Palmer Square Capital BDC Inc. (NYSE:PSBD) Q4 2023 Earnings Call Transcript

Palmer Square Capital BDC Inc. (NYSE:PSBD) Q4 2023 Earnings Call Transcript February 28, 2024

Palmer Square Capital BDC Inc. beats earnings expectations. Reported EPS is $0.81, expectations were $0.57. Palmer Square Capital BDC Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Welcome to the Palmer Square Capital BDC’s Fourth Quarter and Year-End 2023 Earnings Call. At this time, all participants are in a listen mode only. A question-and-answer session will follow the prepared remarks. As a reminder, this conference call is being recorded. At this time, I’d like to turn the call over to Andrew Wedderburn-Maxwell, Investor Relations. You may now begin.

Andrew Wedderburn-Maxwell: Good morning, and welcome to Palmer Square Capital BDC’s fourth quarter and year-end 2023 earnings call. Joining me this morning are Chris Long, Chairman and Chief Executive Officer; Angie Long, Chief Investment Officer; Matt Bloomfield, President; and Jeff Fox, Chief Financial Officer and Director. Palmer Square Capital BDC’s fourth quarter and fiscal year ended 2023 financial results were released earlier today and can also be accessed on Palmer Square’s Investor Relations website at palmersquarebdc.com. We have also arranged for a replay of today’s event that can be accessed on our website for the next six months. During this call, I want to remind you that the forward-looking statements we make are based on current expectations.

The statements on this call that are not purely historical are forward-looking statements. These forward-looking statements are not a guarantee of future performance and are subject to uncertainties and other factors that could cause actual results to differ materially from those expressed in the forward-looking statements, including and without limitation, market conditions caused by uncertainty surrounding interest rates, changing economic conditions and other factors we identified in our filings with the SEC. Although, we believe that the assumptions on which these forward-looking statements are based on are reasonable, any of those assumptions can prove to be inaccurate, and as a result, the forward-looking statements based on those assumptions can be incorrect.

You should not place undue reliance on these forward-looking statements. Palmer Square Capital BDC assumes no obligation to update the forward-looking statements unless required by law. To obtain copies of SEC related filings, please visit our website at palmersquarebdc.com. With that, I will now turn the call over to Chris Long.

Chris Long: Good morning, everyone. Thank you for joining us today. We’re thrilled to have you with us. This is our first earnings call as a publicly traded company, so I want to welcome our new shareholders, prospective investors and recently initiated analysts. I’m going to offer a brief overview of the opportunity we see for the Palmer Square BDC. An overview of our IPO in January, and then turn it over to the team to discuss our market outlook, portfolio update and financial performance. We started Palmer Square Capital Management, the parent investment adviser to PSBD’s Investment Advisor in 2009, amidst the financial crisis to deliver superior relative value opportunities across corporate and structured credit. Today, the broader firm manages close to $30 billion in assets and have invested over $45 billion of capital since inception.

Notably, Palmer Square has established its reputation in the global corporate and structured credit market as the top-ranked CLO issuer by deal volume in 2023. This strong performance during a difficult environment for CLO issuance demonstrates our ability to find attractive opportunities and deliver for our investors across market conditions. The performance also highlights the merits of our durable, relative value-driven approach that we are excited to bring to a broader range of investors through PSBD. Palmer Square’s platform is focused on corporate and structured credit across three significant strategies, opportunistic, income short duration; and finally, private and structured credit. PSBD was launched in 2019, and we started investing in early 2020.

We will continue to benefit from the broader Palmer Square platform with our deep credit expertise, strong relationships across capital markets and thoughtful approach to liability structures. Unlike traditional direct lending models, we believe our model offers investors attractive risk-adjusted returns through a more liquid and transparent strategy, given our ability to invest across the syndicated and direct lending markets. We are incredibly excited about the long-term opportunity for our strategy and especially in this present moment in time, given the compelling risk return we see in today’s market. As you evaluate, our offering amidst the broader sector, we want you to understand three critically important tenets about our investment profile.

First, we have a differentiated strategy across markets, that provides more optionality and the ability to be more agile than the broader BDC sector. This means, we have more upside potential with the ability to generate long-term total return through building NAV. Second, because our strategy is more liquid and focused on larger borrowers, we believe our portfolio offers more stability and less risk to our investors. In short, we believe PSBD generates more competitive yield than the broader landscape with significantly less risk. And third, we are extremely committed to enhance transparency, offering monthly NAV updates and estimates, as well as the unique fee structure that charges only on net assets. Now, let’s dive deeper into those three points and review how these attributes are growth drivers for us.

First, our differentiated investment strategy offers the opportunity to invest across multiple markets and deliver long-term total return through NAV expansion. This ability to invest across the liquid and private markets at scale, gives us multiple shots on goal. We can drive returns for investors through both attractive income generation and purchasing discounted loans to generate NAV growth and total return. Specifically, our team has the ability to identify the best relative value in the larger, more liquid parts of the market in both the broadly syndicated market and private credit. We’ve already seen private credit issuers return to the broadly syndicated mode market to refinance the tighter spreads. And we expect the overlap between the two markets will continue to grow.

The broader BDC industry is frequently constrained by illiquid assets and portfolio adjustment challenges in the face of economic disruption. We believe we have the ability to capitalize across various markets due to the multifaceted nature of our investment capabilities and strategy. Importantly, our emphasis on higher quality, shorter duration and liquid credits should enable us to opportunistically rotate investments. This is the case when attractive relative value opportunities arise or when we were able to capitalize on market dislocation. Again, our ability to drive growth in a uniquely created high-quality portfolio should grow NAV and drive long-term shareholder return. My second takeaway is that we have constructed an opportunistic portfolio that we believe generates strong returns, while mitigating risk.

We focus on investing in large, broadly syndicated loans and large private credit. Our focus is on loans to larger companies with strong fundamentals in positions that are senior in the capital structure. We also maintained a smaller pocket for opportunistic investments where our firm possesses specialized investment capabilities. This includes structured credit and European credit. Our portfolio is supported by a rigorous investment process, focused on downside protection and overall credit quality. We have thoughtful credit analysis and cash flow-based lending techniques and a focus on strong structural protection and limited downside. Our highly liquid and first lien weighted portfolio will limit risk and allow us to deploy capital quickly.

In addition, we can generate excess returns during periods of elevated market volatility. My last point is our commitment to enhance transparency and shareholder alignment relative to the broader BDC landscape. Our fee structure is unique to other externally managed publicly-traded BDCs. We only charge a management beyond net, not gross assets. At Palmer Square, we want to be rewarded when we attract more equity capital that grows net asset value, not for taking on leverage. With our current debt-to-equity ratio, the base management fee payable would represent approximately 70 basis points of our gross assets and 1.75% of net assets. We also plan to continue our practice of publishing monthly NAVs. For our liquid assets, this NAV is based on live, actionable prices.

As recently announced, our NAV per share as of January 31st, 2024, was $17.17. We believe this disclosure is best-in-class and reinforces our alignment with shareholders. To close, I want to offer a little more color around our IPO last month. On January 17th, PSBD priced a public offering of approximately 5.5 million shares on the New York Stock Exchange at a price of $16.45 per share. Gross proceeds from the IPO totaled approximately $90 million. The team is delighted with the outcome of the offering and could not be more excited to embark on this journey as a public company. I’ll now hand the call over to Angie to discuss our outlook for the year and how we have already put this capital to good use.

Angie Long: Thank you, Chris. Looking at the current operating environment and outlook, there is a lot to be excited about, while yields are still very attractive for credit products, given spread and base rates, we also have the ability to generate total returns with continued NAV appreciation. We are pleased with the returns we drove in 2023, but it’s worth noting that many of our loans still trade at a discount to par. Remember, these discounted loan prices are included in our monthly NAV. So, as the capital markets continue to reopen and refinancing accelerate, our NAV has room to appreciate and drive long-term total return. We have strong visibility into Q1 and have been encouraged by the overall capital markets activity pickup we’ve seen to the start of the year.

In some cases, borrowers that relied on the private credit markets to finance themselves in the past have come back to the broadly syndicated market. Our recent conversations with sponsors indicate that this trend could continue as they seek more efficient capital solutions in the traditional bank loan market. This is a change from the prior two years when more activity was larger borrowers entering the private credit market. We believe this parallel growth dynamic will continue and our platform was intentionally designed to capitalize on this exact trend. Another hot topic in the industry is around whether or not large banks leveraged finance lending will pick up in 2024 after being less active in the past couple of years. We believe this is already happening as recent deal announcements support that and our conversations with capital markets desk at both the banks and private equity sponsors continue to increase.

We saw loan activity pick up in the fourth quarter of 2023 and have continued to see accelerated activity to start 2024. We expect this will continue to lead interesting opportunities for us across the markets in which we operate. And again, think this could lead to long-term total return opportunities for the portfolio. Now, turning to our investment strategy, which is based on a view that rigorous and disciplined credit selection in senior secured loans is optimal over the course of a credit cycle. Given the idiosyncratic nature of single-name credit, our investment team focuses on downside protection and overall credit quality when evaluating each and every loan borrower. Minimizing default risk is paramount to delivering on the opportunity in credit.

Our experienced leadership team has a proven track record with a deep bench of investment professionals boasting 21 years of industry experience on average. We believe the expertise of the investment team across multiple credit cycles, asset classes and industries provides a competitive advantage in sourcing and idea generation, investment diligence and risk management. This is an opportune time for Palmer Square given these dynamics. We are pleased to be the first BDC IPO in over two years and that we are able to quickly deploy the IPO proceeds and utilize additional borrowings on our flexible financing facilities in the secondary loan market. Given we were not beholden to waiting for new origination activity to deploy capital, we were able to put this capital to work in short order for our investors.

The portfolio mix will look consistent to how we have invested the BDC prior to the IPO. So primarily first lien senior secured loans, which we think continue to offer strong relative value in this yield environment. We are well positioned to capture the opportunities in front of us and look forward to accelerating the growth of our platform this year. With that, I’d now like to hand the call over to Matt, who will discuss our investment process and the portfolio.

Matt Bloomfield: Thank you, Angie. The foundation of our investment process is the strength and depth of our credit platform. PFBD’s investment advisor has established a resource agreement with Palmer Square Capital Management, which is important given the synergies of the Palmer Square Capital Management platform. Across the platform, the investment team reviews approximately $350 billion in annual deal flow as potential investment opportunities suitable for PSBD. In addition to sourcing an idea generation in the primary market, we also have access to the secondary leverage loan market, estimated at $1.4 trillion in size and the ever-growing large-cap private credit market. Our large funnel is critical to our selective approach to investing.

Fundamental to Palmer Square strategy is that each corporate credit analyst has to be an expert in their respective industry vertical, drawing not only from analytical skill set, but also their networks within the industry. At the conclusion of the due diligence process, the credit analyst present the entire investment team, ultimately requiring unanimous approval from the investment committee to move forward. We view this as a unique process across credit investment firms that results in better decision-making. Of equal importance is the monitoring phase of each loan. Detailed write-ups and model updates are performed quarterly, and our credit analysts are digesting daily information regarding our borrowers, their industries and their competitors.

Now, let’s take a more granular look into our diversified portfolio. Our total investment portfolio had a fair value at December 31, 2023, of approximately $1.1 billion across 38 industries that exhibited strong credit quality and diversification. Our strategy focuses on large companies with stable recurring revenue streams, while avoiding cyclical industries. As mentioned, our analysts are organized by industry, which is intentional due to our core belief that trends come by industry and not credit ratings. In the fourth quarter, we invested approximately $85 million across 30 new investment commitments. During the same period, we realized about $53 million through repayments and realization. For the full fiscal year ended 2023, gross investments were $274 million, offset by $247 million in realizations and repayments.

During the fiscal year 2023, there were 67 new investment commitments at an average value of approximately $3.8 million. As of year-end 2023, our weighted average total yield to maturity of debt and income producing securities at fair value was 10.51%, and our weighted average total yield to maturity of debt and income-producing securities at amortized cost was 8.93%. Our portfolio is highly diversified across sectors and borrowers. At the end of the fourth quarter of 2023, the largest portfolio exposure based on industries included software, healthcare, professional services and IT services. Further, the 10 largest investments account for only 10.4% of the overall portfolio. We believe these factors have resulted in a strong credit profile.

On a fair value-added basis, our first lien borrowers have a weighted average EBITDA of $438 million, senior secured leverage of 5.3 times and interest coverage of 2.1 times. Our focus on liquid loans to larger companies with strong fundamentals and positions that are senior in the capital structure has yielded strong credit outcomes, including an average internal rating of 3.6% on a fair valuated basis for all loan investments and no debt investments on non-accrual status. Unlike traditional middle market risk systems, we have a unique relative value-based scoring approach that allows our team to ascertain where the best relative value resides and to reflect that in the portfolio. It’s a dynamic system that is updated quarterly, but given the size of the markets we participate in, the scores are updated in real time when warranted.

As an example, while we might underwrite a new issue loan at a for given attractive spread and OID characteristics at the time, as that loan accretes towards par over time, there might be better relative value in that loan sector or another new issue or in the secondary market. At that point in time, our analysts might deem that to be fair value and score to three, and continue to look for better opportunities. We think that this relative value approach makes for a more precise investment process and leads to strong credit outcomes, all while reinforcing the transparency that you have heard us discuss. Now, I’d like to turn it over to Jeff, who will review our fourth quarter and full year financial results.

Jeff Fox: Thank you, Matt. We were very pleased with our fourth quarter and full year results in 2023. Total investment income was $29.8 million for the fourth quarter of 2023, up 25% compared to $23.8 million for the prior year period. This increase was primarily driven by interest income from our investments. Total net expenses for the fourth quarter were $14.4 million compared to $11.4 million in the prior year period. A major factor in the increases in expenses compared to the prior year was primarily due to the increased average interest rate under our credit facilities. Net investment income for the fourth quarter of 2023 was $15.4 million or $0.57 per share as compared to $12.4 million or $0.51 per share for the comparable period last year.

As one would generally expect higher base interest rates along with higher spreads in the market, provide context for the greater net investment income in Q4 of 2023 versus Q4 of 2022. During the fourth quarter of 2023, the company had total realized and unrealized gains of $6.6 million compared to a loss of $11.4 million in the fourth quarter of 2022. NAV per share was $17.04, up from $16.76 at the end of the third quarter, representing a 1.7% increase sequentially. As a reminder, the December NAV also reflects the payment of a $0.54 dividend intra month. Moving to our balance sheet. As of December 31, 2023, total assets were $1.1 billion and total net assets were $462 million. At the end of Q4, our debt-to-equity ratio was 1.39 times compared to 1.42 times at the end of Q3.

Available liquidity, consisting of cash and undrawn capacity on our credit facilities was approximately $262 million. This compares to $20.1 million of undrawn investment commitments. In addition to upsizing and extending our Wells Fargo credit facility in December of 2023, we continue to have active dialogue with our lending partners to explore alternative financing options, including a potential CLO issuance. Our Board of Directors approved a stock repurchase plan to acquire up to $20 million of PSBD common stock. This program expires on January 17, 2025. Additionally, Palmer Square Capital Management has authorized an incremental $5 million repurchase program that will raise the total authorization to up to $25 million going forward. Our Board is continuing to evaluate a go-forward dividend policy, and we’ll be updating shareholders on that front at quarter end.

In sum, we are positioned to demonstrate high and attractive levels of investment income earned across our portfolio and strong credit performance across our borrowers, while mitigating risk wherever possible. With that, I’d now like to open up the call for questions.

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Q&A Session

Operator: We are now opening the floor for a question-and-answer session. [Operator Instructions] Our first question comes from Kenneth Lee from RBC Capital Markets. Your line is now open.

Kenneth Lee: Hey, good morning. Thanks for taking my question. Just wanted to get your thoughts broadly across the liquid loan markets. Where are you seeing the current pockets of opportunity right now? Thanks.

Matt Bloomfield: Hey, Ken, it’s Matt. Thanks for the question. I appreciate it. Yes, I mean, we’ve certainly seen a pretty significant pickup in activity in the syndicated loan market really starting in the fourth quarter of 2023 and certainly continuing this year for January and February. I’d say we’ve seen a few of the larger private credit transactions coming back to our market. There’s been a couple of larger syndicated transactions that were rumored to be going to the private credit markets that came to the syndicated market. So I think that trend likely continues from conversations on the capital market side. There’s a lot of conversations going on, on the private equity side from an M&A standpoint. And some of that will take some time to actually make it to the market. But we are seeing a pickup and then think that certainly accelerates through the rest of this year.

Kenneth Lee: Great. And then in terms of the overall portfolio allocation and more in terms of the more opportunistic investments. I wonder if you could just share your thoughts on the outlook for CLO debt or equity investments potentially and how you think about the relative attractiveness of those kind of investments in this environment? Thanks.

Angie Long: Sure. I mean, I think as we think about incremental investments, we have — we are in the more liquid markets. So what that means is incremental capital that has been raised, we’ve been able to put to work in a really similar fashion to how the portfolio was already allocated. And I think this is a really big part of our differentiated strategy is we don’t need to only wait and rely on a new private credit transaction to be able to invest the money. We’re seeing strong pockets of opportunity really along the same way that we’ve been invested. So there’s tremendous opportunity in first lien senior secured loans. That’s going to continue to be our predominant way to invest. We feel incredibly constructive, as Matt mentioned, about the new opportunities in the primary market for syndicated loans.

We are also seeing opportunities in the larger space of the private credit market that are interesting. As we look at the CLO debt and equity market, there are some opportunities, very similar to how we’ve already been investing in particular in some of the CLO debt areas and the liquidity there allows us to continue to invest as we’ve already been allocated.

Kenneth Lee: Great. Very helpful there. Thanks again and congratulations.

Chris Long: Thank you.

Operator: Our next question comes from Melissa Wedel from JPMorgan. Your line is now open.

Melissa Wedel: Good morning. Thanks for taking my question. I wanted to circle back on one of your comments about it’s interesting. You’re seeing some private — what maybe would have been private credit opportunities coming back to the broadly syndicated market. I wanted to better understand what that means for PSBD in particular. Is it fair to say that most of your new capital deployment is generally in the sort of the secondary market rather than primary deals? And if that’s the case, would sort of the more active BSL market impact the BDC more in terms of spread narrowing rather than sort of capital deployment. Any color you can provide on that would be great.

Angie Long: Sure. It’s Angie, and I’ll start and maybe have Matt add a little bit more color. You know, I think really what it means is we can and we do and we have purchased in the secondary market as is a big part of our strategy, always. But what’s different, I think, as we look into 2024 compared to 2023 as we are seeing increased opportunities in the primary market and broadly syndicated loans. And we think that’s likely to continue. The stability of the market is giving companies confidence to move forward on transactions. The amount of dry powder in the private equity space remains a catalyst for transactions to happen. The spread narrowing part, it’s interesting because most of the loans in our portfolio are trading at a discount.

And so what we see in a spread compressing market is actually a rallying an increase in price of some of the loans that we already have. As you see, the primary market begin to pick up, we would expect that to continue to offer opportunities to add spread into the portfolio. So in a way, because so many things were already at a discount, we’re able to benefit on both sides.

Matt Bloomfield: Yes. And just one more comment on kind of spreads to Angie’s point, as we get those refinancings at some of the lower spread portfolios, we do think that new issue is going to be an attractive opportunity, both from a credit fundamental credit standpoint, but hopefully from spread as well. And when you look across from the fourth quarter 2023, new investment spreads were about 487 basis points, so higher on average than the existing portfolio. So we do think this kind of reopening of the capital markets, whether it’s in the syndicated or in the large-cap private credit space just presents a lot of optionality for PSBD.

Melissa Wedel: That’s really helpful. I appreciate it. Could you also touch on how you guys are thinking about portfolio leverage? And how — maybe help us kind of understand how you might approach levels of portfolio leverage throughout different parts of the credit cycle. Where is it you’d like to be ideally in this kind of environment? Thank you.

Angie Long: That’s such a great question because we don’t think of portfolio leverage as a forever target kind of a thing. It will definitely be market-dependent and opportunity dependent. With the environment that we’re in now, we feel comfortable in the 1.4x to 1.5x range. But there could be other environments where we want to reduce leverage, either because the opportunity isn’t that or because the risk is higher. And that actually highlights a really key differentiating factor for our BDC, and it’s one of the main reasons why we decided to charge fees on the equity raise as opposed to on the assets invested because we didn’t want fee generation to be in any way a driver of what we believe is the right amount of leverage from a risk management perspective.

Melissa Wedel: Thanks, Angie.

Operator: It comes from [indiscernible]. Your line is now open.

Unidentified Analyst: Thanks for taking my question. Just curious if you could give an update on your view on the distribution policy going forward? Do you expect that to be slowing related to your net investment income per share? Or do you expect to hold a relatively stable level of regular dividend and pay supplemental in addition to that?

Chris Long: Hey, it’s Chris Long here. Thank you so much for that question. Our Board has continued to evaluate a go-forward dividend policy, and we’ll be updating shareholders on that front at quarter end.

Unidentified Analyst: Got it. Okay. And when we think about you are closing the IPO and deploying the proceeds to new investments, how much of a yield impact would that be for the first quarter?

Chris Long: Yeah. So as Angie mentioned in our earlier comments, the benefit of our strategy is that we were able to deploy those proceeds very quickly for shareholders. And as you mentioned, the allocation mix looks very similar to what the portfolio looked like before, both from a first lien senior secured standpoint and roughly from a yield standpoint as well. So we certainly had that benefit of the large secondary market to be able to deploy that capital in a fashion that looks very similar to the existing portfolio allocation.

Unidentified Analyst: Great. Thank you.

Operator: [Operator Instructions] We have our next question from Melissa Wedel from JPMorgan. Your line is now open.

Melissa Wedel: Hi, I am back. I wanted to follow-up with another question about your view on rates, definitely made a note of your shorter duration focus and wanted to get your thoughts on sort of how that sets up into a potentially declining rate environment or maybe begs the question, is that your view that we will be facing a declining rate environment later this year. Thank you.

Angie Long: Sure. Thank you for the question. I don’t want to say that we’re completely agnostic to different rate environments, but different rate environments bring different opportunities. And our strategy allows us to take advantage of those different opportunities. So I think one of the opportunities we see going into 2024 is that the increased, I would say, stability of the interest rate market is giving companies the confidence to engage in more transactions, which is leading to what we expect to be a more robust primary calendar and new deal activity, and that gives us an opportunity to take advantage of newer transactions.

Chris Long: And if I could just add from a product design standpoint, we designed this product in year 2018, 2019 period when rates are incredibly low. And so really believe with lower fee drag, lower financing costs that we’re able to outperform in any rate environment with the benefit of this, obviously, we think is a differentiated product structure and a differentiated investment strategy with the liquid nature of it.

Melissa Wedel: Thank you.

Operator: As of right now, we don’t have any raised hands yet. I’d now like to hand back over the call to Chris Long for closing remarks.

Chris Long: Thank you so much, and thank you, everyone, for joining us today. We couldn’t be more excited for the year ahead. We have so much confidence in this product, this structure, our investment strategy, and we really look forward to continuing to differentiate ourselves in this market and demonstrating our ability to deliver attractive yields with enhanced liquidity and strong alignment with our shareholders. We really think this is just the beginning and look forward to continuing to report to you going forward on PSBD. Thank you so much.

Operator: Attending for today’s conference call. You may now all disconnect. Have a wonderful day.