PennantPark Investment Corporation (PNNT) — Form 10-Q
Reporting period: Three months ended December 31, 2022, compared with the three months ended December 31, 2021; balance-sheet comparisons are to September 30, 2022. The filing is for the quarter ended December 31, 2022, notwithstanding the request metadata’s “2022 Q1” label. Amounts are in U.S. dollars; financial statement amounts are generally in millions unless stated otherwise.
Business context
PNNT is an externally managed business development company investing primarily in U.S. middle-market businesses through secured and subordinated debt and equity. At December 31, 2022, its $1.196 billion investment portfolio spanned 125 companies; business services was the largest reported industry exposure at 19% of portfolio fair value. About 96% of the debt portfolio was floating rate.
Key financial results
| Metric | Quarter ended Dec. 31, 2022 | Quarter ended Dec. 31, 2021 / comparison |
|---|---|---|
| Investment income | $30.0 million | $28.3 million |
| Net investment income | $10.3 million; $0.16 per share | $12.5 million; $0.19 per share |
| Net realized investment gains (losses) | $4.1 million | $(26.1) million on investments, as described in MD&A |
| Net change in unrealized investment appreciation (depreciation) | $(91.6) million | $46.8 million |
| Net change in net assets from operations | $(71.9) million; $(1.10) per share | $25.5 million; $0.38 per share |
| Cash from operating activities | $(9.6) million | $(177.4) million |
| Cash from financing activities | $(14.8) million | $196.6 million |
| Cash and cash equivalents | $28.6 million at Dec. 31 | $52.7 million at Sept. 30, 2022 |
| Net assets / NAV per share | $502.9 million / $7.71 | $585.6 million / $8.98 at Sept. 30, 2022 |
| Distributions declared | $0.17 per share; $10.8 million total | $0.12 per share; $8.0 million total |
Investment income rose 6% year over year, primarily from higher portfolio debt yields. Net investment income fell as debt-related costs and the excise-tax provision increased. Interest and debt expenses were $9.7 million versus $6.9 million; the net investment income tax provision was $2.0 million versus $0.2 million. The sharp unrealized portfolio decline drove the quarterly operating loss and reduced NAV.
Portfolio, debt and liquidity
- Total investments were valued at $1.196 billion versus $1.226 billion at September 30. Debt fair value included $661.3 million first lien, $130.8 million second lien and $148.6 million subordinated debt and corporate notes; equity investments were $255.4 million.
- Net unrealized depreciation on investments was $167.5 million at December 31, compared with $75.7 million at September 30. Two portfolio companies were on non-accrual, versus one at September 30; the two represented 2.7% of portfolio cost and 1.1% of fair value.
- Debt carrying values included $367.3 million for the Truist facility, $147.0 million for the 2026 Notes, $161.6 million for the 2026 Notes-2 and $19.7 million of SBA debentures. Truist borrowings were $380.9 million at cost, with $119.1 million of stated unused capacity, subject to leverage and borrowing-base restrictions. The facility is secured by substantially all company assets other than SBIC II assets.
- Asset coverage was 171%, down from 186% at September 30, against the applicable 150% minimum. SBA debentures are excluded from this calculation under SEC exemptive relief. The filing reports an annualized weighted-average cost of debt of approximately 5.5%–5.6% for the quarter, versus 4.0% in the prior-year quarter.
- Operating activities used cash mainly in connection with investment activity; financing activities used cash mainly for net Truist facility repayments. Cash declined by $24.4 million during the quarter. Management stated that liquidity and capital resources were sufficient for operations.
Material changes, outlook and risks
- The investment portfolio’s weighted-average yield on interest-bearing debt rose to 11.9% from 10.8% at September 30. Quarterly investments were $86.2 million across six new and 29 existing portfolio companies, versus $295.1 million across 15 new and 30 existing companies in the prior-year quarter. Sales and repayments were $30.6 million versus $132.2 million.
- Equity fair value fell materially during the quarter; controlled-affiliate investments recorded $41.0 million of net unrealized depreciation. Most investment valuations are Level 3 and rely on significant unobservable inputs; actual sale values may differ materially from reported fair values.
- Management gave no quantified earnings or portfolio guidance. It intends to continue quarterly distributions, but distributions are board-determined and not assured. The $25 million share repurchase authorization was due to expire earlier of March 31, 2023 or completion; no shares were repurchased in this quarter. Cumulative program repurchases were 1,820,605 shares, leaving approximately $11.8 million authorized.
- Market risks include borrower credit quality, illiquid investment valuations, inflation, economic and credit-market conditions, foreign exchange exposure, and rising interest costs. A hypothetical 1% increase in base rates was estimated to raise annualized net interest income by $5.4 million ($0.08 per share), while a 1% decrease was estimated to reduce it by the same amount; actual results may differ.
- Management reported that disclosure controls were effective for the quarter. It also described remediation steps for a previously identified material weakness involving timely transmission of portfolio-company financial information to valuation providers; the filing does not state that this weakness was fully remediated.
- No material legal proceedings were reported. The company had $172.3 million of commitments to fund investments and no letters of credit outstanding.
Most important facts for investors to verify
- How much of the $91.6 million quarterly unrealized investment decline is recoverable, particularly for equity and controlled-affiliate holdings, and whether further portfolio companies may move to non-accrual.
- Whether recurring net investment income can support the distribution, given quarterly net investment income of $0.16 per share versus a $0.17 distribution and higher borrowing costs.
- Available borrowing capacity and compliance headroom under the 150% asset-coverage requirement and Truist facility covenants, including the effect of valuation declines.
- The filing gives inconsistent Truist facility pricing: the debt note states 225 basis points over SOFR, while MD&A states 235 basis points. Confirm the contractual spread and the applicable weighted-average debt-cost figure.
- Progress in remediating the previously identified internal-control weakness and the reliability of portfolio fair values, given the substantial use of Level 3 inputs.