PennantPark Investment Corporation (PNNT) Q1 2016 Earnings Report, Transcript and Summary

Good morning, and welcome to the PennantPark Investment Corporation's First Fiscal Quarter 2016 Earnings Conference Call. Today's conference is being recorded. At this time, all participants have been placed in a listen-only mode. The call will be open for a question-and-answer session following the speakers' remarks. [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.

Thank you, and good morning, everyone. I'd like to welcome you to PennantPark Investment Corporation's first fiscal quarter 2016 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.

Thank you, Art. I'd like to remind everyone that today's call is being recorded. 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 like also 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 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.

Thank you, Aviv. I'm going to provide an update on the business starting with financial highlights, a discussion of our energy portfolio, followed by discussion of the overall market, the overall portfolio, investment activity, the financials and then open it up for Q&A. For the quarter ended December 31, 2015, we invested $130 million at an average yield of 11.9%. Expected IRR's generally range from 13% to 18%. Core net investment income excluding one-time taxes was $0.25 per share. Given the continued headwinds and volatility, for the last several quarters we've been focused on our energy portfolio, which includes those companies in our schedule of investments listed as oil and gas and energy and utilities. We intend to continue to work with our portfolio companies to maximize our long-term recovery and to provide these companies with runway to weather this tumultuous period. As of December 31, 2015, our energy portfolio had a cost and fair market value of $226 million and $125 million, respectively. This represents 16% of the cost and 10% of the market value of the overall portfolio, respectively. Valuations on our energy investments fell by $42 million from the quarter ended September 30, 2015, representing $0.58 per average share. As we have mentioned previously, independent third-party valuation firms value all of our non-actively quoted investments. Many have asked us what happens to NAV and NII if our energy investments are completely written off. While we do not think our energy investments are worthless and we believe they are fairly valued, as of December 31, NAV would have been $7.28 per share if all the energy investments were written off. If all the energy investments were put on nonaccrual, NII would decrease by less than $0.05 per share per quarter. As shareholders and managers, we are disappointed with the performance of our energy portfolio and intend to work diligently to recover our capital on our energy investments and to grow our NII back to historical levels. We do not believe that the short run option of selling attractive assets at fire sale prices is prudent. In this challenging environment for oil prices, we intend on taking an approach that will maximize value in the long run. We do not see the turmoil in the energy space easing in the near term. For the quarter ended December 31, management waived the management and incentive fees equal to the percentage of the cost to value of our energy portfolio, 16%. This waiver amounted to $1.6 million representing $0. 02 per share. After discussions between management and our board, management has agreed to extend that waiver arrangement and waived 16% of its management and incentive fees for the next four quarters through December 31, 2016. We believe that this waiver demonstrates a strong commitment to our shareholders and our focus on our energy portfolio. In addition to this fee waiver, two other positive factors are helping to offset the energy issues. First, subsequent to quarter end, Z Wireless or AKA Diversified were sold and we realized the capital gain of $3 million or $0.05 per share and prepayment fees of $6 million or $0.08 per share of other income. Other income is a category that we have in our income statement to represent prepayment fees or waiver and amendment fees that are not part of ongoing interest income. Other income has averaged $0.04 per share per quarter over the last few years. Second, in December SBIC legislation was passed which raised the amount of available borrowings to $350 million which will enable us to continue to use this program and create value for our shareholders. We're finding attractive investments for our SBICs and believe that our SBIC licenses will enable us to avail ourselves of that capital. Since quarter end, we have started borrowing on our SBIC II facility. We look forward to fully utilizing the upsides to $150 million of borrowing capacity in SBIC II and utilizing an additional $50 million of borrowing capacity in a potential SBIC III. With regard to our dividend, our Board regularly evaluates the earning power of the company relative to the dividend. Our substantial spillover cushion which was $0.53 per share as of last September 30, the fee waiver through December 31, 2016, substantial other income from payment fees and SBIC usage give us the flexibility to continue to evaluate our portfolio and the market without rushing to make a decision on any change to the dividend at this point. With regard to the market, the economic signals are mixed. With regard to the more liquid capital markets and in particular the leverage loan and high yield markets, during the quarter ended December 31, those markets softened as high yield and leverage loan funds experienced outflows due to expectations of Fed tightening, turmoil in the energy market and weakening Chinese economy. This has impacted the tone of the middle market and has generally resulted in a better opportunity to invest in attractive risk reward. As debt investors and lenders, a flat economy is fine as long as we have underwritten capital structures prudently. A healthy current coupon with deleveraging from free cash flow over time is a favorable outcome for us. We remain focused on long-term value and making investments that will perform well over several years and can withstand different business cycles. Our focus continues to be on companies and structures that are more defensive at low leverage, strong covenants and high returns. As credit investors, one of our primary goals is preservation of capital. If we preserve capital, usually the upside takes care of itself. As a business, one of our primary goals is building long-term trust. Our focus is on building long-term trust with our portfolio of companies, management teams, financial sponsors, intermediaries, our credit providers and of course, our shareholders. We are a first call for middle-market financial sponsors, management teams and intermediaries who want consistent credible capital. As an independent provider of free of conflicts or affiliations, we've become a trusted financing partner for our clients. Since inception, PennantPark entities have financed companies backed by over 150 different financial sponsors. We are excited to be approaching this improving investing market with substantial financial and human capital across our platform. From the standpoint of financial capital, we have SBIC-enhanced liquidity in PNNT. Our sister company PennantPark Floating Rate Capital has recently nearly doubled its financial resources due to the merger with MCG Capital. With regard to human capital, we have made investments in senior and mid-level investment professionals across different geographies. With senior investment professionals in the Midwest, West Coast, Texas and London, our geographic footprint has broadened. All of these senior professionals have worked with us in the past and come onboard sharing our culture. As a result, we should be able to drive significantly enhanced deal flow as PennantPark entities get more looks and can be even more relevant to our borrower clients. We continue to make significant progress on our stock buyback program. Last quarter we purchased about 1.2 million shares for about $8.4 million bringing our total purchases so for to 3.3 million shares for approximately $26 million. Our portfolio is constructed to withstand market and economic volatility. In general, our non-energy portfolio is performing well. We have cash interest coverage ratio of 2.4 times and a debt-to-EBITDA ratio of 4.8 times at cost on our cash flow loans. Additionally, over the last 12 months, the percentage of the portfolio that is in first lien secured assets has increased from 28% to 38%, reducing the risk of the underlying portfolio. We are pleased that we have diversified funding sources with several features that reduce overall risk to the company. First, we have $321 million of long-term unsecured bonds and have only utilized about 25% of our long-term $545 million credit facility. Second, as we discussed, we intend to utilize the expanding capacity under the new SBIC legislation. SBIC financing creates financial cushion and now we have exemptive relief from the SEC to exclude SBIC debt from our BDC asset coverage test and SBIC accounting is cost accounting, not mark-to-market accounting. Third, to better align the measurement of asset and liability values for both GAAP and the BDC asset coverage test, we market both our assets and our liabilities to market. As a result of all these features, we have provided substantial safety to our shareholders, bondholders and lenders in the event of market volatility. We have had some attractive realizations. In addition to Z Wireless, last quarter Foundation Building Materials was sold resulting in our $80 million second lien loan getting taken out of 102 and our $2 million equity co-invest getting realized at over $8 million. The blended IRR on this $82 million investment was about 20%. Last quarter we placed New Gulf Resources on non-accrual. In December 2015, the company filed for Chapter 11 bankruptcy protection. We are a member of the ad hoc group of lenders. There is a $75 million, 11% DIP loan of which we have committed $13.1 million. The restructuring support agreement, the RSA is subject to change due to the bankruptcy court approval process. The RSA contemplates a $50 million rights offering of first lien convertible notes of which our share would be $8.4 million. Under the RSA, the DIP loan will also roll into the first lien convertible notes. Similar to other energy restructurings that have occurred recently, under the proposed plan, the secured creditors would own the majority of the company going forward and the largest holders including PennantPark would have an active role in the ownership of the company. Under the RSA, our equity ownership would be approximately 13%. Due to the bankruptcy process, unfortunately we cannot comment further on New Gulf. Across PennantPark entities, we have had only 11 companies on non-accrual of nearly 400 investments since inception nine years ago despite the recession during that timeframe. Further, we are proud that even though we have had those 11 non-accruals, we have been able to preserve capital for our shareholders. Through hard work and patience and judicious additional investments in those companies, we have been able to find ways to add value. We constantly monitor our deals and re-underwrite them in the face of new information. Situations of our best long-term value for shareholders is created by taking control of the companies and providing capital and expertise we do. Based on values as of December 31, today, we have recovered nearly 80% of the capital invested in those 11 companies that have been on non-accrual since inception of the firm. Historically, our realized gains had nearly offset any realized losses. In terms of new investments, we had another quarter investing in attractive risk adjusted returns, and virtually all of these investments, we have known these particular companies for a while and studied the industries or have a strong relationship with the sponsor. Let’s walk through some of the highlights. We lent $18 million of the senior secured term loan to Broder Bros. Broder is a distributor of promotional power products. Littlejohn & Co. is the sponsor. Corfin Industries is a provider of electronic components with finishing services. We lent $23 million of first lien and purchased 1 million of common equity. SML Capital is the sponsor. We purchased $12 million in the mezzanine loan through Goldsun [ph] Trading Limited, which designs, manufactures and distributes adapted bathroom and kitchen products for the elderly and disabled individuals. ECI Partners is the sponsor. Triad Manufacturing is an employee-owned manufacturer and distributor of custom retail display fixtures. We lent $37 million of our first lien term loan. Turning to the outlook. We believe that the remainder of 2016 will continue to be active due to growth and M&A driven financings. Due to our strong sourcing and networking client relationships, we are seeing active deal flow. Let me now turn the call over to Aviv, our CFO take us through the financial results.

Thank you, Art. For the quarter ended December 31, 2015, recurring net investment income totaled $0.21 per share. In addition, we had $0.02 per share of other income, and $0.02 per share from the fee waiver. As a result, core net investment income for the quarter was $0.25 per share. Additionally, there were $0.02 per share of one-time taxes resulting in GAAP net investment income of $0.23 per share. Looking at some of the expense categories, net management fees totaled $8.7 million, general and administrative expenses totaled $1.8 million and interest expense totaled $6.7 million. During the quarter ended December 31, unrealized losses from investment was $40 million or $0.55 per share. Unrealized gains from our various debt instruments was $7.7 million or $0.11 per share. Realized loss from investments was $25 million or $0.35 per share. The accretive effect of our share buyback was $0.04 per share, and excess dividend over net income was $3 million or $0.05 per share. Consequently, NAV per share went down $0.80 per share from $9.82 to $9.02 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 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 12.2%. On December 31, our portfolio consisted of 62 companies across 30 different industries. The portfolio was invested in 38% senior secured debt, up from 28% a year ago, 38% in second lien secured debt, 14% in subordinated debt and 10% in preferred and common equity. 75% of the portfolio has a floating rate including 69% with the floor and the average LIBOR floor is 1.2%. Now, let me turn the call back to Art.

Thanks, Aviv. To conclude, we want to reiterate our mission. Our goal is a steady, stable and consistent dividend stream, 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, while 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’d like to open up the call to questions.

[Operator Instructions] And we will hear first from Rick Shane with JPMorgan.

Good morning and thank you for taking my questions. I am actually going to be pretty pointed here, which is when I look back at the history of PennantPark and what we saw during the crisis, and again, I don’t think things are that bad, but there are certainly some challenges. You personally were pretty active buyer of the stock. And looking at Bloomberg and again, I maybe misreading this, but I haven’t seen you in there buying stock, I see Aviv in there, I see some of the Directors along the way. Giving the buybacks that are in place, is it something that you’re considering personally supporting at this point as well?

Sure, and as you can imagine, Rick, that’s a great question also. Any investment that the advisor management company makes in the business is - has a big impact on these, so for instance, the fee waiver over the next 12 months and over the last quarter is - does have a personal impact. The $11 million that the management company invested to build the platform with the PFLT, MCG acquisition was a big commitment. And I think about a year ago, I did buy a bunch of stocks. So you will see continued investment by myself as well as the rest of the firm. You should know, when we reiterate this all the time, everybody in the firm takes 30% of their after-tax bonus and buys the stock. So that’s an ongoing program that does not show up in public information, but that continues as an ongoing program.

Got it. And again, I asked the question, but I do also want to knowledge that in things like the fee waiver and the way you’re handling this, I really do think that you guys are doing the right things, managing through a challenging time, but I wanted to put that question out there as well. So thank you.

And next we will hear from Arren Cyganovich with DA Davidson.

Thank you. The fee waiver clearly helps over the next 12 months in terms of your getting more sustainable earnings growth or earnings rate. What can you do - what actions can you take over the following period, increase the recurring level of earnings beyond there? Thanks.

We are looking at two question. If we come the next year and the energy still in the doldrums, of course, we will consider extending the waiver at that point in time. It will be based on the facts and circumstances of what’s going on in the market, the portfolio and energy. So really we just want to put our head down for the next 12 months, optimize as best we can, what’s going on with our energy portfolio as well as the rest of the portfolio, work on building up the SBIC financing portion of our business. We will continue to hopefully have a continued events, like Foundation Building Materials like Z Wireless, which will supplement us both on a realized gain and other income basis. And when you look at it, other income has averaged $0.04 a share last few years per quarter. Next quarter by definition we are going to have at least $0.08 a share of other income. So these positive hits are very helpful. We have got substantial spillover. We are going to work really hard over the next year, [indiscernible] year from now, see what’s going on and make a decision at that point in time.

Thanks. And then just - secondly, the - with the SBIC expanding capacity, are you looking to actually increase total leverage with that or just essentially recycle your existing investments?

It’s a great question. We are very focused on keeping overall leverage reasonable. We like having a cap structure that is heavily weighted in unsecured bonds and has a relatively lightly growing revolver, just have extra liquidity. So it’s we think even more as a recycling more so than an increase in leverage.

Okay, thank you.

Thank you.

And now we will hear from Ryan Lynch with KBW.

Hey, good morning Art. Just want to say I do appreciate the fee waiver you guys are provided providing on your energy investment first off. Second, actually relating to energy, RAM Energy that’s one of your largest investment it’s still accruing income right now. Can you just give us a update on that business model, maybe the current hedges you have in place and how that company performs may be longer term with oil you know sub-$50 per barrel.

I mean, I’ll just on the - great question Ryan. Just on the overall, where is oil need to be, overall we tell people look once oil gets back above 60 to 70, we feel like we have a good shot of getting all of our money back and that applies to that name as well. [indiscernible] we are and management team is an excellent management team is looking in every expense to make sure we keep the business operating but also being absolutely prudent with cash flow, our goal and we think they’re going to do what is to be cash flow neutral. Again, we’re right at the top of the capital structure, have very good collateral and underlying the loan. There are some hedges in place, they do roll off over the course of 2016. And we're hunkering down and playing for the long run there.

And then just a question on the buyback, looks like you guys have about 9 million outstanding remaining on your original $35 million buyback that can probably be easily used in this current quarter. So given where your current stock price is today, what your thoughts on reissuing or increasing your current buyback program?

So, at this time, we’re going to continue with the existing plan. Obviously will be you know obviously management and the board and our whole investment team are buyers of the stock. And then, we’ll pick our head up a quarter from now when this program expires and discuss things with the board, discuss our liquidity, see where the stock is and make a decision at that point in time.

And we’ll now move to a question from Doug Mewhirter with SunTrust.

Good morning, I just have two questions. First just a clarification on the fee waiver. So it's is it 16% of your management fees sort of on a flat basis going forward or is it consistently readjusted with where your energy portfolio at cost basis if for some reason you had an exit one of your energy portfolio and went from 16% to 12%, you would then ratchet it down the waiver to 12% of management fees.

The way it works is we want to make it very easy for people to model. We're going to calculate the normal base and incentive fee each quarter based on the whole portfolio at that point in time and then cut 16% off of it. So take 84% of whatever the overall base and incentive fee would be.

The second question, you talked about performance of your portfolio, your non-energy portfolio. If you could just add a little bit more detail in terms of, if you would add up all of your companies, your non-energy companies into one portfolio and measure say the year-over-year revenue or EBITDA growth, would there be - is there still sort of a small amount of growth there or is it flattened out or how is it doing on that basis?

I don't have the exact number on my fingertips but anecdotally we think would be a slow growth kind of scenario 2%, 3%, 4% growth on average.

And we have another question in queue. [Operator Instructions] And we will go ahead and move to a question from Douglas Harter with Credit Suisse.

Just again on the buyback, can you just say how you’re thinking about buyback versus making any new investments and how you kind of weigh those alternatives?

It’s something we think about all the time, it's a balancing act. We’re happy with the buyback thus far, we think we've gotten attractive pricing on that. At the same time to the extent we can find SBIC eligible investments and most of the deals that we mentioned today that we did last quarter and the deals that we’re doing this quarter so far fit the SBICs, we think that's very accretive as well. So that's really that's the balancing act we’re trying to work on keeping leverage manageable and reasonable, at the same time using SBIC eligible financing.

And our next question comes from Jonathan Bock with Wells Fargo Securities.

Art, I appreciate the commentary you had regarding the credit facility, in particular kind of provisions that you have in place to help protect investors in light of volatility and owning second lien and sub-debt assets as a result of near-term marks that’s important. First the question is, do you actually have a minimum net worth provision in your credit agreement for the credit facility and if so what is that?

We do have a net worth it’s a very low amount, off the top of my head say it’s $150 million to $200 million of net worth.

$100 million to $200 million net worth, okay. And then walk us through they likely have a calculation of how the one-to-one or kind of how you look at leveraging, most credit facilities have a one-to-one trigger. So, could you walk us through what you're bank cares about in terms of how these assets are marked, forget the SEC for a moment, just what you bank is kind of looking at in terms of fair value movement to the portfolio. What do they include, what do they exclude what are the limitations that’s just helpful for investors to gauze downside?

It’s the same, it's a mark to market methodology. The nice thing about the credit facility is, for their one-to-one test, it excludes the SBIC financing. So, again lots of cushion there.

So they exclude the SBIC financing assets on one-to-one even though that your bank has no recourse to those - you see what I'm saying --.

Yeah I know, look we've got a very good relationship with our banks, we’ve lived together for a long time including through the great recession. So yes, even if again you roll all the energy portfolio off to zero and you took more losses than that you don't trigger the one-to-one.

Got it, okay I appreciate that. Then the next question is just walking through math and I know investors kind of heard you outlined it. What would you consider to be kind of stable income on a per share, so we got to get to 28 right. And so let's say you got stable income at the 23 level and then you need, your fee waiver adds $0.02 and then we get to other income and SBIC. Kind of give us a sense over time, let’s do other income historically, what’s that kind of per share number normally then. And then help us all for if you put all the SBIC, if you lever where the SBIC today what's the net per share impact that you could likely be able to grow NOI on a quarterly basis that would be helpful?

And that's great and we're happy to share and happy to be very transparent with both bull case and a potential bear case. So recurring as you said is roughly $0.23 a share, the fee waiver is another $0.02. Other income has averaged $0.04 a share per quarter. The next quarter it's going to be at least $0.08 a share but it’s averaged $0.04 per share. SBIC over time will be $0.01 to $0.03 per share as you lever into it. Look we are hoping that in this down market, we will get increased yields in the yield expansion in our portfolio, which is something that people, even if they look at BDCs may not be factoring in at this point but we should be getting some yield expansion. So, you can see that that is a reasonable bull case scenario that you will cover the $0.28. And then you have to sit there and say okay, what if all of the energy goes to zero and it stops paying, that’s about $0.045 to $0.05 a share. So, that's kind of all the moving parts everyone can handicap what they think those scenarios are, again the reason that we are not looking to change our dividend at this point as we play this off.

So another question because we talk about other income and the ability to collect fees et cetera, which here I mean it’s certainly sweetener, it’s nice. Oftentimes those numbers can be challenged by drops in economic activity. And so, what provides you know let’s say we are walking into some lean years from an economic perspective, I don't necessarily believe we are but the confidence that comes in that number. Are the other income what's the other income that you received over the past two years, is it really indicative of the types of other income that you could receive going forward in light of slower economic activity if that's where the market is going?

Yeah look, certainly that could be the case, if you just take the $0.08 per share for Z Wireless we know that at a minimum for 2016 that averages $0.03 a share. So we've set of $0.04 for 2016 but you're right that might not be $0.04 a share per quarter. We know at a minimum for the next four quarters on average is $0.02 because that's already booked. It could be more, it could be less.

And then, also if we're looking at - would you mind walking through the Infineon investment because I believe that was majority of - a decent amount of the real-life loss that took this quarter?

So what we have in Infineon is we have a relatively large equity position at this point and we have two pieces of debt, we have a piece of second lien debt and we have some new notes that were issued to help get the deal done. So those are the two debt instruments, those are both cash paying debt instruments relatively low levered, we think safe risk rewards and we have an equity stake.

Okay. And so the other question that folks always kind of ask, so I know that kind of has migrated away from the energy book, but a question that people would look at is that, at times, there can be credit losses in other areas. And so while you've been very upfront and shareholder friendly with regard to the energy portfolio, could you talk about why or why not you would include or consider a look back on the NOI and [indiscernible] to protect not only investors who have lost income, but to protect investors who have lost NAV in other areas of the portfolio overtime and again, it's not an easy question to answer, but it's one that lots of folks are always interested in, in light of a lot of the discussions that have surfaced of these types of fee structures?

Well, that's a great question, Jon, and until this energy downturn, our performance has been one of the best in the industry, even though the recession going back to ‘08, ‘09, we’ve had realized capital gains up until this point. So we think we've delivered for shareholders on a capital preservation basis. And right now, we’re recognizing - everyone's paying on energy, and we are taking it for the next 12 months. We’re going to work extremely hard to maximize value in these investments and we think it's - this waiver is aligned to that objective.

And we will now hear from Christopher Nolan with Friedman, Billings, Ramsey & Co.

Art, what’s the spillover income, I missed it if you’ve mentioned it?

Yeah. So, we only disclosed publicly spillover income in September, which was $0.53. But just to give you a sense, since then, we - for the quarter ended December, we paid dividends $0.05 in excess of our NII, but we've also disclosed that, in this quarter, we have $0.08 per share of other income from the sale of Z Wireless. So, we feel like we’re in pretty good shape for the quarter ended March. So that directionally gives you a sense of how to think about the spillover.

Right. And then just a quick follow-up on the leverage ratio question that Jon Bock raised, for the credit rating agencies, are they looking at a 0.85 debt-to-equity ratio, excluding SBIC, is that a fair way to look at it?

Well, both the agencies have reports out and you can look and there are differences in how they do it. I think as importantly, for us as a management, we’re focused on overall leverage too and we’re focused on the style of leverage and the kind of leverage we have. We like having the majority or a lot of our leverage being unsecured bonds that are long-term and we like having a lot of our leverage being SBIC and we like having a lot of excess dry powder in our revolver and I think one of the earlier questions was just, how do you look at the leverage between the SBIC and the revolver. We are going to prioritize the SBIC financing at this point and think of it, perhaps overtime, as a rotation.

As I recall, in the past, signing deals with SBIC for you guys was sort of a slower process. Has that changed at all, or is that wrong or?

That's a great question. It has been I think one of the benefits of this softer market that we have had over the last quarter is, we’re getting an awful lot of looks and obviously, first and foremost, we never want to lay our guard down from a credit standpoint, and we want to make sure we keep our credit standards high. That said, we’ve gotten a lot of nice looks and the majority of the deals that we did in the December quarter and the stuff that we are looking at and have done so far this quarter have been by and large SBIC eligible. So we’re fortunate that the market softening is coinciding with this extra availability.

Final question on management compensation, the fee waiver, I apologize you guys, but still your base management fee before the fee waiver was 2% of assets, you don't have a look back. Your compensation structure tends to be at the richer end of the scale for BDCs, how are you looking at the industry, do you think that as we go forward that the compensation structure for BDCs in general and also PNNT will need to modify to a new investor environment, what are your thoughts on that front?

Chris, we’re focused on what's going on in our portfolio. We don't have any great prognostications about the industry. That said, again, we think our performance over nine years through the downturn has been one of the best with realized gains offsetting realized losses up until this energy downturn. We think this fee waiver representing 16% on both the base fee and the incentive fee is appropriate at this point in time, given what's going on in energy.

And we have a question from John Hecht with Jefferies.

Good morning. Thanks very much. Just curious, you gave us some of the metrics of the deployment in the new deals from last quarter. I'm wondering if you look at your pipeline, are you seeing anything with respect to widening spreads and/or declining of leverage ratios.

That's a great point. This is kind of something perhaps we didn't highlight enough. By definition, unfortunately, BDCs stocks are out of favor when there is better risk reward to buy a new deal. So we are seeing reduced leverage ratio, we’re seeing tighter covenant packages and we’re seeing better upfront fees and we’re seeing higher yields. So over time, as these portfolios mature and rotate and you are doing new deals, the vintages should be getting better. So we’re very excited about having the dry powder that we have to take advantage of that.

Okay. And then kind of more of a conceptual question, I guess largely in part because of some of the restructurings recently, your equity composition of your total portfolios has moved upward, and I'm wondering if you could just describe kind of what's the difference when you kind of approach an equity investment versus a credit investment, in terms of time and things you’re focused on? And then to what degree, can you or are you able to kind of sell and reposition the current equity portfolio, maybe transitioning back to yielding securities?

That's a great question and that is also potentially the upside over time, but when you basically convert debt to equity, you're making investment in private equity and when you’re making investment in private equity, you have to, in your mind, think about as a three to five-year whole period while these companies work in and try to establish growth and cut costs. So that's the way we think about it in our mind. Obviously, in such cases, there is upside and if you look at our track record of recovering on our non-accruals, about $0.80 on the dollar on those non-accruals, given enough time and energy effort and a little bit of capital, we've had a very good track record of recovering that money and then taking that many and redeploying back into cash paying debt instruments to build the NII. So that's our goal here. Obviously, we want to work the equity percentage of the portfolio down, return that to cash and then into cash paying debt instruments.

And we will hear from Chris York with JMP securities.

Good morning, guys. Most of my questions have been asked, but I did want to follow up on a previous question, you talked a little bit about how RAM’s hedges roll off in the current year, are there any other exploration hedges and oil and gas companies and what were those price levels? And then secondly, how much impact do you expect it will have to hurt that service or the price of reserves in the current year.

Other than RAM, almost all the other hedgers have basically rolled off at this point or rolling off over the coming couple of quarters. So I think the game plan is the same for these companies as well as the problem that’s going in rest of the industry that people are looking at every expense, they are looking at every dollar of CapEx, trying to figure out how to cut back, live within their means during a downturn and then preserve the option for the long run.

Got it. And then one last clarification. So in your prepared remarks, you talked about if all your oil and gas or energy companies were non-accruals, about $0.05 per share, is that based off of the $0.25 that you earned in net investment income this quarter?

Yes. So again, just to be clear thinking about recurring $0.22, $0.23 before you talk about other income and the fee waiver and the SBIC upside and the fact we might have upside from spread widening, you could reduce that up to $0.05 if all the energy names went on non-accrual.

Based off of the core, the $0.22 to $0.23

Yes.

And we will now take a question from David Chiaverini with Cantor Fitzgerald.

Thanks. A couple of questions for you. The first is a follow-up on the asset mix. So, first lien loans went from 27% of the portfolio on March 31 to 38% at December 31. How high do you plan on taking that number and do you see better risk rewards in this environment and that asset class?

It's a great question, look, we take deals as they come, the most important thing is the quality of the deal, but that's a nice thing about what happens in the softening environment and in a soften market, we can move up capital structure, be in a great position and get a very attractive yield. So we will look to continue to keep personally and at a high percentage or perhaps a higher percentage if the deal flow dictates.

Okay. And my second question is on dividend policies, so you mentioned about the spillover at $0.53 at September 30 and that's come down a few cents as of December 31, would you guys wait to take that spillover down to 0, before taking into account potentially changing the dividend or at what level - how does that factor into a potential change in the dividend level?

It's a great question, and I wish there were scientific answer to it. Like a lot of things, it’s about judgment, about what's going on in the portfolio, what’s going on in the market. So our board regularly discusses this at quarterly board meetings and we will be discussing every quarter going forward. But we do feel comfortable with the cushion we have as well as with some of the features we have to increase income at the same time as we are dealing with the challenging energy portfolio.

And at this time, that does conclude our question-and-answer session. I would now like to turn the call back over to Mr. Penn for any additional or closing remarks.

Just like to thank everybody for listening in today and we will catch you next quarter. Thank you very much.