Earnings Call Transcript - PFLT Q3 2025

Operator, Operator

Good morning, and welcome to PennantPark Floating Rate Capital's Third Fiscal Quarter 2025 Earnings Conference Call. 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.

Arthur Howard Penn, Chairman and CEO

Thank you, and good morning, everyone. Welcome to PennantPark Floating Rate Capital's Third Fiscal Quarter 2025 Earnings Conference Call. I am joined today by Rick Allorto, our Chief Financial Officer. Rick, please start off by disclosing some general conference call information and include a discussion about forward-looking statements.

Richard Thomas Allorto, CFO

Thank you, Art. I'd like to remind everyone that today's call is being recorded. Please note that this call is the property of PennantPark Floating Rate Capital and that any unauthorized broadcast of this call in any form is strictly prohibited. An audio replay of the call will be available 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.

Arthur Howard Penn, Chairman and CEO

Thanks, Rick. I'm going to spend a few minutes discussing how we fared in the quarter ended June 30, highlight the financing activities we executed during the quarter to strengthen the balance sheets of both PFLT and the PSSL joint venture. Then I'll comment on our new joint venture, the current market environment for private middle market lending and how the portfolio is positioned for upcoming quarters. Rick will conclude with a detailed review of the financials, and then we'll open up the call for Q&A. We are seeing an encouraging recent uptick in deal activity, which we believe will lead to increased loan originations in the second half of 2025. Additionally, we continue to provide additional capital to many of our existing portfolio companies as they execute their respective growth plans. Our platform continues to prove its strength as we support our existing portfolio companies and private equity borrowers with strategic capital solutions to help grow their businesses. With regard to how we fared in the quarter ended June 30, core net investment income for the quarter was $0.27 per share. We believe we will achieve net investment income coverage of the dividend as we scale into our target leverage range as the new joint venture becomes operational. As a reminder, prior to Liberation Day, we proactively built a war chest through our ATM program and debt financing activities based on the expectation of sustained deal flow throughout the year. While market activity slowed following Liberation Day, we have seen a notable rebound in recent weeks. Looking ahead, we are encouraged by the strong outlook for the remainder of the year and anticipate continued NII growth and full dividend coverage. We are pleased to announce the formation of a new joint venture with our long-term and trusted partner, Hamilton Lane. The company and Hamilton Lane have committed to provide $200 million of capital to the joint venture, and combined with an expected $300 million financing facility, the total portfolio will be $500 million. Similar to PSSL, the new joint venture will invest in our core middle market directly originated senior secured loans. We anticipate beginning to invest the capital towards the end of September or the beginning of October. We continue to believe that the current vintage of core middle market directly originated loans is excellent. In the core middle market, leverage is lower and spreads are higher than in the upper middle market. In the core middle market, the pricing on high-quality first lien term loans is SOFR plus 4.75 to SOFR 5.25, and we continue to get meaningful covenant protections while the upper middle market is primarily characterized as covenant-like. Turning to our current portfolio, we continue to maintain what we believe is one of the most conservatively structured portfolios in the direct lending industry. As of June 30, our portfolio's weighted average leverage ratio through our debt security was 4.3x, and the portfolio's weighted average interest coverage ratio was 2.5x. Our new platform investments made during the quarter had a weighted average debt-to-EBITDA of 3.8x and the weighted average interest coverage was 2.6x. Weighted average loan to value was 46%, and yield to maturity was 10.3%. As of June 30, we had 2 investments on nonaccrual status, and total nonaccruals represented only 1% of the portfolio at cost and 0.5% at market value. These are strong credit metrics, reflecting the rigor of our underwriting process and the discipline of our investment approach. We continue to believe that our focus on core middle market loans provides us with attractive investment opportunities where we provide important strategic capital to our borrowers. We have a demonstrated track record of value creation through the successful financing of growing middle market companies across 5 key sectors: business services, consumer, government services and defense, health care, and software and technology. These sectors have been recession-resilient, tend to generate strong free cash flow, and have a limited direct impact from the recent tariff increases and uncertainty. Core middle market companies typically, those with $10 million to $50 million of EBITDA, operate below the threshold of broadly syndicated loan or high-yield markets. The core middle market is our focus as an important strategic lending partner, allowing us to provide attractive packages of terms. We have many weeks to do our due diligence with care. We thoughtfully structured transactions with sensible credit statistics, meaningful covenants, substantial equity cushions to protect our capital, attractive spreads, and equity co-investments. Additionally, from a monitoring perspective, we receive monthly financial statements to help us stay on top of the companies. Regarding covenant protections, while the upper middle market has seen significant erosion, our originated first lien loans consistently include meaningful covenants that safeguard our capital. Credit quality since inception 14 years ago has been excellent. PFLT has invested $7.8 billion in over 500 companies, and we've experienced only 23 nonaccruals. Since inception, PFLT's loss ratio on invested capital is only 11 basis points annually. As a provider of strategic capital, we fuel the growth of our portfolio companies. In many cases, we participate in the upside of the company by making an equity co-investment. Our returns on these equity co-investments have been excellent over time. Overall for our platform, from inception through June 30, we've invested over $583 million in equity co-investments and have generated an IRR of 26% and a multiple on invested capital of 2x. As of June 30, our portfolio grew to $2.4 billion, up from $2.3 billion in the prior quarter. During the quarter, we continued to originate attractive investment opportunities and invested $208 million in 4 new and 17 existing portfolio companies at a weighted average yield of 10.1%. During the quarter, we undertook several key initiatives to fortify our balance sheet, enhance liquidity, and position the company to capitalize on emerging market opportunities. In April, we amended the trust's revolving credit facility and reduced the interest rate on the facility to SOFR plus 2.00 from SOFR plus 2.25. The amendment also extended the revolving period and final maturity by 1 year to August 2028 and August 2030, respectively. Our financial strength was also enhanced by the attractive equity capital raised from our ATM program. During the quarter, we raised $32 million from the issuance of 2.8 million shares of our common stock at an average price of $11.31 per share. Our PSSL joint venture has also taken significant strides in bolstering its financial strength as well. As of June 30, the JV portfolio totaled $1.1 billion. During the quarter, it invested $52 million in 7 new and 2 existing portfolio companies at a weighted average yield of 10.8%. In April, PSSL closed on a new securitization financing at an attractive weighted average price of SOFR plus 1.71. PSSL has $250 million of additional committed debt and equity capital that can boost its total portfolio to $1.4 billion. We believe that the increase in the scale of the JV's balance sheet will continue to drive attractive mid-teen returns on invested capital and enhance PFLT's earnings momentum. From an outlook perspective, our experienced and talented team and our wide origination funnel is well set up to produce active deal flow. Our continued focus remains on capital preservation and being patient investors. Our mission and goal is a steady, stable, and protected dividend stream, coupled with the preservation of capital. Everything we do is aligned to that goal. We seek to find investment opportunities in growing middle market companies that have high free cash flow conversion.

Richard Thomas Allorto, CFO

Thank you, Art. For the quarter ended June 30, GAAP net investment income was $0.25 per share, while core net investment income was $0.27 per share. Operating expenses for the quarter were as follows: interest and expenses on debt were $25.4 million. Base management and performance-based incentive fees were $11.3 million. General and administrative expenses were $1.95 million and provision for taxes was $0.2 million. For the quarter ended June 30, net realized and unrealized change on investments, including the provision for taxes, was a loss of $5.3 million. As of June 30, NAV was $10.96 per share, which is down 1% from $11.07 per share last quarter. As of June 30, our debt-to-equity ratio was 1.3x, and our capital structure is diversified across multiple funding sources, including both secured and unsecured debt. As of June 30, our key portfolio statistics were as follows: the portfolio remains well diversified, comprising 155 companies across 50 industries; the weighted average yield on our debt investments was 10.4%, and approximately 99% of the debt portfolio is floating rate; fixed income equaled only 1.8% of total interest income. We had 2 nonaccruals, which represent 1% of the portfolio at cost and 0.5% at market value. The portfolio is composed of 90% first lien senior secured debt, less than 1% in subordinated debt, 2% in equity of PSSL, and 8% in equity co-investments. The debt to EBITDA on the portfolio is 4.3x, and interest coverage was 2.5x. Now let me turn the call back to Art.

Arthur Howard Penn, Chairman and CEO

Thanks, Rick. In conclusion, I want to express my gratitude to our dedicated team of professionals for their unwavering commitment to PFLT and its shareholders. 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 for questions.

Operator, Operator

We will take your first question from Brian Mckenna with Citizens.

Brian J. Mckenna, Analyst

Congratulations on the new JV with Hamilton Lane. Just a few questions here. If this pickup in the acceleration in deal activity continues, how much of the $500 million could you deploy over the next few quarters? How are you thinking about the potential accretion from the JV within the PFLT? And then obviously, Hamilton Lane is getting access to high-quality core middle market deal flow and transactions. But is there anything you can leverage from the Hamilton Lane platform to drive better outcomes for the JV as well?

Arthur Howard Penn, Chairman and CEO

A bunch of great questions in there, Brian. Let's make sure I hit them all. In terms of being able to ramp it, I think we consider it as kind of a 12-month ramp for the $500 million, maybe 18 months on the outside. But in light of our platform, we think of it as a 12- to 18-month ramp. As you've seen, the 2 other JVs we've had in our platform, both the PFLT and PNNT, have done well and we hope this one will do well in a good symbiotic relationship with Hamilton Lane. They can grow very substantially above and beyond that. So our outlook would be this is a long-term partnership with this JV and we hope it will grow from $500 million to something larger over time. We've been able to get kind of good dividend yields on these JVs in the mid- to upper-teens between the PSSL 1 here and PFLT as well as PSSL for PNNT, which kind of offer mid- to upper-teens returns on an NII basis on the capital invested. So you can model the $150 million we're putting in and use a mid- to upper-teens NII return on that and see what that means. But over time, we hope it's a really fantastic long-term partnership. We've had a lot of exposure to Hamilton Lane to date, which led us to this point. We think there's a true synergy around credit and how we evaluate opportunities. Yes, we expect all these JVs, along with the other JVs we have, to foster real partnerships where both parties contribute ideas, due diligence, and insights regarding what's happening in the economy. Hamilton Lane has a lot of great relationships with private equity sponsors and others that we could be working with. So we are very excited about it.

Brian J. Mckenna, Analyst

Okay. That's really helpful. And then maybe just a little bit of a bigger picture question. You and the team have clearly done a great job growing your public BDCs in aggregate; the market caps for both PFLT and PNNT totaled about $1.5 billion. I'm curious about your longer-term growth plans for both of these vehicles. And I think I asked you this almost every quarter, but at what point or size does it make sense to merge them? And then assuming you ultimately have 1 public BDC longer term, would you ever consider internalizing the corporate structure?

Arthur Howard Penn, Chairman and CEO

In terms of the first question, growth, we're not the type of firm to sit here and set growth parameters and then kind of have goals because we think that's contrary to credit quality and investment selection. In a business where you have quality on one scale and quality on the other, we clearly focus on quality. So the growth will be organic based on the opportunities in the market and where it makes sense to invest. So the growth will be as you've seen throughout these years, based on kind of market opportunity. You do ask the same question every quarter, Brian, about potentially merging, and the answer is always the same. All things are always on the table. That said, PNNT is still working through some equity rotation issues at PNNT. So our main focus there is addressing that. Once we do, we can reassess all the different options available to us, always prioritizing shareholder value, which is our number one focus.

Operator, Operator

We'll hear next from Arren Cyganovich from Truist.

Arren Saul Cyganovich, Analyst

You mentioned in your press release that you expect net interest income will fully cover the dividend over time. Could you please discuss the timing associated with that or your expectations as we progress through the rest of the year?

Arthur Howard Penn, Chairman and CEO

Yes, that's a great question, Arren, and welcome back to PennantPark and PFLT. We have 3 levers of NII growth at the company. Lever 1 is leveraging up to our target leverage ratio of about 1.5x area. We're below that as of quarter end, so that's lever number one. Lever number two is filling out PSSL 1, which is the Kemper JV. There's more capital to deploy there before that’s full. You can always grow these things once you hit capacity, but that's kind of lever number two. Lever number 3 is the new Hamilton Lane JV, PSSL 2. As I just mentioned, that will probably be a 12- to 18-month ramp. So we believe that as we activate those levers - 1, 2, and 3, we can target covering the dividend, if not more. You experts in modeling can extrapolate, but our models indicate that these levers can allow us to more than cover the dividend over time.

Arren Saul Cyganovich, Analyst

That's helpful. And credit quality continues to be very strong. Can you talk a little bit about what you're seeing at the portfolio company level in terms of some of the metrics there in terms of EBITDA growth, et cetera?

Arthur Howard Penn, Chairman and CEO

Yes. Look, EBITDAs continue to grow nicely in general, kind of mid- to upper single digits overall. Certainly, it's dependent on the underlying company in the industry, but nonaccruals are relatively light. We hope to keep them that way. You can also see that we're keeping leverage levels on both new deals and the overall portfolio low as well, new deals averaging 3.8x debt to EBITDA, 2.6x interest coverage, overall portfolio at 4.7x debt to EBITDA, and 2.5x coverage—this indicates a very limited risk in this portfolio. This is what happens when you keep leverage low. We believe we are among the lowest risk in our peer group, in addition to obtaining meaningful covenants to protect the capital. The portfolio is performing well. Of course, like any portfolio with around 150 names, there are some underperformers, which is to be expected. But overall, we see a relatively strong situation with our portfolio.

Operator, Operator

We'll move next to Christopher Nolan from Ladenburg Thalmann.

Christopher Nolan, Analyst

Guys, is the high level of unrestricted cash at quarter end going to be directed towards the joint venture?

Richard Thomas Allorto, CFO

Chris, that cash, some of it will be used for the JV. Quarter end tends to be a high collection period. So part of that cash balance is just timing from a cash management and working capital perspective in terms of using it to deploy and fund new investments versus temporarily paying down debt while waiting for new opportunities.

Christopher Nolan, Analyst

Great. And Art, strategically, given the comments you gave on the lending market, are you expecting to see improved loan pricing power given what seems to be increased appetite for leverage by middle market companies?

Arthur Howard Penn, Chairman and CEO

Yes. Thanks, Chris. By the way, welcome back to PennantPark as well. Good to see you back on the case. We certainly hope so. I mean spreads have come down over the last year, 1.5 years. Today, the range is $4.75 to $5.25. We hope that increased supply will give us an opportunity to maintain and maybe expand those spreads. Constitutionally, though, based on lessons learned over many years, we prioritize credit quality. So we're generally okay if the credit is excellent, even if it means accepting a slightly lower spread, as nonaccruals are the real threat and the source of pain in these portfolios. Therefore, while we hope for better spreads with added supply, there are no guarantees.

Operator, Operator

We'll hear next from Michele Scheff from Raymond James.

Unidentified Analyst, Analyst

So going back to the recent rebound in M&A activity, is there any sort of mix shift in terms of what's in the pipeline or where dollars are being deployed, whether it's versus new borrowers or sponsor versus non-sponsor?

Arthur Howard Penn, Chairman and CEO

Yes. Great question. Until about a month ago, I would have said that the activity was mostly incumbent loans, where we're involved in delayed draws or add-on loans to existing companies. Most of our deals are initiated when a company, typically sold from a founder or a family business, gets acquired by a middle market private equity firm that does between 10% and 20% of EBITDA. It's often in a fragmented industry, and the private equity firm wants to facilitate consolidation in that sector. We provide the capital to fund the initial deal, followed by add-on loans, whether they are delayed draws or otherwise, to grow that initial company from, say, a $20 million EBITDA to $30 million, $40 million, and beyond. In this case, we become a strategic partner, where our capital serves as the fuel for growth, and we participate in the equity upside through our co-investment. However, recently we have been noticing a distinct uptick in new platform activity in the past month. In PFLT, in particular, it's almost exclusively sponsor deals. Again, our focus is capital preservation and yield first. We aim for loan-to-value ratios of 40% or 50%, which is typically where they are today. If a financial hurdle arises, typically the sponsor capital provides a cushion. Often, when they invest 50% to 60% of the equity upfront, this serves as a safety net when bumps occur. This was evident during COVID when nearly every liquidity pinch was addressed with additional sponsor capital. The industry segments we continue to focus on are the same sectors we have significant domain expertise in. We are consciously avoiding sectors tied to tariffs, as we have always done, but generally our focus stays the same.

Operator, Operator

And at this time, there are no additional callers in the queue. I'd like to turn the conference back over to Mr. Art Penn for any additional or closing comments.

Arthur Howard Penn, Chairman and CEO

I think there might be a question in the queue, if we could or maybe not. Yes, it looks like there is.

Operator, Operator

Looks like we just have Paul Johnson from KBW.

Paul Conrad Johnson, Analyst

I hopped on a little late here. I apologize if you already mentioned this on the call or if the question has already been asked. But it looks like, based on the ATM activity for the quarter that you guys issued most of the shares on the ATM pretty early in the quarter. The stock would have been trading at a bigger discount to NAV than where you guys trade today, but you obviously have a history of mitigating that discount when you issue those shares. I'm just curious, is that something that you would plan on doing going forward pretty regularly in terms of just capital management? Is there going to be more, I guess, context around valuation of shares going forward?

Arthur Howard Penn, Chairman and CEO

It's a good question, Paul. The answer is, of course, yes. We did issue $32 million of shares—2.8 million shares at $11.31. That pricing occurred pre-Liberation Day when we were preparing for what we believed would be a very active 2025. Between the ATM program and the initiatives we undertook with our credit facility and the adjustment of the securitization, our timing was favorable for issuing shares at an attractive price. Unfortunately, the deal flow income decreased after Liberation Day, resulting in 60 to 90 days of light deal activity. However, it seems to be picking back up now, and we are hopeful that the remainder of the year will yield good opportunities to deploy that war chest we built using the ATM program and our credit facilities effectively throughout 2025. As you know, ATM programs are quite efficient and cost-effective. They tend to allow us to be surgical regarding how and when we trade our stock. We thoroughly evaluate everything—deal flow, capital structure, and stock trading patterns. Currently, we are in a strong position with ample capital thanks to being under-leveraged at PFLT while also having two JVs with available capital. So at least for now, we are well-positioned.

Operator, Operator

And at this time, there are no additional callers in the queue. Mr. Penn, I'd like to turn the conference back over to you for any additional or closing comments.

Arthur Howard Penn, Chairman and CEO

Yes. I just want to thank everybody for participating today and wish everyone a terrific remainder of summer. Our next quarterly earnings call will follow the 2Q, which will be later than normal due to the annual report, likely mid to late November, just before Thanksgiving. We look forward to talking with everyone then. Thank you for your time and your support of PFLT.

Operator, Operator

That does conclude today's teleconference. We thank you all for your participation. You may now disconnect.