Participants
Arthur Howard Penn; Founder, Chairman, Managing Partner & CEO; PennantPark Investment Corporation
Richard Thomas Allorto; CFO & Treasurer; PennantPark Investment Corporation
Unidentified Company Representative
Kyle Joseph; Equity Analyst; Jefferies LLC, Research Division
Melissa Wedel; Analyst; JPMorgan Chase & Co, Research Division
Paul Conrad Johnson; VP; Keefe, Bruyette, & Woods, Inc., Research Division
Robert James Dodd; Director & Research Analyst; Raymond James & Associates, Inc., Research Division
Presentation
Operator
Good afternoon, and welcome to PennantPark Investment Corporation’s Fourth Fiscal Quarter 2023 Earnings Conference Call. Today’s conference is being recorded. (Operator Instructions)
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 Howard Penn
Good afternoon, everyone. I’d like to welcome you to PennantPark Investment Corporation’s Fourth Fiscal Quarter 2023 Earnings Conference 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 Thomas Allorto
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 filing with the SEC for important factors that could cause actual results to materially differ 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
Thanks, Rick. We’re going to spend a few minutes and comment on the current market environment for private credit, provide a summary of how we fared in the quarter ended September 30, how the portfolio is positioned for upcoming quarters, a detailed review of the financials and then open it up for Q&A.
For the quarter ended September 30, our GAAP and core net investment income was $0.24 per share. Adjusted NAV increased 0.4% to $7.70 per share from $7.67 per share. GAAP NAV decreased slightly to $7.70 per share from $7.72 per share.
The debt portfolio continues to benefit from the current base rate environment. As of September 30, our weighted average yield to maturity was 13%, which is up from 12.7% last quarter and 10.8% last year.
During the quarter, we continue to originate attractive investment opportunities and invested $61 million in 2 new and 31 existing portfolio companies at a weighted average yield of 11.2%. For the investments in new portfolio companies, the weighted average debt-to-EBITDA was 4.4x. The weighted average interest coverage was 1.9x and the weighted average loan to value was 36%.
Credit quality of the portfolio is stable. We had no new non-accruals in the quarter ended September 30. As of September 30, the portfolio’s weighted average leverage ratio through our debt security was 5x and despite the steep increase in base rates over the past 12 months, the portfolio’s weighted average interest coverage ratio at September 30, was 2.3x.
We continue to believe that the current vintage of core middle market directly originated loans is excellent. Leverage is lower, spreads and OID are higher and covenants are tighter than in the upper middle market. Despite reports of covenant erosion in the upper middle market, in the core middle market we are still getting meaningful covenant protections. We are seeing an increase in deal flow compared to the first half of 2023 and have a growing pipeline of interesting and attractive investment opportunities.
Since quarter end, we have continued to be active. From September 30 through November 10, we invested $131 million into new and existing investments and are continuing to see strong deal flow going into year-end.
At September 30, the JV portfolio equaled $804 million and during the quarter, the JV invested $57 million, including $48 million of purchases from PNNT.
During the quarter, the JV closed on the $300 million securitization. This new financing, together with the existing committed junior capital from PNNT and our JV partner will allow the JV portfolio to grow to over $1 billion of assets.
Over the past 12 months, PNNT earned a 17.2% return on invested capital in the JV. We expect that with continued growth in the JV portfolio, the JV investment will enhance PNNT’s earnings momentum in future quarters.
Now let me turn to the current market environment. From an overall perspective, in this market environment of inflation, rising interest rates, geopolitical risk and a potentially weakening economy, we are well positioned as a lender focused on capital preservation in the United States where the floating interest rates on our loans can protect against rising interest rates and inflation. We continue to believe that our focus on the core middle market provides the company with attractive investment opportunities where we provide important strategic capital to our borrowers.
We have a long-term track record of generating value by successfully financing growing middle market companies in 5 key sectors. These are sectors where we have substantial domain expertise, know the right questions to ask and have an excellent track record. They are business services, consumer, government services and defense, health care and software technology. These sectors have also been recession resilient and tend to generate strong free cash flow.
Approximately 12% of our portfolio is in Government Services and Defense, which is a sector with strong tailwinds in this geopolitical environment. In our software vertical, we don’t have any exposure to ARR loans. The core middle market, which is companies with $10 million to $50 million of EBITDA is below the threshold and does not compete with a 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 that we receive is attractive. We have many weeks to do our diligence with care. We thoughtfully structured transactions with sensible credit statistics, meaningful covenants, substantial equity cushions to protect our capital, attractive upfront OID and spreads and equity co-investment. Additionally, from a monitoring perspective, we receive monthly financial statements to help us stay on top of the companies.
With regard to covenants, unlike the erosion in the upper middle market, Virtually all of our originated first lien loans had meaningful covenants which help protect our capital, if there’s a significant reason why we believe we are well positioned in this environment.
Many of our peers who focus on the broadly syndicated loan and upper middle market state that those bigger companies are less risky. That is a perception and may make some intuitive sense, but the reality is different. According to the S&P, loans to companies with less than $50 million of EBITDA, have a lower default rate and higher recovery rate than loans to the companies with higher EBITDA. We believe that the meaningful covenant protections of the core middle market where there’s more careful diligence and tighter monitoring have been an important part of this differentiated performance.
As a provider of strategic capital that fuels the growth of our portfolio companies, in many cases, we also 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 September 30, we’ve invested over $410 million in equity co-investments and have generated an IRR of 26% and a multiple on invested capital of 2.2x.
Since inception, PNNT has invested $7.6 billion at an average yield of 11.3% and has experienced a loss ratio of approximately 20 basis points annually. This strong track record includes our energy investments, which were primarily — and primarily subordinated debt investments made prior to the financial crisis and recently, the pandemic.
With regard to the outlook, new loans and our target market are attractive, and this vintage should be particularly attractive. Our experienced and talented team and our wide origination funnel is producing active deal flow. Our continued focus remains on capital preservation and being patient investors.
We want to reiterate our goal to generate attractive risk-adjusted returns through income, coupled with long-term preservation of capital. 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 investments, and we pay out those contractual cash flows in the form of dividends to our shareholders.
Let me now turn the call over to Rick, our CFO, to take us through the financial results.
Richard Thomas Allorto
Thank you, Art. For the quarter ended September 30, GAAP and core net investment income was $0.24 per share. Operating expenses for the quarter were as follows: interest and credit facility expenses were $9 million; base management and incentive fees were $7.2 million; general and administrative expenses were $1.6 million; and provision for excise tax was $0.7 million.
For the quarter ended September 30, net realized and unrealized change on investments and debt, including provision for taxes was a loss of $2.5 million or $0.04 per share.
As of September 30, our GAAP NAV was $7.70 per share, which is down 0.3% from $7.72 per share in the prior quarter. Our adjusted NAV per share was $7.70, which is up 0.4% from the prior quarter.
As of September 30, our debt-to-equity ratio was 1.05x and our capital structure is diversified across multiple funding sources, including both secured and unsecured debt.
As of September 30, our key portfolio statistics were as follows: our portfolio remains highly diversified with 129 companies across 27 different industries; the weighted average yield on our debt investments was 13%; we had one nonaccrual, which represents 1.2% of the portfolio at cost and 0% at market value; the portfolio is comprised of 53% first lien secured debt, 8% second lien secured debt, 10% subordinated notes to PSLF, 5% other subordinated debt, 6% equity in PSLF and 18% in other preferred and common equity. 95% of the debt portfolio is floating rate.
Our debt to EBITDA on the portfolio is 5x and interest coverage is 2.3x. The portfolio as a whole has a meaningful cushion with regard to interest coverage. On a sensitivity basis for the portfolio’s overall interest coverage to decrease to 1x, base rates would need to go up 200 basis points and EBITDA would need to decrease by 30%. This analysis is based upon current run rate interest coverage and assumes a 5.5% base rate.
Now let me turn the call back to Art.
Arthur Howard Penn
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.
Question and Answer Session
Operator
(Operator Instructions) We’ll take our first question from Robert Dodd with Raymond James.
Robert James Dodd
One actually in response to Rick’s comment about the decline in EBITDA that would be necessary to get to 1x coverage. I mean, helpful but if I remember right, I think last quarter, it was 25%. This quarter, it would have to decline 30%. So can we read into that, that the EBITDA growth, kind of year-over-year or since last quarter, the trailing EBITDA is up 5%. I mean that seems quite a lot over the course of just a quarter, but that does sound like the acquired deterioration now is meaningfully more than it was a quarter ago. Hope that makes sense. If you could elaborate?
Arthur Howard Penn
Yes. I mean Yes. Thanks, Robert. Thanks for the question. In general, that’s right. Our EBITDA is as a general proposition and revenues in the portfolio are up a bit, and they’ve continued overall to trend positively. Obviously, we have got different deals in the portfolio with different leverage amounts and different kind of — the numbers are kind of calculated fresh each quarter based on the portfolio we have at the time. But as a general proposition, you’re right, EBITDA is up.
Robert James Dodd
Got it. And then looking at the pipeline, timing issues aside, are you seeing any change in the type of deals you’re seeing, say, in early-stage pipeline versus ones that you expect that entered the pipeline 3 or 6 months ago and might be closing now. Are the early stage ones have any different characteristics than the others? .
Arthur Howard Penn
Not — I’m trying to think if there’s anything — any material difference. I mean we kind of — we have our box. Our box is our box generally, which is for our kind of high free cash flow companies, we’re willing to tolerate a certain amount of leverage usually below 5x. We’ll occasionally go above 5x if there’s really good reason to do so, either due to quick deleveraging or growth.
The company has got a moat and has a real reason to be and if there’s lots of kind of equity beneath us from sponsors, we’ve done business with, who we’ve known over time, we can handicap their behavior. That’s kind of our box.
Now in the upper end of the core middle market, we say the core middle market is 10% to 50% of EBITDA. In the upper end in certain sectors and certain companies that are viewed as very strong there’s a little bit of competition there. So spreads in that piece of the market may be tightening a little bit as I think players believe the economy is in better shape or the odds of a recession are lower, A. And B, odds of a dramatic increase in interest rates are probably lower as well. So market participants are kind of saying, this is kind of the zone of interest rates we have, the economy is feeling a little bit better. So on that upper end of the core middle market, we’re seeing a — we’re seeing a little bit of spread compression.
Operator
Our next question comes from Paul Johnson of KBW.
Paul Conrad Johnson
You kind of answered my question in terms of just EBITDA and growth rate trends in the portfolio that you’re seeing this year in your answer to Robert. But I guess…
Operator
Mr. Johnson, your line is still connected. Are you able to hear me?
I apologize it looks we lost his audio.
Arthur Howard Penn
Yes. Let’s keep going operator and hopefully he’ll come back.
Operator
Max Mosbacher with Truist Securities.
Unidentified Company Representative
I’m Colin in for Mark Hughes. Going forward, do you have any guidance of what we should expect the mix of the portfolio to be? Should we expect it to stay around the current levels of like first lien as a percent of the total investment, et cetera?
Arthur Howard Penn
Yes. So good question. As a general proposition, yes, it should be generally the same, although we do continue to target lower equity exposure. We have quite a few equity co-investments that are performing well that we would hope over time as deal flow comes back as M&A comes back, we hope to rotate a bunch of those equity positions into cash, which we can then put into yield instruments. And those yield instruments would be a combination of first lien secured debt, occasionally, a piece of second lien or mezz.
And then the JVs, the JVs have been very good. We have the PSLF JV. It’s been generating an upper teens, 17-plus percent return. Capital in there is very, very accretive to our shareholders.
So looking to rotate, I think it’s about 18% of the portfolio in preferred and common equity that is not in that joint venture. We’re looking to work that down over time.
Unidentified Company Representative
And do you have a figure for the percent of the portfolio that’s under 1x interest coverage?
Arthur Howard Penn
It’s — I don’t think there’s anything that’s under 1x interest coverage right now.
Unidentified Company Representative
Great. And if I may sneak in one more. Is there any material or noteworthy sales and repayments thus far in fiscal 1Q?
Arthur Howard Penn
Yes. We put in a recent development, subsequent event about our deal flow. There’s been very limited repayments quarter-to-date.
Operator
We’ll return to Paul Johnson with KBW.
Paul Conrad Johnson
Sorry about that. I’m not sure, I think it’s on my end here. But just kind of given like the growth, obviously, you’ve had in the JVs for both of the BDC vehicles. over the last few years. I’m just curious, what — for the Pennant platform, what is kind of like the ideal hold size, I guess, including, again, all the JVs, the other funds that are managed in the platform in terms of the commitment from the Pennant platform?
Arthur Howard Penn
Yes. So it is public information. We put this out there. We have about $6.8 billion of investable capital across the platform, including the BDCs, the JVs, a variety of private funds, SMAs, CLOs. So if you think about it in terms of proper diversification, a 2% position would be kind of a typical position that we take. So 2% times $6.8 billion, it’s about $135 million. That would be a 2% position. So we say we can kind of $50 million to $150 million is kind of our zone.
Paul Conrad Johnson
Got it. And then kind of a last one, just a little bit of housekeeping, but since we don’t have the filings available, I was wondering if you could just give the distribution on the JV for this quarter.
Richard Thomas Allorto
Sure. Sure. So the distribution from PSLF was $4.4 million, and the distribution from PTSF was $700,000.
Paul Conrad Johnson
And then does that also include — it probably doesn’t, but the income from the sub note piece, your sub-subordinated membership in the JV as well?
Richard Thomas Allorto
It does not. That is just the equity dividend.
Paul Conrad Johnson
Did you have that as well or…
Arthur Howard Penn
I don’t have the quantification of that, no.
Richard Thomas Allorto
It’s in the SOI. You can see the amount of the sub debt and the SOI and the coupon on it. So we can try to get it for you here, but it’s in the statement of investments that’s part of the filing.
Operator
We’ll go next to Kyle Joseph with Jefferies.
Kyle Joseph
Art, I just want to pick your brain on competitive dynamics in the market. Obviously, we’ve seen headlines and rumors of banks pulling back even further from the space, given everything that’s gone on in that industry this year. And then on the other hand, there’s been a ton of private capital raised. So I just want to get kind of your thoughts on competitive dynamics for the industry as we head into ’24.
Arthur Howard Penn
Yes. It’s — and you’ve highlighted, Kyle, some good crosscurrents. Currently we’re seeing banks and regional banks exit the middle market on one hand, on the other hand, the private BDCs or perpetual BDCs have been raising capital. Most of those private perpetual folks are focused on the upper middle market, adding to the fire that’s going on there. And there’s been reports and press about the erosion of covenants and covenant protections in the upper middle market.
So we’re not really seeing that. Maybe on the upper end of our — we say we go from 10% to 50% of EBITDA as I said earlier. Maybe at the upper end of that, we’re seeing a little bit more competition on deals or in industries that are very popular. Everyone thinks they’re very strong at this point.
So we’re seeing in our world kind of in this under the radar core middle market, we’re seeing the same we’re seeing the same players. And there’s very little overlap among the players. I think S&P actually does an interesting chart, which they do as part of their CLO research and kind of middle market middle market players and kind of the players we run into the most, maybe we share deals with them 5% of the time. So it’s a massive market. There is, we think, over 2,000 middle-market private equity firms in America. They have lots of dry powder. They’re trying to do deals. Yes, there’s peers of ours, but there’s not that many, particularly those focused on the core middle market, which is why we can be very thoughtful and careful and do proper due diligence, where we’re not rushed and where our capital has real meaning to the borrower.
So we’re just kind of taking it one deal at a time. Thankfully, our default rate is very low, remains low, and that’s because we’re — we have this defensive posture.
Kyle Joseph
Got it. Very helpful. And then just how the Board is thinking about the dividend, given kind of the shift in the forward curve and the potential for rate reductions next year and the type of cushion you’re looking to have there?
Arthur Howard Penn
Yes. It’s a good question. We’re — it’s an evolving question. Obviously, we’ve — up until this quarter, I’ve raised the dividend for many, many quarters. As their income rose and as our default rate remain very, very limited. We pivoted to a monthly dividend a couple of months ago. So here, this quarter, we earned $0.24, we’re paying out $0.21. I think for now, we’re just going to let a percolate kind of keep a nice cushion to the monthly $0.07 per share dividend.
We’ll come up for air in a couple of months and see how things are looking and see about the trends in the portfolio, see about interest rates. This JV, this PSLF JV has been really, really accretive to earnings and hopefully, will continue to be very accretive to earnings. And no decisions, but it’s something we’re watching and we’re focused on.
Operator
Our next question comes from Melissa Wedel with JPMorgan.
Melissa Wedel
I wanted to first thank you for the disclosure on activity levels in the December quarter to date. Just to clarify, with an 11.9% sort of average yield on that activity — or should we think about that as sort of flow that would end up on balance sheet? Or would that qualify for some of the JV?
Arthur Howard Penn
Yes, it’s a good question. So it would qualify for both. I know some of our peers have different types of assets that they put in their JV versus what they put on balance sheet at the BDC. Some of our peers do — maybe they put some broadly syndicated loans there in their JVs. We put the same exact loans, and we really allocate based on available capital and both the balance sheet of the BDC and the JV have available capital today.
And one of the benefits — there’s a couple of benefits of the JV. One is we get the benefit of a smart institutional investor like our JV partner. Two, we can optimize leverage a little bit more. So it’s a more levered vehicle than we do — and it’s also all first lien. So we’re not putting any mezzanine or any equity in that JV. It’s all kind of first lien senior secured debt and then that gets levered a little bit more than we do on the BDC level. So let’s say, it’s levered 2 to 1 or maybe in an optimized case it’s up to 2.5 to 1, which is higher than on balance sheet in the BDC, but it’s also lower than it would be if it were kind of in a regular middle market CLO. We have a middle market CLO business with third-party investors and there the equity gets levered 4 to 1.
So a little bit more levered than the BDC, less levered than CLOs. We do use CLO technology as a financing tool for the joint venture, and that’s very good financing, matched financing, long-term financing for that joint venture. But we keep a leverage kind of in that 2x to maybe 2.5x range. And if we can continue to have very high quality on this book of first lien loans, the ROEs can be very strong, which is what we’re seeing.
Melissa Wedel
So just a follow-up on that. You led right into my next question, which is leverage in the portfolio. Obviously, with some elevated repayment activity in the September quarter, leverage came down a bit. You’re thinking evolving at all on where you’d like to see on balance sheet leverage within PNNT?
Arthur Howard Penn
Yes. No, we’re still at PNNT targeting about 1.25x. We’re a little over 1x as of September 30. So there is some capacity on balance sheet at PNNT. And so we’re still targeting that 1.25x. Hopefully, over time, we can rotate some of this equity, which will be highly accretive. As we do that, as middle market M&A comes back, for sure, we’re going to be able to rotate it. It’s been slower. I mean deal flow has been slower, which means some of that’s been on our balance sheet a little longer than we would have hoped. But that is — that remains an opportunity.
Operator
And with no other questions holding, I’ll turn the conference back to Mr. Penn for any additional or closing comments.
Arthur Howard Penn
I just want to thank everybody for their participation today. As we come to Thanksgiving next week, we certainly have a lot of gratitude for all of our investors. So thank you for spending your time and capital with us. We’re wishing everyone a Thanksgiving of gratitude. And we look forward to speaking to you next in early February after our next earnings release. Thank you very much. .
Operator
Thank you. This concludes today’s call. Thank you for your participation. You may now disconnect.
