Good morning and welcome to the PennantPark Floating Rate Capital's Third 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 speakers' remarks. .

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 third fiscal quarter 2021 earnings conference call. I'm joined today by Richard Cheung, our new Chief Financial Officer. Richard joined us in June from Guggenheim Partners where he was Head of Alternative Investment Accounting for many years.

Prior to Guggenheim he was at E&Y. We are thrilled that Richard has joined us and are confident that his extensive experience will be a tremendous asset to the company. We thank Aviv Efrat for all his contributions to PFLT since inception and are grateful that he is continuing with PennantPark focusing on strategic initiatives.

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 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 the telephone numbers and pin provided in our earning press release as well as on our website. I also like to call your attention to the customer 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 ended June 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. We are pleased with our performance this past quarter.

Our net investment income grew to $0.27 per share while our credit quality and NAV performance remained solid. We are poised to significantly grow NII through a three pronged strategy, which includes number one, growing assets on balance sheet at PFLT, as we move towards our target leverage ratio of 1.5 times debt to equity from 1.1 times.

Number two, growing our PSSL JV with Kemper to about 730 million of assets from approximately 500 million. And number three, rotating the equity value in the portfolio that has come from a 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% to 12% return.

During the June quarter, PFLT invested 20 million of capital and 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.

The returns on these equity co-investments have been excellent over time. Overall for our platform from inception through June 30th, our 237 million of equity co-investments have generated in IRR of 28% and a multiple on invested capital of 2.9 times.

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 clear differentiator. We are well on our way to implementing the NII growth strategy. Since June 30th PFLT has had new originations of $102 million and PSSL has had new origination of $29 million.

Although in the June quarter repayments exceeded new loans and the September quarter so far, repayment activity has abated and new originations have accelerated. Our portfolio performance remains strong.

As of June 30th average debt to EBITDA in the portfolio was 4.2 times and 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.

We have only two non-accruals out of 105 different names in PFLT and PSSL. This represents only 2.8% of the portfolio of cost and 2.7% at market value. We have largely avoided some of the sectors that have been hurt the most by the pandemic such as retail, restaurants, health clubs, apparel, and airlines and PFLT also has no exposure to oil and gas.

The portfolio is highly diversified with 100 companies in 42 different industries. Our credit quality since inception over 10 years ago has been excellent. Out of 381 companies in which we have invested since inception, we've experienced only 14 non-accruals.

Since inception PFLT has invested over $4.2 billion at an average yield of 8%, this compares with a loss ratio of only 7 basis points annually. We are one of the few middle market direct lenders who is 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 and 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 the recession. This compares to the average EBITDA decline in the Bloomberg North American High Yield Index of 42%.

Based on tracking EBITDA of our underlying 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, software, business services, and select consumer companies and where we have a meaningful domain expertise. The outlook for new loans is attractive. We are as busy as we've ever been in 14 years in 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. We are focused on the core middle market which we generally define as companies with between $10 million and $50 million of EBITDA.

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.

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 received monthly financial statements to be on top of the company's, EBITDA adjustments are more diligent and 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. 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 June 30, net investment income was $0.27 per share. Looking at some of the expense categories, management fees totaled about $4.3 million. Taxes, general and administrative expenses totaled about $450,000 and interest expense totaled about $5.9 million.

During the quarter ended June 30, net unrealized appreciation on investments was about $14 million or $0.37 per share. Net realized losses were about $13 million or $0.33 per share. And changes in the value of our credit facility and notes increased NAV by $0.08 per share. Net investment income was lower than a dividend by $0.02.

Consequently, GAAP NAV went from $12.71 to $12.81 per share. Adjusted NAV, excluding the mark-to-market of our liabilities, was $12.62 per share up from $12.60 per share.

Our entire portfolio, our credit facility, and also mark-to-market by our Board of Directors each quarter using the exit price provided by an independent valuation firm, exchanges by an independent broker dealer quotations when active markets are available under ASC 820 and 825.

In cases where a broker dealer quotes are inactive, we use independent valuation firms to value the investments. We have ample liquidity and are prudently levered. Our GAAP debt to equity ratio was 1.1 times, while GAAP net debt to equity after subtracting cash was 1 times.

The regulatory debt to equity ratio was 1.2 times and our regulatory net debt to equity ratio after subtracting cash was 1.1 times. With regard to leverage, we have been targeting a debt-to-equity range of up to 1.5 times. We have a strong capital structure with diversified funding sources and no near-term maturities.

We have $400 million revolving credit facility maturing in 2023 with $133 million drawn as of June 30. $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.

Our portfolio remains highly diversified with 100 companies across 42 different industries. 85% is invested in first lien senior secured debt, including 14% in PSSL. 2% in second lien debt, and 13% in equity, including a 5% in PSSL. Our overall debt portfolio has a weighted average yield of 7.5%.

98% of the portfolio is floating rate and 82% 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 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 of 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. . And we'll now take our first question. It comes from Mickey Schleien from Ladenburg. Please go ahead. .

Good morning, Art and welcome Richard. Art, this quarter I'm seeing mixed results in terms of the market opportunity, and I'd appreciate your insight. Clearly, the private debt and private equity markets have a lot of dry powder and spreads are tightening, which can result in a high level of repayments as we've seen it PFLT year-to-date.

On the other hand, as you know, the economy is growing sharply and M&A is very active and I think borrowers also seem to be moving toward private debt solutions.

I understand that repayments can be a function of vintage and call protection, but broadly speaking, I'd like to understand how you expect your portfolios across the Pennant platform to develop in the second half of this year and maybe going into next?.

Thanks, Mickey, and good morning. Quarter-to-date, repayments have been light and newer originations have been heavy. So last quarter, there were a lot of repayments. This quarter so far we've seen lighter repayment. We're seeing a lot of new companies come in.

Sometimes there's the same more companies that get recycled and they go from one private equity firm to another, one private lender to another. This quarter, we're seeing many more new companies come into the system. Usually and again we're focused on kind of the $10 million to $50 million of EBITDA space as we have talked about.

In many cases, the deals that we're doing, it’s the first time there's institutional capital in a founder owned business or a family owned business or entrepreneur and the private equity sponsor is buying that company at first institutional capital, at first institutional equity, and we're the first institutional debt.

So, we're kind of on the front lines of bringing new growing companies into the system. And over time, they may grow from 15 of EBITDA to 50 or 60 and they end up going off to the broadly syndicated market or going off to the big Cat sponsors.

But where we play and where we're getting our best returns is when those companies are starting out of 10 to 20 of EBITDA. The sponsor sees a fragmented industry or an organic growth opportunity. They're willing to plough a lot of equity behind it, which is great cushion for us.

Our debt cannot fuel that growth, our equity co-invest can participate in the upside of that growth, and it ends up being a nice win-win. So this quarter, just to answer your question, we're seeing many more new companies come into the system versus the recycling of some very good older companies. For instance, we had an exit over PNNT and DecoPac.

It's a great company. It went off to another sponsor and another direct lender, but the company has now bigger than when we started with it. .

Thanks for that Art. And that kind of leads into my next question in terms of the target market.

Can you remind us what the average size of the borrower is in the PSSL portfolio compared to your own balance sheet portfolio and how would you compare the investment opportunities in those two segments?.

Well PSSL is roughly similar to PFLT. PSSL gives us an ability to write a bigger check and solve a borrower problem, bring some smart institutional capital like Kemper into our ecosystem, and also offer a higher ROE for PFLT shareholders.

So, roughly the same portfolio just increases the wing span, the bite size, and it's very accretive for PFLT shareholders. So, average EBITDA is 25 to 30 in both vehicles. Now some of those were companies where we started out at 15 or 20 and they have grown. Some of those companies have started out at 30 or 40.

So it's a blend of the two and the entire portfolio doesn't start out at 10 or 20 but a chunk of it does and that tends to be the ones where those equity co-invest can be so valuable when we are hoping to fuel the growth of that company up to a bigger company where the sponsor sees a real opportunity for growth and is willing to plough substantial equity behind that opportunity.

So blended it is still 25 million to 30 million. Some are bigger companies from the get go, some are smaller companies that have grown up. .

And Art, how -- can you remind us how you allocate then between those two portfolios given that the borrowers are similar?.

Yeah. So, it's each portfolio has to stand on its own two feet and have proper diversification. So we want at least fifty names in each portfolio, which we have and we want to be increasingly diversified. And that's a smart way to run a senior loan book so they're both highly diversified portfolios. It is based on available capital.

There's an available capital calculation. It's mathematical that when a deal gets done, there's a mathematical calculation that's done based on available capital. .

Okay. .

And again, PFLT owns 87.5% in the joint venture. So, it's a pretty substantial ownership. .

Right, in terms of the economics.

Lastly, a housekeeping question, I don't know if it's for you or for Richard, but what was the main driver of your realized loss this quarter?.

Yeah. It's -- we had -- we did have a non-accrual -- we had additional non-accrual American teleconferencing which is called Premier Global that was unrealized loss. The main driver of the realized loss was Country Fresh, which was a non-accrual which went through bankruptcy and is now not on the balance sheet anymore. .

I understand. .

And that was the main driver of the realized loss. .

I understand. That's it for me. Thanks for your time. And again welcome Richard. .

Thanks Mickey. .

We'll now take our next question. It comes from Ryan Lynch of KBW. Please go ahead. .

Hey, good morning. Thanks for taking my questions. The first one is kind of a follow-up to previous question regarding the balance sheet in the PSSL.

Because you mentioned the several goals for increasing operating earnings, increasing leverage, increasing the portfolio size of PSSL well, on those first two goals, they're both kind of feeding off the same deal flow that kind of the platforms is bringing in.

So, assuming that deals fit both of those strategies, which it sounds like they do, is there any preference to grow one versus the other, meaning add more balance sheet leverage versus try to ramp up the PSSL, which is with the leverage within that fund, it's kind of a higher yielding entity, is there any preference one versus other, I know they're both a goal but they kind of conflict with each other as far as the originations go where they can be placed?.

Yes. It's a great and nuanced question, Ryan. And I won’t say they necessarily conflict, but I would say they worked in a complementary fashion. PFLT itself where our target leverage over time is up to 1.5 times, we have credit ratings to think about there. We have some unsecured funds to think about there. We have where market convention is.

These assets that we're putting in both PFLT and PSSL, we also put in CLOs outside of the BDCs that we run. So, you could put these -- again, if you look at the underlying assets that we have in these PFLT and PSSL, they're among the lowest yield, lowest risk assets in the BDC industry. Our expense load is commensurately low.

As a result we think we can also run these same assets safely in the CLO format and three to four times debt-to-equity than we have and we've run them safely through COVID. So, outside the BDCs, we can run them in a more leverage fashion.

In PSSL, we probably would target running them in a more leveraged fashion than 1.5 times debt to equity, again why is it and why can’t it be so accretive for PFLT is because in the JVs we do target running the leverage a bit higher than that 1.5 times.

So, if you said, we've stated publicly here today our target over time for the JVs is 750 million, excuse me, 730 million of total bite size and total junior capital is 275 million by definition, the leverage is higher. .

Understood. And then as you guys are looking to deploy capital out in the market, certainly, overall market activity has increased, but obviously competition has kind of resumed back to pre-COVID levels. I'm just curious, do you guys use any sort of macroeconomic backdrop as kind of a base case when you guys are underwriting these loans.

Obviously, you guys are going to do a bottoms up due diligence on each loan, but you guys look at a loan today with same terms that alone maybe had a 2018, 2019 as a better risk, a better proposition, just given that the economy today is kind of on an upswing from a credit cycle versus in 2018, 2019 we are 10 years from the last credit cycle.

Does that inform your guys willingness to deploy capital in today's environment, obviously knowing that it's going to be ultimately a bottoms up approach for credit, but do you guys use that microeconomic backdrop to kind of inform how aggressive you'll be in today's market?.

Yeah, it's a good question and we do. I mean, just if you look back at the 2017 and 2019 time period, we were very public and others were too, that we were getting concerned that the cycle was getting long in the tooth. And there would be some sort of softness, of course, we never could have predicted COVID.

But, I think a lot of us and we were public about it thought that we're getting late in the cycle and therefore operating in a more defensive posture. Today, we see it in our portfolio of companies, we get the monthly numbers, the economies in a strengthening position. Sometimes quite dramatically.

So for sure, we feel more comfortable playing offense as a general macro matter today than we did say 2017 to 2019. That said, you're right, it's bottoms up industry by industry specific. The companies that we're financing today all came through COVID in a very strong fashion. So, in many cases, they benefited from COVID.

So we are playing a little bit more offensively a little bit more offensive posture. And these are companies that we think are very high quality companies that we're prepared to back. One of the big lessons for us over all of our years in business, you got to find the right companies. You got to pick the right companies.

And you can stretch a little bit of leverage. You might be able to be willing to stretch a little bit on yield. If you find the right companies, the rest of it takes care of itself, and that's the business we're in..

Yes. That makes sense. And then the last one that I had was, I know PFLTs equity portfolio is smaller than the PNNT and I know PNNT had some cash proceeds.

I was curious, did PFLT have any level of cash proceeds either from like dividends, dividend recapture or anything like that or actually exits this quarter and what is your outlook as far as obviously that's one of your goals of equity rotation, what is your outlook on your ability to have meaningful equity exits over the max 12 months or so?.

Yes. That's a good question. So PFLT and PNNT are roughly the same investment size in Walker Edison. So last quarter and we'll talk about it a little later, I mean, there were two capital events for Walker Edison in this past quarter.

One was a dividend recap where two times we got back two times our money on the equity and then there was an investment by Blackstone where we got another two times our investment. So that was a nice cash realization on Walker Edison that came our direction on equity. Just looking at the quarter, I mean, that was the big one.

It was about four point -- that was a realized gain of about 4.3 million in the quarter. It was offset by Country Fresh. So the realization of the Country Fresh loss offset that, we had about a 1.4 million realized gain on DecoPac equity. And we had about $700,000 gain on WBB equity. So some of the same names, different order of magnitude in PFLT.

Going to the book itself and the equity co-invest there, you could see there's some that are performing very well based on the marks. Buy Right is one that we talked about a lot, that's about a $1 million market value there. We've got a company called Infosoft about 3.5 million, excuse me, about 5.7 million of equity, GCOM of over 4 million of equity.

PFLT is 7.6 million of equity. There's still another 6.9 million of equity value in Walker Edison. So still some nice equity bites to be potentially exited and rotated over the coming year or two. .

Okay, that’s helpful detail. I appreciate the time today. .

Thank you, Ryan. .

We'll now take our next question. It comes from Devin Ryan of JMP Securities. Please go ahead. .

Great. Good morning, Art and Richard. Just a couple of follow-ups from us. I guess, the first one, the past couple of quarters you had I believe characterized the current vintage loans being the most attractive in the past decade or so.

And I'm just curious, if that's still the case today, I suspect that speaks to the strong originations and of its posture, but how is the pipeline evolving, I guess more recently from an attractiveness perspective and is there any other I guess color you can share around that?.

Yes, it's a good question, Devin. The best thing about the vintage is, again the companies that we're financing today came through COVID in really good shape and in some cases strengthened through COVID. So, we're in the credit selection business. We have to pick good credits. We have to avoid mistakes.

So the quality of the company is paramount and that's the most attractive thing is we're seeing companies that have come through the last couple of years of chaos and uncertainty with the strong posture, which gives us confidence that our capital will be preserved and in some cases with the equity co-invest beginning we will be increasing value through these equity co-invest.

So, that's really the most attractive thing. And look, the deal machinery was put on hold for year and half, right. There were no deals or very little deals. So all of this pent up deal demand is kind of coming to fruition today, and that's one of the things driving it.

We also think there's a piece of it that's potentially focused around the potential capital gains increase sometime in the future and a desire by some sellers to capture a gain before a potential capital gain increase.

So I think that's playing into it a little bit, kind of the pent up demand from a year and a half and the potential capital gains increase on the horizon are both working together to bring a lot of deals. .

Yes, okay great. That makes lot of sense. Thank you. And then just follow-up on one of your prior comments just about recent repayment activity slowing.

I know it's episodic, but do you see any trend there around that and are there any of the factors that you see shifting?.

Yes, I mean, it could be. And I'm just making a supposition, Devin that as I said earlier, we're seeing more new names to our ecosystem. The repayments and refis are done with names that are already in the ecosystem. It's an opportunistic market, the company's is getting sold or there's a refi or whatever.

And when you're bringing new companies into the ecosystem, there may be companies that we start out with where it starts out with 10 to 20 of EBITDA and in three years, it's a 50 it goes to somewhere else in our ecosystem, maybe the mega lenders or whoever or the big private equity shops.

Today, we're seeing more new names that are new to this middle market credit, middle market direct lending ecosystem. And again, many of the companies that we see where we are focused are this is the first institutional capital.

It's a family, it's an entrepreneur, it's an owner, a family who is selling their baby that they've built up over 20, 30, 40, 50 years, and they're selling it to a private equity firm.

And it does 10 or 15 or 20 or 25 of EBITDA and it's the first time institutional capital has been in there and that private equity firm brings all kinds of things like all financial statements and policies and procedures and financial controls with the goal of taking that $15 million or $20 million EBITDA company and getting it to $40 million, $50 million, or $70 million.

We are the first kind of private debt lenders in that company. Our debt helps fuel that growth from $20 million to $50 million in certain cases and this has worked, we've co-invested the equity and we're helping -- we are participating in that upside and we are helping to create with our debt capital.

So I'd say, I'm making a supposition that this quarter we're seeing many more new names into the ecosystem than we were last quarter where it was just refinancing the same old name. Some of the same old names are very good names, but the same old names. .

Yes. Okay, terrific. Yeah. I appreciate it. A little of a crystal ball question, but that's great color. So I'll leave it there. Thank you. .

This concludes our question-and-answer session. I'd now like to hand the call back to Mr. Art Penn for any additional comments or closing remarks. .

I wanted to just thank everybody for their participation today in the call, and our next call will be in November. It's our 10-K so it will be slightly later in the quarter than our normal Qs, but kind of mid-November timeframe we will have our next quarterly conference call. In the meantime I hope everybody has a great and safe summer.

Thank you very much. .

This concludes today's call. Thank you for your participation. You may now disconnect..