OREANDA-NEWS. Fitch Ratings has affirmed the long-term Issuer Default Rating (IDR), secured debt rating, and unsecured debt rating of PennantPark Investment Corporation (PNNT) at 'BBB-'. The Rating Outlook is Stable.

These actions are being taken in conjunction with a broader industry review, which includes 10 business development companies (BDCs). For more commentary on the broader sector review, please see 'Fitch Takes Several Negative Rating Actions Following BDC Peer Review', available at 'www.fitchratings.com'.

KEY RATING DRIVERS

The rating affirmation reflects PNNT's low leverage, consistent operating performance, moderate investment concentrations, solid asset quality trends, improved funding flexibility and experienced management team.

Rating constraints include PNNT's higher exposure to mezzanine and subordinated debt relative to peers, elevated energy sector exposure, the capital markets impact on leverage given the need to fair value the portfolio each quarter, dependence on the capital markets to fund portfolio growth, and a limited ability to retain capital due to dividend distribution requirements.

The Stable Outlook reflects Fitch's expectations for continued strong net investment income dividend coverage, management of leverage within the stated target range and consistent operating performance. PNNT is expected to seek to deploy portfolio proceeds and revolver capacity into cash-yielding investments with attractive risk-adjusted returns, but improving operating performance remains largely dependent on improving spreads.

Leverage, as measured by total debt to total equity, including Small Business Administration (SBA) debt, increased to 0.76x at Dec. 31, 2014, from 0.64x at Sept. 30, 2014, as PNNT utilized its credit facility to fund a seasonally strong fourth quarter. Although leverage increased modestly, it still remains within management's targeted range of 0.6x-0.8x. Fitch expects PNNT to operate with an appropriate leverage cushion given outsized exposure to energy and the potential for asset quality deterioration across the sector more broadly.

Asset quality trends have remained solid. Since inception in 2007, PNNT has had only nine out of 350 positions go on non-accrual status. At Dec. 31, 2014, there were two investments on non-accrual totaling 1.7% and 1.4% of the portfolio, on a fair value and cost basis, respectively. Fitch believes PNNT's relatively higher exposure to mezzanine and subordinated debt may expose it to heightened asset quality issues, but current asset quality metrics are consistent with peers. However, industry metrics are believed to be at unsustainable levels and deterioration is expected over the medium term. In addition, PNNT has successfully restructured all of its non-accrual positions, and realized an average 88% recovery since inception.

PNNT's investment portfolio is modestly concentrated for the BDC space, with the top 10 positions accounting for 41.6% of assets and 75.4% of equity, as of Dec. 31, 2014. Nonetheless, Fitch expects portfolio concentrations to improve modestly over time with portfolio growth, and as the firm works to reduce exposure to RAM Energy LLC, which was its largest portfolio investment, representing 6.5% of assets, as of Dec. 31, 2014.

Oil and gas investments accounted for 14.4% of the portfolio, as of Dec. 31, 2014, and according to Fitch estimates, the combined energy exposure of 21.4%, was well above the peer average of 10.5%. In fiscal 1Q'15, PNNT recorded \$30.5 million of unrealized depreciation on seven energy-related investments. Further market movements or company-specific challenges could yield incremental valuation hits in coming quarters and eventual credit losses, particularly if oil prices remain at depressed levels.

Fitch recently conducted a stress test on BDC energy exposures and believes PNNT's leverage ratio is among the most vulnerable in the peer group, given its outsized exposure to energy overall, and oil & gas, more specifically. A stress on the overall energy book, based on Sept. 30, 2014 balances, yielded a 4 basis point increase in the leverage ratio, which was already approaching the upper bound of PNNT's stated leverage target. PNNT's energy exposures are primarily invested in first- and second-lien positions, which should be better protected from an asset coverage perspective. Thus, the possibility that all oil and gas investments are worth nothing is extremely remote.

PNNT's core operating performance remains relatively sound, despite the impact of competitive conditions on portfolio yields. Net investment income (NII) grew 8.5% for the first three quarters of 2015, year over year, due largely to 10.9% growth in the size of the portfolio, which drove an increase in interest income.

PNNT's funding flexibility improved markedly, as the firm accessed the unsecured debt markets for the second time in September 2014, issuing \$250 million of five-year, senior notes. The notes pay interest of 4.5% and mature on Oct. 1, 2019. Unsecured debt accounted for 53.7% of total debt at Dec. 31, 2014, an increase from 15.4% at Dec. 31, 2013. Fitch views the issuance and the increase in unsecured funding positively and expects the company to opportunistically access these markets in the future.

PNNT's liquidity profile remains strong with \$54.3 million of balance sheet cash and \$494 million of availability on its secured revolving credit and SBIC II facility, subject to borrowing base requirements, at Dec. 31, 2014. Although net investment income did not fully cover the dividend during the quarter ended Dec. 31, 2014, it was still relatively strong at 92.6%, which is consistent with fiscal year ended Sept. 30, 2014 coverage of 92.7%. The dividend is further supported by the presence of spillover income, which Fitch believes provides further stability to the dividend over the medium term, particularly in an origination environment characterized by tighter spreads. Fitch would view sustained net investment income coverage of current-period dividend declarations favorably.

RATING SENSITIVITIES


Negative rating actions could be driven by an increase in leverage above the targeted range, resulting from material unrealized depreciation, and/or an increase in the proportion of equity holdings without a commensurate decline in leverage. Declines in operating performance, a prolonged increase in non-accrual levels and weaker dividend coverage would also be viewed unfavorably from a ratings perspective. The performance on mezzanine and subordinated investments in an environment where asset quality reversion is expected bears particular monitoring, as does the performance of energy investments especially if oil prices remain at or below current levels.

Although positive rating momentum is unlikely in the near term, positive rating actions could be influenced by consistent operating performance through market cycles, the maintenance of solid asset quality, particularly on 2013-2014 vintages, which were originated in a more competitive environment, lower leverage, an increase in unsecured debt funding, and the improvement and stability of cash earnings coverage of the dividend.

Headquartered in New York, NY, PNNT is an externally managed business development company, formed in 2007 with an objective to generate both current income and capital appreciation through debt and equity investments. As of Dec. 31, 2014, the company had investments in 66 portfolio companies amounting to approximately \$1.3 billion at fair value.

Fitch has affirmed the following ratings:

PennantPark Investment Corporation
--Long-term IDR at 'BBB-';
--Senior secured debt at 'BBB-';
--Senior unsecured debt at 'BBB-'.

The Rating Outlook is Stable.