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Edited Transcript of PNNT earnings conference call or presentation 7-Feb-20 3:00pm GMT

Q1 2020 PennantPark Investment Corp Earnings Call

NEW YORK Feb 12, 2020 (Thomson StreetEvents) -- Edited Transcript of PennantPark Investment Corp earnings conference call or presentation Friday, February 7, 2020 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Arthur Howard Penn

PennantPark Investment Corporation - Founder, Chairman & CEO

* Aviv Efrat

PennantPark Investment Corporation - Treasurer & CFO

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Conference Call Participants

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* Casey Jay Alexander

Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst

* David Brian Miyazaki

Confluence Investment Management LLC - SVP and Portfolio Manager

* Kyle M. Joseph

Jefferies LLC, Research Division - Equity Analyst

* Mickey Max Schleien

Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst

* Richard Barry Shane

JP Morgan Chase & Co, Research Division - Senior Equity Analyst

* Robert James Dodd

Raymond James & Associates, Inc., Research Division - Research Analyst

* Ryan Patrick Lynch

Keefe, Bruyette, & Woods, Inc., Research Division - MD

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Presentation

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Operator [1]

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Good morning, and welcome to the PennantPark Investment Corporation's First Fiscal Quarter 2020 Earnings Conference. Today's call is being recorded. (Operator Instructions)

It is now my pleasure to turn the call over to Mr. Art Penn, Chairman and Chief Executive Officer of PennantPark Investment Corporation. Mr. Penn, you may begin your conference.

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Arthur Howard Penn, PennantPark Investment Corporation - Founder, Chairman & CEO [2]

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Thank you, and good morning, everyone. I'd like to welcome you to PennantPark Investment Corporation's First Fiscal Quarter 2020 Earnings Conference Call. I'm joined today by Aviv Efrat, our Chief Financial Officer. Aviv, please start off by disclosing some general conference call information and include a discussion about forward-looking statements.

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Aviv Efrat, PennantPark Investment Corporation - Treasurer & CFO [3]

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Thank you, Art. I'd like to remind everyone that today's call is being recorded. But please note that this call is a property of PennantPark Investment Corporation and that any unauthorized broadcast of this call in any form is strictly prohibited. Audio replay of the call will be available by using the telephone numbers and PIN provided in our earnings press release as well as on our website.

I'd also like to call your attention to the customary safe harbor disclosure in our press release regarding forward-looking information. Today's conference call may also include forward-looking statements and projections, and we ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these projections. We do not undertake to update our forward-looking statements unless required by law. To obtain copies of our latest SEC filings, please visit our website at pennantpark.com or call us at (212) 905-1000.

At this time, I'd like to turn the call back to our Chairman and Chief Executive Officer, Art Penn.

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Arthur Howard Penn, PennantPark Investment Corporation - Founder, Chairman & CEO [4]

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Thanks, Aviv. I'm going to provide an update on the business starting with financial highlights, followed by a discussion of the overall market, the portfolio, investment activity, the financials and then open it up for Q&A. We were active in the quarter ended December 31, 2019. We invested $174 million in primarily first-lien secured debt at an average yield of 8.8%. Our NAV increased from $8.68 per share to $8.79 per share. Net investment income was $0.15 per share, which was all recurring income. We had no other income in the quarter. Other income is typically $0.01 to $0.03 per share.

As we have discussed, we are generally moving into first-lien secured positions higher in the capital structure and into a more diversified portfolio. As of December 31, first-lien exposure was 57% of the portfolio, up from 48% a year ago. Along with a lower risk portfolio, we are prudently targeting higher leverage.

As of December 31, regulatory leverage was 1.06x. 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 time to reach the new target. A careful and prudent increase in leverage against primarily first -- against primarily a first-lien portfolio should lead to higher earnings. In early October, we also received green light for our SBIC III. We are extremely gratified that our long-term track record and excellent relationship with the SBA will result in attractively priced long-term financing for the company.

We are also actively assessing a new senior loan joint venture similar to the successful joint venture at PFLT, which can also increase our earnings over time. Our recently amended credit facility, issuance of unsecured bonds last fall, SBIC III, and the potential joint venture should provide a solid pathway for earnings growth. Solid coverage of our dividend should come as a result of this prudent increase in leverage. Above and beyond the prudent increase in leverage, earnings should grow as we exit performing equity investments and reinvest those proceeds and loans.

As of the last fiscal year, we had taxable spillover of $0.34 per share, which provides significant dividend cushion. Our primary business of financing middle market sponsors has remained robust. We manage relationships with about 400 private equity sponsors across the country from our offices in New York, Los Angeles, Chicago and Houston, and we've done business with about 190 sponsors.

Over the last 12 months, about 65% of the companies we invested in were existing borrowers. These were generally cases where we had an option to continue to finance an existing borrower or could opt out. To us, this encompasses the best of both worlds. Staying with solid credits, which reduced competition or choosing to exit. In a market where investors are asking about differentiation among middle-market direct lenders, the value of incumbency can't be overstated. With 135 borrowers in our overall platform, we are deriving substantial benefits of incumbency. Our growing team, capital resources and incumbency put us in a position to be both active and selective. Today, we're only investing in approximately 4% of the opportunities we are shown.

Due to the wide funnel of deal flow that we receive, we will continue to be extremely selective with our investments. As you will recall, in 2007, just as today, PNNT was focused on financing middle-market financial sponsors. Our performance through the global financial crisis and recession was solid. Prior to the onset of the global financial crisis in September 2008, we initiated investments which ultimately aggregated $480 million. The investments performed well. Average EBITDA of the underlying portfolio companies fell about 7% at the bottom of the recession. According to the Bloomberg North American High Yield index, the average high-yield company EBITDA was down about 40% during that time frame. As a result, we had few defaults and attractive recoveries on that portfolio. The IRR of those underlying investments was 8%, even though they were done prior to the financial crisis and recession. We are proud of this downside case track record.

We have had only 13 companies go on nonaccrual out of 245 investments since inception over 12 years ago. Further, we are pleased that even when we have had those nonaccruals, we've been able to preserve capital for our shareholders. As of December 31, 2019, we had no nonaccruals. Since inception, PNNT has invested about $5.8 billion at an average yield of about 12%. This compares to an annualized loss ratio, including both realized and unrealized losses, of approximately 30 basis points annually. This strong track record includes both our energy investments as well as our primarily subordinated debt investments made prior to the financial crisis.

At this point in time, our underlying portfolio indicates a strong U.S. economy and no signs of a recession. We remain focused on long-term value in making investments that will perform well over an extended period of time and can withstand different business cycles. We are first call for middle-market financial sponsors, management teams and other intermediaries who want consistent credible capital. As an independent provider free of conflicts or affiliations, we are a trusted financing partner for our clients.

In general, our overall portfolio is performing well. We have cash interest coverage ratio of 2.7x and a debt-to-EBITDA ratio of 4.7x at cost on our cash flow loans. With regard to Ram Energy, as we have discussed, Ram is focusing on its core 13,500 contiguous gross acres Austin Chalk project in the Giddings field outside of Houston, Texas. This area has received renewed focus. Ram's first 7 wells have all ranked in the top 20 wells in terms of an initial production with 4 of these in the top 10 including the #1 and #3 wells in the Austin Chalk.

Ram's acreage is surrounded by well-known and active strategic oil and gas companies. Today, Ram has over 100 potential additional locations in this project. We decided to convert a portion of the company's outstanding debt to equity. And today, we have about $40 million of funded revolver outstanding. That in addition to the $30 million funded portion of a Macquarie loan represents less than 3x leverage on Ram's 2020 estimated EBITDA, which is consistent with comparable companies in the industry.

18% of our portfolio was preferred in common equity as of December 31. This is higher than our long-term target of 5% to 10%. A substantial portion of the growth in equity is due to the positive performance of quite a few investments. The strong performance of MidOcean J&F, Wheel Pros, ITC Rumba, DecoPac, PT Network, Walker Edison, Dominion and others has resulted in markups in those equity positions over the last few quarters.

About $120 million or nearly half of our equity portfolio has increased in value over the past 18 months, where we can envision an exit over the next 12 to 24 months. Our goal is to make substantial progress over the next 12 to 24 months and exiting equity positions at attractive prices. As we reinvest those proceeds into our core cash-paying debt instruments, our income should grow.

To give you a sense, if we were to exit only $60 million of that $120 million and reinvest in loans consistent with our recent yields, our NII would increase $0.015 per share per quarter. If we were to exit all $120 million, NII would increase by $0.03 per share per quarter. On a mark-to-market basis, this past quarter, positive movements in the value of MidOcean J&F and PT Network were offset by valuation declines in ETX.

Overall asset appreciation generated $0.18 per share of NAV gain. In terms of new investments, we've known these particular companies for a while, have studied the industries or had a strong relationship with the sponsor.

Let's walk through some of the highlights. We purchased $13.7 million of DRS holdings' Dr. Scholl's first-lien term loan with revolver and common equity. Dr. Scholl's is a leading brand in the foot care category in North America, including insoles, skin treatments and orthotics. Yellow Wood is the sponsor.

We've purchased $2.9 million of ECM Industries first-lien term loan with revolver and common equity. ECM is a provider of a broad range of tools and consumables for electrical and harsh environment applications under highly regarded brands. Sentinel Capital Partners is the sponsor.

We purchased $5.5 million of Sargent and Greenleaf first-lien term loan. Sargent and Greenleaf is a global manufacturer of high-end locks for safes, for residential ATM and government end markets. OpenGate Capital is the sponsor.

We purchased $5.2 million of first-lien term loan of TeleGuam Holdings. The company is a quad-play telecom operator in Guam. Huntsman Family Investments is the sponsor.

Turning to the outlook. We believe that the remainder of 2020 will be active due to growth in M&A-driven financings. Due to our strong sourcing network and client relationships, we are seeing active deal flow.

Let me now turn the call over to Aviv, our CFO, to take us through the financial results.

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Aviv Efrat, PennantPark Investment Corporation - Treasurer & CFO [5]

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Thank you, Art. For the quarter ended December 31, 2019, net investment income totaled $0.15 per share. Looking at some of the expense categories: management fees totaled $5.5 million; taxes, general and administrative expenses totaled $1.5 million; and interest expenses totaled $8.9 million. Our investment gained $0.18 per share on a mark-to-market basis. Our dividend exceeded our GAAP net investment income by $0.03 per share, and our liabilities reduced NAV $0.04 per share on a mark-to-market basis. Consequently, NAV share went from $8.68 per share to $8.79 per share.

During the quarter, we exercised under a greenshoe of our unsecured bond trading on the NASDAQ under the ticker PNNTG and issued an additional $11.3 million. The total amount of the bond is $86.3 million. As a reminder, our entire portfolio, credit facility and senior notes are marked-to-market by our Board of Directors each quarter using the exit price provided by independent valuation firms, securities and exchanges or independent broker-dealers quotes when active markets are available under ASC 820 and 825.

In cases where broker-dealer quotes are inactive, we use independent valuation firms to value the investments. Our overall debt portfolio has a weighted average yield of 9.6%. On December 31, our portfolio consisted of 78 companies across 30 different industries. The portfolio was invested in 57% first-lien senior secured debt, 20% in second-lien secured debt, 5% in subordinated debt and 18% in preferred and common equity. 98% of the portfolio has a floating rate.

Now let me turn the call back to Art.

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Arthur Howard Penn, PennantPark Investment Corporation - Founder, Chairman & CEO [6]

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Thanks, Aviv. To conclude, we want to reiterate our mission. Our goal is to generate attractive risk-adjusted returns through income, coupled with long-term preservation of capital. Everything we do is aligned to that goal. We try to find less risky middle-market companies that have high free cash flow conversion. We capture that free cash flow primarily in debt instruments, and we pay out those contractual cash flows in the form of dividends to our shareholders.

In closing, I'd like to thank our extremely talented team of professionals for their commitment and dedication. Thank you all for your time today and for your continued investment and confidence in us. That concludes our remarks.

At this time, I would like to open up the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

And we'll first hear from Kyle Joseph of Jefferies.

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Kyle M. Joseph, Jefferies LLC, Research Division - Equity Analyst [2]

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First question, just wanted to talk about sort of the pace or the cadence of deployment during the quarter. Was it a little bit backloaded in the quarter? I just want to get a sense for the yield dynamics in the quarter?

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Arthur Howard Penn, PennantPark Investment Corporation - Founder, Chairman & CEO [3]

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Yes. Thanks, Kyle. Yes, as usual, we had a large number of deals closed right around year-end December 31. So a big chunk of the flow came at -- right at year-end and -- or shortly thereafter. So a very active quarter in general. We're pleased with the activity, like the risk-adjusted returns that we're getting that is very back-end loaded.

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Kyle M. Joseph, Jefferies LLC, Research Division - Equity Analyst [4]

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Got it. And then just on yields. Obviously, you are subject to market movements, you're subject to base rates. And lastly, we've been seeing portfolio rotation. Obviously, you guys are only in control of one of those aspects, but at least in terms of the portfolio rotation, can you give us a sense as -- a sense for how much progress you've made? How much more of the portfolio there is to rotate, which would ultimately pressure assets? I know that rotating equity into yield investments would actually enhance the yield on the portfolio. So just give us a sense on the progress you've made? And how much would you have to check, if you will?

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Arthur Howard Penn, PennantPark Investment Corporation - Founder, Chairman & CEO [5]

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Yes. It's a good question. And look, it's -- as the saying goes, it's a process. A while ago, we said, look, we're in this environment, we are going to be much more cautious about second lien and mezz given where the leverage ratios were, and we're going to pivot and do more first lien and take advantage of the higher leverage, the higher leverage availability in BDC space.

So we're in the midst of that transition. Today, first-lien exposure is 57% of the portfolio, up 10% from -- about 10%, 9% from last year, which is 48%. Almost everything we're doing going forward is going to be first lien, where we'll be able to leverage it up a bit more. Occasionally, we'll do a second lien and mezz, but it's going to have to be very, very compelling for us. So we're kind of in the middle of this transition of more first lien, higher leverage, lower yield but made up with leveraged safer portfolio. And at the same time, working on exiting as best we can, our equity investments and replacing those with cash-paying debt instruments.

The fact that a bunch of the equity investments are performing very well, and the valuations are rising, that's a good sign. It's a -- it sets a nice foundation for exit over the coming quarters. Again, we don't really control most of that. But it sets up this dynamic where, over time, with increased leverage with the ability to exit these equity investments, not only should we see solid dividend coverage, we should see some growth well beyond that. So that's the game plan.

We knew it was not going to be flipping a switch and turning the lights on. We know it's going to take some time. We are in the middle of that. And it's very labor-intensive. We're committed to it. We think in the end, it'll be a much better company, much better cash flow stream and NAV for our shareholders.

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Operator [6]

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(Operator Instructions)

We'll next hear from Robert Dodd of Raymond James.

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [7]

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On the equity book, obviously, which went up this quarter because of Ram and some other things, but can you give us any color that you're willing to on what proportion of the book, if any, is in active discussions to exit? Or is it all just -- it's -- obviously, it's a process. But is it all sitting out there? Or is any of it currently in active discussion?

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Arthur Howard Penn, PennantPark Investment Corporation - Founder, Chairman & CEO [8]

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It's a good question because sometimes we are in a room when we -- we're in the room where it happens, and sometimes we're not in the room where it happens. So -- and I know, Robert, you like Broadway. So there is a portion of the book. I'm going to say, of that $120 million, 10% to 20% more in the room where it happens, and we know of discussions at this point. The rest of it, we are not in the room where it happens, and you would hope and think that as the companies perform well and as they're in the hands, primarily of middle-market financial sponsors, it's just a matter of time. It might be 6 months, it might be a year, it might be 18 months or 2 years, but it should just be a matter of time until that value is realized.

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [9]

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Got it. Got it. On the JV, you said you're actively assessing so where -- which act would you be in, so to speak, to bring Broadway into play again. I mean is that early stages? I mean any color you can give us on when something might go live on that front?

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Arthur Howard Penn, PennantPark Investment Corporation - Founder, Chairman & CEO [10]

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Yes. So we're actively assessing proposals right now from potential parties, from potential partners. So we are hopeful that by the time we speak in early May, we'll have something more concrete to talk about.

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [11]

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Got it. And then just one on Ram, which, as you said, you restructured a little bit, it looks to be doing pretty well. Will that -- and you obviously just got another permit, I think, to drill out just a couple of days ago. Will there be more needed debt, either from you guys or from Macquarie to fund incremental wells. I mean, again, you just got permitted. So is that going to require more debt capital? Or is the drilling program through this year already funded from capital they have?

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Arthur Howard Penn, PennantPark Investment Corporation - Founder, Chairman & CEO [12]

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Yes. So we're kind of done with 10 wells. There's 2 more potential wells in this project. At this point, that would come from Macquarie. So we will see kind of one day at a time.

Again, reason we kind of did this recap is we wanted the debt-to-EBITDAs to be kind of in a zone of where the comparables were, which is about 3x EBITDA. So we would only go forward with the other 2 wells if we felt we could keep it within the zone. In terms of our capital, I think at this point, we're set. We're not planning to put any more capital in. And the idea -- rolling back the paper over the last number of quarters, and we've shared this with everybody is, we thought we had a really good -- we thought we've had some really good acreage there in this Giddings field area and the mission has been to prove it out, so that we can position the company best -- as best as possible for moving it to the right long-term hands. We are not the right long-term hands for these assets. And there's 3 or 4 big strategics who are active in surrounding our acreage. So the idea has been prove it out to best position the company for potential exits in the strongest way. So the wells have been very good. The 7 wells where we have our results are all in the top 20 in that area. So we think we're setting ourselves up as best we can for potential exit. But it's a volatile market out there in energy as we all know and we can do what we can do. But in terms of our capital commitment, at this point, we're finished and the additional wells would come from Macquarie if we decide to go with those additional 2 wells.

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [13]

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Got it. Got it. And then one 1, if I can. On -- obviously, your indication of a target regulatory leverage 1.1:1.5, it's a pretty wide range. Obviously, you're sitting at 18% equity in the portfolio right now. What would -- how -- where in that range would you be willing to go if equity, for the time being, remains at 20% of the portfolio? And where would it need to be for you to be willing to go to the 1.5?

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Arthur Howard Penn, PennantPark Investment Corporation - Founder, Chairman & CEO [14]

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Yes, it's really -- it's a good question. Really, for us, depends on the underlying assets. As you know, most of what we're doing is first-lien senior secured. The debt-to-EBITDA we're originating today on a senior basis is 4 to 4.5x. We're getting 8% to 9%. That kind of collateral, as we know, in a more dramatic world could go into middle market CLO and be leveraged 4:1. We're not suggesting that. But what we are suggesting that as we have more senior collateral, getting -- depending on what's financing that, whether it be SBIC, credit facility or otherwise, we would potentially take it towards the upper end of that range, assuming what we have by and large as first-lien senior secured loans.

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Operator [15]

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Next we'll question here from Mickey Schleien of Ladenburg Thalmann.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [16]

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I want to follow up on Robert's question about leverage. Just to clarify, is the target you announced a regulatory target or a total debt-to-equity target?

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Arthur Howard Penn, PennantPark Investment Corporation - Founder, Chairman & CEO [17]

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It's a regulatory, which, just to be clear, excludes SBIC financing.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [18]

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Okay, I understand. And can you walk us through the dynamics of winding down SBIC I and putting SBIC III into place? And what proportion of your deal flow in today's market is SBIC compliant?

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Arthur Howard Penn, PennantPark Investment Corporation - Founder, Chairman & CEO [19]

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Yes. So once you -- SBIC financing is a 10-year financing. Once you get kind of past the midpoint at 5 years, the SBIC says, "Hey, we really need to see a game plan for getting us fully paid out by the end of year 10."

So after 5 years, you don't really increase it that much. You really have to start winding it down. And we're getting towards the back end of SBIC II. And so we've kind of started winding it down, and we paid back a bit of the SBA debt last quarter. As part of that, and as part of the overall relationship, we're pleased we got a green light letter. Again, I just want to be clear, green light letter is, we think, very good and usually leads to getting a license, we are still in the licensing process. We think we'll get a license, but there are no guarantees. We like the financing. It's very attractive.

In terms of what fits, usually, there's a lot of our key rules around what fits and what doesn't. Usually, if a company has some form of manufacturing in the United States, it fits, as a general rule of thumb. And as you look at our portfolio today, about 25% or so of the portfolio kind of fits. So that actually fits nicely with the size of potential SBIC III. And it's a nice adjunct to our tools.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [20]

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And Art, does 25% of your deal flow fits? In other words, are you willing to invest in businesses that are oriented towards manufacturing, given where we are in the economic cycle?

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Arthur Howard Penn, PennantPark Investment Corporation - Founder, Chairman & CEO [21]

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That's a good question. And what we said is when we do manufacturing, it's usually light manufacturing. So we generally avoid heavy CapEx, big, cyclical CapEx, pulp and paper, steel, chemicals. It's usually lighter manufacturing, which, by the way, is a lot of what's going on in the economy. But it is about 25% -- fits in as we kind of look to the flow over the course of time, it's a reasonable amount.

In some cases, nonmanufacturing companies fit. There's lots of rules about number of employees and what your net income is. So there's lots of different rules about what fits. But as a general proposition, something that does some form of manufacturing in the United States fits.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [22]

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And one last question, Art. In the current environment, how long from a green light letter typically to a license. I know there's a lot of moving parts. But would that be a calendar year 2020 event in your mind?

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Arthur Howard Penn, PennantPark Investment Corporation - Founder, Chairman & CEO [23]

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Yes. I mean we think of it as a 6 month process. So since we got the license kind of, I think, in -- when did we get the license, Aviv?

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Aviv Efrat, PennantPark Investment Corporation - Treasurer & CFO [24]

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Just around October of this year. 6 months is a very safe assumption, but we never know. Obviously, we're in the process.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [25]

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And how would you capitalize SBIC III, Art?

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Arthur Howard Penn, PennantPark Investment Corporation - Founder, Chairman & CEO [26]

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Yes. We'll be with new -- it's on new deals, you need to provide $1 of equity. And over time, you get up to $2 of debt. So we would borrow to finance the equity portion of the SBIC.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [27]

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And the credit facilities allow for that, is that correct?

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Arthur Howard Penn, PennantPark Investment Corporation - Founder, Chairman & CEO [28]

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Well, they don't give you a lot of credit for it. They allow for it or you could do some unsecured bonds. So we did some unsecured bonds last quarter, and that could help finance it as well.

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Operator [29]

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Next we'll hear from Ryan Lynch of KBW.

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Ryan Patrick Lynch, Keefe, Bruyette, & Woods, Inc., Research Division - MD [30]

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First one, just wanted to talk about Ram a little bit from a higher level. Art, how do you balance thinking about exiting an investment like Ram that seems to be performing pretty well and making some pretty good progress, but is in a very out-of-favor industry. So clearly, I think, Ram is an investment on your balance sheet that I think investors would like to see you guys exit, particularly because of the equity component and the sector, but you're trying to sell that into a sector that is very out of favor today. So how do you weigh trying to get out of that investment that investors probably want to see you get out of, but also wanting not to give up a significant amount of value in a sector that's really out of favor today?

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Arthur Howard Penn, PennantPark Investment Corporation - Founder, Chairman & CEO [31]

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Yes. It's a great question, something we grapple with all the time. And I want to say all options are on the table, right? We know we're not the best long-term holder for this asset, particularly as the wells are performing extremely well, and there's some active strategics right around the geography. So we know we're not the best long term holder, and we'd rather not sell into weakness either. So that's the conundrum.

It is an important investment for us. We do want to convert it to cash over time. So we have to play out. We're -- we now have a very active website on Ram. Anyone can go to it. I encourage anyone to go it, which really shows the geography and the wells and give you a sense of the results versus the comparables and the peers and who the peers are. So we are open minded, and happy to take suggestions from people who -- how we can maximize the value of that asset. So it may just take some time. Ram's important, but I don't want to obsess on it because we have a lot of other really good equity investments that are growing in value based on strong performance that we hope to exit, those are in more in-favor industries than energy.

So I think with Ram, we're just going to play it out. We have a couple more wells potentially to drill, put up the good results, and then try to maximize value as best we can. In the long run, all options are going to be on the table.

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Ryan Patrick Lynch, Keefe, Bruyette, & Woods, Inc., Research Division - MD [32]

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Okay. Yes, that's helpful. I had a question regarding your leverage. So your target regulatory leverage is 1.1 to 1.5. I'm just wondering, obviously, the SBIC debentures do not count against that. That's about 20 points of additional leverage that you guys have on, if you include the SBIC to your total leverage. If you guys get another SBIC license, that can even become a larger component. So I'm just wondering, do you guys think about total leverage at all as you guys are operating? Or is your main focus just going to be on that regulatory leverage target?

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Arthur Howard Penn, PennantPark Investment Corporation - Founder, Chairman & CEO [33]

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Look, we obviously think about overall leverage as well, and we think about what's the appropriate leverage against the particular asset. So clearly, we're doing primarily first-lien senior secured loans today, which, as we said, there are ways to finance that to much more aggressive leverage than even 2:1. 2:1 is the BDC regulatory cap, regulatory limit. And in theory, if you had the SBICs, I guess, we could get to 2:1 leverage on an overall basis.

Again, that would be against, at that point in time, mostly a senior book. We're not there yet. It's going to take some time. Don't know that we're going to want to get even get there at that point in time, but it does give us a lot of dry powder, particularly against senior assets to generate earnings in a safe way.

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Ryan Patrick Lynch, Keefe, Bruyette, & Woods, Inc., Research Division - MD [34]

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Okay. And then last one, on your -- obviously, you guys are -- you have the green light hoping to get another SBIC license. Do you know where the all-in rates would be if you were to get an SBIC license today and draw down some debentures, do you know where those current all-in costs are today, roughly?

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Arthur Howard Penn, PennantPark Investment Corporation - Founder, Chairman & CEO [35]

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Yes. Those are like 3.5% to 4.5% as a general indicative zone.

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Operator [36]

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Next we'll hear from Rick Shane of JPMorgan.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [37]

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First on Ram. From a governance perspective, I believe you guys now have 2 of the 3 Board seats. I'm curious, from an ownership perspective, could you just tell us a little bit more about the capital structure. What percentage of the capital that your equity represents? What percentage of ownership do you have?

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Arthur Howard Penn, PennantPark Investment Corporation - Founder, Chairman & CEO [38]

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Yes. So we own all the equity. That said, we have a program for management to participate in upside. And participate in a potential exit. So for us, management is key here. We think we've got a great management team led by Larry Lee and some really talented operators. And we think highly of them, and we've wanted to -- we have arrangements in place where they will participate in upside. So -- but we do own 100% of the equity at this point.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [39]

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Got it. Okay, great. And then and this is obviously related in a tangential way, historically, BDC didn't have higher concentrations of equity investments and traded at significant discounts to NAV. You're obviously highly aware of that. You're addressing that in terms of your outlook. I am curious, given the discount and that opportunity, how important is repurchasing shares as you move forward? You haven't been particularly active on the buyback the last several quarters. But given the discount and given that investment opportunity, how do you weigh it against deploying capital?

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Arthur Howard Penn, PennantPark Investment Corporation - Founder, Chairman & CEO [40]

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It's a good question, Rick. And we -- it's something we and the Board talk about regularly, which is capital allocation. We've now done 2 buybacks. The last one ended a couple of quarters ago. Management's been buying the stock regularly through -- even past then, and will continue to do so. It's something we evaluate. It's on the table all the time.

Look, we want to -- as you said, we want to exit some of these equity investments, and that will be a very good and nice thing to happen when it happens. And that will -- and then we'll evaluate all the different options in front of us, whether it be new investments, buybacks, et cetera.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [41]

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Got it. And look, I understand the signaling indication of management buying shares, and that's important and the market certainly looks to that, but given the discount to NAV, the company buying shares is different, not only because of the signaling in that, but more importantly, because of the in-depth potential investment return associated with that.

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Arthur Howard Penn, PennantPark Investment Corporation - Founder, Chairman & CEO [42]

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Agree and that's why we've done 2 buybacks in the last few years. And why it's always something

(technical difficulty)

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [43]

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I lost you. Can you hear me?

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Arthur Howard Penn, PennantPark Investment Corporation - Founder, Chairman & CEO [44]

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Yes. I said, that's -- it makes a lot of sense, which is why we've already done 2 buybacks, and it's something that we continue to discuss regularly.

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Operator [45]

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Next question from Casey Alexander of Compass Point Research.

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Casey Jay Alexander, Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst [46]

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I just have one question. The reclassification of the Ram loan into equity and the additional equity that you put into Ram, was that done at the 9/30 valuation or the 12/31 valuation?

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Arthur Howard Penn, PennantPark Investment Corporation - Founder, Chairman & CEO [47]

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So if you look at it, Casey, as of 9/30, the fair market value of the bundle of Ram was $124 million. We put $10 million of new money in bringing that to $134 million. And as of 12/31 that value of $134 million, which was at 9/30, is worth about $138 million. So there was a markup in the valuation of the overall bundle because the wells had excellent performance. And as we discussed, we converted some of that debt-to-equity during that time period.

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Casey Jay Alexander, Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst [48]

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But that -- was it -- was the conversion of the debt to equity also at the 9/30 valuation?

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Arthur Howard Penn, PennantPark Investment Corporation - Founder, Chairman & CEO [49]

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It was done at the 9/30 valuation. It was debt that we converted at that valuation and where it was marked as of 9/30.

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Operator [50]

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Next we'll hear from David Miyazaki of Confluence Investment Management.

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David Brian Miyazaki, Confluence Investment Management LLC - SVP and Portfolio Manager [51]

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Art, you talked a little bit about the overall shift that you're moving more towards senior secured with what you have on the balance sheet. And I'm just wondering, from a broad perspective, when you talk about doing only 4% of your deal flow, what kind of trends are you seeing across the entire underwriting opportunity with regard to revenue and EBITDA trends for your target market? Is it stable? Is it getting a little better?

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Arthur Howard Penn, PennantPark Investment Corporation - Founder, Chairman & CEO [52]

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Yes. No. The economy, as a general proposition, is in good shape. I mean we're seeing solid mid-single-digit revenue and EBITDA growth as a general proposition across the economy. There are certain areas of weakness. Order related has been a little weak. Manufacturing that has been related to tariffs is a little weak. We haven't really been -- our portfolio has seen much from 737 MAX that's been muted at least with our portfolio. So -- okay, so far, so good. We don't yet know the outcome of this virus issue, it's early. But as a general proposition, the economy is good.

And because we have a wide funnel, we can stay in our lane and our lane has been a good one for -- in that kind of first-lien mid-4s to low 4s debt-to-EBITDA. So we think it's really good risk-adjusted return in the market where people are saying, gee, it's -- the cycle is long in the tooth, and multiples are high, and what do we do? 8% to 9% on first-lien, 4, 4.5x debt-to-EBITDA to us seems like a really solid place to put money and then you put appropriate leverage against that asset and you can get a very solid ROE, which is kind of the game plan.

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David Brian Miyazaki, Confluence Investment Management LLC - SVP and Portfolio Manager [53]

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Okay. That's very helpful. Along those lines, as you shift toward being more senior and more secured, I get the sense that part of that is your opinion of where the conditions are right now and where we are in the credit cycle, but it also seems to be that it's where your advance rate is on what you underwrite and how you can change the leverage of your balance sheet. So is it fair to say that it is probably equal parts of both that are driving the decision to underwrite more senior secured?

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Arthur Howard Penn, PennantPark Investment Corporation - Founder, Chairman & CEO [54]

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It's a really good question. I think if you think about -- we at PNNT, we like to say, has a strategy of being across the capital structure. When first lien -- and when that -- when we think that's best, we'll be at the top. In certain times, second lien and mezz is really attractive. We'll go there when that's really attractive. The biggest driver has been the elevated leverage levels on second lien and mezz and being obviously subordinated. So in PNNT, we do, do second lien and mezz periodically, the bar is really high now because we want to see reasonable leverage and it's 6.5x leverage or whatever where the market in general seems to be.

In general, we're not -- we don't really like going that deep in capital structure at those elevated leverage levels. Occasionally, we see a company that just really clears the bar that we love that we'll do on that basis. But as a general proposition, once we get much above 5x in any security, we start to get a little nose bleed as a general proposition. Sometimes we'll go a little bit above when we see very strong growth or quick deleveraging.

But generally, once you get above 5x, we start to become a little allergic. So that's the primary thing. Now fortuitously, roughly at the same time, the BDC rules changed and BDCs can now leverage their assets more than 1:1. So that puts us in a position -- a lot of BDCs in a position to say, okay, you can move higher in the capital structure to be safer and put more leverage in. And when it all comes out in the wash, you have a very attractive ROE. So that was -- this has all happened roughly at the same time. And for now, we think this is appropriate for PNNT. There may be a time, a year or 2 down the road, when we say, gee, that second-lien deal is at 12% or 13% at 4.5 or 5x debt-to-EBITDA is really attractive. We're going to do more of those.

So that's kind of how we think about it.

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David Brian Miyazaki, Confluence Investment Management LLC - SVP and Portfolio Manager [55]

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That's very helpful. And I know that's the way that you thought about it coming out of the credit cycle.

So then if you could contrast that with the SBIC loans that you're making, it's great that you're making progress on your license, congratulations on that front. However, I think that it's probably fair to say that you're not going to be doing senior secured floating rate loans with the SBIC underwriting. So can you talk a little bit about how you're working in that dynamic where the ability to go up and down the capital structure is more limited in the SBIC? And how you're going to underwrite against the back half of the high leverage that you're talking about on the subordinated loans?

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Arthur Howard Penn, PennantPark Investment Corporation - Founder, Chairman & CEO [56]

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Yes. It is true that the SBIC does not discriminate between first lien and second lien and mezz. So that's true. So it is a very good vehicle to the extent you see good second lien and mezz deals. That's totally accurate. That said, first and foremost, we have to be good investors. Now if we can borrow at 3% or 4% from the SBIC or anyone else and put senior debt into it at a 2:1 leverage, that makes sense just as well.

So most importantly for us is we have to make good loans, we have to make good investments, and then we have to match with the financing. The SBIC gives us the optionality to do second lien and mezz in that bucket and give us the same advance rate but it's not -- it's not necessarily what we're going to be doing.

It will depend on the facts and circumstances at the time. Now SBIC financing is a 10-year facility. You ramp it over 5 years. So who knows what's going to happen over the course assume -- hoping we get a license here in the next few months. You got 5 years of investment ramp from then. We'll see. Most importantly, we have to be good investors and put good risk-adjusted returns on the balance sheet.

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David Brian Miyazaki, Confluence Investment Management LLC - SVP and Portfolio Manager [57]

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Would you -- I know that this is -- 5 years is a long time to think about, but would you say in the current environment that it's probably likely that you won't ramp this license, assuming you get it, as quickly as the previous ones because the subordinated loans are carrying so much more leverage?

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Arthur Howard Penn, PennantPark Investment Corporation - Founder, Chairman & CEO [58]

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No. I mean I think the reality is, once we get the license, if it's a solid deal, first lien or second lien or otherwise, and it fits the SBIC, we're going to put it in there. It's attractive financing, and it's long-term money. And if we end up filling up with first lien, we end up filling up with first lien, it's still ROE accretive to our shareholders.

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Operator [59]

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And it appears there are no further questions at this time. I'll turn the call back over to Art for any additional or closing comments.

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Arthur Howard Penn, PennantPark Investment Corporation - Founder, Chairman & CEO [60]

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Thanks, everybody. I just want to appreciate -- thank everybody for being on the call today. We appreciate it, and we will speak to you in early May, which is -- will be our next quarterly call. Thank you very much.

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Operator [61]

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That does conclude today's conference. Thank you all for your participation. You may now disconnect.