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PennantPark Floating Rate Capital Ltd  (NASDAQ:PFLT)
Q1 2019 Earnings Conference Call
Feb. 07, 2019, 10:00 a.m. ET

Contents:

Prepared Remarks:

Operator

Good morning, and welcome to the PennantPark Floating Rate Capital's First Fiscal Quarter 2019 Earnings Conference Call. Today's conference is being recorded. (Operator Instructions) It is now my pleasure to turn the conference over to Mr. Art Penn, Chairman and Chief Executive Officer of PennantPark Floating Rate Capital.

Mr. Penn, you may now begin your conference.

Art Penn -- Founder and Managing Partner

Thank you, and good morning, everyone. I'd like to welcome you to PennantPark Floating Rate Capital's First Fiscal Quarter 2019 Earnings Conference Call. I'm joined today by Aviv Efrat, our Chief Financial Officer. Aviv, please start off by disclosing some general conference call information and include a discussion about forward-looking statements.

Aviv Efrat -- Chief Financial Officer and Treasurer

Thank you, Art. I'd like to remind everyone that today's call is being recorded. Please note that this call is a property of PennantPark Floating Rate Capital and that any unauthorized broadcast of this call in any form is strictly prohibited. Audio replay of the call will be available by using the telephone numbers and PIN provided in our 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 www.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.

Art Penn -- Founder and Managing Partner

Thanks, Aviv. I'm going to spend a few minutes discussing financial highlights, followed by a discussion of the portfolio, investment activity, the financials and then open it up for Q&A.

For the quarter ended December 31st, we invested $180 million in primarily first lien senior secured assets and an average yield of 8.6%. PennantPark Senior Secured Loan Fund or PSSL continued to grow. As of December 31st, PSSL owned a $493 million diversified pool of 43 names with an average yield of 8.2%. Over the last several years we have substantially grown our platform by adding senior and mid-level investment professionals in regional offices as well as in New York. The additional people and offices combined with additional equity and debt capital we've raised has significantly enhanced our deal flow. This puts us in a position to be both active and selective. The growth is evidence of this enhanced platform.

Net investment income was $0.28 per share. Core net investment income excluding accrued non-payable incentive fee and one-time credit facility amendment cost was $0.30 per share. Due to the activity level we are seeing and the growth of PSSL, we are pleased that our current run rate net investment income covers our dividend. Our earnings stream should have a nice tailwind based on a gradual increase in our debt to equity ratio, while still maintaining a prudent debt profile. As of September 30, our spillover was $0.31 per share.

With regard to the Small Business Credit Availability Act, a reminder that our Board approved the modified asset coverage that was included in the law, reducing asset coverage from 200% to 150% effective April 5, 2019. Over time, we are targeting a debt to equity ratio of 1.4x to 1.7x. We will now reach this target overnight. We will continue to carefully invest and it may take us several quarters to reach the new target.

The Company has generated an excellent track record over the last eight years, investing in lower-risk first lien senior secured floating-rate assets. We believe that such assets represent an appropriate risk profile that can be prudently leveraged to provide attractive returns for our investors. Our successful operation of PSSL, which is today operating at the same targeted debt to equity ratio is evidence of this strategy.

During the quarter, we upsized our credit facility to $520 million from $405 million and completed the necessary amendments to enable us to reach the targeted debt-to-equity ratio. We are pleased that we received the support of all existing lenders and then we expanded our lender relationships. The support also highlights the confidence they have in our excellent track record. Our primary business of financing middle-market financial sponsors has remained robust. We have relationships with about 400 private equity sponsors across the country and elsewhere that we manage from our offices in New York, Los Angeles, Chicago, Houston and London and we've done business with about 180 sponsors to date.

Due to the wide funnel of deal flow that we receive relative to the size of our vehicles, we can be extremely selective about what we ultimately invest in. We remain primarily focused on long-term value and making investments that will perform well over several years and can withstand different business cycles. Our focus continues to be on companies and structures that are more defensive, have low leverage, strong covenants and high returns.

We are first call for middle-market financial sponsors, management teams and intermediaries, who want consistent and credible capital. As an independent provider free of conflicts or affiliations, we've become a trusted financing partner to our clients. As a result of our focus on high-quality companies, seniority in the capital structure, floating rate assets and continuing diversification, our portfolio is constructed to withstand market and economic volatility. The cash interest coverage ratio, the amount by which EBITDA or cash flow exceeds cash interest expense, continued to be a healthy 2.7x. This provides significant cushion to support stable investment income. Additionally, at cost, the ratio of debt-to-EBITDA on the overall portfolio was 4.6x, another indication of prudent risk.

In our core market of companies with $15 million to $50 million of EBITDA, our capital is generally important to borrowers and sponsors, we are still seeing attractive risk/reward, and we're receiving covenants, which help protect our capital. Our credit quality since inception nearly eight years ago has been excellent. Out of 343 companies in which we have invested since inception, we have experienced only five non-accruals. On those five non-accruals, we've recovered $0.98 on the dollar so far. As of December 31st, we had no non-accruals on our books.

With regard to economy and credit cycle, at this point, our underlying portfolio indicates a strong U.S. economy and no sign of a recession. From an experience standpoint, we are one of a few middle-market direct lenders who was in business prior to the global financial crisis and have a strong underwriting track record during that time. Although PFLT was not in existence back then, PennantPark as an organization was, and was focused primarily on investing in subordinated and mezzanine debt. Prior to the onset of the global financial crisis in September 2008, we initiated investments which ultimately aggregated $480 million, again primarily in subordinated debt.

During the recession, the weighted average EBITDA of those underlying portfolio companies declined by 7.2% at the trough of the recession. This compares to the average EBITDA decline of the Bloomberg North American High Yield Index of down 42%. As a result, the IRR on those underlying investments was 8%, even though they were done prior to the financial crisis and recession. We are proud of this downside case track record on primarily subordinated debt.

In terms of new investments, we had another active quarter investing in attractive risk-adjusted returns. Our activity was driven by a mixture of M&A deals, growth financings and refinancings. In virtually all these investments, we've known these particular companies for a while, have studied the industries or have a strong relationship with the sponsor.

Let's walk through some of the highlights. We purchased $14.7 million in the first lien term loan and $300,000 of the common equity of American Insulated Glass. The Company is a fabricator and value-added distributor of glass products, AV Capital is the sponsor. ECommission Financial Servicesis an online finance platform that specializes in providing real estate agents with advanced payment of commissions.

We purchased $24.8 million of the first lien term loan and $200,000 of the common equity. Lightyear Capital is the sponsor. We purchased $11.2 million of the first lien term loan of Peninsula Pacific Entertainment. The company is a new -- is newly formed to develop, own and operate gaming opportunities in the newly regulated Virginia market. PGP Investors is the sponsor.

Turning to the outlook, we believe that 2019 will be active due to both growth and M&A-driven financings. Due to our strong sourcing network and client relationships, we're seeing active deal flow. Let me now turn the call over to Aviv, our CFO, to take us through the financial results.

Aviv Efrat -- Chief Financial Officer and Treasurer

Thank you, Art. For the quarter ended December 31, 2018, net investment income was $0.28 per share. Core net investment income was $0.30 per share, excluding our reversal of $0.04 per share of accrued, not payable incentive fee and excluding $0.06 per share of one-time financing costs, net of investment -- incentive fees.

Looking at some of the expense categories. Management fees totaled about $3 million, excluding $1 million, accrued not payable incentive fees. General and administrative expenses totaled about $1.1 million, and interest expense totaled about $5 million, excluding the one-time $4.5 million dollars credit facility financing amendment costs.

During the quarter ended December 31st, net unrealized depreciation on investment was about $12 million or $0.32 per share. Net realized gains was about $1 million or $0.02 per share. Net unrealized appreciation in our credit facility and notes was $6 million or $0.14 per share. Net investment income covered our dividends. Consequently, NAV went from $13.82 per share to $13.66 per share.

Our entire portfolio, our credit facility and notes are marked-to-market by our Board of Directors each quarter using the exit price provided by an independent valuation firm exchanges or independent broker-dealer quotations when active markets are available under ASC 820 and 825. In cases where broker-dealer quotes are inactive, we use independent valuation firms to value the investments.

Our portfolio is highly diversified with 85 companies across 25 different industries. 91% is invested in first lien senior secured debt, including 12% in PSSL, 2% in second-lien debt and 7% in equity, including 5% in PSSL. Our overall debt portfolio has a weighted average yield of 9.2%. 100% of the portfolio is floating rate.

Now let me turn the call back to Art.

Art Penn -- Founder and Managing Partner

Thanks, Aviv. To conclude, we want to reiterate our mission. Our goal is a steady, stable and protected dividend stream, coupled with the preservation of capital. Everything we do is aligned to that goal. We try to find less risky middle-market companies that have high free cash flow conversion. We capture that free cash flow, primarily in first lien senior secured floating rate debt instruments, and we pay out those contractual cash flows in the form of dividends to our shareholders.

In closing, I'd like to thank our extremely talented team of professionals for their commitment and dedication. Thank you all for your time today and for your investment and confidence in us. That concludes our remarks. At this time, I would like to open up the call to questions.

Questions and Answers:

Operator

Thank you. (Operator Instructions)

Art Penn -- Founder and Managing Partner

This is Art Penn. It looks like we may be having some technical difficulties on the Q&A with the system this morning. We are around at the Company, feel free to call me or our CFO, Aviv Efrat, should you have any questions following up on this call. My apologies for the technical difficulties.

Thank you very much. And we'll talk to you next quarter.

Operator

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

Duration: 14 minutes

Call participants:

Art Penn -- Founder and Managing Partner

Aviv Efrat -- Chief Financial Officer and Treasurer

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