Earnings Call Transcript - PNNT Q1 2025

Operator, Operator

Good afternoon, and welcome to the PennantPark Investment Corporation's First Fiscal Quarter 2025 Earnings Conference Call. Today's conference is being recorded. 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 your conference.

Arthur Penn, CEO

Good afternoon, everyone. I'd like to welcome you to PennantPark Investment Corporation's First Fiscal Quarter 2025 Earnings Conference Call. I'm joined today by Rick Allorto, our CFO; and Rick, please start off by disclosing some general conference call information and include a discussion about forward-looking statements.

Richard 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 Investment Corporation 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 Penn, CEO

Thank you, Rick. We will spend a few minutes discussing the current market landscape for private middle market credit, how we performed in the quarter ending December 31, and how our portfolio is positioned for the upcoming quarters. We will also discuss our dividend coverage, spillover income balance, provide a comprehensive review of the financials, and then open the floor for questions. For the quarter ending December 31, our GAAP and core net investment income was $0.20 per share, which is $0.04 less than our quarterly dividend. PNNT holds $65 million or $0.99 per share of undistributed spillover income. To comply with tax regulations, we need to distribute this spillover income over time. We believe PNNT can generate a core NII of $0.21 to $0.22 per share. However, if core NII stays at the current level of $0.20 per share, it would take more than 24 quarters or 6 years to fully distribute the spillover income. GAAP and adjusted NAV rose by 0.1% to $7.57 per share from $7.56. As of December 31, our portfolio totaled $1.3 billion. During the quarter, we successfully identified appealing investment opportunities, deploying $296 million across 12 new and 61 existing portfolio companies with a weighted average yield of 10.6%. The core middle market continues to present attractive vintage opportunities. For new portfolio company investments, the weighted average debt-to-EBITDA ratio was 4x, the weighted average interest coverage was 2.2x, and the weighted average loan-to-value was 62%. As of December 31, the portfolio's weighted average leverage ratio through our debt securities was 4.9x, and the weighted average interest coverage stood at 1.9x. These positive credit statistics reflect our careful selection process, conservative approach, and commitment to the core middle market. In this segment, market yields on first lien term loans seem to have stabilized within the SOFR plus 500 to 550 range. As indicated by the credit statistics, we maintain our belief that the current vintage of core middle market loans is strong, with lower leverage, higher spreads, and tighter covenants compared to the upper middle market, while still securing meaningful covenant protections. Our joint venture portfolio is growing and significantly contributing to our net investment income. By December 31, the JV portfolio reached $1.3 billion, and during the quarter, it invested $354 million, including $286 million in purchases from PNNT. Over the past 12 months, PNNT achieved an 18.4% return on invested capital in the JV. The JV has the capacity to expand its portfolio to $1.6 billion, and we anticipate that this continued growth will boost PNNT's earnings momentum in future quarters. The credit quality of our investment portfolio remains robust, with two nonaccruals as of December 31, representing 4.3% of the portfolio cost and 1.5% of market value. Now, let’s discuss the current market environment. We are well positioned as a lender dedicated to capital preservation in the United States. We continue to believe that our focus on the core middle market offers attractive investment opportunities where we provide essential strategic capital to our borrowers. We have a long-term history of creating value by financing growing middle market companies across five key sectors: business services, consumer, government services and defense, healthcare, and software technology. These sectors have displayed resilience in economic downturns and typically generate strong free cash flow. Moreover, core middle market companies with EBITDA ranging from $10 million to $50 million operate below a threshold that puts them at odds with broadly syndicated loans or high-yield markets, distinguishing us from competitors in the upper middle market. In the core middle market, our role as a crucial lending partner enables us to receive attractive terms and packages. We have ample time for thorough due diligence, allowing us to structure transactions thoughtfully with sensible credit metrics, meaningful covenants, significant equity cushions to protect our investment, and favorable spreads, along with equity co-investments. Furthermore, from a monitoring standpoint, we receive monthly financial statements to keep us informed about the companies. As for covenants, unlike the erosion witnessed in the upper middle market, nearly all of our originated first lien loans boast meaningful covenants that help protect our investments. This provides a significant advantage for us in the current environment. Many of our peers focusing on the upper middle market assert that larger companies carry less risk; while this perception may seem logical, the reality diverges. Data from S&P shows that loans to companies with less than $50 million in EBITDA have a lower default rate and a higher recovery rate compared to those with higher EBITDA. We attribute our differentiated performance to the significant covenant protections found in the core middle market, where careful scrutiny and tighter monitoring play vital roles. As a strategic capital provider, we fuel the growth of portfolio companies. In numerous instances, we partake in the upside by making equity co-investments. Our returns on these investments have consistently been strong over time. Overall, since inception, we have invested over $563 million in equity co-investments at an internal rate of return of 26% and a multiple on invested capital of 2 times. Since our inception nearly 18 years ago, PNNT has invested $8.6 billion at an average yield of 11.3% with an annual loss ratio on invested capital of approximately 20 basis points. This solid track record encompasses primarily subordinated debt investments made prior to the global financial crisis, legacy energy investments, and impacts from the pandemic. Looking ahead, new loans in our target market are appealing. Our skilled and experienced team, along with our extensive origination funnel, is generating active deal flow. Our ongoing focus will be on capital preservation while being patient investors. We reaffirm our goal to achieve attractive risk-adjusted returns through income, coupled with long-term capital preservation. We aim to identify investment opportunities in growing middle market companies with high free cash flow conversion, primarily capturing that cash flow through debt instruments and distributing it as dividends to our shareholders. Now, I will turn the call over to Rick, our CFO, for a review of the financial results.

Richard Allorto, CFO

Thank you, Art. For the quarter ending on December 31, both GAAP and core net investment income were $0.20 per share. During this quarter, net investment income was negatively affected by $0.012 per share due to our investment in Pragmatic Institute being placed on full nonaccrual. Operating expenses for the quarter included interest and credit facility expenses of $11.7 million, base management and incentive fees of $7 million, general and administrative expenses of $1.75 million, and provision for excise taxes of $0.7 million. For the quarter ending December 31, the net realized and unrealized change on investments and debt, including tax provisions, resulted in a gain of $3.1 million. As of December 31, our GAAP and adjusted net asset value was $7.57 per share, an increase of 0.1% from $7.56 per share in the previous quarter. Our debt-to-equity ratio is diversified across various funding sources, including both secured and unsecured debt. As of December 31, our key portfolio statistics indicate that our portfolio remains highly diversified with 158 companies spanning 35 different industries. The weighted average yield on our debt investments was 12%. We had two nonaccruals, which represented 4.3% of the portfolio at cost and 1.5% at market value. The portfolio consists of 50% first lien secured debt, 4% second lien secured debt, 11% subordinated notes to PSLF, 6% other subordinated debt, 6% equity in PSLF, and 23% other preferred and common equity. Additionally, 94% of the debt portfolio is on a floating rate basis. The debt to EBITDA ratio for the portfolio is 4.9 times, and interest coverage is at 1.9 times. Now let me hand the call back to Art.

Arthur Penn, CEO

Thanks, Rick. In closing, I'd like to thank our dedicated and talented team of professionals for their continued commitment to PNNT and its shareholders. Thank you all for your time today and for your continued investment and confidence in us. That concludes our remarks at this time. I would like to open up the call to questions.

Operator, Operator

We'll now take our first question from Mark Hughes with Truist.

Mark Hughes, Analyst

Art, I'm just sort of curious, any commentary about the level of capacity or competition in the core middle market? I think you described spreads as relatively stable. So that's one meaningful indicator. I'm just curious whether you've seen more folks in the market pursuing these types of loans?

Arthur Penn, CEO

It's a good question, Mark. We have not seen new entrants; the larger companies have chosen not to enter this space and have instead moved upmarket. There are only a few players we consider peers in this market, and not many of those have a strategy like ours of financing a $10 million EBITDA company and then planning to support its growth to $30 million, $40 million, or $50 million of EBITDA. We are among the few willing to finance that kind of growth. Often, we'll provide an initial loan to the platform and structure a delayed draw term loan to support the company's growth. So, there aren't any significant new competitors; spreads have stabilized in general, and it's a favorable environment for lending.

Mark Hughes, Analyst

How about your appetite or the companies or private equity appetite for the equity co-investments? Is that something you're pursuing more or less, is that going to be a stable part of the investment portfolio?

Arthur Penn, CEO

I don't think we do it more or less; they're each individual investment decisions. We first try to figure out if we can make a good and safe loan. And then separately, as a separate investment, we evaluate the equity co-invest in those prototypical deals where we're fueling the growth, and we're helping these companies and private equity sponsors grow. We think it makes a lot of sense to participate in that upside to some extent that we're helping to create with our loans. So in many of those cases, we will ask for and receive some form of upside equity co-invest instruments to capture some of that growth. And we think it makes a lot of sense as a portfolio matter because even though we're highly diversified and we're very selective and we try to keep leverage low, we like having something in our portfolio that's got a little bit of lift. And on those co-invest, over time, as we've said, we've had a 26% IRR and 2x MOIC, so that's helped to solidify NAV over time.

Mark Hughes, Analyst

Yes. And then when we think about net investment activity for PNNT, obviously, the JV took down a lot of the investments. How do you think that will trend in the first half of the year? Would we expect PNNT to be net investor net positive investment activity?

Arthur Penn, CEO

At this point, PNNT is optimized. I still think we believe PNNT, long term, should be leveraged in the 1.25x, 1.3x debt-to-equity range. So is a little bit higher than that right now, really just as a holding PNNT for assets that are going to end up in that growing joint venture. So long term, we're still anticipating PNNT's leverage back down to that 1.25x, 1.3x zone. But a little bit more leverage than that for now temporarily as it holds assets that will ultimately end up in that joint venture.

Operator, Operator

We'll now take our next question from Robert Dodd with Raymond James.

Robert Dodd, Analyst

Regarding the spillover income question, you mentioned in the prepared remarks that it's $0.99, which aligns with your dividend run rate. This indicates that you can't reduce the dividend until that amount decreases, especially without incurring corporate tax. What level would you aim for in reducing that spillover income, considering how many quarters of dividend or specific dollar amount? It's going to take quite a while at the current rate of decrease. Any insight on your target level would be appreciated.

Arthur Penn, CEO

It's a great question. Part of it involves understanding the market opportunity, the yield in the market, and our equity rotation. At this point, we believe we should be earning more than 20 on a core basis, as we indicated for 2021-2022. We are optimistic that 2025 will allow us to rotate equity, and we've seen some names appreciate in value. We hope to convert some of those into cash. While we don't have a specific target, we know our shareholders appreciate a steady, stable dividend stream, and we feel we have ample opportunity to maintain that under the current framework. We will continue to assess the situation through 2025, engaging with our Board to gauge the market and the overall performance of the platform regarding equity rotation. I don't have a precise answer for you; we take it as it comes. This year's strategy is straightforward for 2025: maintain our course, work through it, aim to rotate some equity, and reassess in a year. We are committed to keeping the dividend at its current level.

Robert Dodd, Analyst

Got it. Moving on to Pragmatic, we are currently in full nonaccrual. What are the prospects for a restructuring there, possibly involving the equitization of some of the debt or a scenario where the remaining debt returns to accrual? Is that a likely or potential outcome in the near to medium term for that asset?

Arthur Penn, CEO

Yes. It's a good question, and we're figuring out as we speak. Our current assumption is that during this quarter, the quarter ended March, there will be some form of restructuring there; some debt will be converted, and there'll be a yield instrument coming out of that.

Robert Dodd, Analyst

Got it. Following on from Mark's question, in terms of the environment, you are very active. What areas do you see as particularly attractive? Are there specific areas where you would like to increase exposure in the portfolio? Within the joint venture, you have industry concentrations that you are managing. Are you observing industries that are appealing enough to consider for managing those concentrations both in that vehicle and directly on the balance sheet?

Arthur Penn, CEO

Yes. We respond to market trends and where the middle market private equity community identifies value. We can shift our focus to emphasize certain areas while deemphasizing others. Health care constitutes the largest segment of our portfolio, and within that, we aim to navigate reimbursement risk by targeting providers and companies that can offer health care services at a lower cost while ensuring high quality. This focus is a significant aspect of our portfolio, and I believe our performance in health care surpasses that of many peers. Some peers may struggle due to not selecting the right investments that align with cost containment or because of excessive leverage. Our incoming debt-to-EBITDA ratio for new loans is below 4x, allowing us to handle unexpected challenges effectively. Health care will continue to be a focus area. Given the current governmental landscape, we are also strategically financing companies that enhance cost containment for the government and align with government payments. We are responding to the preferences of our sponsors while also exploring a variety of other industries, such as business services and consumer sectors. We have the ability to increase or decrease our focus as needed, always beginning with the goal of securing stable, protected cash flow streams. We consider whether a company is essential and aim to keep leverage as low as possible, ensuring alignment with sponsors who invest substantial equity in our ventures.

Operator, Operator

We'll now take our next question from Brian McKenna with Citizens JMP.

Brian McKenna, Analyst

Great. So just on the portfolio rotation opportunity, is there any way to think about the timing and magnitude of monetizing some of your equity investments? And then redeploying this capital into loans? And I guess, ultimately, where does the percent of equity investments within the portfolio settle at longer term?

Arthur Penn, CEO

I'll address the last question first regarding our targets. We are aiming for a reduction in equity. You can observe the equity book to see areas where we have experienced markups, which serve as potential indicators for monetization opportunities. Excluding the joint venture equity, which represents about 6% of our portfolio and is generating a robust cash return of 18%, we have approximately 20% in other equity. Half of this is from co-investments, while the remainder stems from restructured equity, where we have converted debt into equity. Both of these categories have seen some markups. We anticipate that 2025 will be a pivotal year for increased M&A activity in the core middle market, allowing us to monetize some investments and turn that equity into cash and ultimately yield. Our aim is to reduce that equity percentage of around 20% by half over time. Unfortunately, we have not yet achieved that goal, and the process has taken longer than expected. While we have some control over this situation, there are factors beyond our influence, but this remains our target, and we will continue to strive toward it.

Mark Hughes, Analyst

Okay. Great. That's helpful. And then, Art, I've asked this in the past, but assuming you are successful kind of rotating out of the equity and into loans and that kind of ratio looks similar and the percent looks similar to PFLT, I mean, do you ultimately, maybe potentially look to merge the two, so you have one publicly traded BDC? I'd just love to get your updated thoughts there.

Arthur Penn, CEO

Yes. Look, there's nothing more to update than what we've talked, which is we've got a little bit of a cleanup scenario here. We've got to focus on it. Then we'll lift our head up and kind of look at the options. There are certainly arguments to do something, and there are certainly arguments not to do something. All options are always on the table. There has been historically a differentiated portfolio, difference in yields, difference in underlying portfolio. We've got a little bit of a job to do first, and then we'll come up and try to assess what's best for shareholders.

Operator, Operator

We'll now move to Paul Johnson with KBW.

Paul Johnson, Analyst

On some of those investments that were marked higher, I noticed Bilight was marked higher again this quarter as the market has been moving up over the past few quarters. Should we see that as an indication of interest that the company might be receiving, or has it just been more of a result of performance?

Arthur Penn, CEO

Yes. It's difficult for me to discuss M&A matters. However, I can say that the company has performed well, which you can see reflected in the markups. Most of these companies are owned by private equity firms that typically aim to sell. I can't address any specific company, but overall, the company has been doing well.

Paul Johnson, Analyst

Art, and then last question was, I noticed that PNNT participated in the marketplace events loan that PennantPark reinvested with the company following the sale of the business. Just given that I don't believe PNNT participated in the previous investment and it's just a slightly lower yield. I was just curious as to why PNNT participated this time?

Arthur Penn, CEO

I'm going to defer to Rick. I don't think that PNNT was involved in the marketplace. Rick, any color?

Richard Allorto, CFO

You're correct in terms of the realization. But PNNT did participate in the new loan and the thought there all is, again, that, that loan will ultimately leave at the joint venture.

Arthur Penn, CEO

Yes, the new loan. Yes.

Richard Allorto, CFO

So there was a new buyer that came in and bought marketplace events. PFLT and a group of other lenders, or the shareholders, and PFLT was the lead equity investor. A new private equity sponsor came in, bought the company at an attractive price. And as part of that, there was an attractive loan to be made in a company that we obviously knew very well. So we did buy that loan across the platform, PFLT, PNNT, and ultimately, the joint ventures will own a piece of that marketplace events alone.

Operator, Operator

We'll now move to Mickey Schleien with Ladenburg.

Mickey Schleien, Analyst

Art, just a couple of questions from me. What did you assume in terms of the fund's balance sheet leverage and equity rotation in your core NII guidance?

Arthur Penn, CEO

Core net interest income was actual net interest income. There's no similar actual for the quarter ended December 31. Regarding the guidance moving forward, your question pertains to that. We mentioned that it assumes ongoing growth in the joint venture.

Mickey Schleien, Analyst

Okay. And the balance sheet leverage remaining where it is.

Arthur Penn, CEO

Yes, yes. And over time, kind of getting back down to 1.3 after we fill up that joint venture, we could grow that joint venture, we could do another joint venture. We hope to be able to get some equity realizations here in the next number of quarters, which will certainly be helpful.

Richard Allorto, CFO

The main factors contributing to the unrealized changes were a write-up in JF Intermediate and another in Federal Advisory Partners, which were the two largest write-ups. The overall decrease was mainly due to the equity investment in Cascade Environmental and an additional write-down on Pragmatic, which were the primary contributors to the downturn. Regarding the realized loss for PNNT, it was primarily attributed to a restructuring involving STG, also known as Reception Purchaser, and that was the key factor for the realized loss during the quarter.

Operator, Operator

We'll now move to Melissa Wedel with JPMorgan.

Melissa Wedel, Analyst

Most of mine have been asked, but I thought I would follow up and clarify a couple of things. Firstly, on the growth of the JV, when we look at the dividend income to the BDC from that JV, it looks like that was pretty flat quarter-over-quarter, except that the portfolio assets that the JV had grown pretty decently even since September 30. How should we think about the growth in the dividend to the BDC from PSLF and like the cadence of that going forward?

Arthur Penn, CEO

Yes. It's a great question, and the growth in the underlying JV portfolio should match what comes over to PNNT. But we don't book income unless it's actually distributed. So there's a bit of a reserve that we create at the joint venture. And there's no particular reason we're creating a reserve there, other than to have excess cash so that we have a bit of a reserve. But you would imagine, and it would certainly normalize over time where growth in the joint venture and growth in the investment in that joint venture will yield the dividends. Rick, I don't know if you have any particular explanation for the phenomenon Melissa is talking about in this particular quarter.

Richard Allorto, CFO

Yes. Sure. Melissa, last quarter, the JV did distribute some of that reserve Art just mentioned. And I believe we detailed that out last quarter as kind of a core NII adjustment because that portion was, I'll say, less recurring. Additionally, we see through both debt and equity. So as we fund additional capital to fuel the growth of that JV portfolio, the economics back to us, a portion is in that debt instrument, so you just don't see it in that dividend line item on the income statement.

Arthur Penn, CEO

One way to look at it is comprehensively between the debt instrument and the equity instrument side.

Melissa Wedel, Analyst

Yes. Just to clarify, I wasn't entirely sure I understood your comments regarding the exposure to government services and defense companies. How much exposure does the portfolio have to potential reimbursement risks, whether in the government, defense, or healthcare segments? Have you taken a closer look at that?

Arthur Penn, CEO

Yes. No, we're looking at...

Melissa Wedel, Analyst

Sorry, there's any tariff exposure as well.

Arthur Penn, CEO

Tariffs, yes. Yes. We have limited tariff exposure. Most of the companies that would be impacted by tariffs, we're not really involved in, and the ones that we are kind of had a dry run of tariff exposure during the last Trump administration. So the tariff exposure is very, very limited. The biggest part of the U.S. economy and biggest part of our portfolio is health care. So for sure, there is government reimbursement risk in health care, the way we comport ourselves in that is we try to focus on health care companies that are driving lower costs with reasonable quality. So if we're on the right side of that, which is lower cost, reasonable quality in any environment, we're likely to be okay. And then we layer on the fact that we keep leverage lower. The average new loan is 4x debt to EBITDA in this portfolio with at least 50% equity beneath us. So where some of our peers may have stumbled occasionally in health care, to date, we're relatively clean because of those 2 facts. So same applies on the government services and defense side, when you look at that portfolio, we're not doing tanks; we're not doing missiles. We are focused typically on service companies where you have individuals, people walking into offices and sitting behind computers, doing things like cybersecurity, intelligence, maneuvering satellites, doing technology updates. Those, again, typically are what we would call on the right side of cost, on the right side of being very efficient with taxpayer dollars going into government contracting and defense. And then when you drill down one layer deeper, in those companies, they typically get paid in 2 ways. One is cost-plus where they provide the cost, and they create a margin above that. And on those companies, those companies by and large are making single-digit EBITDA margins. They're not making excess margins on cost-plus. If they were making excess margins and cost-plus, they would be more at risk. And then the other way companies get paid is through fixed price where they take risk; they can essentially go along providing a service for fixed price, in which case the government is dishing the risk off to the provider, the providers taking risks. In those cases, those companies could earn higher margins, and they could also earn lower margins, depending on how they priced their service relative to their costs. Again, if you look at that piece of that portfolio, we've seen very good operators who are generating fair margins, not exorbitant, but fair margins, and they're taking risks off the government and going long service. So we think we're relatively well insulated. But every day is a new day, as you know, we don't know, but kind of we've comported ourselves in those 2 industries, which have government exposure to be focused on the right side of cost containment and then add on the layer of keeping debt-to-EBITDA 4x or below so that if there are curve balls, they can be dealt with appropriately.

Melissa Wedel, Analyst

I appreciate all the detail you provided. I have one final question for you. I understand your perspective on anticipating some equity rotation in the upcoming quarters. However, it seems to me that you also hold a significant amount in treasuries. Could that be a potential source of funds to invest in higher yielding opportunities until the equity rotation occurs?

Arthur Penn, CEO

Yes. Good question. The treasuries are balance sheet management that we do at quarter end, typically. That's temporary to optimize our 30% bucket. We want to optimize our 30% bucket for the JV and for other 30% type assets. So that is a technique we use to optimize that bucket.

Operator, Operator

We'll now move to Casey Alexander with Compass Point.

Casey Alexander, Analyst

Art, I've got a few questions for you. First of all, we know that base rates have gone down 100 basis points, but there's a delay in the way in which they flow through your balance sheet. What percentage of that 100 basis points would you suggest has already flowed through?

Arthur Penn, CEO

That's a great question. Rick, do you have an estimate or any insight on this? If not, we can follow up with you later, Casey, but do you have a sense of it?

Richard Allorto, CFO

The majority of borrowers are choosing 3-month LIBOR contracts, so they are operating on a 3-month basis. At the end of the quarter, there is a higher volume and more borrowers rolling their contracts, but this occurs throughout the entire period as well. I would estimate that between 50% and 75% has already been reflected in the numbers.

Casey Alexander, Analyst

So you're halfway through flowing through to maybe 3/4 of the way flowing through. That would be your guess?

Arthur Penn, CEO

And we also have liabilities, obviously, that are floating as well. So we have some fixed, and we have some floating liabilities. So there's some matching going on.

Casey Alexander, Analyst

Yes, I'm aware. Based upon the amount that you shipped down to the JV this quarter, another quarter like that, and you're basically going to be at capacity. Do you think that you'll be at or near that capacity by the end of the first calendar quarter?

Arthur Penn, CEO

I would estimate that it will take us 2 to 3 quarters to fully ramp up and optimize the joint venture. This timeframe will allow us to assess financing options and consider equity rotation opportunities. Once we are optimized, we will focus on adding value. We are also hoping for some form of equity rotation between now and then.

Casey Alexander, Analyst

So we should be thinking about a little bit slower pace going down to the JV over the next couple of quarters if we compare it relative to this last quarter?

Arthur Penn, CEO

Yes, yes. And part of it is just the activity levels. We're seeing a, what I'll call, a normal quarterly flow; the December quarter was very busy, as you saw the March quarter that we're in today is a little bit slower. That's a normal seasonal activity. We still think '25 can be a very active year, but this quarter that we're in right now is a little bit slower.

Casey Alexander, Analyst

Right. Okay. So let's have a conversation about the dividend distribution. I'm just curious, have you guys considered switching off to a year-end special distribution to clear up some of the spillover and rightsizing the dividend? Because it's pretty common knowledge that when you appear as though you're chronically under-earning your dividend, the market tends to impact your valuation in a negative way because you're doing that. And if you switch to a year-end special distribution, you could right size the dividend relative to your current earnings power, and perhaps the market would treat your valuation better? Have you considered that as an option?

Arthur Penn, CEO

We are open to discussing dividend policy at any time and exploring ways to improve our stock's trading performance. We can have conversations about the preferences of our shareholders, both institutional and retail, and gauge their reactions. It’s important for us to have these discussions within our community, and we are always willing to collaborate with our Board on strategies that could enhance our stock's trading performance. If there are alternative methodologies or approaches to consider, we are eager to hear them.

Casey Alexander, Analyst

I would be happy to discuss that with you. You mentioned that when the joint venture reaches its capacity, you might consider another one. I'm curious if there are any technical limitations, given that when this joint venture is at capacity, it will exceed the size of the on-balance sheet BDC itself. I'm wondering if there are any practical limits to how much can be kept off the balance sheet compared to the size of the on-balance sheet BDC.

Arthur Penn, CEO

That's a good question. There are a few limitations: first, it falls within the 30% rule, meaning no more than 30% of PNNT's total balance sheet can be allocated to one of these vehicles. You're right that the joint venture can grow quite large, but PNNT's stake in it might differ. PNNT holds just over 50% ownership. The joint venture can expand, and PNNT's ownership might drop below 50%. Some of our peers have BDCs owning as little as 10%, 12%, 15%, or 20% of a joint venture that can be substantial with third-party investor capital. The key point is to consider the 30% limit and how much of that is in a joint venture structure. The joint ventures have been very beneficial for us, generating an 18% return which adds value to PNNT. It's important to note that our management oversees these assets without charging our shareholders an additional management fee, which translates into increased return on equity. We believe this approach is advantageous for PNNT and seems beneficial for other BDCs as well. We will keep exploring this and monitor our 30% limit while determining how we can create value through the joint venture structure.

Casey Alexander, Analyst

Lastly, have there been any notable credit events that have taken place in the portfolio since the end of the quarter?

Arthur Penn, CEO

There's a company called Zips Car Wash, which has filed a prepackaged bankruptcy. It's not particularly big in our vehicle here, but it is out there, it's public information. It's not that material. It was appropriately marked, we believe, as of 12/31 and is in the marks. If you were to flow through the potential income impact, it might be $0.05 a share.

Operator, Operator

That includes the amount of Zips that is located within the JV?

Arthur Penn, CEO

Yes, JV and on balance sheet.

Operator, Operator

We'll now take a follow-up from Robert Dodd with Raymond James.

Robert Dodd, Analyst

I just wanted to follow up on Melissa's question. There is a noticeable gap regarding stopping the reserve. Additionally, a few million was paid out in June. Can we expect a true-up distribution from the joint venture? Will it be an annual occurrence, or will it happen occasionally? Should we anticipate an annual distribution from that vehicle, or will it be a true-up determined by you and your partner as needed?

Arthur Penn, CEO

More of the latter; kind of we try really to distribute the vast majority of NII out on a quarterly basis. Every so often, because the credit performance has been good there, we just have a little bit of excess, and we'll distribute it when appropriate.

Operator, Operator

And we'll now take a follow-up from Melissa Wedel with JPMorgan.

Melissa Wedel, Analyst

One more follow-up, actually, to Brian's question about whether Penn and PFLT would ever make more sense in a combined vehicle. You mentioned that there's a little bit of cleanup work to do. And I just wanted to better understand what that means to you. Is that a function of nonaccruals, equity exposure, something else? And I asked that because in the past, I know you've probably gotten that question a number of times over the years. In the past, you had referenced the multiple and the disparity between multiples on the two vehicles, and that seems to be less of an issue now. So I appreciate any clarifying thoughts you have on that.

Arthur Penn, CEO

Yes. It may all be related, Melissa. I think if we can achieve some reasonable equity rotation, it will reduce the risk in the portfolio and the net interest income, leading to the cleanup I mentioned. After that, we can assess and explore different options.

Operator, Operator

That does conclude today's question-and-answer session. I'd like to turn the conference back over to Mr. Penn for any additional or closing comments.

Arthur Penn, CEO

Just really want to thank everybody for their participation. I want to thank the research community for your excellent questions. It's good that there's engagement and some interest. And we look forward to speaking with you all again next in early May as we discuss the March numbers. Thank you very much. Have a good rest of the winter.

Operator, Operator

And once again, that does conclude today's conference. We thank you all for your participation. You may now disconnect.