Good morning, and welcome to the PennantPark Floating Rate Capital's fourth fiscal quarter 2021 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 remark. 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, please 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, and good morning, everyone. I'd like to welcome you to PennantPark Floating Rate Capital's fourth fiscal quarter 2021 earnings conference call. I'm joined today by Richard Allorto, our Chief Financial Officer. Richard, 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 Floating Rate Capital, and that any unauthorized broadcast of this call in any form is strictly prohibited. Audio replay of the call will be available by using telephone numbers and PIN provided in our earnings press release as well as 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 filing 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.
Thanks, Richard. I'm going to spend a few minutes discussing how we fared on the quarter ended September 30th, 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 core net investment income grew to $0.28 per share, which excludes a one-time expense of $2.9 million in connection with the amendment of our credit facility. Our credit quality generally remains solid. We are poised to significantly grow NII through a three-pronged strategy, which includes, one, growing assets on the balance sheet of PFLT as we move towards our target leverage ratio of 1.5x debt to equity from 1.3x . Number two, growing our PSSL JV with Kemper to about $730 million of assets from approximately $550 million.
Three, rotating the equity value in the portfolio that has come from our strong equity co-investment program into cash-paying debt instruments. With regard to the PSSL JV, with the CLO financing we completed earlier this year, as well as additional capital contributions from PFLT and Kemper, the JV will grow over time. The capital contributions from PFLT are targeted to generate a 10%-12% return. We intend to invest another $42 million over time in order to bring PFLT's investment into PSSL to approximately $243 million. 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 September 30th, our $246 million of equity co-investments have generated an IRR of 28% and a multiple on invested capital of 3x. In a world where investors may want to understand differentiation among middle market lenders, our long-term returns on our equity co-investment program are a clear differentiator. We are well on our way to implementing the NII growth strategy. During the September quarter, PFLT had new originations of $48 million, and PSSL had new originations of $77 million, far outpacing the repayment activity. As a result, the investment portfolio of PFLT increased by approximately $46 million to $1.08 billion from $1.04 billion.
PSSL's investment portfolio also grew this quarter from $530 million to $565 million, an increase of $35 million. We continue to be busy. Since September thirtieth, PFLT has had new funded investments, net of sales and repayments of $82 million. PSSL has had new funded investments, net of sales and repayments of $23 million. We are focused on the core middle market, which we generally define as companies with between 10 and 50 million of EBITDA. We like the core middle market because it is below the threshold and does not compete with the broadly syndicated loan or high yield markets.
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 diligent, 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 than achievable, and we typically have six to eight weeks to make thoughtful and careful investment decisions. According to S&P, loans to companies with less than 50 million of EBITDA have a lower default rate and a higher recovery rate than those loans to companies with higher EBITDA.
Our portfolio performance remains strong. As of June 30, the average debt-to-EBITDA on the portfolio was 4.3x , and the average interest coverage ratio, the amount by which cash income exceeds cash interest expense, was 3.2x . This provides significant cushion to support stable investment income. These statistics are among the most conservative in the direct lending industry. As of September 30, we had only two non-accruals out of 115 different names in PFLT and PSSL. This represents only 2.7% of the portfolio at cost and 2.6% at market value. For the quarter ended September 30th, the decline in the value of DBI Holding was the largest driver of the decline in NAV and represented a negative impact of $0.29 per share.
This was somewhat offset by increases in the valuations of Lash OpCo, Marketplace Events, and SFP Holding. Since quarter end, DBI has continued to underperform, and the company has decided to pursue a partial sale and liquidation of the business. It is unclear at this point how this will play out. In the worst case scenario, if PFLT and PSSL have no recovery, NAV would be negatively impacted by $0.28 per share. From an NII perspective, the impact of DBI to NII is expected to be $0.003 per share per quarter. The portfolio is highly diversified with 110 companies and 45 different industries. Our credit quality since inception over 10 years ago has been excellent. Out of 418 companies in which we have invested since inception, we have experienced only 14 non-accruals.
Since inception, PFLT has invested over $4.4 billion at an average yield of 8%. This compares to a loss ratio of only 8 basis points annually. We are one of the few middle market direct lenders who was in business prior to the global financial crisis and have a strong underwriting track record during that time. Although PFLT was not in existence back then, PennantPark as an organization was investing at that time. During that recession, the weighted average EBITDA of our underlying portfolio companies declined by 7.2% at the bottom of that recession. This compares to the average EBITDA decline of the Bloomberg North American High Yield Index of 42%. Based on the tracking of EBITDA of our underlying portfolio companies through COVID, our EBITDA decline was substantially less than it was during the global financial crisis.
Our median EBITDA decline at the bottom of COVID in June 2020 was 1.4%. This compares favorably to the 7% decline in EBITDA during COVID of the Credit Suisse High Yield Index. Many of our portfolio companies are in industries such as government services, healthcare, technology and software, business services, and select consumer companies where we have a meaningful domain expertise. The outlook for new loans is attractive. We are as busy as we have ever been in 14 years in business, reviewing and doing new deals. With our experienced and 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 selected 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 September 30th, core net investment income was $0.28 per share, which excludes a one-time expense of $2.9 million in connection with the amendment to the credit facility. Looking at some of the expense categories, management fees and performance-based incentive fee totaled about $3.3 million. Taxes, general, and administrative expenses totaled about $450,000, and interest expense totaled about $8.5 million, which includes the credit facility amendment expense. During the quarter ended September 30th, net change in unrealized appreciation on investments was a loss of $7.5 million or $0.19 per share. Net realized gains were about $2.5 million or $0.06 per share, and changes in the value of our credit facility and notes decreased NAV by $0.01 per share.
GAAP investment income was lower than the dividend by $0.05 per share. Consequently, GAAP NAV went from $12.81 to $12.62 per share. Adjusted NAV, excluding a mark-to-market of our liabilities, was $12.43 per share, down from $12.62 per share. Our entire portfolio, our credit facility, and notes are marked to market by our board of directors each quarter using the exit price provided by an independent valuation firm, except on independent broker-dealer quotations when active markets are available, under ASC 820 and 825. In cases where broker-dealer quotes are inactive, we use independent valuation firms to value the investments. With ample liquidity and appropriately levered, our GAAP debt-to-equity ratio was 1.3x , while GAAP net debt-to-equity after subtracting cash was 1.2x .
Regulatory debt-to-equity ratio was 1.4x , and our regulatory net debt-to-equity ratio after subtracting cash was 1.3x . With regard to leverage, we have been targeting a debt-to-equity ratio of up to 1.5x . 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 $219 million drawn as of September 30th. $118 million of unsecured senior notes maturing in 2023. $228 million of asset-backed debt associated with PennantPark CLO I due 2031 and $100 million of unsecured senior notes maturing in 2026.
Subsequent to September 30th, PFLT issued an additional $85 million of the 4.25% 2026 unsecured senior notes, bringing the total principal 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 provide additional capital for investments. Our portfolio remains highly diversified with 110 companies across 45 different industries. 86% is invested in first lien senior secured debt, including 13% in PSSL, 1% in second lien debt, and 13% in equity, including 4% in PSSL. Our overall debt portfolio has a weighted average yield of 7.4%. 99% of the portfolio is floating rate and 81% of the portfolio has a LIBOR floor. The average LIBOR floor is 1%.
Now, let me turn the call back to Art.
Thanks, Richard. To conclude, we wanna 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.
Thank you. As a reminder, ladies and gentlemen, please press star one to ask a question. Our first question today comes from Paul Johnson of KBW, I'm sorry.
Good morning, guys. Thanks for taking my questions. Sounds like the pipeline is pretty strong. You've got some pretty strong growth activity here, quarter to date, this is the calendar fourth quarter. I'm just wondering, you know, given the investment opportunities that you guys are looking at, I mean, you're getting up close to the leverage range. Are you compelled to be, given what you're looking at, you know, do you have any idea in mind where you would like to be operating at in terms of, your leverage range on the low end versus the high end?
Thanks, Paul, good morning. Yeah, I think we're targeting, you know, kind of the zone of 1.5x for PFLT. That's kind of where we're targeting. Of course, PSSL is a joint venture, you know, kind of side by side. That vehicle we hope and think can over time, you know, grow to be over $750 million vehicle, which, you know, we got a boost from the CLO financing we did there a little while back. You know, we'll continue to grow that platform. Yes, you're right, we're at 1.3. I think at 1.5 zone, we kinda top out PFLT.
Great. Appreciate that. One thing just on the sort of, I guess, the change quarter-over-quarter in your equity investments. I was wondering if there was anything particular going on there or if there's any sort of restructuring or new equity investment that looks like, at least on a cost basis, went up, you know, pretty quite a bit quarter-over-quarter. I'm wondering what's going on there.
Yeah, I mean, I think part of that's probably PSSL and the growth of PSSL. That's probably the main driver of that. Other than that, no. Look, we do continue to, you know, on these deals where we think there's a very good opportunity to participate in the upside. We are, you know, gradually and thoughtfully, you know, doing these equity co-invests, which have worked out well for us over 14 years. We don't say yes to all of them. We decline many of them. But we do say yes to the ones that we think are very attractive. So I'd imagine the biggest change is the PSSL investment that we keep making in growing that vehicle.
Got it. Thanks for that. My last question, you touched on a little bit during the call, but any sort of color you can give on your investment in DBI, maybe exactly what that business is and just if at all. I'm also curious if there was any overlap with that in the JV .
Yeah. There's DBI in both PFLT and the JV. When we, you know, we on the transcripts kinda talked about what it would mean, you know, for you know, on a consolidated basis between both PFLT and PSSL. The company is a labor services company that does work for municipalities and states. Think about managing vegetation, cutting lawns, managing laboratories, you know, things of that nature. The issue there and you know, you read about newspapers and inevitably when you have a portfolio of over a hundred names, you're gonna get, you know, one of them, at least one of them may have some challenges. This is most of their employees are unskilled labor.
It's been hard to get unskilled labor and it's, when you get unskilled labor, it's more expensive on one hand. On the other hand, they enter into fixed price contracts with the states and cities. Unfortunately, this company got mismatched between the fixed price contracts they have with the states and the cities and the unskilled labor market where they need to hire. That's basically the key reason it's underperformed. As we said, they're looking at a partial sale and a partial liquidation. Don't yet know how that is going to play out. We gave the statistics, you know, on the transcript as to, in the worst case scenario, if it's a zero, what that would look like.
It may or may not be the worst case scenario, A, and B, obviously, you know, we have a wide range of equity co-invest throughout the portfolio, which have had some lifts. If you look at this last quarter, the quarter ended September 30th, DBI had a negative impact of $0.29 a share, but that was offset to some extent by some of the other co-invest, like Lash, Marketplace Events and SFP. You know, we have a diversified book of these co-invest. Some perform well. Over time, they've performed really well. Some underperform. DBI is an example of an underperformer, and this is an example of, you know, some of the things that are going on in the economy. We think this is not endemic of our portfolio. This is a one-off.
The vast majority of our names have 25%-30% EBITDA margins, where they are able to increase their pricing to their customers to hopefully more than cover their costs.
Got it. Appreciate it. Thanks for the color. Very helpful detail. Those are all my questions.
Thanks.
Our next question comes from Mickey Schleien of Ladenburg.
Yes, good morning, everyone. Art, in your prepared remarks, you mentioned a lot of the advantages of investing in the lower middle market, and I certainly agree. My question is, given how intense the competition is higher up in the middle market with, you know, so much private debt and private equity capital available, are you seeing any signs of that trickling down into the middle market and the lower middle market? And are you seeing competitors, you know, perhaps idiosyncratically behaving erratically or irrationally?
Yeah, it's a good question, and thankfully, we don't see much of the, what we'll call, seeping down into the core middle market. You know, some of these folks have raised so much money, and they are aggressively deploying it, and they're bringing kinda covenant light and low yield and shorter diligence processes into the market. You know, we kinda say core middle market's $50 million and below. Occasionally, you'll see a $40 million EBITDA company kind of, you know, fall sway to that. One of the big guys will swoop down and pick that one off, and we'll kinda say, you know, "God bless." But, you know, kind of below 40, we're not seeing it. That could change, and we're vigilant about it, but below 40 we're not seeing it.
You know, we really like and where our added value has been, if you look at our track record, you know, and we'll go into it in the PNNT call over the last six years. It's where we can start out with these companies that are doing 10-20 EBITDA. The sponsor has injected a lot of equity, a lot of equity cushion, so we feel very safe about our capital preservation. There's a real growth plan to take that $10 million or $20 million EBITDA company up to 30, 40, 50 and higher. Where our debt capital can grow with the company, we can deploy really, really attractive capital. We have the front row seat. Obviously, we're the incumbent, and there's less competition by definition on the debt.
Of course, we'll co-invest in the equity occasionally and participate in the upside that our debt is helping to drive. Those deals are kinda where we can add the most value today, where our capital is not commoditized, where we can get a front row seat for the long term, and then when we can get some upside. That's kind of, you know, kind of the prototypical deal for us across our platform. Some of those companies do grow to 40, 50, 100 million in EBITDA, and that's terrific, and sometimes they leave us on the debt side, and we hold the equity, and sometimes that equity's worth a lot of money. That's kind of, you know, where we see our, you know, highest value add today.
Thanks for that, Art. To follow up, given the size of those private funds, do you think there's effectively a barrier of entry into the lower middle market where, you know, the average deal size just doesn't move the needle for them? You know, even though the terms may be interesting, it's just not something that they're gonna put, you know, a lot of time in, and does that benefit you?
Yeah, I think that's fair. You know, when you know, when you're in the AUM growth business, and it's about AUM growth, and you're looking at the amount of labor intensity you need to put against a deal versus how much capital you can deploy, I would agree with you. A long time ago, I was at a big firm. I know how sometimes, you know, they think, you know, below a certain bite size, it just doesn't make sense for the model.
I understand. My last question, Art, is just a little more philosophical thinking about next year, relative to what we've had the last couple of years. You know, this year in particular, there's been a lot of tailwinds in the sector, apart maybe from high levels of repayments and prepayments. Next year, you know, economic growth might decelerate. The Fed might start raising rates. Certainly defaults probably can't go any lower. They've been historically very low. We have an election, so it could be messy.
When you think of those issues, how are you considering the right-hand side of your balance sheet, both at, I guess, at both of your funds or all of your funds in terms of, you know, you wanna take some money off the table and keep leverage perhaps below your long-term targets next year and see how things work out?
Yeah, you know, you're right. Obviously, in 2022, we've got supply chain, labor, inflation, you know, any number of different potential challenges as an economy. How do you think about leverage in light of that? Well, first, we have to underwrite companies that can deal with that that have enough cushion in them so that they can, for instance, raise prices relatively easily as their costs go up, you know. We have to underwrite, you know, very carefully, you know, in this environment. We think we're well-positioned. You know, EBITDA interest, you know, is kind of roughly 3x or 3.2x in this portfolio, so plenty of cushion in the portfolio generally to deal with rising interest rates. It is something that we think about.
In terms of the leverage of the vehicles, I mean, for PFLT in particular, you know, we're kind of saying targets 1.5x. We know and you know that you could take these same assets and walk them over to another department at S&P called the CLO department, and you could safely get 3x or 4x, debt to equity in a box that's very robust and safe and has weathered pandemics and weathered global financial crises, et cetera.
For the assets that we put in PFLT, which we think are among the lowest risk assets in the BDC space, we're very comfortable kind of at that 1.5x , knowing that another option is we could take move these assets, you know, right over and get more leverage if we wanted to and still feel safe about those capital structures. You know, we could talk about PNNT later, but again, you have to look at the underlying assets. You know, we have a lower target ratio there because the underlying assets are different kind of assets. You know, you've seen us do bonds. We've done unsecured bonds recently.
That'll continue to be an interesting and important tool for us to manage risk and always have diversified financing sources.
Thank you for that, Art. That's very helpful, and I look forward to talking to you later today. Thanks.
Thanks.
The next question comes from Devin Ryan of JMP Securities.
Hi, good morning. This is Kevin Fulton for Devin. First question, over the past few quarters, you've talked about the platform's approach to continue growing operating earnings, and clearly you've made progress this year in growing NII. This quarter, core NII was just shy of covering the dividend. Could you talk about when you expect net investment income to cover the dividend going forward? Thanks.
Yeah, look, we believe that as we continue to execute on this plan that we outlined, you know, in the very near future. Hard for me, Kevin, to kind of say, you know, on February third, you know. It's kind of dependent on the deal flow, it's dependent on repayments, it's dependent on rotation of equity, it's dependent on how quickly we can ramp PSSL. We would hope that sometime in 2022 we could safely cover this dividend.
Okay. Makes sense. Could you provide an update on the current amount of spillover income?
Yes. Richard, do you wanna handle that one?
Sure. The current spillover is $0.22 per share, and assuming the distribution remains the same, we should be able to cover that over the next 3 quarters.
Okay. That's as of September 30th, 2021?
Yes, correct. Yes.
Great. Thank you. That's it for me, and thank you for taking my questions.
Kevin, thank you. We appreciate it.
After no further questions, I would like to hand the call back to Art for any additional or closing remarks.
Thanks, everybody, for listening in and giving us your time and attention. Our next quarterly call will be in early February. In the meantime, wishing everybody a terrific Thanksgiving, a terrific holiday season, and a season filled of health. Speak to you soon.
Ladies and gentlemen, that concludes today's conference call. We thank you for your participation.