Good afternoon, and welcome to the PennantPark Investment Corporation's second fiscal quarter 2022 earnings 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, 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 Investment Corporation. Mr. Penn, you may begin your conference.
Good afternoon, everyone. I'd like to welcome you to PennantPark Investment Corporation's second fiscal quarter 2022 earnings conference call. I'm pleased, and I'm joined today by Richard Cheung, 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 a property of PennantPark Investment Corporation, and 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 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.
Thanks, Richard. I'm going to spend a few minutes discussing how we fared in the quarter ending March 31, how the portfolio is positioned for the upcoming quarters, our capital structure and liquidity, the financials, then open it up for Q&A. From an overall perspective, in this era of inflation, rising interest rates, and geopolitical risks, we believe we are well-positioned as a lender focused on the United States, where the floating rates on our loans can protect against rising rates and inflation. We are pleased to be lending into the core middle market, where we are important strategic capital to our borrowers and are not commoditized. We believe we are additionally well-positioned as a company that has a clear game plan for growth of net investment income and dividends.
The highlight of the quarter ending March 31 was the sale of Pivot Physical Therapy, which generated cash proceeds of $232 million. Our second lien position, which had a cost of $49 million, exited for cash proceeds of $78 million, resulting in an IRR of 14.3% and a multiple on invested capital of 1.6x. Our common and preferred stock investment, which had a cost of $35 million, was exited for $164 million, resulting in a 40% IRR and a multiple on invested capital of 3.3x. Due primarily to this successful exit of Pivot, we have made progress on our 3-part plan to increase long-term shareholder value. Number 1, last quarter, we increased our quarterly dividend to 14 cents per share, up from 12 cents.
We are announcing another increase this quarter to $0.145 per share. Number two, we made progress on our $25 million stock buyback program by purchasing 913,000 shares for $70 million. Number three, we completed a CLO securitization financing in our PSLF JV with Pantheon, which gives the JV ammunition to grow to about $750 million and enhance PNNT's NII over time. Now to review the operating results. For the quarter ending March 31, net investment income was $0.18 per share, including $0.04 per share in other income. Despite the overall choppy market, NAV was resilient and decreased by only 0.6%.
The exit of Pivot was the primary reason the portfolio shrunk by $231 million during the quarter, and our leverage ratio, debt to equity, went from 1.2x down to 0.8x. Over the last couple years, we've been targeting the reduction of the equity portion of our portfolio and using the cash proceeds to invest in loans to increase net investment income. At its peak, equity was 36% of the portfolio on March 31, 2021. The percentage of our portfolio and equity as of March 31, 2022, is down to 25%. Our long-term target continues to be 10%.
With regard to net investment income, we continue to have a strategy which includes, number one, optimizing the portfolio and balance sheet of PNNT as we move towards our target leverage ratio of 1.25 times debt to equity. Number two, growing our PSLF JV with Pantheon to about $750 million of assets from approximately $450 million of assets. And number three, the opportunity to rotate out of our equity investments over time and into cash pay yield instruments. We have a long-term track record of generating value by successfully financing high-growth middle market companies in five key sectors. These are sectors where we have successful domain expertise, know the right questions to ask, and have an excellent track record. They are business services, consumer, government services and defense, healthcare, and software technology.
These sectors have also been resilient and tend to generate strong free cash flow. As an aside, government services and defense is approximately 11.3% of the portfolio inclusive of the JV and should be a beneficiary of the geopolitical environment. In many cases, we are typically part of the first institutional capital into a company where a founder, entrepreneur or family is selling their company to a middle-market private equity firm. In these situations, there is typically a defined game plan in place with substantial equity support from the private equity firm to significantly grow the company through add-on acquisitions or organic growth. The loans that we provide are important strategic capital that fuels the growth and helps that $10-$20 million EBITDA company grow to $30, $40, $60 million of EBITDA or more.
We typically participate in the upside by making an equity co-investment. Our returns on these co-investments have been excellent over time. Overall, for our platform from inception through March 31, our $324 million of equity co-investments have generated an IRR of 28% and a multiple on invested capital of 2.7x. Because we are an important strategic lending partner, the process and the package of terms we receive is attractive. We have many weeks to do our diligence with care. Transactions with meaningful covenants, substantial equity cushions to protect our capital, attractive upfront fees and spreads, and equity co-investments. Additionally, from a monitoring perspective, we receive monthly financial statements to help us stay on top of the companies. With regard to covenants, virtually all of our originated first lien loans have meaningful covenants which help protect our capital.
This is one reason why our default rate and performance during COVID was so strong. This sector of the market, companies with 10-15 million of EBITDA, is the core middle market. As we just highlighted within the core middle market, we think our capital can add the most value and where we get the strongest package of risk and return is within the 10-30 million of EBITDA range. Our track record in this part of the market has been excellent for 15 years, but it took a step up and improved as we increased our focus on this portion of the market starting in 2015. The IRR of our investments made prior to 2015 was 9.7%. Since 2015, we have achieved a 13.7% IRR.
The core of the middle market is below the threshold and does not compete with the broadly syndicated loan market. As many of you know, they have enormous amount of capital raised by some of our large peers, and as such we are forced to focus on the upper middle market, which are companies with over $50 million of EBITDA. Those upper middle market companies can typically also efficiently access the broadly syndicated loan market. As a result, in the upper middle market, our large peers need to aggressively compete with the broadly syndicated loan market and among themselves. This results in transactions where leverage is high, covenants are light or non-existent, spreads and upfront fees are compressed, and decisions need to be made quickly. Additionally, from a monitoring perspective, they only receive financial statements quarterly. The argument you will hear is that bigger companies are less risky.
That is a perception and may make some intuitive sense, but the reality is quite different. 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 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. Our portfolio performance remains strong. As of March 31, average debt-to-EBITDA on the portfolio was 5.1x , and the average interest coverage ratio, the amount by which cash income exceeds cash interest expense, was 3.1x . This provides significant cushion to support stable investment income even when interest rates rise. We have one non-accrual on our books in PNNT and PSLF.
This represents 3.5% of the portfolio at cost and 2.8% at market value. The last time PNNT had a non-accrual was December 2020. Since inception, PNNT has invested $6.8 billion at an average yield of 11%. This compares to a loss ratio of about 10 basis points annually. This strong track record includes our energy investments, our primarily subordinated debt investments made prior to the financial crisis, and recently, the pandemic. With regard to RAM Energy, following a record 2021, the company continues to benefit from higher commodity prices. RAM recently drilled and completed two new wells. We are encouraged, as we anticipated, this production is far more liquid rich than prior wells RAM has drilled in this acreage. RAM expects to complete flowback procedures and report results to the Texas Railroad Commission in May.
With regard to the outlook, new loans in our target market are attractive. With our experienced talent and growing team, our wide origination funnel is producing active deal flow. Let me now turn the call over to Richard, our CFO, to take us through the financial results.
Thank you, Art . For the quarter ended March 31, net investment income totaled $0.18 per share, including $0.04 per share of other income.
Looking at some of the expense categories, the management fee totaled $5 million. Taxes, general and administrative expenses totaled $1.2 million, and interest expense totaled $6.5 million. Net realized and unrealized change on investments, net of any associated tax provision, was a loss of $8.7 million, or $0.13 per share. We redeemed a portion of our SBA debenture, which resulted in a realized loss from debt extinguishment of $1.1 million, or $0.02 per share. Change in the value of our credit facility increased our NAV by $0.02 per share. Our net investment income was in excess of our dividend by $0.04 per share. We repurchased about 900,000 shares this quarter for under NAV, adding $0.03 per share.
Consequently, NAV per share went from $10.11 per share to $10.05 per share, down 0.6% from the prior quarter. As a reminder, our entire portfolio and credit facility are marked-to-market on ASC 820 and 825. Our board of directors each quarter using the exit price provided by independent valuation firms, securities exchanges, or independent broker-dealer quotes when active markets are available. In cases where broker-dealer quotes are inactive, we use independent valuation firms to value their investments. Our GAAP debt-to-equity ratio, net of cash, was 0.8x. Our overall debt portfolio has a weighted average yield of 8.4%. On March 31, our portfolio consisted of 113 companies across 30 different industries.
The portfolio was invested in 55% in first lien secured debt, 11% in second lien secured debt, 9% in subordinated debt, including 6% in PSLF, and 25% in preferred and common equity, including 4% in PSLF. 99% of the debt portfolio is floating rate, all of which has a 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 to generate attractive risk-adjusted returns through income, coupled with long-term 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 debt instruments and 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 continued investment and confidence in us. That concludes our remarks at this time. I would like to open up the call for questions.
Thank you. If you would like to ask a question, please signal by pressing star one on your keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, please press star one to ask a question. Again, that is star one. We'll take our first question from Paul Johnson with KBW.
Hey, good morning, guys, or good afternoon. Say, thanks for taking my call. Thanks for taking my questions. I'd just like to ask about the joint venture, just the decision to put a little bit more capital into the JV this quarter. Assuming that, you know, obviously came out of the proceeds from the large exits this quarter. Maybe just also talk a little bit about the deal opportunity set between the JV versus what goes on to the balance sheet. Any differences in those two, and if you're seeing, you know, one market more attractive than the other.
Yeah. Thanks, Paul, and good afternoon. Our deal flow does generally get allocated. The JV is a mechanism for us to enhance our NAV through, you know, kind of leverage. It's obviously mostly senior first lien loans that go into that vehicle. Equity co-invest does not go into that vehicle, so the equity co-invest stays with PNNT. The joint venture with Pantheon takes just the first lien deals, very diversified. As we said, we did a CLO securitization financing in the joint venture this past quarter, which is really attractive long-term efficient financing and allows us to leverage, you know, leverage the junior capital really nicely and in a safe way.
You know, kind of the goal there is to take the joint venture up to about $750 million of total assets, which should be a nice enhancer to the NII of PNNT, given that it, you know, it's a little bit more leverage than what we're doing over at the BDC itself. Of course the co-invest stick with the BDC. You know, nice tool for us. Helps us write bigger checks to these companies so that we can fuel their growth and can be very efficiently financed. Track record so far has been very good. We're pleased with this. I think Pantheon's pleased, otherwise they wouldn't have been willing to put additional capital in.
Again, PNNT is about 60% of the capital and Pantheon's about 40% of the capital. They're pleased so far with the performance and they're willing to continue to invest in it.
Thanks for that. Yeah, that's been a great investment for you guys and, I think a pretty good way to deploy at the moment. Appreciate that. My other question, I'm hoping that you can maybe just quickly go over the non-core investment this quarter, JF Holdings. I believe that's MidOcean. What exactly is that business? I guess what's kind of going on there? Any sort of update?
Yeah. The non-accrual is a company called Cascade Environmental, which does environmental drilling of soil. It did get impacted by COVID, as you know, drilling crews couldn't do their work. You know, governmental entities who are a big chunk of their customers have pushed things off. There's work to do there. It just got delayed and deferred, and Omicron did not help that company either. There's a refinancing going on to refinance that capital structure. Our security has become a junior capital security, more of a preferred stock. You know, the idea is to set the company up with a capital structure so that it can now kind of grow reasonably well post-COVID.
Of course, we hope to, and the sponsor hopes to look for an exit hopefully in the next year or two. It's been about, you know, 18 months since we had a non-accrual, so it's the first one we've had in a while. Obviously, we're not thrilled with it, but you know, we are optimistic that, you know, over time, we can get an exit.
Got it. Appreciate that. I also appreciate that, you know, your credit performance has been pretty good and there has not been many non-accruals in the recent past. Just a few more if I can. As far as write-downs in the quarter, just the net depreciation, how much of that reflected just kind of marking to market on loan prices during the quarter to the more just sort of idiosyncratic write-down?
Yeah. There was a little bit of diminution in overall pricing for loans, of course, and the independent valuation firms certainly take overall market choppiness into account. They layer that on top of the idiosyncratic, you know, individual name by name performance and come up with a blend of the two. You know, we had a substantial mark-up in RAM Energy. PT wasn't fully marked. Pivot Physical Therapy was not fully marked the last time, so we had additional mark-up there as that worked towards exit. The markdowns were Cascade, Jones & Frank, which you just alluded to, and Cano. Cano of course is a public stock and that's been volatile. Those were the big movers, both plus and minus, you know, in the portfolio from last quarter.
Got it. Appreciate that. Last question. Kind of a technical one, but in the filing, you give some of the abbreviated financials for RAM Energy, and I know that the investment had a pretty nice mark-up this quarter. I'm curious. I believe you gave the first quarter financials. What is the reason for the company being, I guess, profit negative this year? Whereas I think the underlying performance has been pretty good through last year, seems to be things going pretty well this year so far. What is the reason for just the negative profitability in this quarter?
Well, you know, I think certainly, drilling, you know, is an expense, the biggest expense. As you know, we drilled two wells. You put, you know, let's say, you know, hypothetically, you put $20 million into drilling, you know, into the ground, and then you hope and I think the numbers are panning out, you hope for, you know, good cash flow back from that. Just the nature of the business. You know, you put-
Yeah.
You make your wells and then you hopefully get the cash flow back and a lot more so. Wells seem to be, you know, in reasonable shape. They seem to be kind of in line with the general performance of the rest of the geography and we're encouraged, you know, early days, you know, about the performance of those wells.
Got it. Great. That's really good to hear, on an investment that's obviously a big piece of your portfolio. Appreciate those are all my questions this morning.
Thank you.
Our next question will come from Robert Dodd with Raymond James.
Hi. Nicely light one for you. Considerable proceeds obviously from a very successful exit of Pivot. Leverage went down. You have a lot of excess liquidity. How long do you think it's gonna take you to get back closer to where you were on leverage, previously? Obviously this time it would be with income producing assets, which could have a significant benefit on NII quite apart from the whole latent vibe.
Yeah.
I was kidding with an easy question, but there you go.
Because Robert, we know exactly how
Yeah.
Our origination flow into the future. This is, it's a science, you know? I'm only kidding. Look, part of it's gonna be kind of, you know, this market that we have in 2022. Like, are we? I mean, we could, in some sense, get lucky by, you know, this might sound weird, but if our capital becomes, you know, more dear to companies, we might be able to deploy quicker at better risk-adjusted returns in a choppy market, right? We might have been lucky rather than smart to be super liquid today and have the market come our direction and you know, have higher yields and lower risk in which case we could, you know, deploy sooner. So far we're not seeing that, but we're only a couple few weeks into this kind of choppier market.
In a more normal basis, I'd say, you know, kinda, I don't know, 6-12 months, you know, kinda, you know, ramping, you know, $several hundred million would be a 6-12 months kinda thing. Of course, we're getting repayments along the way too. That's what happens, you know, when you pick good credits, which we never complain about. I'd say on a normal basis, 6 months, maybe a little bit more. It might, you know, nine, 12 months, depends. Is deal flow gonna slow up because of the choppiness? Are we just gonna get a lot of deal flow at better risk-adjusted returns? We don't really know the answers to these questions yet.
It certainly feels good to be liquid right now in an environment that looks, you know, different than it was three or six months ago. As always, it's deal by deal, name by name. A good deal comes, you know, a good pitch comes across the plate, we're gonna swing. You know, that's how you develop these portfolios. It's hard for us to make, you know, really macro projections.
I understand. I appreciate that. I mean, just sort of related. I mean, on the deal flow that maybe deal memos that are coming across the desk, et cetera. I mean, it's unfair to compare, you know, today to, you know, three months, well, three months ago wasn't 2022, but, you know, to the end of 2021, but obviously that was a crazy period. I mean, is the... Are the number of new memos coming to you depressed? Or has there been, or were they depressed and they're starting to ramp back up? I mean, anything on that?
Yeah. Yeah. 2021 was crazy. Particularly the end of 2021 was crazy. I think everyone in our business was exhausted and burned out. In some ways, thankfully, the first quarter was light. I think it's normalizing right now. I'd say we're kind of looking at a 2019 type pace pre-COVID for our business. We have invested in our origination platform. We have five offices across the United States. We keep investing in the team. Today, we're now covering actively over 600 middle market financial sponsors. That's probably up 200 or 300 over, you know, over the pre-COVID period. We've invested in that, you know, in that team, in those offices, and in relationships so that we can get more looks.
You know, the idea is to get the looks, and then you have to figure out, do you like what you're seeing or not? I'd say, as a firm, we're getting more looks. Our origination platform is broader and deeper. You know, we're deeper in the regions where we have the five offices and elsewhere. The platform, you know, feels like it's good, and it feels like, you know, gee, if we really wanted to ramp, you know, we can do that. Of course, we need to make sure we ramp in a way where the quality is high. That's the key, and the trick in our business is to make sure the quality is high as you're ramping.
Understood. I appreciate. Again, congratulations on the quarter and the shape of the business and being liquid right now.
Thank you.
Our next question will come from Mickey Schleien with Ladenburg.
Yes, good afternoon, Art and Richard. Just a couple of questions from me. We've talked about RAM Energy obviously a lot in the past. So my question today is simply, you know, what do you think it's gonna take for M&A in the oil and gas sector to pick up and potentially more positively impact RAM's valuation? Is it a situation where, you know, folks are just gun shy and they don't believe these prices are sustainable? Or what's holding things back?
It's a great question. We are right now there is not a middle market M&A wave for oil and gas. We are starting to see some small trades not too far from our geography, which is promising. That's point number one. Point number two is you're still in a timeframe where if you're a seller, you still you know are modeling $100 oil and $7 or $8 gas. If you're a buyer, you're thinking you know you should be buying off $70 oil and $4 or $5 gas, right? You know there's still a gap. Over time that will you know collapse and there'll be an equilibrium. I wanna be clear here at PennantPark we're not holding out for the last nickel or dime to sell RAM.
We would want an efficient process, a process that's, you know, that is a good process, that gets fair value. As soon as it makes sense, and as soon as there is a bit of an M&A activity where buyers and sellers are coming together in a reasonable timeframe, we will, you know, kinda start to assess options. We're not quite there yet. In the meantime, we're, you know, heads down focused on completing these wells and optimizing the output and, you know, getting ourselves organized and getting the numbers put together and getting the engineering reports and setting ourselves up to have, you know, hopefully interesting conversations in the not too distant future.
You know, we'd still look to get out in a reasonable timeframe at a fair price. In the meantime, as long as you can, you know, make good investments, you know, kind of in wells and get good returns, that's not a bad backup strategy. Not our top strategy, but not a bad backup strategy if things don't go, you know, the way we'd like.
Thanks, Art. That's really helpful. In the past, you've talked about the RAM has a loan from the federal government. I think it was under the Main Street Lending Program.
Yes.
You know, there's a potential, I guess, to refinance that and maybe liberate some cash up to Pennant. Is that still on in the cards or given where the markets are, that's completely off the table?
That's possible. I mean, I think, again, we wanna kinda execute on these wells, get the cash flow, and it's possible that towards the end of the year we might be able to take it out. Again, all these processes may come together where we're evaluating strategic options, we're evaluating our financing options. You know, we'd hope to have enough cash kind of in the till, you know, towards that end of the year to potentially refinance that, take it out. Yes, that would be, you know, one avenue for liberating, as you say, liberating cash for PNNT shareholders.
Okay, that would be great. Just last question, sort of housekeeping maybe for Richard. Where does the Pivot exit leave the fund in terms of undistributed net capital gains, if any, on a tax basis?
We're in a net capital loss situation from a tax basis, even with the Pivot transaction. With respect to just NII, we do have $0.52 per share of spillback.
Did you say 52? 5 2?
52. Correct.
Okay. Thank you for that. That's it for me. Thank you.
Thanks. Thank you.
Our next question will come from Melissa Weddle with J.P. Morgan.
Good afternoon. Appreciate you taking my questions today. You've actually answered a lot of mine already, but I was hoping to just get your thoughts at a high level about the volatility that we've seen in the forward curve and you know, how you're thinking about both your portfolio investments but also the broader market and what trade-off there might be between you know, sort of higher investment income from those floating rates moving higher and what offset there could be on the credit side of things and companies' ability to really digest those borrowing costs.
Great question. It's something we all need to be modeling in even more so in the coming environment, you know, kind of, you know, companies' ability to weather, you know, higher interest rates. You know, as I said, the average EBITDA to interest ratio we have today is 3.1x at PNNT. So I think we feel pretty good that even if rates go up at PNNT, we've got, you know, substantial cushion. That said, your point's an excellent one. I think we have to, you know, take it even more seriously in the modeling and projecting going forward in our cases, investment committee memos, you know, higher interest rates.
It could lead you to, which is I think we've always had this discipline of keeping, you know, our leverage levels reasonable. You know, here in this portfolio, we're about 5.1x debt-to-EBITDA. You know, that's a comfortable zone for us. We don't like high debt-to-EBITDA multiples because it's just more burden that the company, you know, has to bear. We are still oriented to cash flow. We're still oriented to free cash flow, and getting paid down. I mean, there's a lot of other people who are doing, you know, deals based on recurring revenues where there's not EBITDA, and those have worked so far.
We are certainly in, you know, choppier waters and, you know, we need to maintain our prudence and then maybe even double down on that, you know, in this choppier environment.
Art, do you think that could impact the opportunity set for you too? I know the portfolio is almost essentially nearly entirely floating rate. If there's demand from companies to lock in, some financing costs at fixed rates, but perhaps at better spreads, is that something that your team would be thinking about?
Sure. I mean, look, we like to think we're economically rational. That's what we like to think. I believe we are the vast majority of the time. Yes, if there's you know like when we started out 15 years ago, Melissa, you know, we did you know a lot of mezzanine debt, which was and still is, not that there's a lot of it going on, you know, fixed rate, you know, kind of teens type of capital. For the right credits, you know, for the right structure, the right call protection, the right co-invest package, the right covenant package, we should be, you know, willing to trade that off. You know, we don't come at it with you know an absolute view that we don't do fixed rate.
With the right set of circumstances, I think we'd be open to that.
Are you seeing demand from that from borrowers yet?
Not yet. I mean, there might be a deal or two kind of in our pipeline that looks like that, you know, kind of what we would call traditional mezz. But it could come back. You're right. In this environment, there might be more demand for, you know, kind of back to the future kind of structures, you know. You know, we've had a good. You know, we know we're doing in that world and got a good track record. Again, opportunistically, and in PNNT, this would be the place to do that versus PSLF, opportunistically for the right kind of teens return, you know, we would be open to that.
Thanks, Art.
Thank you.
That does conclude the question and answer session. I'll now turn the conference back over to Mr. Art Penn.
Thanks, everybody, for listening in today. We appreciate your focus on us. Our next quarterly earnings will be in early August, and we look forward to speaking with you then.
Thank you. That does conclude today's conference. We do thank you for your participation. Have an excellent day.