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Edited Transcript of PNNT earnings conference call or presentation 8-Feb-19 3:00pm GMT

Q1 2019 PennantPark Investment Corp Earnings Call

NEW YORK Feb 11, 2019 (Thomson StreetEvents) -- Edited Transcript of PennantPark Investment Corp earnings conference call or presentation Friday, February 8, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Arthur H. Penn

PennantPark Investment Corporation - Founder, Chairman and 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

* James Young

West Family Investments, Inc. - Investment Analyst

* Kyle M. Joseph

Jefferies LLC, Research Division - Equity Analyst

* Melissa Marie Wedel

JP Morgan Chase & Co, Research Division - Analyst

* Mickey Max Schleien

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

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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 2019 Earnings Call. Today's conference 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 H. Penn, PennantPark Investment Corporation - Founder, Chairman and 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 2019 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. Please note that this call is the 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 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 www.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 H. Penn, PennantPark Investment Corporation - Founder, Chairman and 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. For the quarter ended December 31, 2018, we invested $194 million in primarily First Lien Secured Debt at an average yield of 9.5%. Net investment income was $0.18 per share. We are pleased that our current run rate net investment income covers our dividends. Other income such as prepayment penalties was $0.01 per share for the quarter, although it averaged between $0.02 and $0.03 per share per quarter and can vary.

We purchased $7.5 million of our common stock as part of the $30 million stock repurchase program, which was authorized by our board. Today, we have purchased $23 million.

The stock buyback program is accretive to both NAV and income per share. We're looking forward to continuing this program over the coming quarter. As of September 30, we had taxable spillover of $0.30 per share, which provides further dividend cushion. With a generally stable underlying portfolio and substantial spillover, we believe that PNNT stock should be able to provide investors with an attractive dividend stream along with potential upside as our equity investments mature.

As you all know, the Small Business Credit Availability Act was signed into law in late March 2018. Our shareholders have just approved the reduction of the asset coverage test from 200% to 150%. In connection with this reduction, we have reduced our base fee from 1.5% to 1% on gross assets that exceed 200% of PNNT's NAV at the beginning of each quarter.

Over time, we are targeting a 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 several quarters to reach the new target.

Since our $250 million notes mature in less than a year, we announced that on March 4, 2019, we will prepay the notes at 100% of the principal amount, plus accrued and unpaid interest as well as make whole premium. To enhance our liquidity, we are advance -- we are in advance discussions on an additional $250 million credit facility to complement our existing $445 million credit facility and our $150 million of SBIC II financing. We have paid off the remaining $30 million loan from the SBA on our SBIC I. In addition, our SBIC III application is still pending approval with the SBA.

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, Houston and London, and we have done business with about 180 sponsors. Due to the wide funnel of deal flow that we receive, relative to the size of our vehicles, we can be extremely selective with our investments. In this environment, we have not only been extremely selective, but we have generally moved up the capital structure to more secure investments.

A reminder about our long-term track record. PNNT was in business in 2007, then as now, focused on financing middle-market financial sponsors. Our performance through the global financial crisis and recession was solid. Prior to the global financial crisis in September 2008, we initiated investments which ultimately aggregated $480 million. Average EBITDA on the underlying portfolio companies was down about 7% to 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 track record.

We've had only 12 companies going nonaccrual out of 214 investments since inception over 11 years ago. Further, we are proud that even when we have had those nonaccruals, we've been able to preserve capital for our shareholders. Based on values as of December 31, today, we have recovered about 76% of capital invested on the 12 companies that have been on nonaccrual since inception of the firm. We currently have no investments on nonaccrual.

Since inception, PNNT has made 214 investments, totaling about $5.3 billion at an average yield of 12.3%. This compares to an annualized loss ratio, including both realized and unrealized losses, of about 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 with no signs of a recession. We remain focused on long-term value and making investments that will perform well over an extended period of time and can withstand different business cycles. We are a first call for middle-market financial sponsors, management teams and intermediaries who want consistent, credible, capital. As an independent provider free of conflicts or affiliation, we are a trusted financing partner for our clients.

In general, our overall portfolio is performing well. We have a cash interest coverage ratio of 2.8x and a debt-to-EBITDA ratio of 5.0x at cost on our cash flow loans. With regard to our energy-related portfolio, we are pleased to be continuing to make progress monetizing those investments at reasonable values. We started 2018 with 4 investments in energy, with a stated goal of monetization over time. We held these investments over the last several years, during the energy downturn, with a goal of maximizing value over the long run. We believe we are starting to see the fruits of that strategy. Last quarter, U.S. Well Services announced the merger with Matlin Partners Acquisition Corp. That merger closed on November 9, 2019. As a result of the transaction, our loan was refinanced. We hold equity in the public company, with a current value of $7 million. As a result of the transaction, the company has significant liquidity to execute its business plan. With regard to ETX, in the fourth quarter '18, the company's shareholders provided additional financing to support ETX' Eagle Ford opportunity and pivot from its historical focus, the results of which have been disappointing. The new funding was in the form of senior preferred equity. Ram is focusing on its Austin Chalk position in East Texas. The company has commenced a limited drilling program. The early results have been strong on an absolute basis, and relative to other operators in the area, we are encouraged by their performance. Ram plans to solely focus on the development of the Austin Chalk asset and monetize all other assets over time. In terms of new investments, we've known these particular companies for a while, have studied the industries or have a strong relationship with the sponsor. Let's walk through some of the highlights.

We purchased $30.5 million of the first lien term loan and $700,000 of the common equity of American Insulated Glass. The company is a fabricator and value-added distributor of glass products. AB Capital is the sponsor. Confie Seguros is an insurance broker and managing general agent primarily offering personal nonstandard auto insurance products. We purchased $14.2 million of the second lien term loan, ABRY is the sponsor.

We purchased $26.4 million of the first lien term loan of ProVation Medical. The company is a provider of clinical productivity software for healthcare professionals. Clearlake Capital is the sponsor.

Turning to the outlook. We believe that 2019 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 you 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, 2018, net investment income totaled $0.18 per share. We had about $0.01 per share of other income. Looking at some of the expense categories, management fees totaled $7.1 million, general and administrative expenses totaled $1.1 million, and interest expense totaled $6.3 million. During the quarter ended December 31, unrealized loss from investment was $20 million or $0.29 per share. Unrealized gain on debt instruments was $6 million or $0.09 per share. We had about $9 million or $0.12 per share of realized gains. The accretive effect of our share buyback was $0.02 per share. Our income -- net investment income rather covered our dividend. Consequently, NAV per share went from $9.11 per share to $9.05 per share.

As a reminder, our entire portfolio, credit facility and senior notes are mark-to-market by our board of directors each quarter using the exit price provided by independent valuation firms, securities and exchanges or independent broker-dealer quotations 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 10.9%. On December 31, our portfolio consisted of 56 companies across 26 different industries. Debt portfolio was invested in 48% first lien senior secured debt, 34% in second lien secured debt, 4% in subordinated debt and 14% in preferred and common equity. 90% of the portfolio has a floating rate. Now let me turn the call back to Art.

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and 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 to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And first we'll hear from Casey Alexander with Compass Point Research & Trading.

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Casey Jay Alexander, Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst [2]

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I have two questions. One that's a little more specific and then one that is a little more market general. First of all, on the specific side, could you take us through the actual puts and takes on the investment gains and losses in the quarter? There's -- looks like there's some tides going in both directions and I think it would be helpful both on individual names that had significant moves as well as how much or to what degree there were marks taken that were directly related to the volatility of the credit markets and commodity markets in the fourth quarter.

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [3]

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Thanks, Casey. Was that your first question?

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Casey Jay Alexander, Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst [4]

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That's the first question, yes.

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [5]

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Okay. So look, about 15% -- overall, about 15% of the portfolio is broker-dealer quoted. Clearly, the broker-dealer quotes were real soft as December 30 -- December 31, wasn't a lot of trading as far as we can tell. I don't have a quick quantification of how much that was, but it's about 15% of the portfolio.

In terms of substantial unrealized winners and unrealized losers, at least on a mark-to-market basis, I'll just give you some of the names. The winners included Ram Energy, AKW and Blackhawk Industrial. And some of the markdowns included Superior Digital and ETX. I mean, those were kind of the handful of 5 biggest movers up and down over the course of the quarter.

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Casey Jay Alexander, Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst [6]

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Okay, great, that's helpful. Secondly, and this is more -- well, it's certainly general and specific. Obviously, everybody knows that there was a lot of volatility in credit markets during the fourth quarter. Love to hear how it impacted the -- your originations and how you feel it impacts the originations that you're doing? How it may have impacted or changed your pipeline? And your thoughts around that, because it clearly was volatile market, but you guys had a very successful origination quarter.

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [7]

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Yes. So this -- I'll give you, hopefully, not much of a long-winded answer, but we think it's important for you and others to understand the -- maybe the differences between the various types of markets. There's the broadly syndicated loan market, which takes its cue from the volatility and ETFs and CLOs. And that was where you saw some mark-to-market move -- real movement in December over a 2-, 3-week time period. That's where deals get financed, where companies generally have over $50 million of EBITDA, to where they generally come to get financed. Investors basically make their investment decisions based on a 1-hour bank meeting. There's generally no covenants. These are covenant-light deals. Generally, there's more leverage, they're higher levered than the deals we do. And we generally shy away from that end of the market.

We focus, today, mostly on the self-originated middle-market, which generally doesn't really move. It's a much more placid environment. And if a 2- or 3-week time period of volatility in the broadly syndicated market did not and does not have an impact on that private, self-originated, classic, middle market where deals just get done and they got done as indicated and that just motors on.

If we were to have a situation where the broadly syndicated loan market were to be extremely volatile over, let's say, 3 to 6 months or longer, all of a sudden, all the new deals that would normally have gone to that market, they start to work their way towards people like us. Syndicators of those deals start to test the market and premarket those deals. People like us spend a lot of time on due diligence. We don't make decisions after 1-hour meetings. We spend a lot of time on diligence. We negotiate covenants. And in all cases, we reduce leverage from where it would ultimately or where it would have happened in the broadly syndicated market. And all of a sudden, if that were to happen, people like us could be financing larger companies than we are and still doing the type of diligence and getting the covenants that we like to get. So there's no real immediate impact over a 2-, 3-week time period. Over a 3- to 6-month time period, you start to see an impact. And that would also ultimately impact the middle-market, as the markets kind of mesh together. And as all of a sudden people like us finance companies with $40 million, $50 million, $60 million of EBITDA in the same manner we'd be financing companies today that do $20 million to $30 million of EBITDA.

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Operator [8]

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And moving on, from Ladenburg Thalmann, we have Mickey Schleien.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [9]

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Wanted to talk about a little bit about portfolio weigh. It declined about 30 basis points in a quarter when LIBOR went up but your portfolio allocation was fairly steady. So I'd like to understand what were the key new investments or exits that affected portfolio weigh and sort of where are you looking to see weigh on a go-forward basis.

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [10]

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So weigh is just -- I think I understand the question -- just for everybody, weighted average yield, correct?

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [11]

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Yes.

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [12]

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Yes, look, we're -- as we continue to pivot to a more senior, more secure portfolio that can be leveraged more than 1:1. And we've been -- we've said publicly for 8 years as the law was been discussed that first lien asset you could leverage prudently more than 1:1, nonfirst lien, you probably wouldn't want to leverage more than 1:1 even if you could. So we are pivoting. We're continuing to pivot to higher in the capital structure, lower-risk, lower-reward investments that we could leverage more than 1:1. So we through -- we, today, for the first time, came out with our target of overall 1.1 to 1.5x. And we believe that with the enhanced leverage and even with the lower yield, we can generate a very stable, steady -- and we think growing ROE for our shareholders.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [13]

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Art, can you tell us what the yield was on your new investment this quarter?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [14]

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Yes, we talked about it in the call. Let's get it for you, 9.5%.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [15]

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Okay. So that's below, certainly, where you've been historically. If I understand you correctly, are you lending then to larger companies at -- or are you looking for lower levels of leverage? Can you just give us a little insight into what you're looking at in terms of lower-risk assets?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [16]

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Yes. So one way to reduce risk is to lend to slightly larger companies. The other way is what we've been doing a lot of, which is moving higher in the capital structure. So moving higher in the capital stack to more first lien senior secured areas of the capital stack.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [17]

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Okay. And following up on Casey's question about unrealized appreciation, just conceptually, can you tell us whether some of that has been recuperated so far this quarter, given the rebound in the loan markets?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [18]

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Yes, I mean, certainly, the 15% of the bulk that's broker-dealer quoted likely to see some ups in that. Again, don't have a real number for you, but that should be better. In terms of the names that I enumerated earlier, yes, I mean, those each quarter get valued independently and there -- because most of them are equity securities there, and most of them have idiosyncratic individual reasons that are either good or not so good for their movement, hard to give a blanket statement. We know U.S. Well Equity, for instance, which is publicly traded, is up a couple million dollars since quarter-end. So that is kind of a more daily mark-to-market kind of thing and the rest of the names. I didn't enumerate on our private yield liquid and every quarter we go through the independent valuation process, and whatever is going on in those underlying companies will drive the mark.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [19]

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Art, looking at Ram Energy, you marked up the equity. Was that related to the strategy that you discussed in your prepared remarks or was that simply the waterfall effect and movements of cash flows?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [20]

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Yes. So it's a good question. We mentioned the auction -- Austin Chalk formation in East Texas. They've been drilling some very successful wells there and the early results are promising. And we're very encouraged by those results. More work and development are needed, but it -- they've found a very nice -- they've 14,000 acres in the Austin Chalk area. They've got nice JV partners who are in and around that area, including Magnolia, GeoSouthern and EOG. So they're surrounded by some nice, strategic players who are partners with them in some of the drilling, and the initial wells have had good results.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [21]

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And with that success, Art, is there any insight as to your potential construct to monetize some of these investment, let's say, this calendar year?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [22]

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Yes, it's a good question on timing. We think of these things as long term. And if this -- if they continue to have nice wells, we may decide too because those have very good returns on investment. You would continue to maximize the opportunity. You'd continued to operate for a year, for 2 years, something like that to really prove out the geography. So probably 12 months is early. If things are going well, if things are going well, you want to maximize that opportunity. So we'll see where we go, but the early results are very promising and we're hopeful that they'll continue to get very nice results there and we'll an opportunity to get our money back. So that's the goal.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [23]

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Okay. Just a few more sort of housekeeping questions, if I may. I see you retained the equity in SBIC I, even though there is no debentures in that subsidiary. Is your intent to use that equity to eventually fund SBIC III? Is that the point?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [24]

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So that's a good question, and you have a sharp eye, but that would be the ideal. We're not allowed to undo SBIC I until the SBA gives us permission to do so. So even though we've paid off all the debt, we do not yet have SBA permission to unravel that SBIC. Once we do, we will, as we look hopefully to get SBIC III going, we will use that equity over at SBIC III.

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

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Okay. So for the meanwhile, it's sort of trapped, I guess, in that subsidiary?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [26]

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Yes.

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

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Couple more. Your other income, as you noted, I think it was up about $0.01 penny per share, usually runs higher than that, but you had an active quarter for -- in terms of portfolio velocity. Was there something -- was there a reversal or something unusual in the quarter that caused the decline in other income?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [28]

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No. I mean, a lot that's driven by prepayment penalties and refinancing fees when something gets taken out. There was a -- we just didn't get that kind of income this quarter, whether it was -- we had refinancing, but we didn't get the prepayment. But there weren't prepayment penalties associated with it. But it was much lower than normal. Typically it's been $0.02 to $0.03 per share. Sometime it's $0.05, sometimes $0.01, but typically it's been $0.02 to $0.03 per share, which was a little light this quarter.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [29]

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So you're still comfortable with a sort of $0.02 to $0.03 run rate?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [30]

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Yes, yes. Some quarters may be higher, some quarters may be lower. But I think that's a nice mean or median to be thinking about.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [31]

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Okay. And lastly, and I appreciate your time, last quarter you estimated the make-whole premium for the redemption of the notes to be $2.5 million to $3 million. Is that still the number you're working with? And are you still expecting to report that above the line or could it be below the line?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [32]

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Yes. So there's -- it's a great question and thank you. The exact make-whole on the bonds will be something like $2.1 million. And that will be -- we report when we have these onetime events like this, we report. Obviously, we have to report a GAAP NII and then we also report a core NII. And the core NII usually excludes onetime fees, in this case of the make-whole of $2.1 million. So we will obviously disclose GAAP NII, and we'll disclose a core NII. One additional point, just to be clear, I want to be totally transparent with people. Because we're negotiating another $250 million credit facility, which will probably happen this quarter, which will have some upfront fees. Those upfront fees are likely to be around $2.9 million. So $2.1 million for the make-whole on the bonds, $2.9 million for the new credit facility. Again, strategically, overall, we're pivoting both our underlying investments to higher in the capital structure as we go to more than 1:1 leverage, and we're also pivoting our financing. And so these are all onetime costs that we're incurring of the $2.1 million for the make-whole, potentially the $2.9 million for the credit facility that are onetime in nature as we pivot both the left side and the right side of the balance sheet.

So next quarter, again, we will, of course, disclose GAAP NII, and we will disclose core NII, which will exclude those 2 onetime events.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [33]

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And just to confirm, Art, on that point, because you used fair-value accounting on your debt liabilities, you're required to take that fee for the origination of the credit facility upfront, right? You can't amortize it?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [34]

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Yes, so that's -- we can go into a dissertation of mark-to-market liabilities. We like it due to the matching. We also like it in that once we pay that upfront fee, everyone knows very clearly what the cost of financing is, everyone can model it. And we also like the matching, which helps in times of turbulence. So we as a -- just as a matter of course, mark-to-market liabilities, and we take the upfront fees at inception of these loans.

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Operator [35]

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(Operator Instructions) And next from Jefferies, we have Kyle Joseph.

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Kyle M. Joseph, Jefferies LLC, Research Division - Equity Analyst [36]

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Just want to stick with the balance sheet here and kind of get your thoughts on how the balance sheet is going to get -- look from a longer-term perspective? Obviously, you're churning out the fixed-rate debt. But as we progress and look out a few years, can you give us an idea for how your liabilities look in terms of fixed-rate debt, SBA debt versus credit facilities?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [37]

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It's a great question, Kyle, and we can give you a sense of how we think because we don't exactly know. And a lot of it will take its cue from what's going on, on the left-hand side of the balance sheet, like, what's our underlying asset composition, how much first lien is it, how much nonfirst lien is it? And we've already stated that first lien can be prudently leveraged more than 1:1. If it's not first lien, we wouldn't do it anyway. So a lot of it will take its cue on the left-hand side of the balance sheet and where we see the best risk-adjusted returns. There may be a time in the next couple of years where we say, gee, second lien is the place to be because it's so great in these -- for these attributes. We can get really great returns and low risk and we may pivot the left-hand side of the balance sheet in one direction, which will then have ramifications to the right-hand side. So we gave a fairly wide range of 1.1 to 1.5x debt-to-equity to kind of give a wide range based on a number of different scenarios with what's going on, on the left-hand side of the balance sheet.

Now for the right-hand side of the balance sheet, we have the SunTrust facility, we have SBIC II, and we're negotiating a third credit facility of $250 million, as we speak. That will be short term. We are hopeful that one day we get SBIC III. There's no assurance. It may never -- it may not happen, but we're hopeful. We certainly have had an excellent track record on SBIC I and SBIC II, and the SBA should be very happy with the performance that we've generated for the government. But there's no assurance we get an SBIC III.

Other options over the long run could include bonds. It could include other credit facilities. But I think, kind of, in the short term this new credit facility we're negotiating and the potential SBIC III should be fine for now.

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Kyle M. Joseph, Jefferies LLC, Research Division - Equity Analyst [38]

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Got it, that's helpful. And then I know you guys have no nonaccruals, you talked about some portfolio companies getting marked up, some getting marked down. But could you give us a sense in terms of either revenue growth trends or EBITDA growth trends you guys are seeing and whether there's been any sort over change over last few months?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [39]

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The U.S. economy still appears to be strong. And as a general proposition, clearly, there's certain pockets of weakness. Labor costs have gone up and have hurt some companies that have labor. Logistics costs have gone up in some cases. So there are some pockets of weakness, but the U.S. economy is generally strong. I think we're seeing probably mid-single-digit EBITDA growth as a broad and general statement in the portfolio.

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Operator [40]

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And moving on, from JPMorgan, we have Rick Shane.

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Melissa Marie Wedel, JP Morgan Chase & Co, Research Division - Analyst [41]

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It's Melissa on for Rick today. I'm wondering if there was any impact of timing of exits or originations during the quarter. Put another way, were exits here sort of front-end loaded or originations back-end loaded?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [42]

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It was a generally -- a good question, Melissa, and thanks for calling in, it was generally flat throughout the quarter. We've had some good originations. So I mean, I think a run rate of $0.18, $0.19 is a fine way to model it before you add any other income or anything to it. So kind of the effect gives you what you're looking for, hopefully, that does.

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Melissa Marie Wedel, JP Morgan Chase & Co, Research Division - Analyst [43]

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Sure. Yes, it does. And then, I guess, I'm wondering if the 9.5% average yield on new originations in the December quarter is good run rate for sort of the new sort of more senior mix that you're targeting?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [44]

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It probably is. I guess the weighted average yield on the portfolio overall is upper 10s right now. I think we said over time, over last year, too, as we've been pivoting more towards senior secure that weighted average yield is going to come down and right now it's upper 10s tens. That may come down to 10.5% to 10% over time, and as we move up capital structure and as we take advantage of the higher leverage.

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Melissa Marie Wedel, JP Morgan Chase & Co, Research Division - Analyst [45]

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Okay, got it. And if I may, but the U.S. loan services equity stake, is that something that you are sort of locked into for any planned period? Or is that something you can sort of pull the trigger on it any point, if you decided?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [46]

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Yes, it's a good question. We have a lockup probably about half is -- when the deal happened, half was restricted for 6 months, the other half for 12 months. We're probably 3 months into it, if that gives you a sense. I don't have the exact dates, but we have 3 more months -- 3 months probably on the first piece.

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Operator [47]

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Next question is from Jim Young with West Family Investments.

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James Young, West Family Investments, Inc. - Investment Analyst [48]

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Couple of quick ones. First, could you talk about your share repurchase program? It looks like you bought 1 million share in the fourth quarter at $7.5 million. So did you buy all the stock in early October? Or could you share with us a little of your thoughts there? And it doesn't appear that you bought any more back in late December.

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [49]

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Yes, it's a good question. We did the buybacks in our window, which is, call it, a month after earnings. So unfortunately, we did not take advantage of the volatility at the end, but that's kind of how we've done it over the course of time.

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James Young, West Family Investments, Inc. - Investment Analyst [50]

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So in December, were you in a blackout period then?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [51]

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Yes.

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James Young, West Family Investments, Inc. - Investment Analyst [52]

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Okay. And then the second question is, could you just share with us your greatest thoughts about the credit cycle, how you experienced several cycles throughout your career? You alluded a little bit to the underlying effects of the economy, but can you just share a little bit more of how you're thinking about this cycle and how it's unfolding?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [53]

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Yes, it's a great question and something we think about all the time and we were very public 3 or 4 years ago saying it's getting long in the tooth, so -- which is why we've been generally moving up capital structure and how we underwrite credit. I mean, we underwrite these days assuming there's going to be a recession next year. And we've been underwriting that for the last 3 years that assuming there's a recession next year. So if you were to look at credit memos, you'll see some nice downside cases, EBITDA down 10%, down 20%, down 30%, trying to handicap how these companies are going to perform. We look at what happened in the last recession. We look at customer concentrations, supplier concentration, the levers management can pull should there be weakness, whether it'd be working capital or CapEx.

So we're very aware and cognizant that there might be a recession down the corner. Again, we don't see any signs of it today, but we underwrite it as if there will be. And turn it back to clock of time to 2007, then we were doing mostly subordinated mezzanine debt. And we did our original IPO in April of '07. By June of '07, we're starting to see some weakness in the underlying portfolio companies. And we made a conscious decision then to continue to invest, but only invest in companies and industries that we thought were recession-resistant, only in situations where we thought the leverage was very reasonable, where we can get good covenants and good yields. So we raised the bar quite a bit starting September of '07, proactively. And again, this was in mostly second lien and subordinated debt. And then -- it's interesting that vintage of deals that we did between, let's say, June of '07 and September of '08, performed very well because we had proactively raised the bar, even though they were done before September '08 when the financial world blew up, and even though they were subordinated debt, in most cases we had proactively underwritten in a more cautious, conservative fashion, so -- which meant that the EBITDA was down only about 7% on a blended basis of the portfolio when the average high-yield company in America EBITDA was down 40%. So fast forward to today, we're not seeing any weakness currently in the economy. And we'd be happy to share that with all of you next quarter or the following quarter or whenever that is. But we're not seeing. That said, we're underwriting assuming there's a recession next year, and the vast majority of what we're doing senior in the capital structure. So we think we're as well positioned as we could be at this point in time in the credit cycle, and we still see some attractive risk-adjusted returns. And as you could tell, right now we're okay giving up a little yield if we feel very good about the credit and about the ability of the credit to perform well over time. So that's how we're thinking about it.

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Operator [54]

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And ladies and gentlemen, that does conclude our question-and-answer session. I'd like to turn the floor back to Art Penn for any additional or closing remarks.

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [55]

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Thanks, everybody, for being on the call today. Our next quarterly call will be in early May. And we appreciate all your interest in our company. Thank you so much.

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Operator [56]

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And ladies and gentlemen, that does conclude our conference for today. Thank you, again, for joining us. You may now disconnect.