Flock Financial, LLC: IIQ 2024 Update

Remains Rated CCR 5 And Important Underperformer

October 2, 2024

We've not written about Flock Financial, LLC before but the financial company has been rated 5 on our 5 point scale and listed as an Important Underperformer since the IQ 2024. Until the IIIQ 2023 all seemed to be going fine but the $33mn at cost subordinated debt held by the company's only BDC lender - PennantPark Investment (PNNT) - was discounted (18%) at the end of last year, triggering a rating of 3. The next quarter's non-accrual brought about a further downgrade to 5.

In the IIQ 2024, a major restructuring occurred. This was spelt out in a May 6, 2024 press release:

Flock Financial, LLC, ("Flock" or the "Company"), a leading financing partner to middle market receivables management and consumer finance companies active in the purchase, sale, and collection of performing and nonperforming receivable assets, announced today that various investment funds affiliated with PennantPark Investment Advisers, LLC ("PennantPark") have invested $25 million in the Company. Flock's existing lenders have also reaffirmed their commitment to the business by providing additional borrowing flexibility and extending maturity.

As part of the transaction, PennantPark retained and added key leadership personnel to manage the strategic and operational efforts of Flock. The executive team leading Flock now includes Damon W. Edmondson as Chief Investment Officer, Greg Paulo as Chief Revenue Officer, and Jeff Shaver as Chief Financial Officer. Flock's founder, Michael Flock, has transitioned to the role of Non-Executive Chairman.

The PennantPark funds now hold a controlling interest. PNNT had this to say about its plans for Flock:

...Once you kind of get that company in a good position, it's a company that we could sell. It's a company that we could hold, it certainly generates a very attractive yield. So first things first, we got to get the company on the right track. We've reconstituted management, brought some ex managers in back into the company, added some board oversight and put some capital into the company so that they can deploy into this attractive market.

At this point, total exposure has increased to $48mn at cost - consisting of $21mn in subordinated debt due in 2027 , with a nominal yield of 14.5%. (We say nominal because the debt is structured as a Pay-In-Kind (PIK) and is also carried as non-performing for the moment. Another $27mn is in the form of preferred, generating no income. Given the debt is non-performing - and despite the fact that PNNT has chosen to value the entire exposure at par - i.e. no discount - we are retaining the CCR 5 rating and the Important Underperformer status.

This is far from resolved, notwithstanding the generous IIQ 2024 self-valuation. PNNT is forgoing ($4.8mn) of interest income that was being received till the end of 2023. If we consider the incremental $15mn of capital as well at a pro-forma yield of - say - 12%, PNNT is out ($6.6mn) of annual income here for some period. For a BDC whose Net Investment Income in all of 2023 was $65mn, this is no small matter. We'll be keeping a close eye on Flock going forward to see if all the high hopes for the business are valid or if this will become more of a money pit.

We've not yet had the time to undertake a full scale credit review of PNNT as of the IIQ 2024. We can report, though, that the number of non-accruals on the books has risen to 3 - including Flock - in this most recent quarter, from 2 in the IQ 2024 and 1 at year-end 2023. At the moment, non-accrual assets account for "4.2% and 2.5% percent of our overall portfolio on a cost and fair value basis, respectively". That's within normal boundaries for a BDC even if the trend is not PNNT's friend of late. There is no self-reported quarterly estimate of the overall value of underperforming assets in PNNT's filings - a service management has chosen not to offer its shareholders.

Our slightly stale estimate of further losses that might come out of the 4 Important Underperformers we've identified comes to ($21mn) - a slightly elevated (4.3%) of the BDC's net book value. However, Flock accounts for more than half the potential loss so much depends on how this bold venture to take over and grow this specialty finance company plays out.