Earnings Call Transcript - PNNT Q1 2026

Operator, Operator

Good afternoon, and welcome to the PennantPark Investment Corporation's First Fiscal Quarter 2026 Earnings Conference Call. Today's conference is being recorded. Operator instructions: participants may ask questions following the prepared remarks. It is now my pleasure to turn the call over to Mr. Art Penn, Chairman and Chief Executive Officer of PennantPark Investment Corporation. Mr. Penn, you may begin. Go ahead and begin your conference.

Arthur Penn, Chairman and Chief Executive Officer

Good afternoon, everyone, and thank you for joining PennantPark Investment Corporation's First Fiscal Quarter 2026 Earnings Call. I'm 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 Allorto, Chief Financial Officer

Thank you, Art. I'd like to remind everyone that today's call is being recorded and is the property of PennantPark Investment Corporation. 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. Our remarks today may include forward-looking statements and projections. Please refer to our most recent SEC filings 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 Penn, Chairman and Chief Executive Officer

Thanks, Rick. I'll begin with an overview of our first quarter results and discuss our forward dividend strategy. I will then discuss the exit of our investment in JF Holdings and our ongoing strategy to reduce the portfolio's equity exposure. Lastly, I will share our perspective on the current market environment and how the portfolio is positioned for the quarters ahead. Rick will follow with a detailed review of the financials, and then we'll open up the call for questions. For the quarter ended December 31, core net investment income was $0.14 per share. Turning to the dividend, beginning with the dividend payable in April. The total dividend will remain $0.08 per share, but will be comprised of a $0.04 per share base dividend and a $0.04 per share supplemental dividend. The base dividend is expected to be fully supported by current core net investment income and the supplemental dividend will be supported by our $41 million or $0.63 per share of undistributed spillover income. We anticipate maintaining the supplemental dividend payment through December 2026. During the quarter, we fully exited our equity investment in JF Holdings and received total proceeds of $68 million and generated a realized gain of $63 million. With the exit, we monetized 20% of the fair value of our equity portfolio. While we are pleased with the outcome for JF, we remain focused on reducing the total equity exposure of the fund. Turning to the market environment. We are seeing an increase in M&A transaction activity across the private middle market. This trend is expanding our pipeline of new investment opportunities. We also expect that this increase in M&A activity will drive repayments of existing portfolio investments, including opportunities to exit some of our equity co-investments and rotate that capital into new current income-producing investments. We believe the current environment favors lenders with strong private equity sponsor relationships and disciplined underwriting, areas where we have a clear competitive advantage. In the core middle market, the pricing on high-quality first lien term loans remains attractive, typically ranging from SOFR plus 475 to 525 basis points with leverage of approximately 4.5x. Importantly, we continue to get meaningful covenant protections in contrast to the covenant-light structures prevalent in the upper middle market. Turning to our portfolio performance. As of December 31, the median leverage across the portfolio was 4.5x with median interest coverage of 2.1x. During the quarter, we originated 3 new platform investments with a median debt-to-EBITDA of 4x, interest coverage of 2.9x and a loan-to-value ratio of 49%. With regard to the software risk that has been a recent market focus, we have stuck to our knitting. Only 4.4% of the overall portfolio is software and that 4.4% is structured consistently with how we invest. They are primarily all cash pay loans with covenants, reasonable leverage and an average maturity of 2.2 years. It's enterprise software that is integral to their customers' businesses and the vast majority is focused on heavily regulated industries such as defense, health care and financial institutions where safety, security and data privacy are paramount and where change will be slower. Peers typically invested much larger percentages of their portfolios in software, 20% to 30% with much higher leverage, 7x, 8x or more, or loans against revenue, not cash flow, with substantial PIK, covenant-light structures and long maturities. This story is a significant differentiator from our peers. We ended the quarter with 4 nonaccrual investments, representing 2.2% of the portfolio at cost and 1.1% at market value. These strong credit metrics reflect the rigor of our underwriting process and the discipline of our investment approach. We continue to believe that our focus on the core middle market provides us with attractive investment opportunities where we provide important strategic capital to our borrowers. The core middle market, companies with $10 million to $50 million of EBITDA, is below the threshold and does not compete with the broadly syndicated loan or high-yield markets, unlike our peers in the upper middle market. In the core middle market, because we are an important strategic lending partner, the process and package of terms we receive is attractive. We have many weeks to do our diligence with care. We thoughtfully structure transactions with sensible credit statistics, meaningful covenants, substantial equity cushions to protect our capital, attractive spreads and equity co-investment. Additionally, from a monitoring perspective, we receive monthly financial statements to help us stay on top of the companies. Our rigorous underwriting standards remain central to our investment philosophy. Nearly all of our originated first lien loans include meaningful covenant protections, a key differentiator versus the upper middle market where covenant-light structures are common. Since inception nearly 19 years ago, PNNT has invested $9.2 billion at an average yield of 11.2%, while maintaining a loss ratio on invested capital of roughly 20 basis points annually, a testament to our consistent and disciplined approach through multiple market cycles. As a provider of strategic capital, it fuels 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 December 31, we have invested over $615 million in equity co-investments and have generated an IRR of 25% and a multiple on invested capital of 1.9x. As of December 31, our portfolio totaled $1.2 billion. And during the quarter, we continued to originate attractive investment opportunities and invested $115 million in 3 new and 51 existing portfolio companies. Our PSLF joint venture portfolio continues to be a significant contributor to our core NII. At December 31, the JV portfolio totaled $1.4 billion. And over the last 12 months, PNNT's average NII yield on invested capital and the JV was 16.4%. The JV has the capacity to increase its portfolio to $1.5 billion, and we expect that this additional growth in the JV will enhance our earnings momentum in future quarters. From an outlook perspective, our experienced and talented team and our wide origination funnel is producing active deal flow. We remain steadfast in our commitment to capital preservation and a disciplined, patient investment approach. We reiterate our objective to deliver compelling risk-adjusted returns through stable income generation and long-term capital preservation. We seek to find investment opportunities in growing middle market companies that have high free cash flow conversion. We capture that free cash flow primarily through debt instruments, and we pay out those contractual cash flows in the form of dividends to our shareholders. With that overview, I'll turn the call over to Rick for a more detailed review of our financial results.

Richard Allorto, Chief Financial Officer

Thank you, Art. For the quarter ended December 31, GAAP net investment income was $0.11 per share and core net investment income was $0.14 per share. Operating expenses for the quarter were as follows. Interest and credit facility expenses were $10.5 million, base management and incentive fees were $3.9 million. General and administrative expenses were $1.3 million and provision for excise taxes were $0.7 million. For the quarter ended December 31, net realized and unrealized change on investments and debt, including provision for taxes, was a loss of $2 million. As of December 31, our NAV was $7 per share, which is down 1.5% from $7.11 per share in the prior quarter. As of December 31, our debt-to-equity ratio was 1.3x, and our capital structure is diversified across multiple funding sources, including both secured and unsecured debt. In January, we raised $75 million of new unsecured debt, which will be used to partially repay our existing unsecured debt that is maturing in May. As of December 31, our key portfolio statistics were as follows. Our portfolio remains highly diversified with 158 companies across 37 different industries. The weighted average yield on our debt investment was 10.9%. The portfolio is comprised of 48% first lien secured debt, 3% second lien secured debt, 14% subordinated notes to PSLF, 6% other subordinated debt, 6% equity in PSLF and 23% in other preferred and common equity co-investments. 89% of the debt portfolio is floating rate. The debt-to-EBITDA on the portfolio is 4.5x, and interest coverage is 2.1x. With that, I'll turn the call back to Art for closing remarks.

Arthur Penn, Chairman and Chief Executive Officer

Thanks, Rick. In conclusion, we remain committed to delivering consistent performance, preserving capital and creating long-term value for all stakeholders. Thank you to our team for their dedication and our shareholders for their continued partnership and confidence in PennantPark. That concludes our remarks. At this time, I would like to open up the call to questions.

Operator, Operator

Operator instructions: To ask a question, press star then one. Our first question, Robert Dodd from Raymond James.

Robert Dodd, Analyst

A couple of semi-housekeeping items first. On the dividend, you said the supplemental program will stay in place through December 2026. Just to clarify, you mean the $0.04 specifically supplemental monthly will stay in place through '26 and beyond that, who knows, right? But that's not just that there will be a supplemental, but it's the $0.04 level?

Arthur Penn, Chairman and Chief Executive Officer

That's correct.

Robert Dodd, Analyst

Got it. Second one, will there be any one-time expenses in calendar Q1 related to the new bond or the partial paydown of the May? Or are you just going to hold the cash until then? I mean, is there going to be anything one-time in Q1?

Richard Allorto, Chief Financial Officer

No, Robert. There won't be any one-time expenses related to that. For that facility, the fees associated with issuing that new debt will be capitalized and amortized and there will be no real impact from a one-time perspective on the revolving facility.

Robert Dodd, Analyst

Got it. Got it. Then I'm not going to ask you exactly the same question as I did earlier on software. But as you look at the core niches that you've really focused on at PNNT and obviously a combination of the size of businesses, but the type of borrowers that you have typically focused on, do you think AI represents more of a risk or an opportunity for the typical borrowers that you lend to in those industries?

Arthur Penn, Chairman and Chief Executive Officer

Yes, it's a great question, and we debate this every time we go through a company and investment committee: is it a help or a hindrance? Ultimately, we keep asking ourselves the same question all over again, which is if this company goes away, who really cares? If the company going away doesn't matter, we shouldn't be investing in that company. Usually, if people care, it means they have really great customer relationships or a high market share or a defensible niche. Usually, AI could be a help and present some upside to companies that are well positioned and have a moat, although there's no assurance. One of the famous quotes is people tend to overestimate the impact of technological change in the short run, and they tend to underestimate the impact of technological change in the long run. It feels like we're in a short-run moment where the whole market is kind of spinning on the concept of AI and software. As we've discussed, for us software is a very small percentage, manageable and deeply embedded. But where things will be in 10 years, I don't know. It's nice to have a credit portfolio with short maturities. Our average software maturity might be around 3 years. Our average maturities are 3 to 5 years. It's nice to have covenants. It's nice to get cash flow. We don't have any PIK in these portfolios. That's how we defend ourselves. We also have to find companies that people will care about and that have resilience — you see it in margins and how they gain share. Hopefully, we're selecting those companies well. Of course, there's never a guarantee.

Operator, Operator

Our next question, Paul Johnson with KBW.

Paul Johnson, Analyst

In terms of the equity rotation that's left in the portfolio, there's still quite a bit even after the JF Holdings exit. Do you still think there's potential this year for additional meaningful exits at this point? It sounds like you're fairly optimistic about M&A coming in this year, but has any of the recent volatility backed up interest in doing M&A in any of those names?

Arthur Penn, Chairman and Chief Executive Officer

Yes. We still think there's ample M&A activity. Granted, we're not big in software, so I couldn't speak to M&A in that space. In the rest of the market, we're still seeing good M&A. I will highlight that two of our bigger sectors are military, defense and government services as well as health care, both of which seem to be performing well and both of which, from what we can tell, represent meaningful M&A activity and where we have substantial equity co-invest. Those have been two of our larger sectors and they've performed very well for us. There are not many people heavily focused on defense and government services, which has been a big space. The U.S. government seems to be increasing its expenditures and there's some tailwinds there. On health care, we've had a better experience than many of our peers. I think that stems from not leveraging up companies as much. Peers tend to accept higher leverage. When we do health care, we try to find companies with a defensible moat and keep leverage reasonable. In health care, our approach is to find companies that provide high-quality service at a reasonable or low cost, given that government reimbursement is always a risk. If we can find companies that reduce cost and still provide good service, it's hard for them to be hurt. I think that's one reason our health care names have probably performed better than some of our peers.

Operator, Operator

Our next question is from Brian Mckenna from Citizens.

Brian Mckenna, Analyst

I'm curious, why not adjust the dividend to reflect the current outlook for core earnings and then repurchase stock with that capital? That would drive some NAV per share accretion versus diluting it by about 1% plus a quarter. And then should we expect to see some insider buying post-earnings here with the stock trading at 77% of book and an 18% dividend yield?

Arthur Penn, Chairman and Chief Executive Officer

We have substantial spillover that we are obligated to pay out. There's been some debate about whether to pay it all out at once or over time. Given we want to maintain good credit ratings and provide a smooth glide path for our shareholders, we've elected to pay it out over time and we also want to keep our leverage reasonable. We aim to keep leverage around 1.2x to 1.3x debt-to-equity. As we rotate capital, whether from equity or debt exits, we are obligated to pay the supplemental dividends. How we allocate excess capital after those obligations is something we're always thinking about. We're mindful of our credit ratings and debt-to-equity ratio. Buying back equity, albeit cheap, does impact debt-to-equity, but it's something we always consider. We've done buybacks in the past at PNNT and we always evaluate that option. Insider buying has been substantial over time; it's also on the table and under continuous consideration.

Brian Mckenna, Analyst

Okay. That's helpful. And then, Art, you've clearly had a great tenure in the industry. You've managed the business in a number of different operating environments and through periods when the industry came in and out of favor. What past experiences are you leaning on today to prudently manage the portfolios in the current environment as it continues to evolve? And is there an opportunity to lean into some of the dislocation we've seen in the market, either from an origination perspective or strategically at the broader manager level?

Arthur Penn, Chairman and Chief Executive Officer

Chaos does bring opportunity, and it's brought opportunity for us over time, whether during the global financial crisis, the energy downturn, or more recently COVID. You have to defend first and build resilience in the vehicles. Then you can look to take advantage of some of the dislocation. We stick to our discipline. When we see reasonable leverage with covenants and good risk-adjusted return, we'll lean in and try to take advantage. We're watching cash flows into the industry — whether through high-net-worth channels or insurance channels — to see if they hold up. We want to remain prudent, well-balanced and opportunistic. At the management company level, we are always looking for opportunities at the BDC level and more broadly. We think our navigation of software risk is a differentiator and underscores the benefits of the core middle market where covenants are still prevalent, leverage is reasonable and there's limited PIK. That may be a better focus for large allocators than chasing high-leverage covenant-light allocations. We'll continue to defend first and play offense judiciously when appropriate.

Operator, Operator

Our next question comes from Rick Shane with J.P. Morgan.

Richard Shane, Analyst

It's been a while. I think I was there 19 years ago, actually. One of the things that has changed is the competitive landscape. Many peers effectively have a different cost of capital; they can raise capital essentially at par. You guys are trading at a significant discount. How do you close that gap? Can you continue to compete if your primary competitors have a lower funding cost? With that, could you talk about the sizing of the debt deal you guys just did? It's $75 million, which represents about 25% of your pending maturities this year. How do you think about the next steps there?

Arthur Penn, Chairman and Chief Executive Officer

Good to hear your voice, Rick. On the maturities, the $75 million was the first step. Over the coming 3, 6, 9 months we'll chip away at them judiciously and consider various ways to raise debt capital. On the competitive framework, PNNT is a work in progress. We took some stumbles during the energy crisis and it's been a challenging period since. The main focus is reducing equity exposure — the sale of JF was a big milestone to significantly reduce equity exposure, but we have more to do. Our focus is to rotate the equity, clean up the portfolio, and then determine the next steps for PNNT. Regarding cost of capital, we have a strong track record in first lien core middle market senior secured debt with reasonable leverage (around 4.5x), maintenance tests, monthly financials and ample time for due diligence. That track record can be financed and captured well for PNNT in the JV format where we use credit facilities and securitization facilities to efficiently finance and generate strong risk-adjusted returns for PNNT shareholders. The JV structure is well financed and efficiently managed from a cost standpoint; no management fees are charged on the JV. In essence, we manage a larger pool of capital without charging management fees, which is attractive on a blended basis. The plan is to rotate the equity, manage the JV, make progress on deleveraging and then reassess the next steps.

Operator, Operator

Our next question comes from Christopher Nolan with Ladenburg Thalmann.

Christopher Nolan, Analyst

The decline in dividend income quarter-over-quarter, is that related to the senior loan fund?

Richard Allorto, Chief Financial Officer

Chris, yes, it was related to PSLF, correct.

Christopher Nolan, Analyst

Great. And then should we expect use of the expanded facility for some of the refinancings going forward?

Arthur Penn, Chairman and Chief Executive Officer

Yes. The expanded facility gives us the ability to pick our spots on when to issue bonds. It provides more liquidity and dry powder. In times of market turbulence, it's good to have excess liquidity for both defensive and offensive purposes.

Christopher Nolan, Analyst

Final question: Are you finding that you're trading coupon for stronger covenants, or is that not really a dynamic available in your negotiations?

Arthur Penn, Chairman and Chief Executive Officer

In our part of the market — the core middle market — covenants are typical. For borrowers doing $20 million or $30 million of EBITDA, we are almost always getting covenants. We will trade off yield for credit quality. Our lesson is not to skimp on credit quality even if it means giving up a few basis points; higher credit quality is usually the right call.

Christopher Nolan, Analyst

Great. Final question: I asked this on the last call. The $36 million in credit facility and debt issuance costs, was that relating to the $75 million issuance in January?

Richard Allorto, Chief Financial Officer

No, that was related to the amend and extend of the revolving facility in the fourth quarter.

Operator, Operator

Our next question comes from Casey Alexander with Compass Point.

Casey Alexander, Analyst

I'm glad you brought up the PSLF JV. The leverage in the JV is 2.8x, which is the highest I've heard of any JV in a BDC. At the same time, your fair value of your equity in the JV has been marked down $22 million, which contributes to that high leverage ratio. At what point will you be forced to add more equity to the JV or shrink the JV to temper the leverage ratio?

Arthur Penn, Chairman and Chief Executive Officer

These are good points. To level set, the broader PennantPark platform has a large senior secured first lien middle market business. When a first lien loan comes into the platform, it gets allocated across the platform, including the JVs where it makes sense, the private funds, the BDCs. We also have a CLO platform in the middle market and appreciate the benefits of securitization technology. We've run securitizations through COVID and feel we understand them. Middle market CLOs often run at 4x or 5x leverage, and we run them well. The CLO portion of our business is understood and managed to reduce risk. The goal for the joint ventures is usually to run them at least around 2x; 2.8x is on the higher end. I don't anticipate going any higher. We still think it's a prudent structure given the low-levered senior secured covenanted cash-pay debt in the JV — there's no software exposure in these assets and there are covenants. You raised a good point about equity diminution. When you have a book of largely debt, you can have losses and equity diminution. At PennantPark, we have an equity co-invest program that over time has generated nearly a 2x MOIC and a 25% IRR. That program helps fill gaps that can occur with debt. The JV partner does not want equity in the JV; we create equity and have it ready to deploy if needed to shore things up. That's why we maintain excess liquidity and access to bonds. The JF sale was a big milestone and we used that equity to deleverage PNNT, creating dry powder and prudent cushion in the overall platform. We're aware of the leverage dynamics and are comfortable with where we are at this point.

Operator, Operator

That will conclude our question-and-answer session. I'd like to turn the call back over to Art Penn for closing remarks.

Arthur Penn, Chairman and Chief Executive Officer

I want to thank everybody for participating on today's call. We look forward to speaking with you next in early May.

Operator, Operator

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