The following is from the PNNT Deep Dive that was previously provided to subscribers of Premium BDC Reports along with revised target prices, dividend coverage and risk profile rankings, potential credit issues, earnings/dividend projections, quality of management, fee agreements, and my personal positions for all business development companies (“BDCs”).
PNNT Dividend Coverage Update:
PNNT continues to cover its dividend for a few reasons including the previously reduced management fees, the ability to use higher leverage with SBA borrowings, and rotating the portfolio into income-producing assets from upcoming monetizations (selling and reinvesting) of its equity investments:
“With asset yields coming down over the last several years, we’re looking to create attractive risk-adjusted returns and our portfolio. We’re executing a three point plan to do so. Number one, we’re focused on lower risk primarily secured investments, thereby reducing the volatility of our earnings stream. Number two, we’re also focused on reducing risk from the standpoint of diversification, as our portfolio rotates, we intend to have a more diversified portfolio with generally modest by sizes relative to our overall capital. Number three, we look forward to continuing to monetize the equity portion of our portfolio. Over time we’re targeting equity being 5% to 10% of our portfolio.”
The company had approximately $0.30 per share of taxable spillover income/gains and the current dividend is sustainable after taking into account higher leverage offsetting lower portfolio yield with the adjusted fee structure as shown in the Leverage Analysis. Also, management discussed the possibility of increased earnings through a senior loan joint venture:
“We are also actively assessing other options for increased earnings, including another SBIC and the senior loan joint venture, similar to the successful JV with PFLT.”
As shown below, equity investments are now around 14% of the portfolio and the company will likely continue to use higher leverage as it increases the amount of first-lien positions that now account for 59% of the portfolio (up from 40% five quarters ago).
For calendar Q2 2019, PNNT reported just below its base case projections lower portfolio yield partially offset by higher ‘other income’. ‘Provision for taxes’ of $0.3 million is not included when calculating ‘Core NII’ resulting in net investment income (“NII”) per share of $0.178 and 99% coverage of the dividend.
There was a meaningful decline in the overall portfolio yield from 10.6% to 10.1% as expected partly due to the previously discussed exit of its largest investment Parq Holdings in May 2019 that was yielding 14.6%. On February 5, 2019, shareholders approved the adoption of the modified asset coverage requirements allowing higher leverage and the advisor agreed to reduce the base management fee from 1.50% to 1.00% on gross assets that exceed 200%.
Art Penn, Chairman and CEO: “We are pleased that we are making substantial progress toward enhancing our portfolio by moving into more senior secured positions, which we believe will result in even more steady and stable coverage of our dividend over time. Additionally, our earnings stream will continue to improve based on a gradual increase in our debt-to-equity ratio, while maintaining a prudent debt profile.”
PNNT will be offsetting the impact from lower yields through the rotation out of non-income producing assets as well as increasing leverage. Previously, PNNT was keeping a conservative leverage policy of GAAP debt-to-equity (includes SBA debentures) near 0.80 until it can rotate the portfolio into safer assets.” However, the company has already increased the amount of first-lien debt from 40% to 59% of the portfolio over the last five quarters and is slowly increasing its regulatory debt-to-equity (excludes SBA debentures) to 1.50:
“Along with a lower risk portfolio, we intend to prudently target higher leverage. Over time, we are targeting a regulatory debt-to-equity ratio of 1.1 to 1.5x. We will not reach this target overnight. We will continue to carefully invest, and it may take us several quarters to reach this new target.”
The company has significant borrowing capacity due to its SBA leverage at 10-year fixed rates (current average of 3.1%) that are excluded from typical BDC leverage ratios. PNNT has applied for its third SBIC license that would provide an additional $175 million of SBA financing.
On September 25, 2019, PNNT priced its public offering of $75 million of 5.50% unsecured notes due October 15, 2024, trading under the symbol “PNNTG” and are included in the BDC Google Sheets and currently considered a ‘Hold’.
On September 4, 2019, PNNT amended its SunTrust Credit Facility increasing the amount of commitments from $445 million to $475 million and amended the covenants “to enable us to utilize the flexibility and incremental leverage provided by the SBCAA.
As expected, there have been no additional share repurchases due to only around $0.5 million of availability. Previously, PNNT purchased 1 million shares during the three months ended March 31, 2019, at a weighted average price of around $7.10 per share or a 22% discount to its previously reported NAV per share.
“We purchased $7 million of a common stock this quarter as part of our stock repurchase program, which was authorized by our board. We’ve completed our program and have purchased $29.5 million of stock. The stock buyback program is accretive to both NAV and income per share. The accretive effect of our share buyback was $0.03 per share.”
PNNT Risk Profile Discussion:
- Please see the end of this report for previous management discussion of historical credit performance including during the previous recession.
As mentioned earlier, management is in the process of “de-risking” the portfolio which is currently invested 59% in senior first-lien secured debt, 23% in second-lien secured debt, 4% in subordinated debt and 14% in preferred and common equity. Management has its “three-point plan” that includes rotating the portfolio into higher credit quality first and second-lien lower-yielding debt that will likely result in continued lower portfolio yields:
“We are focused on lower risk, primarily secured investments, thereby reducing the volatility on our earnings stream. Investments secured by either a first or second lien are about 82% of the portfolio. We are also focused on reducing risk from the standpoint of diversification. So number two, as our portfolio rotates, we intend to have a more diversified portfolio with generally modest bite sizes, relative to our overall capital. And number three, we look forward to continuing to monetize the equity portion of our portfolio. Over time, we’re targeting equity being between 5% to 10% of our overall portfolio. Our portfolio is constructed to withstand market and economic volatility. In general, our overall portfolio is performing well. We have a cash interest coverage ratio of 2.5 times and a debt to EBITDA ratio of 4.7 times at cost on our cash flow loans.”
During calendar Q2 2019, PNNT’s net asset value (“NAV”) per share declined by $0.09 or 1.0% (from $8.83 to $8.74) due to multiple markups and markdowns during the quarter. Some of the largest markdowns were previously discussed companies including Hollander Sleep Products, ETX Energy and AKW Holdings Limited. Similar to PennantPark Floating Rate Capital (PFLT), its investment in Hollander Sleep Products, was previously added to non-accrual status and marked down by another $7.9 million during the recent quarter impacting NAV per share by almost $0.12.
PT Networks was also marked down and needs to be watched. Some of the largest markups included its investments MidOcean JF Holdings and RAM Energy (similar to the previous quarter). On June 14, 2019, Superior Digital Displays, LLC filed for Chapter 7 bankruptcy protection and is no longer reflected on the Schedule of Investments.
During calendar Q2 2019, Hollander filed for bankruptcy “citing a severe cash squeeze due in part to substantial price increases for materials”. A Chapter 11 reorganization plan negotiated with lenders would convert about $166.5 million of Hollander’s $233 million debt burden to equity but the company said it “will also be running a marketing process to determine whether there are alternative transactions to ensure that the company maximizes value.”
CEO Marc Pfefferle said “Upon emergence [from bankruptcy], we will have a stronger balance sheet and the financial flexibility needed to compete in today’s dynamic business environment now and over the long-term.”
In June 2019, Hollander announced that it could be closing its plant in Thompson, Georgia. In addition, Hollander has been spending money to integrate Pacific Coast Feather Co., which it acquired in 2017. Hollander accounted for around 0.9% of PNNT’s portfolio as of Ju ne 30, 2019, but was not contributing to earnings as it had been put on non-accrual. The worst-case scenario is a complete writedown and would impact NAV per share by around $0.17 or 2.0%. Management discussed Hollander on the recent call:
Q. “On the Hollander, could you give us — I don’t — obviously, you’ve got historically a good track record of recoveries when you do have a nonaccrual, but you have that many and you have a track record of being very patient in order to get that recovery. So Hollander, obviously, it’s now filed Chapter 11. You’ve got a dip in there. There’s a debt-to-equity conversion proposal, I think, in the restructuring. I mean can you give us any outlook on what’s going on? Whether the objections within the creditors or if that’s likely to — how exactly that’s likely to evolve?”
A. “I can only give you what’s public information but I think kind of give you directionally what’s going on. So it’s going through the bankruptcy process now. They’re talking horse bids that are being cultivated outside of the creditors. We will see where those stalking horse bids come. We’ll see what the creditors to. We are not the largest lender here. There is another Wellman lender who is larger than us who was in this, who was going to be a driver of the — a big driver of the ultimate outcome. So that’s an independent entity from us. So we have — we can’t really control them. We can control our capital. So unclear. In the coming weeks I think this process will roll through, there’ll be clarity on it, where we are hugely disappointed in, obviously, the performance of this company. We think that given time, this company can have a lot of value, but we are not as much in control as we’d like to be in this particular situation. So we’ll see, we’ll see where it’s going to play out in the bankruptcy court in the coming weeks and that’s all I can really tell you right now,
Its investment in U.S. Well Services (USWS) is a common equity position which is a publicly-traded company that has not done so well since the end of Q2 2019 as shown below. I am expecting unrealized losses over the coming quarters.
Energy, oil & gas exposure increased to 12.8% of the portfolio fair value (previously 12.3%) due to the previously discussed unrealized appreciation and an additional $10 million debt investment in RAM Energy.
As discussed in previous reports, RAM Energy and ETX Energy have previously sold non-core assets to generate liquidity/stability. Its investment in RAM Energy was previously restructured to reduce the amount of PIK income and ETX Energy was restructured resulting in realized losses but potential equity upside potential.
This information was previously made available to subscribers of Premium BDC Reports, along with:
- PNNT target prices and buying points
- PNNT risk profile, potential credit issues, and overall rankings
- PNNT dividend coverage projections and worst-case scenarios
- Real-time changes to my personal portfolio
To be a successful BDC investor:
- As companies report results, closely monitor dividend coverage potential and portfolio credit quality.
- Identify BDCs that fit your risk profile.
- Establish appropriate price targets based on relative risk and returns (mostly from regular and potential special dividends).
- Diversify your BDC portfolio with at least five companies. There are around 50 publicly traded BDCs; please be selective.