Nine years into running his eponymous lending firm on, for the most part, BDCs and subordinated debt, Art Penn has been quietly expanding in other areas. PennantPark is now doing more senior and unitranche deals, has doubled the assets of its senior debt oriented BDC, PennantPark Floating Rate Capital (“PFLT”), expanded its offices, and made a string of senior hires.
The firm is also growing its asset base via products tailored to institutional investors and opportunistically tapping different regions in the US and Europe for investments. Penn recently shared the thinking behind some of these moves with PDI.
Q: Tell me what you’ve been working on?
AP: About 18 months ago, in response to feedback from our sponsor relationships, we decided to make a push to be even more relevant in direct lending and senior debt. The first step was to expand the investment team and geographic footprint to enhance origination. The second was the merger of PFLT with MCG Capital Corporation (“MCG”), which closed a year ago. Since then, we’ve been working on putting the new PFLT capital to work prudently while building a private version of the Senior Credit Strategy for institutional investors.
Q: Who are some of your latest hires?
AP: James Stone came on board a year ago to look after the West Coast, based in LA and Dan Horn is doing the same thing for the Midwest out of Chicago. We also added Steve Winograd as a managing director in New York to further enhance East Coast deal flow, and brought on Stephen Conway in London. Sal Giannetti, who has been with us from the start, is spending more time in Houston to focus on energy and building sponsor relationships in that part of the country. Eileen Patrick and Mark Linnan joined two years ago to focus on strategy and fundraising, respectively.
Q: What are these people working on?
AP: On the West Coast, it’s getting our name out and building closer, deeper relationships with sponsors. By definition, you’re dealing with TMT more there, though healthcare is big too.
Chicago is more about industrial and distribution companies, though again healthcare is prominent. In Texas, as you might imagine, energy is a big focus; that said, the southwestern US economy has certainly diversified away from oil and gas.
London is a little more idiosyncratic. This may change over time, but today we generally think the US offers better risk-adjusted returns than Europe. A lot of capital has been raised there relative to the market size and opportunity set. Unlike the US, banks are still active in Europe, particularly the regional players. Keep in mind that private debt is still relatively new in Europe – most of the growth came after the credit crisis. By contrast, the US market has a much longer history and a single language/legal system which has been proven over multiple cycles.
Q: What’s your take on Brexit?
AP: The markets seem to be indicating that it’s not a big deal; the event is still a couple of years away, and it’s in both sides best interest to remain relatively integrated on key issues.
Europe for us is opportunistic at this point. We focus on Northern and Western Europe, where bankruptcy laws are consistent and credible; akin to those in the US. But as I said, it’s a tighter market, so we remain selective.
Q: How is your private fundraising going?
AP: The feedback on our Senior Credit Strategy has been very encouraging. Institutional investors are expressing interest in accessing our platform and robust origination/underwriting.
We’re fortunate to have several macro trends working in our favour: regulated entities continue to pull back, opening up a big opportunity in the US middle market for non-bank lenders like PennantPark. In addition, alternative asset allocators, who traditionally looked to private equity, venture capital and hedge funds, are realising that in a world of compressed returns, direct lending can often match the performance of those asset classes with less risk/volatility.
Traditional fixed-income investors such as insurers and pensions are suffering even more: returns are way below their long-term projections. They are increasingly deciding to give up some liquidity to get an enhanced yield in a safe position with senior debt.
Over the past two years, we’ve made significant investments into the platform, including new offices in Los Angeles, Chicago, Houston and London. Those investments have resulted in even better deal flow, especially on the senior side. The enhanced senior origination, combined with the macro tailwinds at our back, suggest that now is a good time to be broadening funding sources to include private structures for institutional investors.
Q: What’s your approach to energy right now?
AP: Energy is the primary reason our subordinated debt focused BDC, PennantPark Investment Corporation (“PNNT”) has traded at a discount to book value. While we’re by no means out of the woods yet, there have been some encouraging developments which lead us to believe there’s a good shot of healing these situations over time. We’re working with our energy portfolio companies to re-align their capital structures and liquidity to give them a long runway for recovery.
Clearly we did not foresee $25-$30 oil. When it was $90-$100/barrel, our downside cases were $60-$70. We and many others made that mistake, and it’s been a painful lesson learned. We feel it’s important to own up to mistakes, learn from them, and work tirelessly to fix them. Towards that goal, we communicated to the PNNT shareholders that we will not collect management or incentive fees from the energy portion of the portfolio right now.
Q: Where are you putting new money?
AP: Interestingly for a firm which started as a subordinated lender, the pipeline has been heavily first lien and unitranche. We’re lending to companies we think have good risk-adjusted returns, with sponsors we know well. The industries have been across the map: aerospace/defense, consumer, software and distribution.
Q: How do you differentiate your platform?
AP: Experience, relationships, and reputation are key. Many on our senior investment team, including myself, have been doing this for 25-30 years. That helps a lot because we have seen almost everything – it allows us to think creatively and provide solutions that are not simply “cookie cutter”. Relationships and reputation are built over years via consistent, value-add behaviour across many transactions. People tell us they like doing business with PennantPark because we’re direct, trustworthy and always strive to be great partners. Borrowers know what to expect going in and, of equal importance, how we’ll behave if a deal does not go according to plan.
The evergreen, permanent capital structure of the BDCs also provides several advantages: first, the sponsors know we will be here for them for the long run. Second, when there are issues such as we’re experiencing today in energy, permanent capital allows us to be patient and work to maximise value over the long run. Third, the BDC’s have provided us the means to continually invest in our platform. Lastly, because these vehicles are subject to strong regulatory oversight and reporting, the organisation is used to being transparent and always “squeaky clean” about how we do business.
Q: You’ve worked at some large firms throughout your career, any good lessons from those places?
AP: It’s all about the people you surround yourself with and the culture you cultivate for them to succeed. We’ve experienced almost no employee turnover because we endeavour to find outstanding people and provide them with a long-term career opportunity where they can develop and grow. We start with a flat/nimble organisation and overlay a culture which fosters teamwork, asks individuals to put the firm above themselves, and never treats people or clients as disposable.
Q: Why did you decide to start your own firm?
AP: Two forces came together at the same time. On the personal side, I really wanted to do something entrepreneurial with a team of like-minded people. On the business side, our sponsor clients made it clear they’d like to see a conflict-free lender: while there are lots of great shops affiliated with PE sponsors and/or distressed managers, some borrowers are wary of providing sensitive information to what is essentially a competitor. We took that opening to build a firm which values its people and prioritises above all else a “long term trusted partner” reputation. It’s been a lot of fun thus far; we’re looking forward to the next 10 years!
PENNANTPARK AT A GLANCE
Deployment:Over $5bn, across 411 companies sourced from 160 sponsors since inception
Target EBITDA:$10-$50m range; $20-$30m sweet spot
Typical deal size:$15-20m, aiming to go up to $30-$50m
• PennantPark Investment Corporation (PNNT) – $1.29bn in assets
• PennantPark Floating Rate Capital (PFLT) – $572.68m in assets (doubled through an acquisition of MCG Capital
Corp in 2015)
Offices: New York (headquarters), Chicago, Houston, Los Angeles and London
Penn’s previous firms: Drexel, Banker’s Trust, Lehman Brothers, UBS, Apollo Global Management
This article is sponsored by PennantPark. It was published in the US Special supplement of PDI's September 2016 issue.