Participants

Arthur Penn; Chairman of the Board, Chief Executive Officer; Pennantpark Investment Corp

Richard Allorto; Chief Financial Officer, Treasurer; Pennantpark Investment Corp

Brian Mckenna; Analyst; Citizens JMP Securities, LLC

Robert Dodd; Analyst; Raymond James

Mickey Schleien; Analyst; Ladenburg Thalmann & Co. Inc.

Mark Hughes; Analyst; Truist Securities

Casey Alexander; Analyst; Compass Point Research & Trading LLC

Kyle Joseph; Analyst; Jefferies

Presentation

Operator

Please stand by. Good afternoon, and welcome to the PennantPark Investment Corporation's second fiscal quarter 2024 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 Penn

Good afternoon, everyone. I'd like to welcome you to PennantPark Investment Corporation's second fiscal quarter 2024 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 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 disclosures 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

Thanks, Rick. We're going to spend a few minutes and comment on the current market environment for private middle market credit, provide a summary of how we fared in the quarter ended March 31, how the portfolio is positioned for the upcoming quarters, a detailed review of the financials, and then open it up for Q&A.
For the quarter ended March 31, our GAAP and core net investment income was $0.22 per share. We are pleased to announce that the Board of Directors has approved an increase in the monthly dividend to $0.08 per share. The increase will be effective beginning with the June monthly dividend, which will be payable on July 1 to shareholders of record as of June 14. This represents a 14% increase in the monthly dividend.
GAAP and adjusted NAV increased 0.5% to $7.69 per share from $7.65. As of March 31, our portfolio grew slightly to $1.2 billion or 2% from the prior quarter. During the quarter, we continue to originate attractive investment opportunities and invested $188 million in six new and 43 existing portfolio companies at a weighted average yield of 11.7%.
For the investments in new portfolio companies, the weighted average debt-to-EBITDA was 4.3 times, the weighted average interest coverage was 2.1 times, and the weighted average loan to value was [40%]. We added two new investments to non-accrual status and removed on investment. Non-accruals represent 3.7% of the portfolio at cost and 3% at market value.
For the quarter ended March 31, PIK income remained low at only 2.9% of total investment income, which we believe is among the lowest in the BDC sector. As of March 31, the portfolio's weighted average leverage ratio through our debt security was 4.4 times, and the portfolio's weighted average interest coverage was 2.2 times. These attractive credit statistics are a testament to our selectivity and conservative orientation, as well as our focus on the core middle market.
On average, we have seen a 50-basis-point tightening of first lien spreads over the last six months. However, we continue to believe that the current vintage of core middle market directly originated loans is excellent.
In the core middle market, leverage is lower, spreads and upfront OID are higher, and covenants are tighter than in the upper middle market. Despite covenant erosion in the upper middle market, in the core middle market, we are still getting meaningful covenant protections.
At March 31, the JV portfolio equaled $924 million. And during the quarter, the JV invested $113 million, including $103 million of purchases from PNNT. With its current capital base, the JV portfolio can grow to $1.1 billion.
Over the last 12 months, PNNT earned a 17.5% 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. We are well positioned as a lender focused on capital preservation in the United States. We continue to believe that our focus on core middle market opportunities provide the company with attractive investments, 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 five 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, healthcare, and software and technology. These sectors have also been recession resilient and tend to generate strong free cash flow.
In the core middle market, companies with $10 million to $15 million of EBITDA, those companies are below the threshold, and we do not compete with the broadly syndicated loan or high-yield markets unlike our peers in the upper 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 structured transactions with sensible credit statistics, meaningful covenants, substantial equity cushions to protect our capital, attractive spreads, and upfront OID as well as an 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 helped protect our capital. This is a significant reason why we believe we are well positioned in this environment.
Many of our peers are focused on the upper middle market, state that those bigger companies are less risky. That is a perception that may make some intuitive sense, but the reality is different. According to S&P, loans to companies with less than $50 million of EBITDA have a lower default rate or higher recovery rate than loans to companies with higher EBITDA.
We believe that the meaningful covenant protections of core middle market loans, 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 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 March 31, we've invested over $469 million in equity co-investments and have generated an IRR of 26% and a multiple on invested capital of 2.1 times.
Since inception nearly 17 years ago, PNNT has invested $8.1 billion at an average yield of 11.3% and has experienced a loss ratio on invested capital of approximately 19 basis points annually. This strong track record includes investments in primarily subordinated debt made prior to the global financial crisis, our legacy energy investments, and recently, the pandemic.
With regard to the outlook, new loans in our target market are 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 instruments, and 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 Allorto

Thank you, Art. For the quarter ended March 31, GAAP and core net investment income was $0.22 per share. Operating expenses for the quarter were as follows. Interest and credit facility expenses were $11.9 million, base management and incentive fees were $7.2 million, general and administrative expenses were $1.9 million, and provision for excise taxes were $0.8 million.
For the quarter ended March 31, net realized and unrealized change on our investments and debt, including provision for taxes, was a gain of $1.8 million or $0.03 per share. As of March 31, our GAAP and adjusted NAV was $7.69 per share, which is up 0.5% from $7.65 per share in the prior quarter.
As of March 31, our debt-to-equity ratio was 1.4 times, and our capital structure is diversified across multiple funding sources, including both secured and unsecured debt. As of March 31, our key portfolio statistics were as follows.
Our portfolio remains highly diversified with 138 companies across 30 different industries. The weighted average yield on our debt investments was 12.5%. PIK income equaled only 2.9% of total investment income. We had two non-accruals which represent 3.7% of the portfolio at cost and 3% at market value.
The portfolio is comprised of 58% first lien secured debt, 5% second lien secured debt, 10% subordinated notes to PSLF, 4% other subordinated debt, 6% equity in PSLF, and 17% in other preferred and common equity. 97% of the debt portfolio is floating rate. Debt to EBITDA on the portfolio is 4.4 times, and interest coverage is 2.2 times.
Now, let me turn the call back to Art.

Arthur 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

Thank you. (Operator Instructions) Brian Mckenna, Citizens JMP.

Brian Mckenna

All right. Thanks. I just had one question on the dividend and coverage. So great to see the 14% increase in the monthly distribution, but that equates to $0.24 on a quarterly basis. And so probably look at NII in the period, that came in at $0.22.
So I'm curious. Why set the new dividend above the 1Q NII run rate? Does that imply you expect some healthy growth in core earnings moving forward? And ultimately, where do you think you'll shake down on dividend coverage over the next several quarters?

Arthur Penn

Yeah. Thanks, Brian. It's a good question. First, it's important for everyone to know we have a lot of spillover, probably about $1 a share of spillover, that we're going to need to be to pay out a significant portion of that anyway.
Now then, you turn to what's our recurring ongoing NII? And we believe that based on the performance of the portfolio, based on continued growth of the joint venture, that that $0.24 is achievable on a recurring basis anyway. So that led us to -- those two factors are the key factors that led us to the dividend increase.

Brian Mckenna

Okay. Got it. Makes sense. Thank you.

Operator

Robert Dodd, Raymond James.

Robert Dodd

Hi, guys. Can you give us a rundown on Flock; obviously, the non-accrual; and what the situation is there and what your plans are? I mean, what point does it make sense for a business like that, that's a lending business, to just keep it as a portfolio of company, run it, and operate it as a specialty finance lease business yourself?

Arthur Penn

Yeah. So the company's name is Flock Financial, and it's involved -- it's a specialty finance company involved in financing and purchasing busted consumer receivables. It's an area that, Robert, you focus on as well as BDCs.
We think it's a really interesting vintage, where we recapitalized the company. We converted some debt to equity. And we put some more capital in to fuel the growth of the company because we think it's a very good vintage for that space to be adding on assets and growing that company. So we're going to grow the company. We've added excellent management to that team.
And you're right. Once you get that company in a good position, it's a company that we could sell. It's a company that we could hold. It certainly generates a very attractive yield.
So first things first, we got to get the company on the right track. We've reconstituted management, brought some x managers in -- back into the company, added some board oversight, and put some capital into the company so that they can deploy into this attractive market.
That was the biggest non-accrual. We also put Walker Edison, which is a much smaller position that's been marked down for a number of quarters. We proactively put that on non-accrual as well.

Robert Dodd

Understood. On just -- at what point do you think, one way or the other -- whatever there's an asset -- what point do you think that capital could become income producing again?

Arthur Penn

Certainly, we think within the next year. That's our goal. We think it's -- we're building in a one-year horizon to start clicking yield again. Again, we've added to the management. We just want to kind of get things stabilized and then also moving in the right direction with growth.

Robert Dodd

Got it. I appreciate that. On the JV, obviously, you do (inaudible) on balance sheet. You still want to grow that. It is an extremely attractive return on capital through that structure. Can you give us update on how -- obviously, it depends on the market environment. But how large would you like that to be, say, a year from now?

Arthur Penn

Yeah. So as of March 31, it was $924 million. Based on -- with the current capital, we can get that to $1.1 billion. And we are in discussions about potentially growing that joint venture, and we're open to doing other JVs.
It's been a terrific structure for PNNT. It's been a good structure for PFLT. When you're generating an upper teens return consistently, it's something that we like. It's very good for shareholders.
We're managing more assets. We're not increasing our base fees. So it's attractive yield and returns for shareholders on a cost-efficient basis. So we're going to look to potentially upsize this JV. And who knows? Maybe we'll do other JVs over time.

Robert Dodd

Got it. Thank you.

Arthur Penn

Thank you.

Operator

Mickey Schleien, Ladenburg.

Mickey Schleien

Hi, Art and Rick, Art, just to follow up on the JV. You've already funded your commitments to the capital structure of the JV. Pantheon still has some unfunded commitment. This target of $1.1 billion, does that assume Pantheon finishes funding their commitment? And what's stopping that from occurring?

Arthur Penn

Yeah. It's a good question, and Rick may know off the top. I think we've all funded. If we haven't funded, we're going to be all funding shortly right now to a 60-40 split between PNNT and Pantheon.
So we're a quarter or max two quarters away of capping out to that $1.1 billion. And then the question is, is that where we stand or do we upside? Do we do another JV? So all options are on the table.
Clearly, we like the structure. Pantheon's a terrific partner, by the way. And we're optimistic that we can do more over time.

Mickey Schleien

So Art, as that JV grows, how are you going to manage the non-qualified asset bucket, which is already at 22%?

Arthur Penn

Yeah. So we're constantly watching the 30% bucket. You may see that at quarter end, we've been purchasing T bills on the balance sheet of PNNT, which is a qualifying assets which can help expand the 30% bucket.

Mickey Schleien

Okay. I appreciate that. And the leverage of the JV is running around 2 times. Is that where you want to see it? That's counting the notes to the members as debt. Is that about where you want it to be?

Arthur Penn

Yeah. Notes to the members, we -- it's all part of the junior capital. So we're looking at 2:1, $2 of external debt to $1 of junior capital, which would include the subordinated notes that we and Pantheon own along with the equity. So to us, that's junior capital. We leverage that 2:1 or so.

Mickey Schleien

Okay. 2:1, okay. That's it from me this afternoon. Thanks, Art.

Arthur Penn

Thanks, Mickey.

Operator

Mark Hughes, Truist.

Mark Hughes

Yeah. Thank you. I think you've addressed a lot of this. I was going to just ask about the sustainability of returns in the JV. You talked about high teens here recently. Is that something that's sustainable with that structure, just assuming the reasonable returns in the underlying investments?

Arthur Penn

Yeah. We believe it is. Obviously, if rates come down -- if and when rates come down, yields will -- these are floating rate assets. Of course, yields will come down. We do finance the JV with floating rate liabilities, either credit facilities or floating rate securitization CLO financing. So it's matched, albeit when rates are higher, you get a higher ROE.
And then, of course, it's about credit performance. And can we continue to have very strong credit performance? I think we can. The portfolio, as a senior portfolio that we do here, is well constructed, conservatively underwritten. I think we've been sharing with you that the senior loans we're doing today are 4.3 times debt-to-EBITDA was last quarter, interest coverage of 2.1 times, and a loan to value of about 40%.
So that's what's populating that joint venture. And then we leverage that with the floating rate credit facilities and the floating rate securitization. So we're optimistic. Although if rates come down, it may be hard to retain that. And of course, we got to keep underwriting credit well and try to minimize the non-accruals.

Mark Hughes

Appreciate it. Thank you.

Arthur Penn

Thank you.

Operator

Casey Alexander, Compass Point.

Casey Alexander

Hi. Good afternoon. Thanks for taking my questions, Art. I'm just curious. In the schedule of investments, Flock is listed as a sub-debt position. So I'm just curious why you guys -- who is ahead of you? And why would it be you guys who is making the decision to put management in?

Arthur Penn

Yeah. So a great question. So this is a specialty finance company. Regions Bank is the senior lender. We are a mezzanine lender, subordinated debt. As part of the restructuring, we're converting some of the mezzanine debt to equity, and we're doing some additional mezzanine debt, which is junior to Regions Bank.
So this was a non-sponsored deal. So it was a founder that was running the company. And when the company needed extra liquidity, we're the ones who provide the liquidity. And between the liquidity you provided and the conversion of debt to equity, we're in a majority equity position.

Casey Alexander

Okay, great. That's excellent color. Thank you. Just as a matter of course, is there any Flock or Walker Edison that is also in the JV?

Arthur Penn

I think -- no. Actually, no. There's no Walker Edison in the JV or Flock.

Casey Alexander

Okay, great. And lastly, I think you mentioned it, but I think I whiffed it. What was the company that came off non-accrual in the quarter?

Arthur Penn

Yeah. The company historically was called Mailsouth. Its name changed to Mspark. It's been marked at zero for the last few quarters. It got sold, and we realized that zero, unfortunately. But it's now off the SOIBs. The company got sold.

Casey Alexander

All right, great. Well, sorry to hear that result. But, all right. Thanks for taking my questions. I appreciate it.

Arthur Penn

Thank you.

Operator

Kyle Joseph, Jefferies.

Kyle Joseph

Good morning. Thanks for taking my questions. I apologies if I missed this, but just wanted to get a sense for competition and spreads. It looks like your yields for the quarter were fairly stable.
Just give us a sense of what base rates versus spreads there. And it looks like the yields on new investments were a little lower. But just -- I've been hearing mixed messages about banks either exiting or entering the space and just what you're seeing in terms of competition.

Arthur Penn

Yeah. It's a good question, Kyle, and we did not cover that earlier. Spreads have contracted about 50 basis points over the last six to nine months in the core middle market, which is where we focus under $50 million of EBITDA. AND that's just what the market has been.
M&A flow has been a little light. We've been busy, as you can tell. A lot of our business comes from both new platforms and existing companies, but spreads have tightened a bit to average [550] over the risk-free rate in our space. That, along with what -- we think are attractive credit statistics like 4.3 times debt-to-EBITDA, interest coverage of 2.1 times, a loan-to-value of 40%.
So we still think those credit stats along with, call it, 550 over risk-free rate average is very attractive, very attractive risk reward. Unclear what happens between now and year end. We are optimistic. We believe there's going to be a lot of activity between now and year-end, a lot of deal flow.
And there may be a scenario where supply demand widens spreads again. No guarantees, but you can certainly see that if a lot of supply hits the market, which we think is a possibility, spreads may widen again. But either way, we're -- most important for us is we are credit-oriented. We're focused on credit, and we're okay taking a little lower yield if the credit is well underwritten.

Kyle Joseph

Great. Thanks for taking my question.

Arthur Penn

Thank you.

Operator

And that does conclude the question-and-answer session. I'll now turn the conference back over to Mr. Art Penn.

Arthur Penn

Thanks, everybody, for participating. We really appreciate it. Next time, we'll be doing the call in early August for the June 30 quarter. In the meantime, wishing everybody a terrific spring and summer. Speak soon.

Operator

Thank you. That does conclude today's conference. We do thank you for your participation. Have an excellent day.