PSBD - NYSE

Welcome to Palmer Square Capital BDC's Third Quarter 2024 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the prepared remarks. As a reminder, this conference call is being recorded. At this time, I'd like to turn the call over to Andrew Wedderburn-Maxwell, Investor Relations. Andrew, you may begin.

Welcome to Palmer Square Capital BDC's third quarter 2024 earnings call. Joining me this afternoon are Chris Long, Chairman and Chief Executive Officer; Angie Long, Chief Investment Officer; Matt Bloomfield, President; and Jeff Fox, Chief Financial Officer and Director. Palmer Square Capital BDC's third quarter 2024 financial results were released earlier today and can also be accessed on Palmer Square's Investor Relations website at palmensquarebdc.com. We have also arranged for a replay of today's event that can be accessed on our website for the next six months. During this call, I want to remind you that the forward-looking statements we make are based on current expectations. The statements on this call that are not purely historical are forward-looking statements. These forward-looking statements are not a guarantee of future performance and are subject to uncertainties and other factors that could cause actual results to differ materially from those expressed in the forward-looking statements, including and without limitation, market conditions caused by uncertainty surrounding interest rates, changing economic conditions and other factors we identified in our filings with the SEC. Although, we believe the assumptions on which these forward-looking statements are based on are reasonable, any of those assumptions can prove to be inaccurate and as a result the forward-looking statements based on those assumptions can be incorrect. You should not place undue reliance on these forward-looking statements. The forward-looking statements made during this call are made as of the date hereof and Palmer Square Capital BDC assumes no obligation to update the forward-looking statements unless required by law. To obtain copies of SEC related filings, please visit our website at palmersquarebdc.com. With that, I will now turn the call over to Chris Long.

Good afternoon, everyone. Thank you for joining us today for Palmer Square Capital BDC's third quarter 2024 conference call. Today, I will begin by providing an overview of the quarterly highlights then turn the call to the team to discuss our market outlook, portfolio and financial performance. PSBD delivered strong third quarter earnings results, supported by healthy credit performance across our portfolio. During the third quarter, our team deployed $66 million of capital and generated total net investment income of $37.3 million and $15.7 million, marking 30% and 6% year-over-year growth, respectively. We delivered net investment income of $0.48 per share and paid a $0.47 per share third quarter total dividend, including a $0.05 supplemental distribution. As a reminder, PSBD is the only publicly traded BDC that discloses monthly NAV to the Street, providing real-time visibility into the health and value of the portfolio. In line with our commitment to industry-leading transparency, we recently announced our September 30 NAV per share of $16.61, a 1% decrease from the end of Q2 by some mild mark-to-market and realized losses in the quarter. Our commitment to driving shareholder value, while delivering exceptional credit quality across the diversified opportunistic portfolio that has differentiated in its breadth and ability underpins our third quarter results. Palmer Square is providing investors with strong and consistent returns and opportunities for capital growth in a wide variety of economic and market conditions. As we begin to see non-accruals tick up across the BDC sector overall, we remain confident that our portfolio of large, high-quality borrowers is positioned to outperform on a credit basis, while still generating attractive levels of total and relative return compared to other floating rate investment options. We continue to see very strong credit performance across the vast majority of the portfolio and notably, our portfolio benefits from some of the lowest levels in the sector of PIK income. We believe this will be a differentiator for PSBD in the near future as some managers grapple with an evolving rate environment and lower cash pay in their portfolios. I do want to acknowledge that we had our second and third ever non-accruals in the PSBD portfolio this quarter. That being said, neither loan was material from a size and income perspective. We are monitoring both situations closely and the Palmer Square team is working to ensure an optimal resolution for our shareholders. I'd like to reiterate the benefit of PSBD's opportunistic credit investment strategy, which enables us to act quickly across liquid and private markets. We believe our mandate is differentiated and positioning within our portfolio of predominantly high-quality BSLs which are purchased in both the primary and secondary markets, large private credit loans and select structured credit investments enables more upside through NAV appreciation and total return. As a reminder, given our experience in past tightening cycles, we tend to see a pickup in new M&A and deal activity across both the private credit and broadly syndicated loan markets. We believe this could enable PSBD to have multiple options and avenues to find attractive new credit but also to potentially see an increase in accelerated OID income flowing through the income statement. I will now hand the call over to Angie to discuss our outlook heading into 2025.

Thank you, Chris. In the third quarter, PSBD continued to deliver an attractive yield opportunity for our investors, despite the spread tightening environment that was taking place across credit markets. I'll now offer more color on our views of the current market environment. As you all know, in the third quarter, the Federal Reserve initiated its first interest rate cut in four years. While we expect the Federal Reserve to take a measured, data-driven approach to additional rate cuts over the coming months, we believe our borrowers have adjusted well to the higher rate environment over the past few years and can operate successfully in any of the potential scenarios extrapolated by the dot plot or forward curve. Moreover, when you look at the interest coverage ratios of the broadly syndicated loan market, we believe most investors and analysts would say they remain higher than many would have assumed. Today, we believe the trough in coverage ratios is likely behind us. Against the current market backdrop, we are diligent in maintaining our disciplined underwriting standards, with a 96% senior secured loan portfolio and spreads at pre-COVID levels of tightness, we are still able to provide investors with an 11.3% yield as of September 30, which is very attractive by historical measures and relative to current yields in the BDC sector. While we continue to hunt for pockets of value across liquids, private and structured credit, primary and secondary markets, we are very well positioned to move more aggressively if or when the opportunity set becomes more attractive overall. As a reminder, Palmer Square Capital management celebrated its 15th anniversary this summer. We have managed our strategies through multiple spread tightening cycles. When we see spreads near recent types, we move our portfolios up in quality. Our management of the BDC has and will follow this time-tested strategy, which allows our liquid strategy to be differentiated from traditional middle-market private credit lenders. History has shown that in tight spread environments, stretching for incremental yield further out on the credit spectrum can lead to mistakes. We believe that remaining disciplined and patient tends to provide investors with a better long-term risk adjusted returns. And with the liquid portion of our portfolios, we should have plenty of capacity to move when opportunities arise. The broader deal pipeline is evenly split across both the BSL and private credit markets. Much of the refinancing activity we saw over the past quarter involved loans shifting from one part of the market to the other. We've seen private credit lenders move spreads to within 100 basis points of the BSL market to remain more competitive. We believe current spreads are more a function of demand than supply at this point and we anticipate they could widen as M&A gradually begins to pick back up. Additionally, we are confident that deal activity should continue to pick up in the near-term as we receive clarity around the election and the rate environment stabilizes. This, in turn, could drive spreads modestly higher as there are more attractive opportunities for investors, including PSBD to deploy capital. We are beginning to see some new money deals on both sides of the market but the rate cut in September has not opened the floodgates for deal activity yet. Activity within the broadly syndicated loan and private credit markets over the past quarter was driven largely by refinancings and dividend recapitalization in addition to a stream of repricings within the loan market. Although, we cannot precisely predict how quickly M&A activity will accelerate, given the numerous factors involved, we believe sponsors have grown to appreciate the flexibility provided by having the opportunity to finance in either the syndicated or private markets. We anticipate both markets will be well supported over the long-term as sponsors prefer multiple tools. It's important to reiterate that our differentiated strategy allows us to manage the portfolio in different market environments. Despite the spread tightening environment that we've mentioned, we were able to maneuver the portfolio in a manner to reduce lower spread syndicated loans and rotate into higher spread private credit opportunities, thus only reducing the overall spread of the portfolio by 1 basis point. Additionally, as we did deploy into new opportunities, we have been doing so in smaller overall position weights, thus increasing the diversity of the portfolio. Palmer Square has a long track record of generating total return for shareholders through attractive investments with optimal risk profiles. While the current rate environment will surely impact portfolios across the sector, we're confident that it will present meaningful opportunities for managers that specialize in ROE generation. Palmer Square has a proven track record of being one of those managers and we believe we are well positioned for continued performance for the rest of 2024 and beyond. With that, I'd like to hand the call over to Matt, who will discuss our portfolio and investment activity.

Thank you, Angie. Turning to our portfolio and investment activity for the third quarter. Our total investment portfolio as of September 30, 2024 had a fair value of approximately $1.39 billion across 39 industries that demonstrate both strong credit quality and a diverse mix of core service offerings. This compares to a fair value of $1.43 billion at the end of the second quarter of 2024, reflecting a small decline of approximately 3%. In the third quarter, we invested $66 million of capital, which included 21 new investment commitments at an average value of approximately $2.7 million. During the same period, we realized approximately $83 million through repayments and sales. As Angie mentioned, overall spreads have tightened in both the broadly syndicated loan and private credit markets, which is especially true for existing borrowers refinancing their capital structures. That being said, we continue to look across both markets to find appropriate risk-adjusted spreads for the PSBD portfolio. And given the size of these markets, we remain confident we will find appropriate investments to meet these thresholds. Additionally, as spreads in the large cap private credit market continue to offer a premium to the syndicated market in most circumstances, we have continued to build a large cap private credit allocation to the PSBD portfolio, which is now approaching 10% of the portfolio and could grow from there as we look forward into next year. As a reminder, our team is organized by industry, which is intentional due to our core belief that deep sector knowledge, experience and market engagement are essential to driving the best possible credit outcomes. We use this industry expertise and deep continuous underwriting to monitor not just our portfolio but essentially all the relevant issuers in the market so that they have been proactively evaluated by our investment committee, and we can move quickly on new transactions and especially important when those issuers loans trade down to below what we believe to be fair value. We believe our ability to capture discounts in the secondary market as well as pursue the broadest range of opportunities in the primary market, offers our shareholders meaningful upside compared to the broader direct lending universe. Looking back at the third quarter, I wanted to highlight key portfolio statistics, which underscore our belief that PSBD represents one of the most compelling investment opportunities in the sector. As of September 30, PSBD shares offered an annualized dividend yield of 11.3% on a portfolio focused on first lien, predominantly floating rate liquid securities. In our opinion, this provides investors access to a flexible investment strategy with more upside to NAV appreciation and total return. At the end of the third quarter, our weighted average total yield to maturity of debt and income-producing securities at fair value was 10.48% and our weighted average total yield to maturity of debt and income-producing securities at amortized cost was 9.41%. Our investors benefit from a highly diverse portfolio of high quality sectors and borrowers. Based on industry, our largest portfolio exposure at the end of the third quarter of 2024 included software, healthcare, professional services, IT services and insurance, which is mostly brokerage or services, not balance sheet risk all industries that we believe offer highly stable and growing income profiles. Further, the 10 largest investments only account for 10.1% of the overall portfolio. We believe these factors point to industry leading diversification, which will continue to drive strong credit performance across market cycles. Our portfolio is 96% senior secured with an average hold size of approximately $6 million. On a fair value rated basis, our first lien borrowers have a weighted average EBITDA of $457 million, senior secured leverage of 5.5x and interest coverage of 2.0x. Both the weighted average EBITDA and senior secured leverage reflects small increases quarter-over-quarter, while interest coverage ticked down by 10 basis points. We believe these metrics compare favorably with the best-in-class portfolios trading at a premium in the public markets. During the third quarter, we moved two loans to non-accrual status, representing just 0.26% of fair value, well below reported BDC market averages. As Chris mentioned, we view these as idiosyncratic, event driven situations and will remain diligent in our pursuit of an optimal outcome for our shareholders. In the quarter, new private credit loans comprised 12% of overall new investments and were funded at a weighted average spread of 530 basis points over the reference rate. In addition, we have approximately $15 million of existing private credit commitments outstanding at an average spread of 483 basis points that are expected to close later in the fourth quarter. Finally, I want to again highlight that our PIK income as a percentage of overall total investment income remains very low relative to the industry at approximately 0.5%. While this may pick up as we use PIK as a tool on certain new private credit opportunities we see in the market, we anticipate PSBD to remain on the lower end of the industry in terms of percentages of overall NII. Our focus on liquid loans to larger companies with strong fundamentals, senior in the capital structure produces what we believe to be the most attractive risk adjusted returns. This is represented by an average internal rating of 3.6% on a fair value weighted basis for all loan investments. As a reminder, we have a unique relative value based scoring system that allows our team to ascertain where we believe the best relative value resides and reflect that in our portfolio. It's a dynamic system that is updated quarterly, but given the size of the markets we participate in; the scores are updated in real time when warranted. Now I'd like to turn it over to Jeff, who will review our third quarter 2024 financial results.

Thank you, Matt. PSBD delivered strong third quarter results. Total investment income was $37.3 million for the third quarter of 2024, up 30% from $28.8 million for the prior year period. The increase was primarily driven by the growth in our portfolio as well as the interest income from our investments. Total net expenses for the third quarter were $21.6 million compared with $14 million for the prior year period. The increase in expenses compared to the prior year was driven by the higher interest expense in line with our portfolio expansion. Net investment income for the third quarter of 2024 was $15.7 million or $0.48 per share compared to $14.8 million or $0.57 per share for the comparable period last year. During the third quarter of 2024, the company had total net realized and unrealized losses of $8.2 million compared to the net realized and unrealized gains of $19.0 million in the third quarter of 2023. For the three months ended September 30, 2024, this consisted of net unrealized depreciation of $10 million related to existing portfolio investments and net unrealized depreciation of $8.9 million related to exited portfolio investments, a portion of which has been reclassified to realized gains. At the end of the third quarter, NAV per share was $16.61 compared to $16.85 at the end of the second quarter of 2024, driven by realized and mild mark-to-market losses in the quarter. As a reminder, the September NAV also reflects the payment of a $0.47 quarterly distribution comprised of a base dividend of $0.42 and a supplemental dividend of $0.05 per share. Now moving to our balance sheet. As of September 30, 2024, total assets were $1.4 billion and total net assets were $541.9 million. At the end of Q3, our debt-to-equity ratio was 1.52x compared to 1.49x at the end of Q2. Available liquidity, consisting of cash and undrawn capacity on our credit facilities was approximately $181 million. This compares to approximately $20 million of undrawn investment commitments. As a reminder, our Board of Directors approved a stock repurchase plan to acquire up to $20 million of PSBD common stock. The program expires on January 17, 2025 In the third quarter, we repurchased 9,312 shares at an average price of $16.16 for a total purchase cost of $150,000. On November 5, the Board of Directors declared a fourth quarter 2024 base dividend of $0.42 per share, in line with our formalized dividend policy. Given the liquid nature of the portfolio, we plan to announce the supplemental dividend in December, which allows for repayments to settle. This supplemental distribution will be paid out of the excess of PSBD's quarterly undistributed net investment income above the base quarterly distribution. With that, I'd now like to open up the call for questions.

[Operator Instructions] And it looks like our first question today comes from the line of Doug Harter with UBS Financial.

Can you just talk about -- you talked a little bit about moving into slightly more private credit, kind of how you would think about kind of a maximum for the portfolio in order to keep the liquid nature of the portfolio?

Doug, it's Matt. It's a very fair question. I mean I think the way we've always looked at it is everything on a relative value basis. Obviously, over the past couple of years, as the markets have evolved, these borrowers and sponsors have been utilizing both markets. So for us, I don't think we necessarily have a hard cap per se, but we certainly want to maintain a meaningful portion of the liquid pool to have that currency for opportunities when they arise. But I think realistically, we're seeing attractive transactions in both markets. And obviously, the portfolio has continued to migrate up on a percentage basis. And I think that could continue in similar cadence to how it's looked over the past few quarters, if I kind of had to guess on conversations that we're having with sponsors at the current time.

And just given your seat in the market, are you seeing any difference in underwriting quality or covenants as you look at the two markets?

Yes. I think what we're seeing, whether it's on the liquid or private side, I'd say our overall hit ratio frankly, remains still relatively low. I think when you look at the markets and supply demand, there's obviously still a meaningful demand for floating rate loans, whether that's in the private markets or in the syndicated market. So borrowers certainly have that advantage. And I think you've seen that reflected in spreads coming in, in most credit markets, not just on the secured lending side, so I think for us, I think we're trying to be pretty prudent. I think when you look back over the past 10, 20 years in these markets, tighter spread markets I think warrants being a bit more careful and prudent on where you're extending financing to. So I think credit quality has been okay, but I think we'll try to be disciplined and make sure we've got plenty of capacity for transactions that we think make the most sense. And that might not necessarily just be in the primary market that might also be in the secondary market as well.

[Operator Instructions] And our next question comes from the line of Melissa Wedel with JPMorgan.

I wanted to just touch on the portfolio yield. I noticed that has jumped around a little bit over the last couple of quarters, perhaps a bit more than sort of the change in base rates. I'm just curious if there's anything to read into that. I'm not sure if that's just a function of it being a measure on fair value or if there's something else going on?

Melissa, it's Matt again. Yes, I mean, there's certainly been a lot going on just from a market standpoint outside of base rates, which obviously kind of really only came into play there, right, towards the end of September. I'd say, first and foremost, as we mentioned in the prepared remarks, refinancing activity has been the bulk of what we've seen across the markets to date. So there's certainly been some repricing and refinancing activity, where relative value standpoint, those yields might not make sense for the PSBD portfolio. So we've let some of those loans go. We mentioned a bit of an increase in the private credit allocation. I mentioned in the prepared remarks, spreads there are certainly wider obviously, than in the syndicated market. So we've had some benefit there. And then also, to your point, from a fair value standpoint as well, a little bit of movement as well. So I'd say all those things kind of come into play. But the biggest piece of it for sure has been just kind of from the refinancing, repricing activity and how we've moved the portfolio around during the quarter to try to maintain yield within the pool.

I appreciate that. And is there any sort of was there -- given the repricing activity that took place, was there any sort of accelerated OID that's embedded in there -- in the interest income that we're -- maybe isn't separately broken out?

I'd say for this quarter, it wasn't overly robust when you look across in the Q from where we break out the various sources of income that other income line encompasses part of it. I do think we'll continue to see some of that over the next couple of quarters just as there undoubtedly will continue to be refinancing activity. But I don't think from an OID acceleration or accretion standpoint, it was overly material in the quarter.

And if I could, one last question. Thinking about the fourth quarter, I know that in traditionally in BDC portfolios and in the private credit space, in particular, there tends to be sort of a seasonal burst of activity in the fourth quarter as companies are trying to get some deals done. You guys have obviously have a little bit of a different focus, sort of with the more liquid portfolio. I'm curious if we should adjust our expectations for sort of portfolio activity or churn in the fourth quarter just because you guys do have a different focus than there might be a little bit less the seasonality in investment activity and exits? Or do you think it should be directionally similar to what we see in the rest of the private credit space.

Yes. No, that's a really good question. And I think in this particular year being be an election year, I guess today is kind of a very important day. So we have seen things slow down, certainly in the syndicated market over the last week. I think there was probably, frankly, a little bit of pull forward throughout the summer months, which a lot of cases historically would maybe be a bit slower but there was a lot of that activity going on. Again, more skewed towards refinancing but some of the new deal activity over the summer versus, I think, whether it's sponsors or companies wanting to kind of see how things play out this next few days. Undoubtedly though, I do think we will see, as we get kind of into the middle and end of November and early December, some activity. But net-net, just from conversations and what we're seeing now, I think it will be a little bit more muted to your point.

And our next question comes from the line of Derek Hewett with Bank of America.

So what percentage of the decline in one month SOFR was reflected in third quarter results? And more importantly, kind of as rates -- if rates continue to trend lower, kind of how quickly does the portfolio reprice?

I'd say for this quarter, given when the Fed moved at that September meeting and most borrowers, if they're paying on one month kind of locking in those contracts in advance, it was pretty de minimis, quite frankly from the third quarter standpoint. So not much in the way of kind of a read-through for this particular quarter. Obviously, on a go-forward basis, we kind of list out in the back of the 10-Q what a 25 basis point decrease in rates would look like from an investment income, all else being equal, obviously, right, with no other portfolio moves. But I think to your -- the latter point of your question on how, from a borrower standpoint, a lot of that kind of repricing activity has been baked in on kind of what is available from a market standpoint on what a borrower can actually achieve from an all-in spread basis. So I think we're through the thick of the repricing activity in the market. And I think we have seen kind of stabilize here over the past few weeks to months. And that's a comment in both the syndicated and the private credit market. I think there's just a natural floor on what makes sense from a risk-reward standpoint. To the extent to Melissa's question earlier, is we do expect deal activity to continue to pick up into 2025. And just from a supply/demand standpoint, as that activity hopefully does pick up from what we're seeing that could certainly lead to hopefully a little bit more of spread widening. As things have gotten in a lot of cases to kind of 10-year types on a spread basis overall.

Okay. And then short-term investments were down meaningfully this past quarter. I'm assuming it's an important source of liquidity. But how should we -- should we expect kind of more runoff going forward, which would be kind of reinvested in kind of in higher-yielding strategies?

Yes, good question. So that has been kind of cash that had been earmarked for potential investments or actually investments that we'd already committed to. So I think that's kind of gotten into a more normalized range at this point. It's certainly been a bit elevated. And I think I also mentioned in my prepared remarks, we've got about $15 million or so commitments on the private credit side that had not been funded yet that will be funded in the fourth quarter. So that's a use of some of that short-term capacity as well. So I think we're kind of probably finally in a bit of a more normalized range for that bucket.