Palmer Square Capital BDC Inc. — FY2020 Form 10-K Summary
Business context and reporting period
Palmer Square Capital BDC Inc. is an externally managed, non-diversified business development company that invests primarily in corporate debt securities of privately held U.S. companies and, to a lesser extent, CLO structured credit. Its objective is to maximize total return through current income and capital appreciation. The Company commenced operations on January 23, 2020; therefore, fiscal 2020 covers January 23 through December 31, 2020, and no comparable operating period exists for 2019.
The Company elected RIC tax treatment beginning with the taxable year ended December 31, 2020. Its common stock was not listed on a national securities exchange, and there was no public market for the shares at year-end.
Financial performance and key metrics
| Metric | FY2020 |
|---|---|
| Total investment income | $25.5 million |
| Net expenses | $10.8 million, after a $493,447 management fee waiver |
| Net investment income | $14.7 million |
| Net realized gains/(losses) | $(1.0) million |
| Net unrealized gains | $13.1 million |
| Net increase in net assets from operations | $26.7 million |
| Net investment income per share | $1.32 |
| Net asset value per share | $20.15 at December 31, 2020 |
| Total return based on NAV | 4.29% |
| Net assets | $253.1 million |
| Total assets | $667.5 million |
| Cash and cash equivalents | $682,579 |
| Portfolio fair value | $600.1 million of debt and private investments, plus $53.1 million of short-term investments |
Interest income was $25.0 million, with $228,092 of dividend income and $283,577 of other income. Net expenses included $4.7 million of interest expense, $3.9 million of management fees, and $2.4 million of other operating expenses. The operating expense ratio was 5.44% after the fee waiver and 5.69% before the waiver; the net investment income ratio was 7.43% after the waiver.
Cash flow from operations was negative $623.2 million, primarily reflecting $854.5 million of portfolio investment fundings, partially offset by $268.3 million of investment sale proceeds. Financing activities provided $623.9 million, principally from $395.3 million of borrowings and $233.7 million of net common-stock issuance proceeds. Cash and cash equivalents increased by $681,079 during the period.
Portfolio, leverage, and liquidity
- At year-end, the Company held 202 investments in 181 portfolio companies. Investments were concentrated in first-lien senior secured debt: $566.5 million fair value, or approximately 86.7% of total investments excluding short-term investments.
- Second-lien senior secured debt had a fair value of $20.0 million, and collateralized securities and structured products had a fair value of $13.6 million.
- The largest industry exposures included software at 13.3%, healthcare providers and services at 12.0%, insurance at 7.7%, and professional services and media at 4.4% each.
- Weighted-average total yield to maturity was 4.96% at fair value and 5.49% at amortized cost. Approximately 99.79% of new debt investment commitments were floating-rate investments.
- The Bank of America Credit Facility had a $475.0 million commitment, $395.0 million of principal outstanding, and $80.0 million of availability at December 31, 2020. It matures in February 2023 and generally bears interest at LIBOR or the applicable base rate plus 1.30%.
- The Wells Fargo Credit Facility, entered into in December 2020, had a $150.0 million commitment and no borrowings outstanding at year-end. It matures in December 2025.
- The Company’s asset coverage ratio was 164%, above the statutory 150% minimum. Aggregate unfunded commitments to portfolio companies were $1.3 million.
Material changes and unusual items
- The Company moved from a pre-operating position with no investments at December 31, 2019 to a $600.1 million portfolio fair value at December 31, 2020.
- Net asset value increased from $20.00 per share at commencement to $20.15 per share at year-end after $0.98 per share of distributions and $1.13 per share of net operating results.
- Quarterly NAV was volatile: $16.16 at March 31, $18.82 at June 30, $19.79 at September 30, and $20.15 at December 31. The first quarter included a $34.0 million net unrealized loss, followed by recoveries in later quarters.
- The Company declared total 2020 distributions of $12.2 million, or $0.98 per share. A $0.31 per-share distribution declared December 31, 2020 was paid partly in cash and partly through the dividend reinvestment plan.
- The Company issued 12,562,805 common shares for aggregate proceeds of approximately $238.6 million during the period, including shares issued under the reinvestment plan.
- Subsequent to year-end, the Company issued approximately $2.0 million of additional common stock on January 4, 2021 and $27,700 on February 1, 2021.
- Management adopted ESG screening policies effective March 1, 2021; certain investments held before that date may not comply with the new guidelines.
Guidance, outlook, commentary, and risks
Management did not provide quantitative earnings or distribution guidance. The Company intends to make quarterly distributions when legally and financially available and expects to continue seeking RIC qualification. RIC status requires distribution of at least 90% of investment company taxable income and compliance with income-source and asset-diversification tests.
Management identified the COVID-19 pandemic, economic downturns, borrower defaults, credit-market volatility, rising funding costs, illiquidity, valuation uncertainty, leverage, and the discontinuation of LIBOR as significant risks. The portfolio contains below-investment-grade and covenant-lite exposures, and CLO investments may experience payment reductions or total loss in stressed conditions.
Most portfolio investments are valued using market quotations or other observable inputs, but valuation changes can materially affect NAV. The Investment Advisor’s management fee is based partly on net asset value, creating a potential conflict in valuation. The Company also faces dependence on Palmer Square personnel, competition for investments, conflicts with affiliated funds, restrictions under the 1940 Act, and the risk that it may be unable to raise capital or maintain required asset coverage.
The Company’s credit facilities contain covenants and events of default that could accelerate repayment or restrict distributions. The Company disclosed no material litigation and no material changes in internal control over financial reporting. Disclosure controls and procedures were considered effective at a reasonable assurance level.
Most important facts for investors to verify
- Confirm the full audited financial statements and notes, including the quality and valuation methodology of the $600.1 million portfolio.
- Assess leverage relative to NAV, the 164% asset coverage ratio, borrowing-base availability, and the February 2023 maturity of the Bank of America facility.
- Review portfolio credit quality, non-accrual status, covenant-lite exposure, CLO concentration, and industry and issuer concentrations.
- Evaluate whether net investment income and taxable income support the current distribution policy, particularly given non-cash income, RIC distribution requirements, and limited cash on hand.
- Monitor the effect of LIBOR transition, interest-rate movements, and the spread between portfolio yields and borrowing costs.
- Review the absence of a public trading market, transfer restrictions, NAV-based valuation uncertainty, and potential conflicts involving the external Investment Advisor.
- Verify the subsequent equity issuances, the Wells Fargo facility terms, and the continuing impact of COVID-19 on portfolio companies.