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9Questions is our Q&A series featuring key decision-makers in leveraged finance — get in touch if you know who we should be talking to!

Art Penn is the founder and managing partner of PennantPark Investment Advisors, a middle-market credit platform that manages $6.1bn of investable capital. Prior to starting his firm, Penn co-founded Apollo Investment Management and served as the global head of leveraged finance at UBS Warburg (now UBS Investment Bank) from 1999 through 2001.

Penn spoke with 9fin about the outlook for healthcare credit in the face of elevated costs and reimbursement risk, MFN loopholes, as well as competition in the growing private credit space.

1. You had a career in leveraged finance, private equity and direct lending for at least three decades before launching PennantPark in 2007 — what inspired you to move and start your own shop?

The two key drivers for making the move to start PennantPark were: 1) the desire to do something entrepreneurial, and 2) the view that there would be a solid position in the market for a firm that was independent and non-conflicted. In other words, a firm that was unaffiliated with a private equity firm, who could be viewed as a potential competitor to the private equity sponsors we finance. 

Additionally, as an independent firm, our private equity sponsors would not need to worry about information flow getting into the wrong hands inside a larger, affiliated platform. Our sponsors and borrowers like their information to be kept confidential.

2. PennantPark has several portfolio companies tied to the healthcare space and sold physical therapy provider Pivot Health Solutions to BDT Capital Partners last February. Investments in the healthcare sector were considered a defensive play in the past, but the industry is now dealing with a slew of headwinds like staff shortages and rising labor costs. How are you viewing this sector currently?

We like healthcare in general and we have a specific way of thinking about healthcare investments we make. First, we always want to be on the side of financing providers who are driving lower costs along with high quality care. If we finance those providers, we don’t have to worry about reimbursement risk, by definition. Second, we like to focus on healthcare services where the capital expenditures are light and there is solid free cash flow conversion. Third, we like to keep leverage low, equity cushion high, and have a set of reasonable covenants that protect our interests while allowing the company to pursue its goals. 

We have had success when those three elements come into play and have been able to find ample deal flow along those lines.

3. Many firms (including more recently, some investment banks) have expanded into middle-market and private credit opportunities since the 2008 recession — at what point can we expect to see some industry consolidation?

There are always new participants coming into the market and we need to assume there always will be. That said, usually the new participants are managed by people who are experienced in the space and are typically rational competitors. 

The good news is that the market has been growing so much that this additional competition is easily absorbed. We are focused on the core middle market, companies with $10 to $50 million of EBITDA, where there’s less competition and we are an important strategic capital provider to the companies. 

As a strategic capital provider, we have the time to do thorough due diligence, negotiate attractive economics, and structure covenants to protect our capital. Additionally, in many cases we co-invest in the equity alongside the sponsor which gives us some of the upside that we are driving with our strategic debt capital.

4. In August 2020, you teamed up with Pantheon to start a senior loan fund. What does this partnership bring to your business that you didn’t have before?

The partnership brings three elements: 1) Additional capital to drive deal flow and provide solutions to our borrowers, 2) Pantheon is a value-added partner who provides their insight to the business and 3) the structure enhances the NII and ROE of one of our BDCs.

5. Recently we’ve heard lots of grumbling lately around super-priority revolvers, MFN protection, and disqualified parties. Are there any recent trends in private credit terms that you are concerned about?

MFNs have been an interesting area for us recently. Borrower behavior in choppy markets can bring out the best and sometimes the worst in behavior, which allows us to see who we want to be partners with in the long run. 

There have been instances where borrowers have found creative loopholes in MFNs to the detriment of the existing lenders, which is certainly not in the spirit of a trusted partnership.

6. Middle-market CLOs are a small but growing part of the broader CLO universe. What risks do you see in this part of the market?

Middle-market CLOs are growing because the track record has been strong over time. The biggest risk is always credit risk and investors should be selective and choose the right managers.

7. How does PennantPark incorporate ESG into investment decisions or managing portfolio companies? 

We have incorporated ESG for many years and have increased our focus over the last few years. We have an ESG committee that regularly meets, have sector specific diligence, and we review each new loan through the ESG lens, including a thorough check list. Additionally, we are a signatory to UNPRI, ILPA and the Partnership of Carbon Accounting Financials.

8. Last year PennantPark moved its headquarters from New York to Miami. Why did you choose Miami and what plans do you have for that office?

Miami is a world class city in every way including culture, restaurants, and the arts. Additionally, it’s a draw for employees and potential employees. We are always open to new hires in our Miami location.

9. Since you’re now headquartered in Miami: where is your favorite place to eat in the city, and why?

Los Fuegos in Miami Beach because it’s delicious Argentinean cuisine. Another perk is how convenient it is to my home.

9Questions — Art Penn, PennantPark

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