Good morning, and welcome to the PennantPark Floating Rate Capital's first fiscal quarter 2022 earnings conference call. Today's conference is being recorded. At this time, all participants have been placed in a listen-only mode. The call will be open for a question-and-answer session following the speaker's remarks. If you would like to ask a question at that time, simply press star one on your telephone keypad. If you would like to withdraw your question, press star two on your telephone keypad. 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.
Thank you. Good morning, everyone. I'd like to welcome you to PennantPark Floating Rate Capital's first fiscal quarter 2022 earnings conference call. I'm joined today by Richard Cheung, our Chief Financial Officer. Richard, please start off by disclosing some general conference call information and included discussion about forward-looking statements. Richard?
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, that any unauthorized broadcast of this call in any form is strictly prohibited. Audio replay of the call will be available by using the telephone numbers and pin provided in our earnings press release, as well as 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 that we ask you to refer to our most recent filings with 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.
Thanks, Richard. I'm gonna spend a few minutes discussing how we fared in the quarter ending December 31, how the portfolio is positioned for the upcoming quarters, our capital structure and liquidity, the financials, and then open it up for Q&A. Our net investment income grew to $0.33 per share, which includes $0.05 of other non-recurring income. Our credit quality remains solid. We're pleased that we've grown NII through growing the assets on balance sheet at PFLT as well as that of our PSSL joint venture. Now that we have reached the zone of our target debt equity ratio at PFLT, we remain focused on two additional prongs to our strategy to grow NII. Number one, growing our PSSL JV with Kemper to enhance overall ROE at PFLT.
Number two, rotating the equity value in our portfolio that has come from our strong equity co-investment program into cash-paying debt instruments. With regard to the PSSL joint venture, with the CLO financing we completed earlier this year, as well as additional capital contributions from PFLT and Kemper, the JV will continue to grow. The capital contributions from PFLT are targeted to generate a 10%-12% return. We're on a path to grow PSSL to over $700 million in the current quarter. We have started discussions with Kemper to increase the JV to have approximately $1 billion assets over time. We believe that the increase in scale and the attractive ROE will enhance PFLT's earnings and momentum. As part of our business model, alongside the debt investments we make, we selectively choose to co-invest in the equity side by side with the financial sponsor.
Our returns on these equity co-investments have been excellent over time. Overall for our platform from inception through December 31, our $297 million of equity co-investments have generated an IRR of 29% on a multiple on invested capital of 2.9x. In a world where investors may wanna understand differentiation among middle market lenders, our long-term returns on our equity co-investment program are clearly differentiated. We have implemented a significant portion of the NII growth strategy to date. The investment portfolio of PFLT increased by approximately $100 million in the quarter to $1.18 billion from $1.08 billion. PSSL's investment portfolio also grew this quarter from $565 million - $642 million, an increase of $77 million.
We're focused on the core middle market, which we generally define as companies with between 10 and 50 million of EBITDA. The target market where we think we add the most value and where we get the strongest package of risk return is in the 10 million-30 million of EBITDA range. We like the core middle market because it is below the threshold and does not compete with a broadly syndicated loan or high yield markets, unlike the upper middle market. As such, we do not compete with markets where leverage is higher, equity cushion lower, covenants are light, wide, or non-existent, information rights are fewer, EBITDA adjustments are higher and less diligence, and the timeframe for making an investment decision is compressed. On the other hand, where we focus in the core middle market, generally our capital is more important to the borrower.
As such, leverage is lower, equity cushion is higher, we have real quarterly maintenance covenants, we receive monthly financial statements to be on top of the companies, EBITDA adjustments are more diligent and achievable, and we typically have 6-8 weeks to make thoughtful and careful investment decisions. According to Lincoln International, the covenant light share of direct lending loans increased from 20% in Q3 2021 to 35% in Q4. A 15% increase in just one quarter. We believe that this was driven primarily by the growth of the mega multi-billion-dollar direct loans than by the largest direct lenders who compete heavily among themselves, as well as the broader syndicated loan market. Less covenant protection may ultimately have important ramifications down the road to outcomes. Virtually all of our loans in core middle market have meaningful covenant packages which protect lenders.
According to S&P, loans to companies with less than $50 million EBITDA have a lower default rate and higher recovery rate than those loans to companies with higher EBITDA. We believe that the meaningful covenant protections of the core middle market have been an important part of this differentiated performance. Our portfolio performance remains strong. As of December 31, average debt to EBITDA in the portfolio was 4.6 times, and the average interest coverage ratio, the amount by which cash income exceeds cash interest expense, was 3.3 times. This provides significant cushion to support stable investment income. These statistics are among the most conservative in the direct lending industry. As of December 31, we had only three non-accruals out of 120 different names in PFLT and PSSL.
This represents only 2.9% of the portfolio at cost and 2.5% at market value. The portfolio is highly diversified with 115 companies in 46 different industries. Our credit quality since inception over 10 years ago has been excellent. Out of 434 companies in which we have invested since inception, we have experienced only 15 non-accruals. Since inception, PFLT has invested over $4.7 billion at an average yield of 8%. This compares to a loss ratio of only 7 basis points annually. Many of our portfolio companies are in industries such as government services, healthcare, technology software, business services, and select consumer companies where we have meaningful domain expertise. The outlook for new loans is attractive. We've been busy.
We have been as busy as we have ever been at 15 years in the business, reviewing and doing new deals. With our experienced, talented, and growing team, our wide funnel is producing active deal flow that we can then carefully and thoughtfully analyze so that we can be selective as to what ends up in our portfolio. Let me now turn the call over to Richard, our CFO, to take us through the financial results in more detail.
Thank you, Art. For the quarter ended December 31, net investment income was $0.33 per share, including $0.05 per share of other income. Looking at some of the expense categories, management fees and performance-based incentive fees totaled about $6.1 million. Tax, general, and administrative expenses totaled about $900 ,000. Interest expense totaled about $6.6 million. For the quarter ended December 31, net change in unrealized appreciation on investments, net of any associated tax provision, was a loss of $5 million, or $0.13 per share. Net realized gains were about $3.1 million, or $0.08 per share. Changes in the value of our credit facility and notes increased NAV by $0.09 per share. Net investment income was higher than the dividend by $0.04 per share.
Consequently, GAAP NAV went from $12.62 - $12.70 per share. Adjusted NAV, excluding the mark-to-market of our liabilities, was $12.43 per share, flat quarter-over-quarter. Our entire portfolio, our credit facility, and notes are marked-to-market by our board of directors each quarter using exit price provided by an independent valuation firm. It changes on independent broker-dealer quotations when active markets are available under ASC 820 and ASC 825. In cases where broker-dealer quotes are inactive, we use independent valuation firms to value our investments. Our debt-to-equity ratio was 1.5 times, while net debt to equity after subtracting cash was 1.4 times. We have a strong capital structure with diversified funding sources and no near-term maturities.
We have a $300 million revolving credit facility maturing in 2026, with $257 million drawn as of December 31. $97 million of unsecured senior notes mature in 2023, and $228 million of asset-backed debt associated with PFLT CLO I is due 2031. During the December quarter, PFLT issued an additional $85 million of the 4.25 2026 unsecured senior notes, bringing the total principal balance to $185 million. The add-on notes were issued at a premium, resulting in a yield of 3.875%. The proceeds from this note issuance provided additional capital for investments. Our portfolio remains highly diversified, with 115 companies across 46 different industries.
87% is invested in first lien senior secured debt, including 13% in PSSL, less than 1% in second lien debt, and 13% in equity, including 4% in PSSL. Our overall debt portfolio has a weighted average yield of 7.5%. 99% of the portfolio is floating rate, and 84% of the portfolio has LIBOR floor. The average LIBOR floor is 1%. Now, let me turn the call back to Art.
Thanks, Richard. To conclude, we want to reiterate our mission. Our goal is a steady, stable, and protected dividend stream, coupled with the preservation of capital. Everything we do is aligned to that goal. We try to find less risky middle market companies that have high free cash flow conversion. We capture that free cash flow primarily in first lien senior secured instruments, and we pay out those contractual cash flows in the form of dividends to our shareholders. In closing, I'd like to thank our extremely talented team of professionals for their commitment and dedication. 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 to questions.
We'll take our first question from Mickey Schleien with Ladenburg. Please go ahead.
Good morning, everyone. Art, did you accrue any past due interest or any other non-recurring items into interest income this quarter at PFLT?
I think I understand your question. I don't think we did. Just what are you getting at, something specific, Mickey?
I'm just, you know, doing the math. The effective yield looks a little higher than I expected.
Yeah. Okay. I think the growth of the joint venture is certainly helping a lot.
All right. What caused the increase in other G&A expense this quarter, and what's the outlook for that line item?
Richard, do you want to handle that one?
Sure. The G&A increased this quarter because of Fund V's grown in size and activity volume. G&A expenses are made up largely of audit expense, legal, valuation firm, sub-administration, services, and those fees have gone up because of the increase in size and volume of activity. We do expect the G&A to continue to clip at this pace, that we have in the first fiscal quarter, for the remainder of the year.
Okay, thank you for that. Does your on-balance sheet credit facility and securitization measure collateral at fair value or at cost?
It's a classic CLO structure based on cost.
The credit facility, Art?
The credit facility on cost as well.
Terrific. How much leverage does PSSL's credit facility allow, Art?
You know, it's an SPV. You know, we have two kinds of pieces of debt at the joint venture. We have our securitization CLO, and we have an SPV. They kind of work hand in glove, and you get kind of an advance rate based on. Certainly on the SPV, you get an advance rate based on the type of collateral. It can permit kind of essentially 2-to-1 debt to equity in that SPV. The CLO itself can permit, you know, more than that, as a typical CLO can.
Okay, thank you for that. I have a couple more questions, but I'll get back in the queue. Thank you.
Okay. Thank you, Mickey.
Our next question comes from Kevin Fultz with JMP Securities. Please go ahead.
Hi. Good morning, and thank you for taking my questions. Clearly, the December quarter was really nice from a capital deployment standpoint, growing assets on balance sheet as well as PSSL. I know over the past year you've described the vintages as very attractive. Just curious how you would describe the deal-making environment attractiveness of deals here in 2022.
Yeah. First, that's a good question, Kevin. Thank you. Let's just talk about pacing. 2021 was a blistering pace in deal activity, particularly towards year end. A number of things came together and made 2021 extraordinarily active. Is 2022 gonna be as active as 2021? Right now it looks like that's unlikely. You know, the year started out as a typical year, where the Q1 is relatively slower, first calendar quarter is relatively slower as people still digest and still are recovering from a very active, you know, calendar Q4. You know, we think this will probably be more normalized year. Is that gonna look like 2019? You know, that might be a you said okay, you know, is 2019 activity the base case? Probably.
You know, I think that'd be probably a reasonable expectation to model 2019 kind of pacing for 2022 versus the 2021 pacing for 2022. Second part of the question is how do you think about it from a vintage standpoint and the types of deals that you're seeing? I think we're pleased, at least at PennantPark, that we're focused on an area of the market that is not getting the attention and the focus, and therefore we can be much more important to the borrowers, you know.
Where is the focus and the attention, and you're seeing it in all the articles that everyone reads and some of the research you all provide, which is that upper middle market or the Goliath you know investment management firms have very massive pools of direct lending capital, and they are competing heavily among themselves, and they're competing heavily against the broadly syndicated loan market. Their pitch, as you all know, is they're eating share of the broadly syndicated loan market. That's great. You know, up there at that upper middle market, decision-making is compressed. The leverage is higher. There are no covenants. You know, the information rights are far fewer. They only get financial statements, you know, every quarter.
You know, for us, that's all very good because it leaves the core middle market or even the lower middle market a big opportunity for people like us where our capital has meaning to the borrower, where we have 6-8 weeks to do proper due diligence, where we can really understand what we're buying, but we're more important to the borrower and as such, you know, the yields are higher, the upfront OID is higher. The covenants, we get quarterly maintenance that had meaning. In all cases, we get monthly financial statements.
For us, that whole move in the upper middle market is creating this very nice window for us. Our target market today is kind of we start out with these companies that start out with between $10 million and $30 million of EBITDA, and they all have a game plan for growth, whether it be organic growth or inorganic growth. Our debt capital can fuel that growth, and we can participate in the upside through the equity co-invest. We take that $10 million-$30 million EBITDA company along with the sponsor. We grow it to $40 million, $50 million, $60 million, $70 million, $100 million of EBITDA. It then goes up to that upper tier of the market. We exit the debt, and we're still riding the equity co-invest. It's been a very good place for us to be.
Our returns have been over the last, you know, five, six years, excellent because that's kind of the niche we're in, and the niche is getting bigger as the big guys scale up.
Great. That's really helpful color there, Art. Just a follow-up question relating to interest rate sensitivity. Could you provide the weighted average LIBOR floor for floating rate investments?
Yeah. It's about 1%, Richard, right?
Yeah. That's right. An average that, you know, LIBOR floor, average is 1%.
Okay. Thank you. I'll leave it there. Congratulations on a really strong quarter.
Thanks, again.
We'll take our next question from Paul Johnson with KBW. Please go ahead.
Yeah. Good morning, guys. Thanks for taking the questions. Just going back to Mickey's question on the portfolio income. I know you said it doesn't sound like there's really that many non-recurring items in there. If I'm looking at it right, I think it was, you know, roughly $17 million of interest income this quarter. It's like roughly like a 7.5% yield on the debt portfolio. Do you see that as pretty sustainable for where the portfolio is at today going forward?
Yeah. Look, as long as our credit quality remains strong, we do have some more rotation to do in that equity co-invest portfolio. You know, we're gonna talk more about Pivot later at TMNT, but PFLT does have a piece of Pivot. We should continue to have some more equity rotation. Certainly as we upsize the joint venture with Kemper, we're very hopeful that we can continue to grow recurring NII to you know clearly have the case where we're you know repeating the dividends you know handily on a consistent basis.
Great. Thanks for that. My other question, which is on an investment in the portfolio, just curious on Marketplace Events. I think that's been on a call for some time on your books. But the mark on that has been kind of steadily going up over, you know, over time. What do you guys have any kind of update on that company or outlook as far as what's going on there?
Yeah. You can see it in the market, the trade show business, home goods, things of that nature. It's a really well-run company. We took control of it, you know, shortly after COVID. Excellent management team. They've operated very well through COVID and managed to, you know, cut their costs appropriately, still keep the business going, maintain strong cash position. Now that we hopefully are coming out of COVID in a more fully certain fashion, you know, we think it's well positioned to bounce back to what it was pre-COVID and hopefully more and higher, you know, as they operate it. They're the leader in their industry.
We think they're gonna end up doing some add-on acquisitions that could continue to help grow EBITDA, you know, over the coming quarters and year or two, and we expect EBITDA to bounce back very nicely.
Okay, thanks for that. Just last question. Do you guys have any update on an estimated spillover amount from this quarter?
Richard, over to you. I don't think there's anything major since the last quarter. We announce every year, once a year in our September Q what the spillover is. What, Richard, you want to refresh us as to what that was?
Yeah. We could get back to you on that after this quarter.
It's in the Q. I'm gonna say it's $0.20 a share, something, maybe 30, something like 20 a share. Something.
Sure. I think it was like $0.22 last quarter.
Yes. Yeah.
A ppreciate it. Those are all my questions.
Yeah. Yeah. That would have grown you know this quarter with the overall net new business. Right. We take those always on September on September and add that $0.05 or whatever it was, and that'll probably be good enough to you know we can follow up after.
Okay. Thanks for that.
We'll take our next question from Mickey Schleien with Ladenburg. Please go ahead.
Art, just to follow up on that average floor in the debt portfolio, I think you said it was 1% on the balance sheet. Is it similar in the senior loan fund as well?
Yeah. You know, look, I mean, the typical floors are 1% within our portfolios. I think we have a chart in the Q, you know, what it would mean, you know, if LIBOR or if interest rates go up, you know, 1%, I think it ends up being about hurting NII about $0.01 a share a quarter.
Right. Art, how do you feel about the scope to term out some of the credit facilities balance and help protect the balance sheet against rising interest rates?
Yeah. It's something we think about. It has to do with credit rating. It has to do with the markets. We like the securitization market, by the way, as you know. It's a loan market, it's long-term capital, and it's you can do some of that fixed notes with us floating. But we also like being matched. You know, we also like being matched. So it's a there's pluses and minuses, I think. You know, as interest rates go up, yes, we'll probably be hurt a little bit on NII. I think the growth of PSSL, the equity rotation, you know, is gonna mitigate that and more, and at least we'll be matched on the upside if and when rates get there.
Understood. Thank you. Last question. Art, how do you feel about the portfolio company's ability on average to pass through inflation onto their customers?
Yeah. You know, it's something that goes to the core of how we underwrite and how we think about the companies that we invest in. You know, we're always asking ourselves the question, if this company goes away, does anybody really care? Who cares if this company goes away? Which really brings you to kind of how important are these companies to their customers. Do they have price? You know, can they raise prices in a relatively easy fashion? Will their customers accept those price increases? You know, the average EBITDA margins in our portfolio are north of 20%, which by definition means they're getting really attractive margins, and they're really, you know, really well positioned with their customer base. So the vast majority of the companies that have asked for price increases so far have gotten them.
If they haven't asked for it, they are asking for it as we speak. In this environment, you know, these companies are getting them. They're important to their customers. By the way, environment does help everyone knows costs are going up. It's not unreasonable for companies to be asking for price increases in this environment. We've had you know pretty good you know a pretty good experience thus far with the pricing increasing in the portfolio.
Thank you for that, Art. That's really helpful. Those are all my questions this morning.
Thanks, Mickey.
Our next question comes from David Miyazaki with Confluence Investment Management. Please go ahead.
Hi. Good morning. Congratulations on the quarter. Just kind of wanted to talk a little bit about, I mean, since you guys have gone about kind of PennantPark Floating, you have this overt strategy pointing your assets toward floating rate coupons. I think that's something that has become more widely adopted across the industry. I'd just like to hear your perspective on how the LIBOR floors may change as we go into a period when, you know, if you look at the Fed's dots chart, we should be approaching LIBOR or the reference rate around 100 basis points at the end of this year. You know, historically, I don't think that a lot of people have moved their floors up while the Fed is tightening, and they worry more about it when the Fed's coming down.
Could you kind of talk about your views on that?
Yeah. It's interesting. I mean, we'll see how the market validates it. Historically, when we've had rising LIBOR, and you can go back as short as I think a couple of years ago, I think LIBOR was 2.7%-2.8% not too long ago. There was some erosion of the LIBOR floor. The LIBOR floors were getting taken out of the documents. You know, I think the vast majority of the deals still then when LIBOR was at 2.7% still had LIBOR floors. I guess, by the way, they're going to SOFR floors as we see how the things go in the coming months.
If you look at the history, floors seem like they're a permanent part of the landscape, although you do see some erosion when, you know, SOFR or LIBOR are far above what a typical floor would be. That's what we've seen. It'll be interesting to see how things, you know, develop this time around if we do indeed get above 100 basis points in terms of short-term risk-free rates.
Do you ever have the ability? You know, let's go back to that period you talked about when LIBOR was 2% plus. Is it something that you have the ability to negotiate for a higher floor when people aren't worried about lower rates? Is that something that you can extract in your negotiations, or is that just generally not happening?
Yeah, it's a great question. Yeah, the other side of the coin, you're right is when LIBOR is over 2%, you know, the people are happy to give you a 1% floor because it's a flea off their back, right? So, is that an opportunity to go for 1.25 or 1.5? It's certainly something to think about at that time. I think it's really just comes down to the negotiation at that time, how much they need you, what their other options are, you know. PFLT and specifically, we specifically seek out the lower risk portion of the direct lending market. That's always been for PFLT what we're looking to do, to take a lower risk at a lower reward, have a lower expense ratio.
For that, you know, lower risk investor who wants to really sleep well at night, you know, PFLT should be, you know, a good place for them to think about. I would imagine in the strategy if even in a higher short-term rate environment, we're still gonna be trying to fill out the absolute best credits and willing to take a lower yield for that, you know, comfort of sleeping at night. Probably in this strategy, you know, maybe we can get it from time to time, but I won't count on it since we specifically in the strategy, you know, want absolutely the best credits.
Okay, that's helpful. You know, I wanted to kind of extend a little bit on the concept that you talked about with the ability of your borrowers to pass inflation pressure through. You know, because of the LIBOR floors, to some extent, your borrowers haven't benefited as the Fed has dropped rates down to zero, right? Because they're at the floor, which has the opposite effect of kind of insulating them from the first four hikes in the Fed raising the overnight rate. How would you feel? Is there enough pricing power in your borrower's model to handle kind of this duality of rates rising or of LIBOR rising above 100 basis points at the same time, having to push inflationary costs through the customers?
Is there enough room in that 20% EBITDA margin?
Yeah, I mean, we think so. So far it's working. So far the price increases, and it could be at 5% or 7% or 10% or 25 or whatever, I mean, everybody's got their own way of doing their price increases. They've been sticking out. You know, when we look at our credit stats, you know, we're over 3 times interest coverage, 3.3 times interest coverage. We feel like we're in kind of an okay place. Sure, I wish we had the upside of the Fed. We had the upside of the lender as the Fed was rising, but it was raising rates. You know, we've had the benefit of, you know, a very healthy yield, you know, as they were lowering and even through the pandemic.
We can't really complain about it. We think, you know, if we're picking the right credits that have the right cushion built into the credit stats and if we can find credits where they're important to their customers, and that's really kind of hones in on kind of why we're focused today on five key sectors. That's where there's very good, high free cash flow margins, really good margins period, and where we know the right questions to ask. You know, as we kind of think about ourselves and how we try to improve over the years, it's really kind of focusing in on those sectors that really provide those kinds of EBITDA margins.
Okay, great. Thank you very much, and congratulations again on the quarter.
Thanks, David.
There are no further questions at this time. I will now turn the conference back to Mr. Art Penn for any closing remarks.
Thanks, everybody. We really appreciate your attendance today. Next time we chat, it'll be in early May after our March quarter. Thanks, everybody. Take care.
This concludes today's call. Thank you for your participation. You may now disconnect.