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Written by Nick Ackerman
PennantPark Floating Rate Capital (NASDAQ:PFLT) is a business development company that has paid a rather consistent dividend to shareholders. Launching back in 2011, the BDC has never cut its dividend but has increased it on several occasions. I suspect that we won't see any increases for a while, but what it lacks in growth, it can make up for with its 8.76% yield.
As a BDC, the basic concept is quite easy to understand. They will invest by originating loans and investments in smaller companies. They can even work closely with the management team of the other business to help them become more successful. That just helps ensure that their mostly first-lien loans get repaid too.
That's the other benefit to BDCs at this time. They invest in mostly floating rate first-lien loans while issuing debt at fixed-rate costs. PFLT has a sizeable amount of leverage in the form of floating rates, which means it isn't immune to interest cost fluctuations. However, its underlying portfolio is primarily floating rate - which will benefit greatly when higher rates come.
The other general risk for BDCs is they are often investing in financially shaky companies. After all, if they were completely sound, they could get financing through other means that weren't so expensive. That makes them more susceptible to economic conditions. That's why it can be a great thing to find something slow and steady such as PFLT, which had survived through the worst of the COVID pandemic and kept on paying investors.
PennantPark Floating Rate Capital Ltd. [NASDAQ: PFLT] provides primarily first lien debt. PFLT invests in middle market companies located primarily in the U.S., with a proven management team, competitive market positions, strong cash flow, growth potential, and viable exit strategies.
One of the main selling points, in my opinion, is the steady payout the BDC has delivered to investors. They haven't increased from the $0.095 since it initially paid that amount at the beginning of 2015. However, it also hasn't cut its dividend to shareholders either going back to 2011. What it lacks in growth, it is making up for with a dividend yield of 8.72%.
PFLT Annual Dividend (PFLT/Author)
The above shows the annual dividend going back to the launch of the BDC. Starting off in January 2022 comes to little surprise once again, PFLT announced a $0.095 dividend to be paid for the month of February. They pay around the first of the month.
One of the reasons I don't suspect they will raise the dividend is because they can't really. Their coverage has been thin, to flat out being uncovered over the last two years from sources of net investment income ("NII"). NII is typically the gold standard for dividend coverage from BDCs - especially when they have the largest amount of their portfolio invested in loans.
NII is simply the total income that the BDC has received minus expenses. For PFLT, from 2019 to 2020, the total income generated from the underlying portfolio actually increased. It then fell quite dramatically in 2021 as interest payments declined quite materially. At the same time, it was offset to some degree by a sizeable drop in interest and expenses on the debt. Of course, that came about as the Fed slashed rates to 0%. As I mentioned, PFLT actually has a fairly sizeable portion of its debt in a floating rate credit facility.
PFLT Consolidated Statements of Operations (PennantPark)
The above shows us that NAV had risen regardless despite the lack of NII coverage over the last year. That came primarily through some sizeable unrealized gains through 2021. Which makes sense considering it was rebounding from the COVID-induced panic selling of the year prior. Though for the latest quarter, the NAV did slip a bit.
During that period, base management fees and performance-based incentive fees also declined, as they should have. PFLT has some fairly high expenses too, even for a BDC that can frequently see ~10%+ expenses. However, a large portion of this is going to be interest expenses. Of PFLT's 13.32% estimated annual expenses, 5% is from "interest on borrowed funds."
The other sizeable portion is "acquired fund fees and expenses" at 4.54%. This stems from their investment in affiliated investments. This makes PFLT a bit more unique in its sizeable PSSL and PTSF affiliated investments. Total controlled and non-controlled affiliate fair value came to $224.8 million against the total $1.171 billion in total assets.
Our stockholders indirectly bear 87.5% of the expenses of our investment in PSSL. No management fee is charged by PennantPark Investment Advisers in connection with PSSL. PSSL pays the Administrator an annual fee of 0.25% of average gross assets under management. For this chart, PSSL fees and operating expenses are based on our share of the actual fees and operating expenses of PSSL for the fiscal year ended September 30, 2021. Expenses for PSSL may fluctuate over time and may be substantially higher or lower in the future.
Our stockholders indirectly bear 23.08% of the expenses of our investment in PTSF. A management fee equal to 0.30% per annum of the gross assets of PTSF and its subsidiaries is charged by PennantPark Investment Advisers in connection with PTSF (which is waived by PennantPark Investment Advisers). When applicable, fees and operating expenses estimates would be based on historic fees and operating expenses for acquired funds. For PTSF, which has a limited operating history, fees and operating expenses are estimates based on expected fees and operating expenses of PTSF for the applicable fiscal quarter, annualized for a full year. Expenses for PTSF may fluctuate over time and may be substantially higher or lower in the future.
At the end of September 30, 2021, they had a credit facility, 2023 notes, 2026 notes and 2031 asset-backed debt. The borrowings at that time came out to $300 million, $117.8 million, $100 million and $228 million, respectively. Putting the total leverage for PFLT at $745.8 million at the end of September.
The credit facility is LIBOR plus 225 basis points. The weighted average interest rate came to 2.3%. The 2023 notes are fixed at 4.3%, which increased from 3.8% after a ratings downgrade in March 2020. The 2026 notes are also fixed-rate at 4.25%.
The asset-backed debt is more complicated;
In September 2019, the Company completed the $301.4 million term debt securitization. Term debt securitizations, also known as CLOs, are a form of secured financing incurred by the Company, which is consolidated by the Company and subject to the Company’s asset coverage requirements. The 2031 Asset-Backed Debt was issued by the Securitization Issuer. The 2031 Asset-Backed Debt is secured by the middle market loans, participation interests in middle market loans and other assets of the Securitization Issuer. The Debt Securitization was executed through (a") a private placement of: (i) $78.5 million Class A-1 Senior Secured Floating Rate Loans maturing 2031, which bear interest at the three-month LIBOR plus 1.8%, (ii") $15.0 million Class A-2 Senior Secured Fixed Rate Notes due 2031, which bear interest at 3.7%, (iii") $14.0 million Class B-1 Senior Secured Floating Rate Notes due 2031, which bear interest at the three month LIBOR plus 2.9%, (iv) $16.0 million Class B-2 Senior Secured Fixed Rate Notes due 2031, which bear interest at 4.3%, (v") $19.0 million Class C‑1 Secured Deferrable Floating Rate Notes due 2031, which bear interest at the three-month LIBOR plus 4.0%, (vi) $8.0 million Class C-2 Secured Deferrable Fixed Rate Notes due 2031, which bear interest at 5.4%, and (vii") $18.0 million Class D Secured Deferrable Floating Rate Notes due 2031, which bear interest at the three-month LIBOR plus 4.8% and (b") the borrowing of $77.5 million Class A‑1 Senior Secured Floating Rate Notes due 2031, which bear interest at the three-month LIBOR plus 1.8%, under a credit agreement by and among the Securitization Issuers, as borrowers, various financial institutions, as lenders, and U.S. Bank National Association, as collateral agent and as loan agent. The annualized interest on the 2031 Asset-Backed Debt will be paid, to the extent of funds available. The reinvestment period of the Debt Securitization ends on October 15, 2023 and the 2031 Asset-Backed Debt is scheduled to mature on October 15, 2031.
With all that, the weighted average interest rate comes to 2.6% at the end of September 2021. Although, it is a variable rate that will be tied to LIBOR. So the majority of their underlying leverage is tied to floating rates. On the other hand, the rates will still be lower than what they are investing in.
Since that update, they issued an additional $85 million more in the 4.25% unsecured notes due 2026. That boosts its fixed-rate financing a bit more.
Going forward, this could improve for a couple of reasons. I believe the most obvious reason, and the one with the most sizeable impact, would be higher rates. Higher rates will increase the total income as the rates in the portfolio are mostly tied to LIBOR plus a spread.
Below is the breakdown of the type of debt PFLT is carrying. It is dominated by first-lien senior secured debt that overwhelmingly is floating rate.
PFLT Portfolio Breakdown (PennantPark)
As just covered on the leverage, their interest costs will increase too. But the net result should still be positive. In addition, with the latest leverage, they issued by adding $85 million more in the fixed-rate financing category. That should also boost NII going forward as long as they can invest in something that earns greater than the 4.25% rate. Looking at the rest of their portfolio seems a non-issue.
The main points here are the shortfall can be covered through potential appreciation. However, that isn't always as reliable as NII and requires the management to be smart about things. In addition, the increasing interest rates that are expected over the next year should also increase NII generation.
Some BDCs make specific investments and put significant weighting in certain categories of investments. For PFLT, that isn't the case, and the industry mix is incredibly diverse. This greater diversification means they can be better protected from industry-specific risks. In addition to that, they have greater flexibility to invest wherever the management feels makes the strongest investment choice.
PFLT Industry Mix (PennantPark)
Of course, the only area that they aren't diversified in is their 87% allocation to first-line loans. Overall, they have 110 different companies they had invested in at the end of their last fiscal year. The yield at cost on the debt portfolio was 7.4%, which reiterates the lack of coverage we discussed above. The shortfall can be made up through potential appreciation or increasing NII as we head into a rising rate environment.
Overall, PFLT is a BDC that an income investor can get behind. Growth seems limited in terms of its dividend, but the yield itself is pretty attractive on its own. In terms of the valuation of the BDC, while most seem to be trading at lofty premiums at this time, PFLT remains at a relatively modest 3.65% premium.
PFLT NAV/Price $10k Growth (CEFData)
That puts it in a bit better of a situation when things can turn sour. While PFLT would most certainly take a hit, its already lower valuation could provide some cushion relative to other names.
However, their declining NII is also something to watch, as they carry a large portion of their debt in floating rates. That could be two factors that are keeping PFLT at a lower valuation in the first place.
They have remedied some of this by issuing more fixed-rate debt recently. That works in favor of potentially increasing NII coverage by generating higher income on the portfolio and putting in more fixed-rate leverage for when rates rise. So it essentially knocks out two birds with one stone.
6 4 Associated CointreeAlex on 01/02/2022 - 14:07 cointree.com (142...Read More