PENNANTPARK INVESTMENT CORPORATION FORWARD-LOOKING STATEMENTS
This Report, including Management's Discussion and Analysis of Financial Condition and Results of Operations, contains statements that constitute forward-looking statements, which relate to us and our consolidated subsidiaries regarding future events or our future performance or future financial condition. These forward-looking statements are not historical facts, but rather are based on current expectations, estimates and projections about our Company, our industry, our beliefs and our assumptions. The forward-looking statements contained in this Report involve risks and uncertainties, including statements as to: • our future operating results;
• our business prospects and the prospects of our prospective portfolio
companies;
• the dependence of our future success on the general economy and its impact
on the industries in which we invest;
• the impact of a protracted decline in the liquidity of credit markets on
our business;
• the impact of investments that we expect to make;
• the impact of fluctuations in interest rates and foreign exchange rates on
our business and our portfolio companies;
• our contractual arrangements and relationships with third parties;
• the valuation of our investments in portfolio companies, particularly those
having no liquid trading market;
• the ability of our prospective portfolio companies to achieve their
objectives;
• our expected financings and investments;
• the adequacy of our cash resources and working capital;
• the timing of cash flows, if any, from the operations of our prospective
portfolio companies;
• the impact of price and volume fluctuations in the stock market;
• the ability of our Investment Adviser to locate suitable investments for us
and to monitor and administer our investments;
• the impact of future legislation and regulation on our business and our
portfolio companies; and
• the impact of Brexit and other world economic and political issues.
We use words such as "anticipates," "believes," "expects," "intends," "seeks,"
"plans," "estimates" and similar expressions to identify forward-looking
statements. You should not place undue influence on the forward-looking
statements as our actual results could differ materially from those projected in
the forward-looking statements for any reason.
Although we believe that the assumptions on which these forward-looking
statements are based are reasonable, any of those assumptions could prove to be
inaccurate, and, as a result, the forward-looking statements based on those
assumptions also could be inaccurate. Important assumptions include our ability
to originate new loans and investments, certain margins and levels of
profitability and the availability of additional capital. In light of these and
other uncertainties, the inclusion of a projection or forward-looking statement
in this Report should not be regarded as a representation by us that our plans
and objectives will be achieved.
We have based the forward-looking statements included in this Report on
information available to us on the date of this Report, and we assume no
obligation to update any such forward-looking statements. Although we undertake
no obligation to revise or update any forward-looking statements in this Report,
whether as a result of new information, future events or otherwise, you are
advised to consult any additional disclosures that we may make directly to you
or through reports that we in the future may file with the SEC , including
reports on Form 10-Q/K and current reports on Form 8-K.
You should understand that under Section 27A(b)(2)(B) of the Securities Act and
Section 21E(b)(2)(B) of the Exchange Act, the "safe harbor" provisions of the
Private Securities Litigation Reform Act of 1995 do not apply to forward-looking
statements made in periodic reports we file under the Exchange Act.
The following analysis of our financial condition and results of operations should be read in conjunction with our Consolidated Financial Statements and the related notes thereto contained elsewhere in this Report.
OverviewPennantPark Investment Corporation is a BDC whose objectives are to generate both current income and capital appreciation while seeking to preserve capital through debt and equity investments primarily made toU.S. middle-market companies in the form of first lien secured debt, second lien secured debt and subordinated debt and equity investments. We believe middle-market companies offer attractive risk-reward to investors due to a limited amount of capital available for such companies. We seek to create a diversified portfolio that includes first lien secured debt, second lien secured debt, subordinated debt and equity investments by investing approximately$10 million to$50 million of capital, on average, in the securities of middle-market companies. We expect this investment size to vary proportionately with the size of our capital base. We use the term "middle-market" to refer to companies with annual revenues between$50 million and$1 billion . The companies in which we invest are typically highly leveraged, and, in most cases, are not rated by national rating agencies. If such companies were rated, we believe that they would typically receive a rating below investment grade (between BB and CCC under theStandard & Poor's system) from the national rating agencies. Securities rated below investment grade are often referred to as "leveraged loans" or "high yield" securities or "junk bonds" and are often higher risk compared to debt instruments that are rated above investment grade and have speculative characteristics. Our debt investments may generally range in maturity from three to ten years and are made toU.S. and, to a limited extent, non-U.S. corporations, partnerships and other business entities which operate in various industries and geographical regions. 26 -------------------------------------------------------------------------------- Our investment activity depends on many factors, including the amount of debt and equity capital available to middle-market companies, the level of merger and acquisition activity for such companies, the general economic environment and the competitive environment for the types of investments we make. We have used, and expect to continue to use, our debt capital, proceeds from the rotation of our portfolio and proceeds from public and private offerings of securities to finance our investment objectives.
Organization and Structure of
PennantPark Investment Corporation , aMaryland corporation organized inJanuary 2007 , is a closed-end, externally managed, non-diversified investment company that has elected to be treated as a BDC under the 1940 Act. In addition, for federal income tax purposes we have elected to be treated, and intend to qualify annually, as a RIC under the Code. SBIC II, our wholly owned subsidiary, was organized as aDelaware limited partnership in 2012. SBIC II received a license from the SBA to operate as a SBIC under Section 301(c) of the 1958 Act. SBIC II's objectives are to generate both current income and capital appreciation through debt and equity investments generally by investing with us in SBA eligible businesses that meet the investment selection criteria used byPennantPark Investment . Funding I, our wholly owned subsidiary and a special purpose entity, was organized inDelaware as a limited liability company inFebruary 2019 . We formed Funding I in order to establish the BNP Credit Facility. The Investment Adviser serves as the servicer to Funding I and has irrevocably directed that the management fee owed to it with respect to such services be paid to us so long as the Investment Adviser remains the servicer. This arrangement does not increase our consolidated management fee. The BNP Credit Facility allows Funding I to borrow up to$250 million at LIBOR plus 260 basis points during the reinvestment period. The BNP Credit Facility is secured by all of the assets held by Funding I. Our investment activities are managed by the Investment Adviser. Under our Investment Management Agreement, we have agreed to pay our Investment Adviser an annual base management fee based on our average adjusted gross assets as well as an incentive fee based on our investment performance.PennantPark Investment , through the Investment Adviser, provides similar services to ourSBIC Fund under its investment management agreement. OurSBIC Fund's investment management agreement does not affect the management and incentive fees on a consolidated basis. We have also entered into an Administration Agreement with the Administrator. Under our Administration Agreement, we have agreed to reimburse the Administrator for our allocable portion of overhead and other expenses incurred by the Administrator in performing its obligations under our Administration Agreement, including rent and our allocable portion of the costs of compensation and related expenses of our Chief Compliance Officer, Chief Financial Officer and their respective staffs.PennantPark Investment , through the Administrator, provides similar services to ourSBIC Fund under its administration agreements with us. Our board of directors, a majority of whom are independent of us, provides overall supervision of our activities, and the Investment Adviser supervises our day-to-day activities. Revenues We generate revenue in the form of interest income on the debt securities we hold and capital gains and dividends, if any, on investment securities that we may acquire in portfolio companies. Our debt investments, whether in the form of first lien secured debt, second lien secured debt or subordinated debt, typically have a term of three to ten years and bear interest at a fixed or a floating rate. Interest on debt securities is generally payable quarterly. In some cases, our investments provide for deferred interest payments and PIK interest. The principal amount of the debt securities and any accrued but unpaid interest generally becomes due at the maturity date. In addition, we may generate revenue in the form of amendment, commitment, origination, structuring or diligence fees, fees for providing significant managerial assistance and possibly consulting fees. Loan origination fees, OID and market discount or premium and deferred financing costs on liabilities, which we do not fair value, are capitalized and accreted or amortized using the effective interest method as interest income or, in the case of deferred financing costs, as interest expense. Dividend income, if any, is recognized on an accrual basis on the ex-dividend date to the extent that we expect to collect such amounts. From time to time, the Company receives certain fees from portfolio companies, which are non-recurring in nature. Such fees include loan prepayment penalties, structuring fees and amendment fees, and are recorded as other investment income when earned. Expenses Our primary operating expenses include the payment of a management fee and the payment of an incentive fee to our Investment Adviser, if any, our allocable portion of overhead under our Administration Agreement and other operating costs as detailed below. Our management fee compensates our Investment Adviser for its work in identifying, evaluating, negotiating, consummating and monitoring our investments. Additionally, we pay interest expense on the outstanding debt and unused commitment fees on undrawn amounts, under our various debt facilities. We bear all other direct or indirect costs and expenses of our operations and transactions, including:
• the cost of calculating our net asset value, including the cost of any
third-party valuation services;
• the cost of effecting sales and repurchases of shares of our common stock
and other securities;
• fees payable to third parties relating to, or associated with, making
investments, including fees and expenses associated with performing due
diligence and reviews of prospective investments or complementary
businesses;
• expenses incurred by the Investment Adviser in performing due diligence and
reviews of investments;
• transfer agent and custodial fees;
• fees and expenses associated with marketing efforts;
• federal and state registration fees and any exchange listing fees;
• federal, state, local and foreign taxes;
• independent directors' fees and expenses;
• brokerage commissions;
• fidelity bond, directors and officers, errors and omissions liability
insurance and other insurance premiums;
• direct costs such as printing, mailing, long distance telephone and staff;
• fees and expenses associated with independent audits and outside legal costs;
• costs associated with our reporting and compliance obligations under the
1940 Act, the 1958 Act and applicable federal and state securities laws;
and
• all other expenses incurred by either the Administrator or us in connection
with administering our business, including payments under our
Administration Agreement that will be based upon our allocable portion of
overhead, and other expenses incurred by the Administrator in performing
its obligations under our Administration Agreement, including rent and our
allocable portion of the costs of compensation and related expenses of our
Chief Compliance Officer, Chief Financial Officer and their respective
staffs.
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-------------------------------------------------------------------------------- Generally, during periods of asset growth, we expect our general and administrative expenses to be relatively stable or to decline as a percentage of total assets and increase during periods of asset declines. Incentive fees, interest expense and costs relating to future offerings of securities would be additive to the expenses described above.
PORTFOLIO AND INVESTMENT ACTIVITY
As ofDecember 31, 2019 , our portfolio totaled$1,378.9 million and consisted of$791.9 million of first lien secured debt,$270.8 million of second lien secured debt,$63.0 million of subordinated debt and$253.2 million of preferred and common equity. Our debt portfolio consisted of 91% variable-rate investments. As ofDecember 31, 2019 , we had no portfolio companies on non-accrual. Overall, the portfolio had net unrealized depreciation of$14.0 million as ofDecember 31, 2019 . Our overall portfolio consisted of 78 companies with an average investment size of$17.7 million , had a weighted average yield on interest bearing debt investments of 9.6% and was invested 57% in first lien secured debt, 20% in second lien secured debt, 5% in subordinated debt and 18% in preferred and common equity. As ofSeptember 30, 2019 , our portfolio totaled$1,219.4 million and consisted of$695.3 million of first lien secured debt,$269.3 million of second lien secured debt,$61.2 million of subordinated debt and$193.7 million of preferred and common equity. Our debt portfolio consisted of 87% variable-rate investments. As ofSeptember 30, 2019 , we had no portfolio companies on non-accrual. Overall, the portfolio had net unrealized depreciation of$37.6 million as ofSeptember 30, 2019 . Our overall portfolio consisted of 67 companies with an average investment size of$18.2 million , had a weighted average yield on interest bearing debt investments of 9.8% and was invested 57% in first lien secured debt, 22% in second lien secured debt, 5% in subordinated debt and 16% in preferred and common equity. For the three months endedDecember 31, 2019 , we invested$173.7 million in 13 new and 15 existing portfolio companies with a weighted average yield on debt investments of 8.8%. Sales and repayments of investments for the three months endedDecember 31, 2019 totaled$31.2 million . For the three months endedDecember 31, 2018 , we invested$194.5 million in six new and 13 existing portfolio companies with a weighted average yield on debt investments of 9.5%. Sales and repayments of investments for the three months endedDecember 31, 2018 totaled$125.8 million . CRITICAL ACCOUNTING POLICIES The preparation of our Consolidated Financial Statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amount of our assets and liabilities at the date of the Consolidated Financial Statements and the reported amounts of income and expenses during the reported periods. In the opinion of management, all adjustments, which are of a normal recurring nature, considered necessary for the fair presentation of financial statements have been included. Actual results could differ from these estimates due to changes in the economic and regulatory environment, financial markets and any other parameters used in determining such estimates and assumptions. We may reclassify certain prior period amounts to conform to the current period presentation. We have eliminated all intercompany balances and transactions. References to ASC serve as a single source of accounting literature. Subsequent events are evaluated and disclosed as appropriate for events occurring through the date the Consolidated Financial Statements are issued. In addition to the discussion below, we describe our critical accounting policies in the notes to our Consolidated Financial Statements. Investment Valuations We expect that there may not be readily available market values for many of the investments which are or will be in our portfolio, and we value such investments at fair value as determined in good faith by or under the direction of our board of directors using a documented valuation policy and a consistently applied valuation process, as described in this Report. With respect to investments for which there is no readily available market value, the factors that the board of directors may take into account in pricing our investments at fair value include, as relevant, the nature and realizable value of any collateral, the portfolio company's ability to make payments and its earnings and discounted cash flow, the markets in which the portfolio company does business, comparison to publicly traded securities and other relevant factors. When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, we consider the pricing indicated by the external event to corroborate or revise our valuation. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the price used in an actual transaction may be different than our valuation and the difference may be material. Our portfolio generally consists of illiquid securities, including debt and equity investments. With respect to investments for which market quotations are not readily available, or for which market quotations are deemed not reflective of the fair value, our board of directors undertakes a multi-step valuation process each quarter, as described below:
(1) Our quarterly valuation process begins with each portfolio company or
investment being initially valued by the investment professionals of our
Investment Adviser responsible for the portfolio investment;
(2) Preliminary valuation conclusions are then documented and discussed with
the management of the Investment Adviser;
(3) Our board of directors also engages independent valuation firms to conduct
independent appraisals of our investments for which market quotations are
not readily available or are readily available but deemed not reflective
of the fair value of the investment. The independent valuation firms
review management's preliminary valuations in light of their own
independent assessment and also in light of any market quotations obtained
from an independent pricing service, broker, dealer or market maker;
(4) The audit committee of our board of directors reviews the preliminary
valuations of the Investment Adviser and those of the independent
valuation firms on a quarterly basis, periodically assesses the valuation
methodologies of the independent valuation firms, and responds to and
supplements the valuation recommendations of the independent valuation
firms to reflect any comments; and
(5) Our board of directors discusses these valuations and determines the fair
value of each investment in our portfolio in good faith, based on the
input of our Investment Adviser, the respective independent valuation
firms and the audit committee.
Our board of directors generally uses market quotations to assess the value of
our investments for which market quotations are readily available. We obtain
these market values from independent pricing services or at the bid prices
obtained from at least two brokers or dealers, if available, or otherwise from a
principal market maker or a primary market dealer. The Investment Adviser
assesses the source and reliability of bids from brokers or dealers. If the
board of directors has a bona fide reason to believe any such market quote does
not reflect the fair value of an investment, it may independently value such
investments by using the valuation procedure that it uses with respect to assets
for which market quotations are not readily available.
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-------------------------------------------------------------------------------- Fair value, as defined under ASC 820, is the price that we would receive upon selling an investment or pay to transfer a liability in an orderly transaction to a market participant in the principal or most advantageous market for the investment or liability. ASC 820 emphasizes that valuation techniques maximize the use of observable market inputs and minimize the use of unobservable inputs. Inputs refer broadly to the assumptions that market participants would use in pricing an asset or liability, including assumptions about risk. Inputs may be observable or unobservable. Observable inputs reflect the assumptions market participants would use in pricing an asset or liability based on market data obtained from sources independent of us. Unobservable inputs reflect the assumptions market participants would use in pricing an asset or liability based on the best information available to us on the reporting period date.
ASC 820 classifies the inputs used to measure these fair values into the following hierarchies:
Level 1: Inputs that are quoted prices (unadjusted) in active markets for
identical assets or liabilities, accessible by us at the
measurement
date.
Level 2: Inputs that are quoted prices for similar assets or liabilities in
active markets, or that are quoted prices for identical or similar
assets or liabilities in markets that are not active and inputs that
are observable for the asset or liability, either directly or
indirectly, for substantially the full term, if applicable, of the
financial instrument.
Level 3: Inputs that are unobservable for an asset or liability because they
are based on our own assumptions about how market participants would
price the asset or liability.
A financial instrument's categorization within the valuation hierarchy is based
upon the lowest level of input that is significant to the fair value
measurement. Generally, most of our investments, our Credit Facilities and our
SBA debentures are classified as Level 3. Our 2019 Notes were, and our 2024
Notes are, classified as Level 2, as they are financial instruments with readily
observable market inputs. Due to the inherent uncertainty of determining the
fair value of investments that do not have a readily available market value, the
price used in an actual transaction may be different than our valuation and
those differences may be material.
In addition to using the above inputs in cash equivalents, investments, our 2019
Notes, our SBA debentures, our 2024 Notes and our Credit Facilities valuations,
we employ the valuation policy approved by our board of directors that is
consistent with ASC 820. Consistent with our valuation policy, we evaluate the
source of inputs, including any markets in which our investments are trading, in
determining fair value.
The carrying value of our consolidated financial liabilities approximates fair
value. We have adopted the principles under ASC Subtopic ASC 825-10, Financial
Instruments, or ASC 825-10, which provides companies with an option to report
selected financial assets and liabilities at fair value, and made an irrevocable
election to apply ASC 825-10 to our Credit Facilities and the 2019 Notes. We
elected to use the fair value option for the Credit Facilities and the 2019
Notes to align the measurement attributes of both our assets and liabilities
while mitigating volatility in earnings from using different measurement
attributes. ASC 825-10 establishes presentation and disclosure requirements
designed to facilitate comparisons between companies that choose different
measurement attributes for similar types of assets and liabilities and to more
easily understand the effect on earnings of a company's choice to use fair
value. ASC 825-10 also requires us to display the fair value of the selected
assets and liabilities on the face of the Consolidated Statements of Assets and
Liabilities and changes in fair value of the Credit Facilities and the 2019
Notes are reported in our Consolidated Statements of Operations. We did not
elect to apply ASC 825-10 to any other financial assets or liabilities,
including the 2024 Notes and the SBA debentures.
For the three months ended December 31, 2019 , our Credit Facilities had a net
change in unrealized appreciation of $2.6 million . For the three months ended
December 31, 2018 , the Truist Credit Facility and the 2019 Notes had a net
change in unrealized depreciation of $6.1 million . As of December 31, 2019 and
September 30, 2019 , the net unrealized depreciation on our Credit Facilities
totaled $4.7 million and $7.2 million , respectively. We use a nationally
recognized independent valuation service to measure the fair value of our Credit
Facilities and the 2019 Notes in a manner consistent with the valuation process
that the board of directors uses to value our investments.
Revenue Recognition
We record interest income on an accrual basis to the extent that we expect to collect such amounts. For loans and debt investments with contractual PIK interest, which represents interest accrued and added to the loan balance that generally becomes due at maturity, we will generally not accrue PIK interest when the portfolio company valuation indicates that such PIK interest is not collectable. We do not accrue as a receivable interest on loans and debt investments if we have reason to doubt our ability to collect such interest. Loan origination fees, OID, market discount or premium and deferred financing costs on liabilities, which we do not fair value, are capitalized and then accreted or amortized using the effective interest method as interest income or, in the case of deferred financing costs, as interest expense. We record prepayment penalties on loans and debt investments as income. Dividend income, if any, is recognized on an accrual basis on the ex-dividend date to the extent that we expect to collect such amounts. From time to time, the Company receives certain fees from portfolio companies, which are non-recurring in nature. Such fees include loan prepayment penalties, structuring fees and amendment fees, and are recorded as other investment income when earned.
Net Realized Gains or Losses and Net Change in Unrealized Appreciation or Depreciation
We measure realized gains or losses by the difference between the net proceeds from the repayment or sale and the amortized cost basis of the investment, using the specific identification method, without regard to unrealized appreciation or depreciation previously recognized, but considering unamortized upfront fees and prepayment penalties. Net change in unrealized appreciation or depreciation reflects the change in fair values of our portfolio investments, our Credit Facilities and the 2019 Notes during the reporting period, including any reversal of previously recorded unrealized appreciation or depreciation, when gains or losses are realized. Foreign Currency Translation
Our books and records are maintained in
1. Fair value of investment securities, other assets and liabilities - at the
exchange rates prevailing at the end of the applicable period; and
2. Purchases and sales of investment securities, income and expenses - at the
exchange rates prevailing on the respective dates of such transactions.
Although net assets and fair values are presented based on the applicable foreign exchange rates described above, we do not isolate that portion of the results of operations due to changes in foreign exchange rates on investments, other assets and debt from the fluctuations arising from changes in fair values of investments and liabilities held. Such fluctuations are included with the net realized and unrealized gain or loss from investments and liabilities. PIK Interest We have investments in our portfolio which contain a PIK interest provision. PIK interest is added to the principal balance of the investment and is recorded as income. In order for us to maintain our ability to be subject to tax as a RIC, substantially all of this income must be paid out to stockholders in the form of dividends forU.S. federal income tax purposes, even though we may not have collected any cash with respect to interest on PIK securities. 29
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Federal Income Taxes We have elected to be treated, and intend to qualify annually to maintain our election to be treated, as a RIC under Subchapter M of the Code. To maintain our RIC tax election, we must, among other requirements, meet certain annual source-of-income and quarterly asset diversification requirements. We also must annually distribute dividends forU.S. federal income tax purposes to our stockholders out of the assets legally available for distribution of an amount generally at least equal to 90% of the sum of our net ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, or investment company taxable income, determined without regard to any deduction for dividends paid. Although not required for us to maintain our RIC tax status, in order to preclude the imposition of a 4% nondeductibleU.S. federal excise tax imposed on RICs, we must distribute dividends forU.S. federal income tax purposes to our stockholders in respect of each calendar year of an amount at least equal to the sum of (1) 98% of our net ordinary income (subject to certain deferrals and elections) for the calendar year, (2) 98.2% of the excess, if any, of our capital gains over our capital losses, or capital gain net income (adjusted for certain ordinary losses) for the one-year period ending onOctober 31 of the calendar year plus (3) the sum of any net ordinary income plus capital gain net income for preceding years that was not distributed during such years and on which we did not incur anyU.S. federal income tax, or the Excise Tax Avoidance Requirement. In addition, although we may distribute realized net capital gains (i.e., net long-term capital gains in excess of net short-term capital losses), if any, at least annually, out of the assets legally available for such distributions in the manner described above, we have retained and may continue to retain such net capital gains or investment company taxable income, contingent on maintaining our ability to be subject to tax as a RIC, in order to provide us with additional liquidity. Because federal income tax regulations differ from GAAP, distributions in accordance with tax regulations may differ from net investment income and net realized gain recognized for financial reporting purposes. Differences between tax regulations and GAAP may be permanent or temporary. Permanent differences are reclassified among capital accounts in the Consolidated Financial Statements to reflect their appropriate tax character. Temporary differences arise when certain items of income, expense, gain or loss are recognized at some time in the future. We have formed and expect to continue to form certain taxable subsidiaries, including the Taxable Subsidiaries, which are subject to tax as corporations. These taxable subsidiaries allow us to hold equity securities of certain portfolio companies treated as pass-through entities forU.S. federal income tax purposes while facilitating our ability to qualify as a RIC under the Code. RESULTS OF OPERATIONS
Set forth below are the results of operations for the three months ended
Investment Income Investment income for the three months endedDecember 31, 2019 was$26.0 million and was attributable to$16.0 million from first lien secured debt,$7.7 million from second lien secured debt and$2.3 million from subordinated debt, respectively. This compares to investment income for the three months endedDecember 31, 2018 of$27.4 million and was attributable to$13.2 million from first lien secured debt,$12.4 million from second lien secured debt and$1.8 million from subordinated debt, preferred and common equity. The decrease in investments income compared to the same period in the prior year was primarily due to decreases in LIBOR as well as the timing of purchases and sales. Expenses Expenses for the three months endedDecember 31, 2019 totaled$15.8 million . Base management fee for the same period totaled$4.7 million , incentive fee totaled$0.7 million , debt related interest and expenses totaled$8.9 million , general and administrative expenses totaled$1.2 million and provision for taxes totaled$0.3 million . This compares to net expenses for the three months endedDecember 31, 2018 , which totaled$14.8 million . Base management fee for the same period totaled$4.4 million , incentive fee totaled$2.7 million , debt related interest and expenses totaled$6.3 million and general and administrative expenses totaled$1.1 million . The increase in expenses compared to the three-month period ended in the prior year was primarily due to higher leverage costs. Net Investment Income Net investment income totaled$10.2 million , or$0.15 per share, for the three months endedDecember 31, 2019 . Net investment income totaled$12.6 million , or$0.18 per share, for the three months endedDecember 31, 2018 . The decrease in net investment income compared to the three-month period ended in the prior year was primarily due to higher leverage costs and lower investment income. Net Realized Gains or Losses Sales and repayments of investments for three months endedDecember 31, 2019 totaled$31.2 million and net realized losses totaled$12.0 million . Sales and repayments of investments for the three months endedDecember 31, 2018 totaled$125.8 million and net realized gains totaled$8.5 million . The change in realized gains/losses was primarily due to changes in the market conditions of our investments and the values at which they were realized.
Unrealized Appreciation or Depreciation on Investments, the Credit Facilities and the 2019 Notes
For the, three months endedDecember 31, 2019 and 2018, we reported net change in unrealized appreciation (depreciation) on investments of$23.6 million and$(20.4) million , respectively. As ofDecember 31, 2019 andSeptember 30, 2019 , our net unrealized depreciation on investments totaled$14.0 million and$37.6 million , respectively. The net change in unrealized appreciation/depreciation on our investments compared to the same period in the prior year was primarily due to changes in the capital market conditions, the financial performance of certain portfolio companies and the reversal of unrealized appreciation/depreciation on investments that were realized. For the three months endedDecember 31, 2019 our Credit Facilities had a net change in unrealized appreciation of$2.6 million . For the three months endedDecember 31, 2018 , the Truist Credit Facility and the 2019 Notes had a net change in unrealized depreciation of$6.1 million . As ofDecember 31, 2019 andSeptember 30, 2019 , the net unrealized depreciation on the Credit Facilities totaled$4.7 million and$7.2 million , respectively. The net change in net unrealized depreciation compared to the same period in the prior year was primarily due to changes in the capital markets. 30 --------------------------------------------------------------------------------
Net Change in Net Assets Resulting from Operations
Net change in net assets resulting from operations totaled$19.2 million , or$0.29 per share, for the three months endedDecember 31, 2019 . Net change in net assets resulting from operations totaled$6.8 million , or$0.10 per share, for the three months endedDecember 31, 2018 . The increase in the net change in net assets from operations compared to the same period in the prior year was primarily due to appreciation of the portfolio.
LIQUIDITY AND CAPITAL RESOURCES
Our liquidity and capital resources are derived primarily from proceeds of securities offerings, debt capital and cash flows from operations, including investment sales and repayments, and income earned. Our primary use of funds from operations includes investments in portfolio companies and payments of fees and other operating expenses we incur. We have used, and expect to continue to use, our debt capital, proceeds from the rotation of our portfolio and proceeds from public and private offerings of securities to finance our investment objectives. As ofDecember 31, 2019 , in accordance with the 1940 Act, with certain limited exceptions, we were only allowed to borrow amounts such that we are in compliance with a 150% asset coverage ratio requirement after such borrowing, excluding SBA debentures pursuant to exemptive relief from theSEC received inJune 2011 . OnFebruary 5, 2019 , our stockholders approved the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act, as amended by the Consolidated Appropriations Act of 2018 (which includes the SBCAA) as approved by our board of directors onNovember 13, 2018 . As a result, the asset coverage requirement applicable to us for senior securities was reduced from 200% (i.e.,$1 of debt outstanding for each$1 of equity) to 150% (i.e.,$2 of debt outstanding for each$1 of equity), subject to compliance with certain disclosure requirements. As ofDecember 31, 2019 andSeptember 30, 2019 , our asset coverage ratio, as computed in accordance with the 1940 Act, was 195% and 207%, respectively. The annualized weighted average cost of debt for the three months endedDecember 31, 2019 and 2018, inclusive of the fee on the undrawn commitment under the Truist Credit Facility, debt issuance costs on the BNP Credit Facility, prepayment penalties on the 2019 Notes and amortized upfront fees on SBA debentures, was 5.0% and 4.7%, respectively (excluding debt issuance costs and prepayment penalties, amounts were 5.0% and 4.6%, respectively). OnFebruary 22, 2019 , Funding I closed the BNP Credit Facility for up to$250.0 million in borrowings with certain lenders andBNP Paribas , as administrative agent, andThe Bank of New York Mellon Trust Company, N.A. , as collateral agent. As ofDecember 31, 2019 andSeptember 30, 2019 , Funding I had$203.5 million and$171.0 million in borrowings under the BNP Credit Facility, respectively. The BNP Credit Facility had a weighted average interest rate of 4.4% and 4.6%, respectively, exclusive of the fee on undrawn commitments, as ofDecember 31, 2019 andSeptember 30, 2019 . The BNP Credit Facility is a five-year revolving facility with a stated maturity date ofFebruary 22, 2024 and pricing set at 260 basis points over LIBOR. As ofDecember 31, 2019 andSeptember 30, 2019 , Funding I had$46.5 million and$79.0 million of unused borrowing capacity under the BNP Credit Facility, respectively, subject to the regulatory restrictions. The BNP Credit Facility is secured by all of our assets held by Funding I. As ofDecember 31, 2019 , we were in compliance with the terms of the BNP Credit Facility. As ofDecember 31, 2019 , we had a multi-currency Truist Credit Facility for up to$475.0 million in borrowings with certain lenders andTruist Bank , acting as administrative agent, andJPMorgan Chase Bank, N.A ., acting as syndication agent for the lenders. As ofDecember 31, 2019 andSeptember 30, 2019 , we had$330.6 million (including a$15.0 million temporary draw) and$301.6 million , respectively, in outstanding borrowings under the Truist Credit Facility. The Truist Credit Facility had a weighted average interest rate of 4.0% and 4.2%, respectively, exclusive of the fee on undrawn commitments, as ofDecember 31, 2019 andSeptember 30, 2019 . The Truist Credit Facility is a revolving facility with a stated maturity date ofSeptember 4, 2024 ($55.0 million of the$475 million commitment will matureMay 25, 2022 ), a one-year term-out period onSeptember 4, 2023 ($55.0 million of the$475 million commitment has a one year term-out period onMay 25, 2021 ) and pricing set at 225 basis points over LIBOR. The Truist Credit Facility is secured by substantially all of our assets excluding assets held by Funding I and SBIC II. As ofDecember 31, 2019 andSeptember 30, 2019 , we had$144.4 million and$173.4 million of unused borrowing capacity under the Truist Credit Facility, respectively, subject to the regulatory restrictions. The Truist Credit Facility is secured by substantially all of our assets, excluding assets held by Funding I and ourSBIC Fund . As ofDecember 31, 2019 , we were in compliance with the terms of the Truist Credit Facility. As ofDecember 31, 2019 , we had$86.3 million in aggregate principal amount of 2024 Notes outstanding. Interest on the 2024 Notes is paid quarterly onJanuary 15 ,April 15 ,July 15 andOctober 15 , at a rate of 5.50% per year, commencingJanuary 15, 2020 . The 2024 Notes mature onOctober 15, 2024 . The 2024 Notes are direct unsecured obligations and rank pari passu in right of payment with future unsecured unsubordinated indebtedness. The 2024 Notes are structurally subordinated to all existing and future indebtedness and other obligations of any of our subsidiaries, financing vehicles, or similar facilities. The 2024 Notes may be redeemed in whole or in part at our option on or afterOctober 15, 2021 at a redemption price of 100% of the outstanding principal amount of the 2024 Notes plus accrued and unpaid interest. InSeptember 2014 , we issued$250.0 million in aggregate principal amount of 2019 Notes, for net proceeds of$245.5 million after underwriting discounts and offering costs. Interest on the 2019 Notes was paid semi-annually onApril 1 andOctober 1 , at a rate of 4.50% per year. OnMarch 4, 2019 the 2019 Notes were redeemed in full and no amounts were outstanding as ofDecember 31, 2019 . The 2019 Notes were redeemed onMarch 4, 2019 at a redemption price equal to$1,008.65 for each$1,000.00 of principal of notes outstanding, plus accrued and unpaid interest toMarch 4, 2019 , pursuant to the indenture governing the 2019 Notes. Please refer to our indenture agreement filed as Exhibit (d)(8) to our post-effective amendment filed onJanuary 22, 2013 and the supplemental indenture agreement filed as Exhibit (d)(11) to our post-effective amendment filed onSeptember 23, 2014 for more information. We may raise additional equity or debt capital through both registered offerings off our shelf registration statement and private offerings of securities, by securitizing a portion of our investments or borrowing from the SBA, among other sources. Any future additional debt capital we incur, to the extent it is available, may be issued at a higher cost and on less favorable terms and conditions than our current Credit Facilities and SBA debentures. Furthermore, our Credit Facilities availability depends on various covenants and restrictions. The primary use of existing funds and any funds raised in the future is expected to be for repayment of indebtedness, investments in portfolio companies, cash distributions to our stockholders or for other general corporate or strategic purposes such as our stock repurchase program. SBIC II is able to borrow funds from the SBA against regulatory capital (which approximates equity capital) that is paid-in and is subject to customary regulatory requirements including an examination by the SBA. We have funded SBIC II with$75.0 million of equity capital and it had SBA debentures outstanding of$133.5 million as ofDecember 31, 2019 . SBA debentures are non-recourse to us and may be prepaid at any time without penalty. The interest rate of SBA debentures is fixed at the time of issuance, often referred to as pooling, at a market-driven spread over 10-yearU.S. Treasury Notes. Under current SBA regulations, a SBIC may individually borrow to a maximum of$175.0 million , which is up to twice its potential regulatory capital, and as part of a group of SBICs under common control may borrow a maximum of$350 million in the aggregate. As ofDecember 31, 2019 andSeptember 30, 2019 , SBIC II had initial$150.0 million in debt commitments, respectively, all of which was drawn. During the three months endedDecember 31, 2019 ,$16.5 million in SBA debentures were repaid. As ofDecember 31, 2019 andSeptember 30, 2019 , the unamortized fees on the SBA debentures were$3.3 million and$3.9 million , respectively. The SBA debentures' upfront fees of 3.4% consist of a commitment fee of 1.0% and an issuance discount of 2.4%, which are being amortized. 31
-------------------------------------------------------------------------------- Our fixed-rate SBA debentures as ofDecember 31, 2019 andSeptember 30, 2019 were as follows: As of December 31, Fixed All-in Coupon 2019 Issuance Dates Maturity Rate (1) Principal Balance March 23, 2016 March 1, 2026 2.9 % $ 22,500,000 September 21, 2016 September 1, 2026 2.4 25,000,000 September 20, 2017 September 1, 2027 2.9 27,500,000 March 21, 2018 March 1, 2028 3.5 58,500,000 Weighted Average Rate / Total 3.1 %$ 133,500,000 As of September 30, Fixed All-in Coupon 2019 Issuance Dates Maturity Rate (1) Principal Balance March 23, 2016 March 1, 2026 2.9 % $ 22,500,000 September 21, 2016 September 1, 2026 2.4 25,000,000 September 20, 2017 September 1, 2027 2.9 31,500,000 March 21, 2018 March 1, 2028 3.5 71,000,000 Weighted Average Rate / Total 3.1 %$ 150,000,000
(1) Excluding 3.4% of upfront fees.
The SBIC program is designed to stimulate the flow of capital into eligible businesses. Under SBA regulations, SBIC II is subject to regulatory requirements, including making investments in SBA eligible businesses, investing at least 25% of regulatory capital in eligible smaller businesses, as defined under the 1958 Act, placing certain limitations on the financing terms of investments, prohibiting investment in certain industries and requiring capitalization thresholds that limit distributions to us, and is subject to periodic audits and examinations of its financial statements that are prepared on a basis of accounting other than GAAP (for example, fair value, as defined under ASC 820, is not required to be used for assets or liabilities for such compliance reporting). As ofDecember 31, 2019 , SBIC II was in compliance with its regulatory requirements. In accordance with the 1940 Act, with certain limited exceptions,PennantPark Investment is only allowed to borrow amounts such that our required 150% asset coverage ratio is met after such borrowing. As ofDecember 31, 2019 andSeptember 30, 2019 , we excluded the principal amounts of our SBA debentures from our asset coverage ratio pursuant toSEC exemptive relief. In 2011, we received exemptive relief from theSEC allowing us to modify the asset coverage ratio requirement to exclude the SBA debentures from the calculation. Accordingly, our ratio of total assets on a consolidated basis to outstanding indebtedness may be less than 150% which, while providing increased investment flexibility, also increases our exposure to risks associated with leverage. As ofDecember 31, 2019 andSeptember 30, 2019 , we had cash and cash equivalents of$32.1 million and$59.5 million , respectively, available for investing and general corporate purposes. We believe our liquidity and capital resources are sufficient to take advantage of market opportunities. Our operating activities used cash of$71.3 million for the three months endedDecember 31, 2019 , and our financing activities provided cash of$43.8 million for the same period. Our operating activities used cash primarily for our investment activities and our financing activities provided cash primarily from net borrowings under the Truist Credit Facility. Our operating activities used cash of$38.6 million for the three months endedDecember 31, 2018 and our financing activities provided cash of$43.7 million for the same period. Our operating activities used cash primarily for our investment activities and our financing activities provided cash primarily from net borrowings under the Truist Credit Facility. Contractual Obligations
A summary of our significant contractual payment obligations at cost as of
Payments due by period (in millions)
Total Less than 1 year 1-3 years 3-5 years >5 years
BNP Credit Facility $ 203.5 $ - $ - $ 203.5 $ -
Truist Credit Facility 330.7 - 38.3 292.4 -
SBA debentures 133.5 - - - 133.5
2024 Notes 86.3 - - 86.3 -
Total debt outstanding (1) 754.0 - 38.3 582.2 133.5
Unfunded investments (2) 36.6 - 6.3 20.4 9.9
Total contractual obligations $ 790.6 $ - $ 44.6 $ 602.6 $ 143.4 (1) The annualized weighted average cost of debt as of
4.1%, exclusive of the fee on the undrawn commitment on the Credit
Facilities, debt issuance costs on the 2024 Notes and upfront fees on SBA
debentures.
(2) Unfunded debt and equity investments are disclosed in the Consolidated
Schedule of Investments and Note 11 of our Consolidated Financial Statements
We have entered into certain contracts under which we have material future commitments. Under our Investment Management Agreement, which was reapproved by our Board of Directors (including a majority of our directors who are not interested persons of us or the Investment Adviser), inFebruary 2020 , PennantPark Investment Advisers serves as our investment adviser.PennantPark Investment , through the Investment Adviser, provides similar services to SBIC Fund II under its investment management agreements with us. SBIC II's investment management agreements does not affect the management or incentive fees that we pay to the Investment Adviser on a consolidated basis. Payments under our Investment Management Agreement in each reporting period are equal to (1) a management fee equal to a percentage of the value of our average adjusted gross assets and (2) an incentive fee based on our performance. Under our Administration Agreement, which was most recently reapproved by our board of directors, including a majority of our directors who are not interested persons of us, inFebruary 2020 , the Administrator furnishes us with office facilities and administrative services necessary to conduct our day-to-day operations.PennantPark Investment , through the Administrator, provides similar services to SBIC II under its administration agreement, which is intended to have no effect on the consolidated administration fee. If requested to provide significant managerial assistance to our portfolio companies, we or the Administrator will be paid an additional amount based on the services provided. Payment under our Administration Agreement is based upon our allocable portion of the Administrator's overhead in performing its obligations under our Administration Agreement, including rent and our allocable portion of the costs of our Chief Compliance Officer, Chief Financial Officer and their respective staffs. 32
-------------------------------------------------------------------------------- If any of our contractual obligations discussed above are terminated, our costs under new agreements that we enter into may increase. In addition, we will likely incur significant time and expense in locating alternative parties to provide the services we expect to receive under our Investment Management Agreement and our Administration Agreement. Any new investment management agreement would also be subject to approval by our stockholders.
Off-Balance-Sheet Arrangements
We currently engage in no off-balance-sheet arrangements other than our funding requirements for the unfunded investments described above.
Distributions In order to be treated as a RIC for federal income tax purposes and to not be subject to corporate-level tax on undistributed income or gains, we are required, under Subchapter M of the Code, to annually distribute dividends forU.S. federal income tax purposes to our stockholders out of the assets legally available for distribution of an amount generally at least equal to 90% of our investment company taxable income, determined without regard to any deduction for dividends paid. Although not required for us to maintain our RIC tax status, in order to preclude the imposition of a 4% nondeductible federal excise tax imposed on RICs, we must distribute dividends forU.S. federal income tax purposes to our stockholders in respect of each calendar year of an amount at least equal to the Excise Tax Avoidance Requirement. In addition, although we may distribute realized net capital gains (i.e., net long-term capital gains in excess of net short-term capital losses), if any, at least annually, out of the assets legally available for such distributions in the manner described above, we have retained and may continue to retain such net capital gains or investment company taxable income, contingent on our ability to be subject to tax as a RIC, in order to provide us with additional liquidity. During the three months endedDecember 31, 2019 , we declared distributions of$0.18 per share, for total distributions of$12.1 million . For the same period in the prior year, we declared distributions of$0.18 per share, respectively, for total distributions of$12.2 million . We monitor available net investment income to determine if a return of capital for tax purposes may occur for the fiscal year. To the extent our taxable earnings fall below the total amount of our distributions for any given fiscal year, stockholders will be notified of the portion of those distributions deemed to be a tax return of capital. Tax characteristics of all distributions will be reported to stockholders subject to information reporting on Form 1099-DIV after the end of each calendar year and in our periodic reports filed with theSEC .
We intend to continue to make quarterly distributions to our stockholders. Our quarterly distributions, if any, are determined by our board of directors.
We maintain an "opt out" dividend reinvestment plan for our common stockholders. As a result, if we declare a distribution, then stockholders' cash distributions will be automatically reinvested in additional shares of our common stock, unless stockholders specifically "opt out" of the dividend reinvestment plan so as to receive cash distributions. We may not be able to achieve operating results that will allow us to make distributions at a specific level or to increase the amount of these distributions from time to time. In addition, we may be limited in our ability to make distributions due to the asset coverage ratio for borrowings applicable to us as a BDC under the 1940 Act and/or due to provisions in future credit facilities. If we do not distribute at least a certain percentage of our income annually, we could suffer adverse tax consequences, including possible loss of our ability to be subject to tax as a RIC. We cannot assure stockholders that they will receive any distributions at a particular level.
Recent Accounting Pronouncements
InAugust 2018 , the FASB issued Accounting Standards Update, or ASU, 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement, or ASU 2018-13, which changed the fair value measurement disclosure requirements of ASC Topic 820, Fair Value Measurements and Disclosures, or ASC 820. The key provisions include new, eliminated and modified disclosure requirements. The new guidance is effective for fiscal years beginning afterDecember 15, 2019 , including interim periods therein. Early application is permitted. The Company has adopted this accounting standard update effectiveOctober 1, 2019 and the impact its of adoption was not material to the Company's financial statements and related disclosures.
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