Q3 2023 Portman Ridge Finance Corp Earnings Call
Participants
Ted Goldthorpe; CEO & Director; Portman Ridge Finance Corporati
Patrick Schafer; Chief Investment Officer; Portman Ridge Finance Corporati
Jason Roos; CFO, Secretary & Treasurer; Portman Ridge Finance Corporati
Paul Johnson; Analyst; Keefe, Bruyette & Woods North America
Christopher Nolan; Analyst; Ladenburg Thalmann & Co. Inc.
Steve Martin; Analyst; Slater Capital Management LLC
James Powers
Presentation
Operator
Welcome to Portman Ridge Finance Corporation's third-quarter 2023 earnings conference call. Our earnings press release was distributed yesterday, November 8, after market close. A copy of the release along with an earnings presentation is available on the company's website at www.portmanridge.com in the Investor Relations section and should be reviewed in conjunction with the company's Form 10-Q filed yesterday with the SEC. As a reminder, this conference call is being recorded for replay purposes.
Please note that today's conference call may contain forward-looking statements, which are not guarantees of future performance or results and involve a number of risks and uncertainties. Actual results may differ materially from those in the forward-looking statements as a result of a number of factors, including those described in the company's filings with the SEC. Portman Ridge Finance Corporation assumes no obligation to update any such forward-looking statements unless required by law.
Speaking on today's call will be Ted Goldthorpe, Chief Executive Officer, President, and Director of Portman Ridge Finance Corporation; Jason Roos, Chief Financial Officer; and Patrick Schafer, Chief Investment Officer. With that, I would now like to turn the call over to Ted Goldthorpe, Chief Executive Officer of Portman Ridge.
Ted Goldthorpe
Good afternoon, and thanks, everyone, for joining our third-quarter 2023 earnings call. I'm joined today by our Chief Financial Officer, Jason Roos and our Chief Investment Officer, Patrick Schafer. I'll provide brief highlights on the company's performance and activities for the quarter. Patrick will provide commentary on our investment portfolio and our markets, and Jason will discuss our operating results and financial condition in greater detail.
Yesterday, Portman Ridge announced its third-quarter 2023 results, and we are pleased with the solid earnings power of the portfolio despite operating in a somewhat challenging market conditions.
Our core investment income was up year over year, increasing by $700,000 as we continue to see the impact that rising rates have on our debt portfolio. Additionally, our net asset value per share increased from $22.54 per share to $22.65 per share. We continued our accretive repurchase program, purchasing over 60,000 shares at an average cost of approximately $1.2 million during the third quarter.
Due to the continued strong performance this past quarter, the Board of Directors was able to approve a dividend of $0.69 per share, a level that represents a 12.2% annualized return on net asset value. On a year-to-date basis, total dividends to be distributed to shareholders amounted to $2.75 per share, representing 7.4% increase as compared to the dividend distributed in 2022.
As we have discussed in previous quarters, M&A deal flow continues to be at depressed levels year to date, but we remain optimistic on the overall outlook.
On the sponsor finance front, we are starting to see the early innings of deal activity pick up through a combination of valuation expectations being more reasonable, and acceptance that interest rates will remain elevated for an extended period of time. Significant dry powder on the sidelines and private equity LPs encouraging the return of capital from their fund managers. Sponsors are looking to put less total leverage on their companies, which lowers our detachment point. We'll remain cautious on the ultimate execution rate of these M&A processes. The recipe for increased activity levels appear to be in place.
Both the sponsor and non-sponsor activity. We continue to find the investment opportunities to be very attractive, given the combination of higher benchmark rates, lower leverage on new deals, higher equity contributions from sponsors, and better documentation. Given the continued macro uncertainty around inflation, consumer sentiment and ongoing conflict in Ukraine and Israel, we continue to be very selective on new investment opportunities and have overall found investments in existing portfolio companies more attractive than those new borrowers.
Refocusing on Portman Ridge, we continue to believe our stock remains undervalued. Thus, as previously mentioned, we continue to repurchasing shares under our renewed stock purchase program. In the third quarter, we repurchased an incremental 60,559 shares for an aggregate cost of approximately $1.2 million. This follows the trends set throughout 2022 and the first half of 2023 and expect this trend to continue through the final quarter of the year as we are able to do so.
Following my remarks, Patrick will also walk through the potential upside cases for our net asset value. But in addition to the market trading discount of our stock price, we continue to believe that there is significant embedded value to NAV, even when overlaying conservative defaults and recovery rates.
With that, I will turn over the call to Patrick Schafer, our Chief Investment Officer, for a review of our investment activity.
Patrick Schafer
Thanks, Ted. Turning now to slide 5 of our presentation and the sensitivity of our earnings to interest rates. As of December -- as of September 30, 2023, approximately 90.5% of our debt securities portfolio were either floating rate with the spread to an interest rate index such as LIBOR, SOFR, or prime rate, with 98% of these being linked to SOFR.
As you can see from the chart, the underlying benchmark rate of our assets during the quarter lagged to prevailing market rates and still remain below the SOFR rates as of October 30, 2023. But the gap is narrower as it has been since the onset of the Fed rate hike cycle.
For illustrative purposes, if our assets were to reset to either a three-month LIBOR or SOFR rate, respectively, we would expect to generate an incremental $75,000 of quarterly income. Having said that, slide 7 shows a slight decline in NII per share on a run-rate basis, driven largely by slightly lower asset balance as of September 30, 2023, and our simple methodology of not assuming any changes to the portfolio.
Skipping down to slide 11, originations for the third quarter were slightly higher than the prior quarter, but still remain below repayment levels, resulting in net repayments and sales of approximately $11.6 million. Some of this was driven by late repayments during the quarter, and two transactions expect to close in Q3 that are pushed into early Q4.
Our new investments made during the quarter are expected to yield a spread to SOFR of 917 basis points on par value, and the investments were purchased at a cost of approximately [99 spot to 7% of par]. Our investment securities portfolio at the end of the third quarter remained highly diversified with investment spread across 26 different industries and 101 different entities, all while maintaining an average power balance per entity of approximately $3.3 million.
Turning to slide 12. We had one new portfolio company go on non-accrual as of -- as compared to June 30, 2023, and one come off non-accrual due to the completion of a restructuring. In aggregate, securities on non-accrual status remained relatively low at eight investments in the third quarter of 2023 as compared to seven investments on non-accrual status as of June 30, 2023. These eight investments on non-accrual status at the end of the third quarter of 2023 represent 1.6% and 3.6% of the company's investment portfolio at fair value and amortized cost, respectively.
On slide 13, excluding our non-accrual investments, we have an aggregate debt securities fair value of $427 million, which represents a blended price of 93.4% of par value and 88% comprised of first lien loans at par value. Assuming a power recovery, our September 30, 2023 fair values reflect a potential of $28 million of incremental net value, 13.1% increase or $2.94 per share, excluding any recovery on the non-accrual investments.
For illustrative purposes, if you would assume a 10% default rate and a 70% recovery rate on this debt portfolio, there would still be an incremental $1.60 per share of net value or 7.1% increase over time as the portfolio matures and is repaid. Again, this is excluding any recovery on the non-accrual investments. This indicative default rate is above anything the market is expecting or has experienced historically.
Finally, turning to slide 14, if you aggregate the three portfolios acquired over the last three years, we have purchased a combined $435 million of investments, have realized over 78% of these positions at a combined realized and unrealized mark of 103% of fair value at the time of closing the respective mergers. This is an indication of our ability to effectively realize the value of legacy portfolios acquired while rotating into BC Partners' sourced assets. More importantly, we're able to achieve those results despite the global pandemic in 2020 and most of 2021 and a weak market for almost all asset classes in 2022 and the first half of 2023.
I'll now turn the call over to Jason to further discuss our financial results for the period.
Jason Roos
Thanks, Patrick. As both Ted and Patrick previously mentioned, despite operating under a challenging economic environment, our results for the third quarter of 2023 reflect strong financial performance.
Our total investment income decreased slightly by $400,000 to $18.6 million in the third quarter of 2023, in comparison to $19 million in the third quarter of 2022. This reported total investment income represents a $1 million decrease from the $19.6 million of reported total investment income in the second quarter of 2023. The quarter-over-quarter decrease was largely due to reduced fee income and dividend income compared to the second quarter of 2023.
Excluding the impact of purchase price accounting, our core investment income for the third quarter of 2023 was $18.3 million, an increase of $700,000 as compared to $17.6 million for the third quarter of 2022, a decrease of $900,000 as compared to $19.2 million for the second quarter of 2023. Our net investment income for the third quarter of 2023 was $7.2 million or $0.75 per share, a decrease of $1.2 million as compared to $8.4 million or $0.87 per share for the third quarter of 2022, and a decrease of 700,000 as compared to $7.9 million or $0.83 per share for the second quarter of 2023. The quarter-over-quarter decrease was largely due to the aforementioned decreases seen at fee and dividend income.
As of September 30, 2023 and June 30, 2023, the weighted average contractual interest rate on our interest earning debt securities was approximately 12.3% and 12.1%, respectively. We continue to believe the portfolio remains well positioned to generate incremental revenue in future quarters due to the current rate environment.
Total expenses decreased quarter over quarter from $11.7 million for the second quarter of 2023 to $11.4 million in the third quarter of 2023. This decrease was due to reduced expenses, and predominantly, all expense categories, a result of our efforts to reduce overall expenses. Our net asset value for the third quarter of 2023 was $214.8 million or $22.65 per share as compared to $215 million or $22.54 per share in the second quarter of 2023.
Turning to the liability side of the balance sheet. As of September 30, 2023, we had a total of $321.5 million par value of borrowings outstanding at a current weighted average interest rate of 6.9%. This balance was comprised of $74 million in borrowings under our revolving credit facility, $108 million of 4.78% (sic - see press release, "4.875%") Notes due 2026 and $139.5 million in Secured Notes due 2029. The quarter-over-quarter decrease of $12.2 million was primarily driven by an $8.2 million repayment on the Secured Notes due 2029 and a net $4 million repayment on the revolving credit facility.
As of the end of the quarter, we had $41 million of available borrowing capacity under the senior secured revolving credit facility and no remaining borrowing capacity under the 2018-2 Revolving Credit Facility as the reinvestment period ended shortly after our draw on November 20, 2022. As of September 30, 2023, our debt to equity ratio was 1.5 times on a gross basis and 1.34 times on a net basis. From a regulatory perspective, our asset coverage ratio at quarter end was 166%.
Finally, and as announced, November 8, 2023, a quarterly distribution of $0.69 per share was approved by the Board and declared payable on November 30, 2023, to stockholders of record at the close of business on November 20, 2023. This is a $0.02 per share distribution increase as compared to the fourth quarter of 2022. Including the distribution subsequent to the announcement of full year 2022 earnings results, total stockholder distributions for 2023 amounts to $2.75 per share.
With that, I will turn the call back over to Ted.
Ted Goldthorpe
Thank you, Jason. Ahead of questions, I'd like to re-emphasize that we believe we are well positioned to take advantage of the current market environment as we have shown throughout the year so far. Through our prudent investment strategy, we believe we'll be able to deliver strong returns to our shareholders in the final quarter of the year and into 2024.
Thank you once again to all of our shareholders for ongoing support. This concludes our prepared remarks, and I will turn the call over for any questions.
Question and Answer Session
Operator
(Operator Instructions) Paul Johnson, KBW.
Paul Johnson
Yeah. Good evening, guys. Thanks for taking my question.
The first is just kind of lead -- maybe kind of giving your overall thoughts on leverage -- post gross leverage in the (inaudible) and where it is today going? Into next year, there's focus on reducing that, or rotating out of certain investments? They are just basically just redeploying and coming in terms of the name of the (inaudible)
Ted Goldthorpe
Yeah. It's a great question. I think the answer is, again, we have a stated target leverage range, which we're close to the high end of. And so again, I don't feel like our leverage -- of anything our leverage will go down. I don't feel like our leverage will go up going into next year.
I mean, there's a lot of uncertainty going to next year. We're earning very strong ROEs, and we don't need leverage to earn our dividends nor our earnings. So if you recall, we took up leverage for a temporary period of time, which is now coming down because we had a use-it-or-lose-it facility that was very accretive for shareholders. But yeah, we expect leverage to come down or at least stay within the range that we've outlined to people.
Paul Johnson
Yeah, that's helpful. And is that going to -- I guess, you impede your ability to continue buying back shares. How do you see that kind of -- (inaudible) your thoughts around share repurchases?
Ted Goldthorpe
I mean, I think -- listen, we've done it for a bunch of years in a row, like we're very committed to buying back stock. And again, given where ROEs are and given where new investment rates are, it's also very accretive for us to invest. But given where our stock trades and given where our yield is at market, we just think it makes a lot of sense for us to buy back stock.
Paul Johnson
Okay. Thanks for that.
And then my other question is just on interest income. If I'm calculating it right, approximately about 16% or so of total interest income was PIK income this quarter. I just want to make sure if I'm looking at that correctly. And then also, how does that compare, I guess, historically to the portfolio?
Jason Roos
Yeah. I would say we did have more PIK income this quarter relative to prior quarters. That's a function of some of our -- we look at interest income and PIK income as one in the same as a conglomerate source of income.
But you're right. This quarter, we had a larger amount of our investment income being made up of PIK income, which is a function of some of the assets that were previously cash-paying, are now picking due to some of the optionality that they have in the agreements themselves.
Patrick Schafer
Yeah. There was also one specific name that moved from cash to PIK this quarter -- in Q3, but then was exited in where we sit today on the phone in Q4. So all else equal, we expect that to go down a little bit next quarter just because of the exit of one of the assets that had a little bit of PIK for one particular quarter.
Paul Johnson
Yeah. That's very helpful. That's all for me. Thanks.
Operator
Christopher Nolan, Ladenburg Thalmann.
Christopher Nolan
Hi, guys. For your portfolio companies, are you seeing sponsors step up and put in more equity, or not really?
Ted Goldthorpe
Well, I go first, and then Patrick can respond. I think we've seen a -- this is just my own opinion. Like I think you're seeing a bifurcation in the market between size of sponsor. Meaning, I think we're seeing pretty constructive behavior on behalf of middle-market sponsors, and we're seeing more economic decision-making on behalf of larger sponsors.
And again, that more affects the larger players in the BC space and the syndicated markets. But yeah, we're in constant dialogue with our sponsor counterparts. So I think like they've been very, very constructive so far.
Patrick Schafer
Yeah. I don't have much to add, Ted. Ted hit the nail there.
The only thing -- in some instances, sponsors are looking at some of amend and extend for a multi-year period. The thing that ourselves was just -- lenders in the market are focused on as interest coverage at this point as opposed to leverage.
And so there's oftentimes where there needs to be a little bit of incremental equity coming into the structure to bring you down to a coverage perspective, if that makes sense. So those are obviously all kind of one-off conversations. But as Ted said, using those discussions, the bifurcation is really on the size of sponsor and what they're comfortable doing.
Christopher Nolan
And I guess the follow-up question would be, what EBITDA multiples are you seeing given the change in rates? I mean, obviously (technical difficulty)
Ted Goldthorpe
Yeah. So I think there's a push-pull. But every is on the same page, which is sponsors are back solving for their interest coverage ratios, basically, to Patrick's point. But we're not being asked to max leverage our companies.
So we've seen leverage come down anywhere from one to two turns pretty consistently, and that just ties back into interest coverage ratios. There's recent large private equity deal that was done with no debt. And the sponsor is just of the view that they're going be able to finance it later cheaper, which I don't know. I'm not sure if I would make that bet.
But yeah, we're definitely have been asked for lower leverage levels. So it's not intention of like we're being asked for max leverage when we don't want to do it.
Christopher Nolan
Yeah. That's all for me. Thank you.
Operator
(Operator Instructions) Steven Martin, Slater.
Steve Martin
Hey, guys.
Patrick Schafer
Hey, Steve.
Steve Martin
Couple of questions. You said that on the non-accruals that one went on and one went off, but the total went from seven to eight. Am I missing something?
Patrick Schafer
No. Technically, one -- the new non-accrual has just two different securities as a revolver and a term loan, and they're pair with each other. So we have both them on non-accrual. It's one borrower, but two different security. So that table is security account and not borrower account.
Steve Martin
All right. Would you care to elaborate on what that one security was? I know what it is, but what the story is behind it?
Patrick Schafer
The security that came back or the security that went on?
Steve Martin
The one that came back we're less concerned with than one went on.
Patrick Schafer
(inaudible) the legal entity name is HDC. Post way, there's a term loan and revolver. HDC/HW Intermediate Holdings, LLC is the legal name. It's a company that we've had marked below par for a period of time.
They have one business that has been struggling and one side of the house that has been growing pretty well. But the side of the house is growing a little bit smaller than the side of the house that is declining.
We've been working with the other lenders on a potential restructuring pathway for the company and in light of what we hope is a relatively short pathway to a restructuring. We felt the [prudent] to put it on non-accrual. In the quarter, it was the hope that it's a relatively short-lived candidate within there.
Steve Martin
Is it a sponsor-backed deal?
Patrick Schafer
It was a sponsor-backed deal. The sponsor is not very involved at this stage.
Steve Martin
Got it. And was it a BC source deal, or was it one you inherited?
Patrick Schafer
It was not . It was inherited from the Garrison portfolio.
Steve Martin
Okay. Can you talk about on quarter-to-date events vis-à-vis repayments and sales, et cetera, and/or share repurchase?
Jason Roos
I can give you some high-level numbers. On the purchases, we had about 18 -- a little over $18 million of purchases, offset by approximately $30 million of sales and paydowns. If you're doing the role, then you have about $1.7 million of unrealized gain, offset by a realized loss of about [$1.6 million]. And then with accretion and some others, you get the delta in the investment portfolio.
Steve Martin
Okay.
Ted Goldthorpe
You're asking about quarter to date, right?
Steve Martin
Yeah.
Ted Goldthorpe
I mean, (multiple speakers) activity through --
Jason Roos
(inaudible)
Ted Goldthorpe
Quarter end?
Steve Martin
Yeah.
Ted Goldthorpe
I mean, I would say there's nothing -- I mean, Patrick can speak up to, but I think nothing outside of normal course. Like I don't think there's anything particularly different about the market today than we experienced in the third quarter.
Patrick Schafer
So we had one or two handful of portfolio companies to repay. We've invested in one or two new portfolio companies. Again, as Ted said, I don't think there's anything, particularly, outside of the ordinary course that's gone on so far quarter to date.
Steve Martin
Okay. And share repurchase quarter to date?
Jason Roos
I'd have to get back to you on that number, Steve. But as you know, the program is an ongoing program. And when that turns out, we'll set it up as we normally do.
Steve Martin
Okay. Two more. Can you comment on the CLO market? And given you're over earning the dividend and your view on dividends going into the end of the year?
Patrick Schafer
Yeah. I'll take the CLO market and Ted could about dividends. I'd say, in general, the CLO market has been a little bit healthier, particularly back half of Q3 and maybe a touch into the first bit of Q4 here. That has led overall to a little bit better bids and pricing in the syndicated loan market in general as some that CLO formation has driven the need to buy some assets.
So I'd say, generally speaking, the CLO market is like a little bit healthier this quarter or where we sit today relative to perhaps sometimes in the last couple of quarters. Having said that, the CLOs that we are invested in, generally speaking, are out of their investment periods.
So by and large, the CLO managers there are making decisions around what they might expect in terms of repayments on their various portfolios, the relative OC tests, and things like that around distributions, et cetera. So our particular portfolio was a little bit separate from the CLO market broadly. But I'd say, generally speaking, the market has had some improvement over the last, call it, six to eight weeks or so.
Steve Martin
So given your specific portfolio, your CLO portfolio was a source of funds rather than a use of funds.
Patrick Schafer
Well, it's always a source of funds. It's just that it's always a different amount of source of funds. But it's not a use of funds.
Steve Martin
Okay. Yes. I meant (multiple speakers)
Patrick Schafer
I think you're asking about total return versus income return.
Steve Martin
Yes.
Patrick Schafer
Again, we're getting positive income off our portfolio. I mean, well, it's only a couple of weeks in the quarter. I don't think we can. I don't think we can -- I don't think we really know in terms of valuation. And it's small -- and again, it's 2% of our portfolio.
Steve Martin
Okay. And Ted, your comment about year-end dividends.
Ted Goldthorpe
In terms of a special dividend, is that what you're asking about?
Steve Martin
Yeah.
Ted Goldthorpe
(multiple speakers)
Steve Martin
Something along those lines.
Ted Goldthorpe
I mean, listen, we obviously benefited greatly from some of this M&A, which created some advantage for our shareholders around spillover income. I would say we feel really good about our dividends, even if the Fed cuts rates, which we don't obviously speculate on because that's not our thing.
The dividend pretty protected down to a pretty big reduction in short-term rates. So again, we assess every quarter. Obviously, we're comfortably over earning our dividend in a period of time where we're getting (technical difficulty), and we feel good about where our dividend. I don't -- again, like we will assess it at year end and see if there's -- see where we are in terms of spillover income.
Steve Martin
All right. Thanks a lot.
Operator
James Powers.
James Powers
Good afternoon. I was wondering if that is -- I don't know whether I'm pronouncing it correctly, Repertoire Partners. But anyway, they made a filing in the last quarter and had quite a bit of stock. I was wondering if you would talk to them about their intentions and what they -- are they going to be sellers of this block? And how did they get that bigger block?
Ted Goldthorpe
Yeah. I don't think we comment on individual shareholders and individual shareholders intentions. So I'm not sure we want to really make a comment on that.
James Powers
Okay. All right. Thank you.
Operator
And we have no further questions at this time. I'll hand the call back over to Ted Goldthorpe for any closing remarks.
Ted Goldthorpe
Great. Well, thank you all for attending our call. As per always, please reach out to us with any questions, which we're happy to discuss. And hope everybody has a great Thanksgiving, and we look forward to speaking to you again on our next call. Thank you.
Operator
Ladies and gentlemen, thank you all for joining today's meeting. That will conclude our call. You may now disconnect.
