeks to do our diligence with care.

We thoughtfully structured transactions with sensible credit statistics, meaningful covenants, substantial equity cushions to protect our capital, attractive spreads and equity co-investment. Additionally, from a monitoring perspective, we received monthly financial statements to help us stay on top of the companies. Regarding covenant protections, while the upper middle market has seen significant erosion, our originated first lien loans consistently include the meaningful covenants that safeguard our capital. Credit quality since inception of 14 years ago has been excellent.

PFLT has invested $7.8 billion in over 500 companies, and we've experienced only 23 nonaccruals. Since inception, PFLT's loss ratio on invested capital is only 11 basis points annually. As a provider of strategic capital, we 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 June 30, we've invested over $583 million in equity co-investments and have generated an IRR of 26% and a multiple on invested capital of 2x. As of June 30, our portfolio grew to $2.4 billion, up from $2.3 billion in the prior quarter. During the quarter, we continued to originate attractive investment opportunities and invested $208 million in 4 new and 17 existing portfolio companies at a weighted average yield of 10.1%.

During the quarter, we undertook several key initiatives to fortify our balance sheet enhance liquidity and position the company to capitalize on emerging market opportunities. In April, we amended the truest revolving credit facility and reduced the interest rate on the facility to SOFR plus [ 2.00 ] from SOFR plus 2.25. The amendment also extended the revolving period and final maturity by 1 year to August 2028 and August 2030, respectively.

Our financial strength was also enhanced by attractive equity capital raised from our ATM program. During the quarter, we raised $32 million from the issuance of 2.8 million shares of our common stock at an average price of $11.31 per share. Our PSSL joint venture has also taken significant strides and bolstering its financial strength as well. As of June 30, the JV portfolio totaled $1.1 billion. And during the quarter, it invested $52 million in 7 new and 2 existing portfolio companies at a weighted average yield of 10.8%.

In April, PSSL closed on a new securitization financing at an attractive weighted average price of SOFR plus [ 171 ]. PSSL has $250 million of additional committed debt and equity capital [ and ] a gross total portfolio to $1.4 billion. We believe that the increase in scale of the JV's balance sheet will continue to drive attractive mid-teens returns on invested capital and enhance PFLT's earnings momentum.

From an outlook perspective, our experienced [indiscernible] team and our wide origination funnel is well set up to produce active deal flow. Our continued focus remains on capital preservation and being patient investors. Our mission and goal or a steady, stable and protected dividend stream, coupled with the preservation of capital. Everything we do is aligned to that goal. 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 in first lien senior secured instruments, 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 you through the financial results in more detail.

[Richard Allorto, executive]

Thank you, Art. For the quarter ended June 30, GAAP net investment income was $0.25 per share, while core net investment income was $0.27 per share. Operating expenses for the quarter were as follows: interest and expenses on debt were $25.4 million. Base management and performance-based incentive fees were $11.3 million. General and administrative expenses were $1.95 million and provision for taxes was $0.2 million.

For the quarter ended June 30, net realized and unrealized change on investments, including provision for taxes was a loss of $5.3 million. As of June 30, NAV was $10.96 per share, which is down 1% from $11.07 per share last quarter.

As of June 30, our debt-to-equity ratio was 1.3x, and our capital structure is diversified across multiple funding sources, including both secured and unsecured debt. As of June 30, our key portfolio statistics were as follows: the portfolio remains well diversified, comprising 155 companies across 50 industries; the weighted average yield on our debt investments was 10.4% and approximately 99% of the debt portfolio is floating rate; fixed income equaled only 1.8% of total interest income. We had 2 nonaccruals, which represent 1% of the portfolio at cost and 0.5% at market value. The portfolio is comprised of 90% first lien senior secured debt, less than 1% in subordinated debt, [ 2% ] in equity of PSSL and 8% in equity coal investments. The debt to EBITDA on the portfolio is 4.3x, and interest coverage was 2.5x.

Now let me turn the call back to Art.

[Arthur Penn, executive]

Thanks, Rick. In conclusion, I want to express my gratitude to our dedicated team of professionals for their unwavering commitment to PFLT and its shareholders. Thank you all for your time today and for your investment and confidence in us. .

That concludes our remarks. At this time, I would like to open up the call for questions.

[Operator]

[Operator Instructions] We will take your first question from Brian Mckenna with Citizens.

[Brian Mckenna, analyst]

Congratulations on the new JV with Hamilton Lane. Just a few questions here. If this pickup in the acceleration in deal activity continues how much of the $500 million could you deploy over the next few quarters? How are you thinking about the potential accretion from the JV within the PFLT? And then obviously, Hamilton Lane is getting access to high-quality [indiscernible] middle market deal flow and transactions. But is there anything you can leverage from the Hamilton Lane platform to drive better outcomes for the JV as well?

[Arthur Penn, executive]

Bunch of great questions in there, Brian. Let's make sure I hit them all. In terms of being able to ramp it, I think we think of it as kind of a 12-month ramp for the $500 million, maybe 18 months on the outside.

But in light of our platform, we think of it was a 12- to 18-month ramp. And as you've seen, the 2 other JVs we've had in our platform, both the PFLT and PNNT, these things can -- have done well and we hope it will be well in a good [ sympatico ] with Hamilton Lane. They can grow very substantially above and beyond that.

So our vote would be this is a long-term partnership with this JV and then it grows from $500 million to something larger over time. We've been able to get kind of I dividend yields on these JVs in the mid- to upper teens between the PSSL 1 here and PFLT as well as PSSL for PNNT kind of mid- to upper teens [indiscernible] returns on an NII basis on the capital invested, so you can model the $150 million we're putting in and put it mid-to upper teens NII return on that and see what that means.

But over time, we hope it's a really long term -- great long-term partnership. We've had a lot of exposure to Hamilton Lane to date, and that's kind of what led the way to this, and we think there's a real synthetic around credit and how we look at things. And then yes, we expect all these JVs, the other JVs we have as well to be real partnerships where parties contribute ideas and diligence and thoughts with what's going on in the economy. Hamilton Lane has a lot of great relationships with private equity sponsors and other people that we could be doing business with.

So we expect and hope that they will help us in that regard. So we're very excited about it.

[Brian Mckenna, analyst]

Okay. That's really helpful. And then maybe just a little bit of a bigger picture question. You and the team have clearly done a great job growing your public BDCs in aggregate, the market caps for both PFLT and PNNT totaled about $1.5 billion. I'm curious to what's your longer-term growth plans for both of these vehicles? And I think I asked you this almost every quarter, but at what point or size does it make sense to merge them? And then assuming you ultimately have 1 public BDC longer term, I mean, would you ever think about internalizing the corporate structure?

[Arthur Penn, executive]

So in terms of the first question, growth, we're not the type of firm to sit here and put the kind of growth parameters out there and then kind of have goals because we think that's antithetical to credit quality and investment selection.

So in a business where you have quality on 1 scale and quality on the other. Clearly, we focus on quality. So the growth will be organic based on the opportunity in the market and where it makes sense to invest. So the growth will be the growth as you've seen overall all these years, and it will be based on kind of the market opportunity.

You do ask the same question every quarter, Brian, about potentially merging and the answer every quarter and you can record this and play back to yourself going forward is all things are always on the table. That said, PNNT is still -- we still got to work through some equity rotation issues at PNNT. So we -- our main focus there is to do that. And then once we do that, we can come up for air and assess all the different options that are available in the world, we, of course, put shareholder value is, number one, what's best for shareholders. And that's always our north star when we look at these things.

[Operator]

We'll hear next from Arren Cyganovich from Truist.

[Arren Cyganovich, analyst]

You mentioned in your press release that you expect that NII will -- or you anticipate that NII will fully cover the dividend over time. Maybe you could talk a little bit about timing associated with that or expectations as you go throughout the rest of the year?

[Arthur Penn, executive]

Yes. So look, we have -- it's a good question, Arren, and welcome back to PennantPark and PFLT. We have 3 levers of NII growth at the company. Lever 1 is leveraging up to our target leverage ratio of about 1.5x area. We're below that as of quarter end. So that's lever number one. Lever number two is filling out PSSL 1, that's the Kemper JV. We've got some more capital to deploy [indiscernible] before that's kind of full at this point in time, of course. [indiscernible] You can always grow these things once you get full, but that's kind of lever number two. And then lever number 3 is the new [indiscernible] Hamilton Lane JV, PSSL 2. As I just said, that's probably a 12- to 18-month ramp.

So we think as we pull those levers, 1, 2 and 3, we'll will target covering -- certainly covering the dividend, if not more. You guys can do the model. You're an expert of modeling, but our models show that between those levers, we can more than cover the dividend over time.

[Arren Cyganovich, analyst]

That's helpful. And credit quality continues to be very strong. Can you talk a little bit about what you're seeing at the portfolio company level in terms of some of the metrics there in terms of EBITDA growth, et cetera?

[Arthur Penn, executive]

Yes. Look, we -- EBITDAs continues to grow nicely in general, kind of mid- to upper single digits overall. Certainly, it's dependent on the underlying company in the industry, but you could see nonaccruals are relatively light. We hope to keep them that way. You can also see that we're keeping leverage level on both new deals and the overall portfolio low as well, new deals 3.8x debt to EBITDA, 2.6x interest coverage, overall portfolio of 4.7x, debt-to-EBITDA 2.5x coverage, a very limited pick in this portfolio. .

That's what happens when you keep leverage low. Again, we feel like we are among the lowest risk in our -- in the peer group in addition to the fact that we still get covenants that are meaningful to protect the capital. So the portfolio is chugging along well. Of course, like any portfolio with 150 names or so, there's going to be a few underperformers, and there are. But overall, we are seeing a relatively strong situation with the portfolio.

[Operator]

[Operator Instructions] We'll move next to Christopher Nolan from Ladenburg Tolman.

[Unknown Analyst]

Guys, is the high -- or I guess, Rick, is the high level of unrestricted cash at quarter end, going to be directed towards the JV.

[Richard Allorto, executive]

Chris, that cash, some of it will, yes, will be used for the JV. Quarter end tends to be a high collection period. So as just some part of that cash balance is just a timing from a cash management and working capital perspective in terms of using it to deploy and fund new investments versus temporarily pay down debt, waiting for new opportunities.

[Unknown Analyst]

Great. And Art, strategically, given the comments you gave on the lending market, are you expecting to see improved loan pricing power given what seems to be increased appetite for leverage by middle market companies?

[Arthur Penn, executive]

Yes. Thanks, Chris. By the way, welcome back [indiscernible] on the case. We certainly hope so. I mean spreads have certainly come down over the last year, 1.5 years. Today, $4.75 to $5.25 is kind of the range. We hope that and increased supply will give us an opportunity to maintain. And then maybe [indiscernible] expand those spreads. Constitutionally, though, kind of lessons learned over many years is credit first. So we're generally okay if the credit is excellent. [indiscernible] taken a slightly lower spread because, of course, nonaccruals are really what gets you and where the pain is felt in these portfolios. So at the same time, most importantly, select excellent credit. So hopefully, with more supply, there'll be an opportunity to get more spread, but of course, no guarantees.

[Operator]

[indiscernible] from [indiscernible].

[Unknown Analyst]

So going back to the recent rebound in M&A activity, is there any sort of mix shift in terms of what's in the pipeline or where dollars are being deployed, whether it's versus new borrowers or sponsor versus non-sponsor?

[Arthur Penn, executive]

Yes. Great question [indiscernible], So up to about a month ago, I would have said it's mostly incumbencies where we're doing delayed draw drawdowns or add-on loans to existing companies. Again, most of our prototypical deals are where we start with a company that's being bought from a founder or a family and entrepreneur by a middle market private equity firm. It does between 10% and 20% of EBITDA. It's a fragmented industry, and the private equity firm wants to do a consolidation play in a fragmented industry.

We come in, we [indiscernible] by the capital to do the initial deal and then add on [ loans ], whether it delay draw or otherwise to take that into $20 million EBITDA company up to $30 million, $40 million, $50 million and above. And in that case, we become kind of a strategic partner, where -- our capital is the fuel to drive that growth. We participate in the equity through the co-investor there's kind of a built-in equity upside to the package of what we deliver.

So up until about a month ago, I would have said it's virtually all add-ons and delay draws and that's pretty good. I mean we have a lot of incumbency. We have 190-some companies broadly throughout the platform, 158 in PFLT. So there's just a lot of just incumbency and add-ons with credits that you know and like, and that's great. And if we don't like the creditor, we're credits underperforming, we don't have to give them the extra capital. So that's really a built-in competitive edge when you have portfolios of this size and scale.

I do -- I would say that in the last month, in the last month, some new platforms have been increasingly coming to us. And we've been more active starting the new platforms, again, back with that smaller company with the add-on acquisition pipeline and regenerating that. So that's kind of the difference in the last month. In PFLT, in particular, it's virtually all sponsors -- sponsor deals. Again, in -- our focus here is capital preservation and yield the capital preservation first. So we like having a loan to value of 40% or 50%, which is typically what it is today. So that if there's a bump in the road, that sponsor capital provides the cushion.

And typically, when they're putting in 50%, 60% of the equity from the get-go, if there's a bump in the road, typically, they will invest additional capital to solve that problem, and we certainly saw that in spades during COVID when virtually every liquidity situation was solved with additional sponsor capital. In terms of the industries, it's the same old industries where we think we have the domain expertise. Clearly, we're shying away from tariff. We always shied away from tariff impact even more so today. But by and large, it's the same industries.

[Operator]

And at this time, there are no additional callers in the queue. I'd like to turn the conference back over to Mr. Art Penn for any additional or closing comments.

[Arthur Penn, executive]

I think there might be a question in the queue if we could or may bought away -- yes, it looks like there is.

[Operator]

Looks like we just add Paul Johnson from KBW.

[Paul Johnson, analyst]

I hopped on a little late here. I apologize if you already mentioned this on the call or if the question has already been asked. But it looks like just kind of based on the ATM activity for the quarter that you guys issued most likely most of the shares on the ATM pretty early in the quarter, the stock would have been trading at a bigger discount to NAV than kind of where you guys trade today, but you obviously have the history of subsidizing that discount when you issue those shares.

I'm just curious, I mean, is that something that you would plan on doing going forward pretty regularly in terms of just kind of capital management just sort of -- or is there going to be more, I guess, context around valuation of shares, I guess, going forward?

[Arthur Penn, executive]

It's a good question, Paul. And the answer is, of course, yes, and yes. We we did issue 32 million of shares -- 2.8 million shares, at $11.31. That was a pre-Liberation Day price. We were building our war chest for what we thought was going to be a very active 2025.

So between the ATM program and all the things that we were doing with our credit facility and the redialing of the securitization. So our timing was good from the standpoint of issuing shares at a very attractive price pre-Liberation Day. Unfortunately, the deal fluid income after Liberation Day, we had 60 to 90 days of light deal flow. It seems to be picking back up again. And we certainly think and are hopeful that the remainder of this year will be good, and we can deploy that war chest that we built through the ATM program and through our credit facilities nicely here for the remainder of of 2025.

As you know, ATM programs are very efficient. They're low cost. They tend to -- at least the way we've done it and been surgical in terms of kind of how the stock trades. So we look at everything. We look at our deal flow, we look at the capital structure, we look at where the stock is trading. And -- but right now, we are -- as we speak very -- have a lot of capital, as you can see, between being underlevered at PFLT and having 2 JVs that have available capital. So at least at this point, we're set, and we're in good shape to now deploy all the capital that we raised.

[Operator]

And at this time, there are no additional callers in the queue. Mr. Penn, I'd like to turn the conference back over to you for any additional or closing comments.

[Arthur Penn, executive]

Yes. I just want to thank everybody for participating today and wishing everybody a terrific remainder of summer. Our next quarterly earnings will be after 2Q. So later than normal because of the annual report. So it will be kind of mid to late November, probably right before Thanksgiving. We'll talk to everybody next. And thank you for your time and support of PFLT. .

[Operator]

That does conclude today's teleconference. We thank you all for your participation. You may now disconnect.