Good morning and welcome to the PennantPark Floating Rate Capital's First Fiscal Quarter 2022 Earnings Conference Call. Today's conference is being recorded. At this time, all participants have been placed in a listen-only mode. The call will be open for a question-and-answer session, following the 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 first fiscal quarter 2022 earnings conference call. I'm joined today by Richard Cheung, our Chief Financial Officer.

Richard, please start off by disclosing some general conference call information and include a discussion about forward-looking statements. Over to you..

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 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 ended December 31st, how the portfolios positioned for the upcoming quarters, our capital structure and liquidity, the financials, and then open it up for Q&A. Our net investment income grew to $0.33 per share, which includes $0.05 of other non-recurring income.

Our credit quality remain solid. We're pleased that we've grown NII through growing the assets on balance sheet at PFLT, as well as that of our PSSL joint venture. Now that we have reached the zone of our target debt equity ratio at PFLT, we remain focused on two additional prongs to our strategy to grow NII.

Number one, growing our PSSL JV with Kemper to enhance overall ROE at PFLT, and number two, rotating the equity value in our portfolio that has come from our strong equity coinvestment program into cash paying debt instruments.

With regard to the PSSL joint venture, with the CLO financing we completed earlier this year, as well as additional capital contributions from PFLT and Kemper, the JV will continue to grow. The capital contributions from PFLT are targeted to generate a 10% to 12% return. We're on a path to grow PSSL to over $700 million in the current quarter.

We have started discussions with Kemper to increase the JV, to have approximately $1 billion of assets over time. We believe that the increase in scale and the attractive ROE will enhance PFLT's earnings and momentum.

As part of our business model, alongside the debt investments we make, we selectively choose to coinvest in the equity side by side with the financial sponsor. Our returns on these equity coinvestments have been excellent over time.

Overall for our platform from inception through December 31st, our $297 million of equity coinvestments have generated an IRR of 29% 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 coinvestment program are clear differentiator. We have implemented a significant portion of the NII growth strategy to date.

The investment portfolio of PFLT increased by approximately $100 million in the quarter to $1.18 billion from $1.08 billion. PSSL's investment portfolio also grew this quarter from $642 million from $565 million, an increase of $77 million.

We're focused on the core middle market, which we generally define as companies with between $10 million and $50 million of EBITDA, the target market, where we think we add the most value and where we get the strongest package of risk return is in the $10 million to $30 million of EBITDA range.

We like the core middle market because it is below the threshold and does not compete with a broadly syndicated loan or high yield markets unlike the upper middle market.

As such, we do not compete with markets where leverage is higher, equity cushion lower, covenants are light wide or non-existent, information rights are fewer, EBITDA adjustments are higher and less diligence, and the timeframe for making an investment decision is compressed.

On the other hand, where we focus in the core middle market, generally our capital is more important to the borrower. As such leverage is lower, equity cushion is higher. We have real quarterly maintenance covenants. We receive monthly financial statements to be on top of the companies.

EBITDA adjustments are more diligent and achievable, and we typically have six to eight careful investment decisions. According to Lincoln International, the covenant light share of direct lending loans increased from 20% in Q3 2021 to 35% in Q4, a 15% increase in just one quarter.

We believe that this was driven primarily by the growth of the mega multi-billion dollar direct loans done by the largest direct lenders who compete heavily amongst themselves, as well as the broadly syndicated loan market. Less covenant protection may ultimately have important ramifications down the road to outcomes.

Virtually all of our loans in the core middle market and meaningful covenant packages, which protect lenders. According to S&P, loans to companies with less than $50 million EBITDA have a lower default rate and higher recovery rate than those higher EBITDA.

We believe that the meaningful covenant protections of the core middle market have been important part of this differentiated performance. Our portfolio performance remains strong.

As December 31st, average debt EBITDA in the portfolio was 4.6 times and the average interest coverage ratio, the amount by which cash income exceeds cash interest expense was 3.3 times. This provides significant cushion to support stable investment income. These statistics are among the most conservative in the direct lending industry.

As December 31st, we had only three non-accruals out of 120 different names in PFLT and PSSL. This represents only 2.9% of the portfolio at cost and 2.5% at market value. The portfolio is highly diversified with 115 companies and 46 different industries. Our credit quality since inception over 10 years ago has been excellent.

Out of 434 companies in which we have invested since inception, we have experienced only 15 non-accruals. Since inception, PFLT has invested over $4.7 billion at an average yield of 8%. This compares to a loss ratio of only seven basis points annually.

Many of our portfolio companies are in industry such as government services, healthcare technology, software, business services, and select consumer companies where we have meaningful domain expertise. The outlook for new loans is attractive. We have been busy.

We have been as busy as we have ever been at 15 years in the business, review and doing new deals. With our experienced, talented and growing team, our wide funnels 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 December 31st, net investment income was $0.33 per share, including $0.05 per share of other income. Looking at some of the expense categories, management fees and performance based incentive fees totaled about $6.1 million. Taxes, general and administrative expenses totaled about $900,000.

Interest expense totaled about $6.6 million. In the quarter ended December 31st, net change and realized appreciation on investments, net of any associated tax provision was a loss of $5 million, a $0.13 per share.

Net realized gains were about $3.1 million or $0.08 per share, and changes in the value of our credit facility notes increase NAV by $0.09 per share. Net investment income was higher than the dividend by $0.04 per share. Consequently GAAP NAV went from $12.62 to $12.70 per share.

Adjusted NAV, excluding the mark-to-market of our liabilities was $12.23 per share, flat quarter-over-quarter.

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

In cases where broker-dealer corps are inactive, we use independent valuation firms to value the investments. Our debt to equity ratio was 1.5 times while net debt to equity after subtracting cash was 1.4 times. We have a strong capital structure with diversified funding sources and no near-term maturities.

We have a $300 million revolving credit facility maturing in 2026 with $257 million drawn as of December 31. $87 million of unsecured senior notes maturing in 2023, $228 million of asset-backed debt associated with PennantPark CL1 due 2031.

During the December quarter, PFLT issued an additional $85 million of 4.25% 2026 unsecured senior notes, bringing the total principal balance to $185 million. The add-on notes were issued at a premium resulting in a yield of 3.875%. The proceeds from this note issuance provide additional capital for investments.

Our portfolio remains highly diversified with 115 companies across 46 different industries. 87% is invested in first lien senior secured debt, including 13% in PSSL, 1% in second lien debt, and 13% in equity, including 4% in PSSL. Our overall debt portfolio has a weighted average yield of 7.5%.

99% of the portfolio's folding rate and 84% 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 include, we want to reiterate our mission. Our goals are 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 lean senior secured instruments, and we payout those contractual flows in the point of dividends to our shareholders. In closing, I'd like to thank our extremely talented team of professionals for their commitment to 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..

And we will take our first question from Mickey Schleien with Ladenburg. Please go ahead..

Good morning, everyone.

Art, did you accrue any past due interest or any other non-recurring items into interest income this quarter at PFLT?.

I think I understand your question. I don't think we did.

Just -- what are you getting some specific, Mickey?.

I'm just doing the math, the effective yield looks a little higher than expected..

Yeah. Look, I think the growth of the joint venture is certainly helping out..

All right.

And what caused the increase in other G&A expense this quarter? And what's the outlook for that line item?.

Richard, do you want to handle that?.

Sure. The G&A increase this quarter because of finance grown in size and activity volume. So G&A expenses are made up largely of audit expands, legal evaluation firm, sub administration services, and those fees have gone off because of the increase of size and volume of activity.

So, we do expect the G&A to continue to clip at this pace, that we have in the first fiscal quarter for the remaining of the year..

Okay. Thank you for that.

Does your on balance sheet credit facility and securitization measure collateral at fair value or at cost?.

It's a classic CLO structure based on cost. .

And the credit facility, Art?.

The credit facility on cost as well..

Terrific.

And how much leverage does the SLF credit facility allow, Art?.

It's an SPV. So, we have two kinds of pieces of debt. It's a joint venture. We have our securitization CLO and we have an SPV and they kind of work hand in glove and you get kind of an advanced rate based on -- certainly in the SPV, you get advance rate based on the type of collateral.

So, it can permit kind of essentially two to one debt equity in that SPV. The CLO itself can permit more than that as a typical CLO can..

Okay. Thank you for that. I have a couple more questions, but I'll get back in the queue. Thank you..

Okay. Thank you, Mickey..

Our next question comes from Kevin Fultz with JMP Securities. Please go ahead..

Hi. Good morning and thank you for taking my questions. Clearly, the December quarter was really nice from a capital deployment standpoint, growing assets on balance sheet, as well as PSSL. I know over the past year, you've described the vintage is very attractive.

Just curious how you would describe the deal making environment and attractiveness of deals here in 2022..

Yeah. So, first, let's -- good question, Kevin. Thank you. Let's just talk about pacing. 2021 was a blistering pace and deal activity, particularly towards year-end. Number of things came together and make 2021 extraordinarily active. As 2022 going to be as active as 2021, right now looks like that's unlikely.

The year I started out as a typical year where the first quarter is relatively slower. First calendar quarter is relatively slower as people still digest and still are recovering from a very active calendar Q4. So, we think this will probably be more normalized year.

Is that going to look like 2019? That might be? If you said, okay, is 2019 activity the base case probably, I think that'd be a -- probably a reasonable expectation in the model, the 2019 kind of pacing for 2022 versus the 2021 pacing for 2022.

Second part of the question is how do you think about it from a vintage standpoint and the types of deals that you're seeing? I think we're pleased, at least, at PennantPark that we're focused on an area of the market that is not getting the attention and the focus, and therefore, we can be much more important to the borrowers.

Where's the focus and the attention, and you're seeing it and all the articles that everyone reads and some of the research you all provide, which is that upper middle market or the Goliath, investment management firms have very massive pulls of direct lending capital and they are competing heavily among themselves.

And they're competing heavily against the broadly syndicated loan market and their pitch, as you all know, is their eating share of the broadly syndicated loan market. And that's great. Up there at that upper middle market decision-making is compressed. The leverage is higher. There are no covenants. The information rights are far fewer.

They only get financial statements every quarter.

And for us, that's all very good because it leaves the core middle market, or even the lower middle market, a big opportunity for people like us, where our capital has meaning to the borrower, or we have 60 weeks to do proper due diligence, where we can really understand what we're buying, what we're more important to the borrower.

And as such, the yields are higher. The upfront ID is higher. The covenants -- we get quarterly maintenance tests that have meaning. In all cases, we get monthly financial statements. So, for us, that whole move in the upper middle market is creating this very nice window for us.

And our target market today is kind of -- we start out with these companies that start out with between $10 million and $30 million of EBITDA, and they all have a game plan for growth, whether it be organic growth or inorganic growth. Our debt capital can fuel that growth and we can participate in the upside through the equity coinvest.

So, we take that $10 million to $30 million EBITDA company along with a sponsor. We grow it to $40 million, $50 million, $60 million, $70 million, $100 million of EBITDA. It then goes up to that up tier of the market, we exit the debt and we're still riding the equity coinvest.

So, it's been a very good place for us to be our returns have been over the last five, six years excellent, because that's kind of the niche we're in and the niche is getting bigger as the big guys go up..

Great. That's really helpful color there, Art. And then just a follow up question relating to interest rate sensitivity.

Could you provide the weighted average LIBOR for floating rate investments?.

Yeah.

It's about 1%, Richard, right?.

Yeah. That's right. An average that -- yeah LIBOR average is 1%..

Okay. Thank you. And then I'll leave it there. Congratulations on really strong quarter..

Thanks, Kevin..

And we'll take our next question from Paul Johnson with KBW. Please go ahead..

Yeah. Good morning guys. Thanks for taking my questions. Just going back to Mickey's question on the portfolio income, I know you said, doesn't sound like there's really that many non-recurring in there. If I'm looking at it right, I think it was roughly $17 million of interest income in this quarter.

It's like roughly like a 7.5% yield on the debt portfolio.

Do you see that as pretty sustainable for where the portfolio is at today going forward?.

Yeah. Look, as long as, our credit quality remains strong, we do have some more rotation to do in that equity coinvest portfolio. We're going to talk more about pivot later at PNT, but PFLT does have a piece of pivot. And so we would -- we should continue to have some more equity rotation.

And certainly as we upsize this joint venture with Kemper, we're very hopeful that we can continue to grow recurring NII to clearly have the case where we're beating the dividend, handling on a consistent basis..

Great. Thanks for that. My other question, which is on a investment in the portfolio. I'm just curious on marketplace events. I think that's been unfold for some time on your books. But the mark on that has been kind of steadily going up over time.

What -- do you guys have any kind of update on that company or outlook as far as what's going on there?.

Yeah. And you can see it in the market. It's a trade show business, home goods, things of that nature. It's a really well run company.

We took control of it shortly after COVID, excellent management team and they've operated very well through COVID and managed to cut their costs appropriately, still keep the business going, maintain strong cash position.

And now that we hopefully are coming out of COVID in a more fulsome fashion, we think it's well-positioned to bounce back to what it was pre-COVID and hopefully more and higher as they operate.

They're the leader in their industry, we think they're going to end up doing some things on add-on acquisitions, that can continue to help grow EBITDA over the coming quarters and year two, we hope -- and we expect EBITDA to bounce back very nicely..

Okay. Thanks for that. And then just last question.

Do you guys have any update on an estimated spillover amount from this quarter?.

Richard, over to you. I don't think there's anything major since last quarter we announced. We announced every year, once a year in our September Q what the spillover is. Richard, you want to refresh us as to what that was..

Yeah. We could get back to you on that after this call..

Sure..

It's in the Q. I'm going to say it's $0.20 a share something, maybe $0.30, something $0.20 share..

Sure. Yeah. I think it was like $0.22 last quarter..

Yeah. Yeah..

Okay. I appreciate that. Those are all my questions..

Yeah. Yeah. And that would've grown -- that would've grown this quarter with the over on September and add that $0.05 or whatever it was, and probably be good enough for now. But we can follow up after..

Okay. Thanks for that..

And we'll take our next question for Mickey Schleien with Ladenburg. Please go ahead..

Art, just to follow up on that average floor in the debt portfolio.

I think you said it was 1% in the -- on the balance sheet, is it similar in the senior loan fund as well?.

Yeah. Yeah. You look, the typical floors are 1% least in our portfolios. I think we have a chart in the Q, what it would mean, if LIBOR -- if interest rates go up 1%, I think it ends up being about hurting about a penny a share a quarter..

Right.

Art, how do you feel about the scope to term out some of the credit facilities balance and help protect the balance sheet against rising interest rates?.

Yeah. It's something we think about. It has to do with credit rating. It has to do with markets. We like the securitization market. By the way, as you know, CLO market, it's great long-term capital, and it's -- you can do some of that fixed, mostly is floating. But we also like being matched. We also like being matched. So, it's a pluses and minuses.

I think, as interest rates go up, yes, we'll probably be heard a little bit on NII. I think the growth of PSSL, the equity rotation is going to mitigate that and more, and at least we'll be matched on the upside if and when rates get there..

Understand. Thank you. Last question.

Art, how do you feel about the portfolio company's ability on average to pass through inflation onto their customers?.

It's something that goes to the core of what we -- how we underrate and how we think about the companies that we invest in.

We're always asking ourselves the question, if this company goes away, does anybody really care? Who cares if this company goes away, which really brings you to kind of, how important are these companies to their customers? Do they have price, can they raise prices in a relatively easy fashion where customers accept those price increases? The average EBTIDA margins in our portfolio north of 20%, which by the definition means they're getting really attractive margins and they're really well-positioned with their customer base.

So, the vast majority of the companies that have asked for price increases so far have gotten them. And if they haven't asked for it, they are asking for it as we speak. And in this environment, these companies are getting them. They're important to their customers. And by the way, the environment does help everyone.

Those costs are going up and it's not reasonable for companies to be asking for price increases in this environment. So, we've had pretty good -- a pretty good experience as far with pricing increasing in the portfolio..

Thank you for that Art. That's really helpful. Those are all my questions this morning..

Thanks Mickey..

And our next question comes from David Miyazaki with Confluence Investment Management. Please go ahead..

Hi, good morning. Congratulations on the quarter. Just kind of wanted to talk a little bit about, I mean, since you guys brought out, PennantPark Floating, you have this overt strategy pointing your assets toward floating rate coupons, and I think that's something that has become more widely adopted across the industry.

So, I'd just like to hear your perspective on how the LIBOR floors may change as we go into a period when -- if you look at the Fed's dots chart, we should be approaching LIBOR or the reference right around 100 basis points at the end of this year.

Historically, I don't think that a lot of people have moved their floors up while the Fed is tightening and they worry more about it when the Fed's coming down.

So, could you kind of talk about your views on that?.

Yeah. It's interesting. I mean, we'll see how the market evolves, David. Historically, when we've had a rising LIBOR and you can go back -- as short as I think a couple years ago, I think LIBOR was 2.7%, 2.8% not too long ago. There was some erosion of the LIBOR floor. The LIBOR floors were getting taken out of the documents and that's some.

I think the vast majority of the deals still then when LIBOR was a 2.7%, still had LIBOR floors. And I guess by the way, they're going into SOFR floors as we see how things go the coming months.

So, if you look at the history, floors are -- seem like they're permanent part of the landscape, although you do see some erosion when SOFR or LIBOR are far above what a typical floor would be, that's what we've seen, but it'll be interesting to see how things develop this time around.

If we do indeed get above a 100 base points in terms of short-term risk free rates..

Do you ever have the ability -- let's go back to that period -- you talk about when LIBOR is 2% plus.

Is it something that you have the ability to negotiate for a higher floor when people aren't worried about lower rates? Is that something that you can extract in your negotiations, or is that just generally not happening?.

Yeah. It's a great question. And yeah, the other side of the coin, you're right, is when LIBOR is over 2%, people are happy to give you 1% floor because it's the sleeves off their best, right? So, -- and is that an opportunity to go for one in a quarter or 1.5? And that's certainly something we think about at that time.

I think it's really -- just comes down to the negotiation at that time, how much they need you, what their other options are, and PFLT and specifically, we specifically seek out the lower risk portion of the direct lending market.

That's always been for PFLT what we're looking to do, okay, to take a lower risk, get a lower reward, have a lower expense ratio. And for that lower risk investor who wants to really sleep well at night, PFLT should be a good place for them to think about.

So, I would imagine in the strategy, if it -- even in a higher short term rate environment, we're still going to be trying to select the absolute best credits and willing to -- willing to take a lower yield for that, comfort of sleeping at night.

So, probably in this strategy, maybe we can get it from time to time, but I won't count on since we specifically in the strategy want absolutely the best credits..

Okay. That's helpful.

I wanted to kind of extend a little bit on the concept that you talked about with the ability of your borrowers to pass inflation pressure through, because of the LIBOR floors, to some extent your borrowers haven't benefited as the Fed has dropped rates down to zero, right? Because they're at the floor, which has the opposite effect of kind of insulating them from the first four hikes and the Fed raises overnight rate.

So, how would you feel -- is there enough pricing power in your borrower's model to handle kind of this duality of rates rising – LIBOR rising above 100 basis points, at the same time having to push inflationary costs through the customers? Is there enough room in that 20% EBITDA margin?.

Yeah, I mean, we think so. So, far it's working. So far the price increases and it could be a 5% or 7% or 10% or two fives or whatever. I mean, everybody's got their own way of doing their price increases. They've been sticking. They've been sticking. When we look at our credit stats, we're over three times interest coverage, 3.3 times interest coverage.

So, we feel like we're in kind of an okay place. Sure. I wish we had the upside of the Fed. We had the upside as the lender, as the Fed was rising, but -- was raising rates. But we've had the benefit of very healthy yield, as they were lowering and even through the pandemic. So, we can't really complain about it.

And we think, if we're picking the right credits, they have the right cushion built into the credit stats. And if we can find credits where they're important to their customers and that's really kind of homes in, on kind of why we're focused today on five key sectors, that's where there's very high -- very good high free cash flow margins.

Where's good margins period where we know the right questions to ask. So, as we kind of think about ourselves and how we try to improve over the years, it's really kind of focusing in on those sectors that really provide those kinds of EBITDA margins..

Okay. Great. Thank you very much and congratulations again on the quarter..

Thanks David..

There are no further questions at this time. I will now turn the conference back to Mr. Penn for any closing remarks..

Thanks everybody. We really appreciate your attendance today. And next time we chatter it'll be in early May for our March quarter. So, thanks everybody. Take care..

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