Palmer Square Capital BDC Inc. annual report, FY2022

Palmer Square Capital BDC Inc. — FY2022 Form 10-K Summary

Business Context and Reporting Period

Palmer Square Capital BDC Inc. is an externally managed, non-diversified business development company and regulated investment company. It primarily invests in corporate debt securities of private U.S. companies and, to a lesser extent, CLO mezzanine debt and equity. The filing covers the fiscal year ended December 31, 2022, with comparative results for 2021. The company commenced operations on January 23, 2020 and had no public market for its common stock as of the filing date.

• At December 31, 2022, the portfolio comprised 204 debt and private fund investments across 176 portfolio companies with aggregate fair value of approximately $966.9 million, excluding short-term investments.
• Investment focus was concentrated in first-lien senior secured debt, which represented $870.9 million of fair value, or approximately 85.6% of long-term investments at fair value.
• Largest industry exposures included software at 12.9%, healthcare providers and services at 9.9%, IT services at 8.4%, professional services at 5.9% and insurance at 5.8%.

Financial Performance and Key Metrics

Metric	FY2022	FY2021
Total investment income	$74.5 million	$39.7 million
Net expenses	$33.4 million	$16.9 million
Net investment income	$41.1 million	$22.8 million
Net realized gains (losses)	$(8.1) million	$4.8 million
Net unrealized gains (losses)	$(107.4) million	$(8.5) million
Net increase (decrease) in net assets from operations	$(74.5) million	$19.1 million
Net investment income per share	$1.78	$1.47
Net increase (decrease) in net assets per share	$(3.22)	$1.23
Net asset value per share	$14.96	$20.06
Total return	(16.51)%	8.10%

• Net investment income represented approximately 55.1% of total investment income, compared with approximately 57.5% in 2021.
• Interest income was $73.7 million, versus $38.9 million in 2021, and accounted for substantially all investment income.
• Net expenses increased primarily because average debt outstanding rose to $667.5 million from $477.0 million and average net assets rose to $416.4 million from $318.5 million.
• Interest and debt financing expense increased to $23.5 million from $8.6 million. Management fees were $8.3 million, partially offset by a $1.0 million management fee waiver.
• No portfolio investments were on non-accrual status at December 31, 2022.

Portfolio, Cash Flow, Debt and Liquidity

• Total investments at fair value declined to $1.017 billion from $1.194 billion, while investment fair value excluding short-term investments declined to approximately $966.9 million from approximately $1.1 billion.
• The weighted average total yield to maturity on debt and income-producing securities at fair value increased to 11.47% from 5.77%; the weighted average interest rate increased to 8.83% from 4.80%.
• New investment fundings were $279.0 million, compared with $926.4 million in 2021. Investments sold or repaid totaled $314.4 million, compared with $401.8 million in 2021.
• Net cash provided by operating activities was $25.1 million, compared with net cash used in operating activities of $438.0 million in 2021. Net cash used in financing activities was $24.6 million.
• Cash and cash equivalents were $1.7 million at year-end. Short-term money-market investments were $50.3 million, compared with $78.1 million in 2021.
• Total net debt carrying value was $641.3 million, consisting of $513.7 million under the Bank of America facility and $127.6 million under the Wells Fargo facility.
• Outstanding principal was $514.5 million under the Bank of America facility and $126.8 million under the Wells Fargo facility. Available commitments were $210.5 million and $23.2 million, respectively.
• The Bank of America facility matures in February 2025; the Wells Fargo facility matures in December 2025, with the ability to draw under that facility scheduled to terminate in December 2023.
• The asset coverage ratio was 157% at December 31, 2022, compared with the 150% minimum generally required under the 1940 Act. Both credit-facility subsidiaries were reported to be in compliance with applicable covenants.
• Unfunded portfolio commitments declined to $2.6 million from $11.3 million. The commitments related to ARC Falcon I Inc. and Vocus Group and were subject to borrower conditions.

Material Changes Versus the Prior Comparable Period

• Investment income increased approximately 88%, driven primarily by portfolio growth during the prior year and higher floating rates.
• Net investment income increased approximately 80%, but net investment income growth was more than offset by substantially larger unrealized depreciation and realized losses.
• Net unrealized depreciation increased to $107.4 million from $8.5 million, reducing year-end net assets to $363.4 million from $452.8 million.
• NAV per share declined 25.4%, from $20.06 to $14.96, while shares outstanding increased to 24.3 million from 22.6 million.
• Portfolio turnover decreased to 27% from 53%, and new investment commitments decreased to 38 from 155.
• Debt outstanding decreased modestly from $652.0 million of principal at year-end 2021 to $641.3 million of net carrying value at year-end 2022, while average debt outstanding increased materially during the year.
• Quarterly NAV declined from $19.91 at March 31, 2022 to $14.96 at December 31, 2022. The second quarter produced the largest quarterly net loss, primarily because of $74.4 million of unrealized depreciation.

Distributions, Outlook, Risks and Unusual Items

• The company declared total 2022 distributions of $44.1 million, or $1.89 per share, compared with $26.0 million, or $1.38 per share, in 2021. The distributions were funded from ordinary income and capital gains; no return of capital was reported for either year.
• The December 2022 distribution was $0.64 per share, with $6.9 million paid in cash in January 2023 and the balance issued through the dividend reinvestment plan.
• The Investment Advisor waived $1.0 million of management fees in 2022. No incentive fee was payable because the company had not listed its common stock on a national securities exchange.
• Management expects to continue pursuing corporate debt and CLO investment opportunities, but the filing does not provide formal earnings, NAV, dividend or portfolio-growth guidance.
• Subsequent to year-end, the company issued additional common stock, including approximately $9.25 million sold by March 1, 2023. The Bank of America facility was amended in February 2023 to replace LIBOR-based loans with SOFR-based loans and increase applicable spreads.
• Key risks include leverage, rising funding costs, credit losses, valuation volatility, illiquidity, covenant-lite and below-investment-grade investments, CLO structural risk, concentration in leveraged private companies, dependence on Palmer Square personnel, related-party conflicts and limitations on access to capital.
• The company is exposed to the discontinuation of LIBOR and related documentation, pricing, systems and litigation risks. It also faces risks from inflation, economic downturns, geopolitical events, the Russia-Ukraine conflict, cybersecurity incidents and regulatory changes.
• Fair values are subject to management judgment and market conditions. The Investment Advisor became the Board-designated valuation designee effective August 11, 2022.
• Management reported effective disclosure controls and internal control over financial reporting as of December 31, 2022. The independent auditor issued an unqualified opinion; an audit of internal control effectiveness was not required.

Most Important Facts for Investors to Verify

1. Whether the significant 2022 unrealized depreciation reflects temporary market repricing or deterioration in portfolio-company credit quality and expected recoveries.
2. The sustainability of the $1.78 per-share net investment income and the $1.89 per-share annual distribution after higher borrowing costs and the end of the low-rate environment.
3. Compliance with the 157% asset coverage ratio and the borrowing-base and other covenants under both credit facilities, particularly as the Wells Fargo draw period ends in December 2023.
4. Refinancing plans and available liquidity for the February 2025 and December 2025 facility maturities.
5. The effect of the LIBOR-to-SOFR transition on portfolio yields, borrowing costs, spreads and net investment income.
6. The accuracy and conservatism of fair-value marks for private and illiquid investments, including investments held through pledged subsidiaries.
7. Portfolio concentration, exposure to software, healthcare and IT services, and the credit performance of the largest individual portfolio companies.
8. Future distribution composition, including the proportion paid in cash versus shares through the dividend reinvestment plan.