OUR VIEW

Once upon a time PennantPark Investment (PNNT) was one of the most stable BDCs out there. Launched in 2007, PNNT worked its way through the Great Recession without cutting or suspending its dividend by keeping credit losses remarkably low, a fact which management mentions on every conference call to this day. Then the BDC made a major mis-step, investing heavily in energy loans which began to go sour in 2014 on. Rather than write those loans off and ride on, PPNT chose to convert debt to equity or get paid in PIK and advance more monies on the understandable hope that what goes down will eventually come up. Any reader will know that has not happened. Management sought to shift its investing generally to lower risk, lower return investments and reduce – even outside energy – its proportion of non income producing investments. That’s been partly successful but portfolios are hard to reset even over a period of years, and the new approach shaved down earnings. Market-wise, PNNT has found itself lending into very different segments: a few big energy investments; a slew of smaller companies financed by an SBIC license; middle market borrowers for those safer first lien loans and upper middle market borrowers for higher yielding but hopefully good risk second yield loans. That’s a bit of a potpourri and not everyone’s cup of tea. The BDC’s dividend paying capability – which used to be so solid – has taken it on the chin with two reductions since 2016 bringing the payout more than 50% down, most recently to $0.12 a quarter. Book value is down a third or more from the Good Old Days and debt to equity is one of the highest out of there when private and SBIC debt is totted up. Two-thirds of assets are financed with debt, but those assets are still dropping in value.  Management remains eternally optimistic, planning on a new SBIC license given that the SBA has already given a “Green Light” and planning some sort of off balance sheet joint venture just when many other BDCs are heading in the other direction.  Near-term, thanks to Covid-19 the BDC faces a host of challenges including renewed pressure on its equity and other investments;  tightened liquidity; very high leverage and a stock price trading at such a deep discount that even an equity raise below NAV would hardly help. We don’t have much hope that a new SBIC license or JV will happen any time soon and offer any earnings solace. Most likely, management will have to shrink the portfolio to keep liquidity OK and leverage within the rules and that will pressure earnings, as will any non accruals that might come along. The analysts are projecting earnings through the medium term sufficient to cover the new dividend level, but we’re less optimistic.  For our purposes, we’re assuming another one-third haircut of the dividend in 2021. Could matters get even worse ? Notwithstanding its august history and well regarded team, it’s not impossible. For the moment, though, we expect that PNNT will spend the next year just trying to survive, but won’t actually be at risk of going out of business or being bought out or liquidated. With all those uncertainties and despite a juicy dividend yield still being paid in cash, we’re staying away from PNNT. If we were halfway convinced that the drop in earnings and book value was over, or even that the current dividend was sustainable, we’d be buyers in a New York minute, but we’re not there.

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(June 12,2020)