Prospect Capital Corporation (PSEC) Q3 2023 Earnings Call Transcript


Good morning and welcome to Prospect Capital Third Quarter Fiscal Year 2023 Earnings Release and Conference Call. [Operator Instructions] Please note, this event is being recorded.

I would now like to turn the conference over to John Barry, Chairman and CEO. Please go ahead.

John Barry

Thank you, Jordan.

Joining me on the call today are Grier Eliasek, our President and Chief Operating Officer; and Kristin Van Dask, our Chief Financial Officer. Kristin?

Kristin Van Dask

Thank you, John.

This call is the property of Prospect. Unauthorized use is prohibited. This call contains forward-looking statements that are intended to be subject to Safe Harbor protection. Actual developments and results are highly likely to vary materially, and we do not undertake to update our forward-looking statements unless required by law. For additional disclosure, see our earnings press release and 10-Q filed previously and available on our website,

Now I’ll turn the call back over to John.

John Barry

Thank you, Kristin.

In the March quarter, our net investment income, or NII was $102.2 million, or basic NII of $0.21 per common share exceeding our distribution rate per common share by $0.03. Our basic NII coverage of our common distribution is now 117%. Our annualized basic NII yield is 8.9% on a book basis and 13.2% based on our May 8 stock price close.

Prospect’s 92.1% interest income, as a percent of total investment income in March 2023, was at the highest level since September 2020 demonstrating Prospect’s strong recurring revenue model. Our basic net income, net loss applicable to common shareholders, was $108.9 million or $0.27 per common share.

Our NAV stood at $9.48 per common share in March, down $0.46 and 4.6% from the prior quarter, largely due to unrealized mark-to-market depreciation. Since inception in 2004, Prospect has invested $20 billion across 414 investments exiting 278 of those investments.

On the cash shareholder distribution front, we are pleased to report the Board’s declaration of continued steady monthly distributions. We are announcing monthly cash common shareholder distributions of $0.06 per share for each of May, June, July and August. These four months represent the 69, 70, 71 & 72nd consecutive $0.06 per share cash distributions.

Consistent with past practice, we plan on announcing our next set of shareholder distributions in August. Since our IPO 19 years ago through our August 2023 distribution at the current share count, we will have paid $20.28 per common share to original shareholders, representing 2.1x March common NAV, and aggregating over 3.96 billion in cumulative distributions to all common shareholders.

Since October 2017, our NII per common share was preferred dividends has aggregated $4.40, while our common shareholder distributions per common share have aggregated $3.96, with our NII exceeding distributions during this period, by $0.44 per common share, $166 million of excess NII representing 111% coverage.

We’re also pleased to announce continued preferred shareholder distributions following successful launches of our $2 billion non-traded preferred programs, and $150 million listed preferred. We’ve raised over 1.5 billion in preferred stock to-date with strong support from institutional investors, RIAs and broker dealers, including the addition of two top five size independent broker dealer systems, as well as top warehouses and regional broker dealer systems.

Thank you, I will now turn the call over to Grier.

Grier Eliasek

Thank you, John.

Our scale platform with over 8.4 billion of assets and undrawn credit at Prospect Capital Corporation continues to deliver solid performance in the current dynamic environment. Our experienced team consists of over 100 professionals, representing one of the largest middle market investment groups in the industry. With our scale, longevity, experience and deep bench, we continue to focus on a diversified investment strategy that spans third-party private equity sponsor related lending, direct non-sponsor lending, Prospect sponsored operating and financial buyouts, structured credit and real estate yield investing.

Consistent with past cycles, we expect during the next downturn to see an increase in secondary opportunities coupled with wider spread primary opportunities, with a pullback from other investment groups, particularly highly leveraged ones. Unlike many other groups, we have maintained and continued to maintain significant dry powder and low leverage that we expect will enable us to capitalize on such attractive opportunities as they arise. This diversity of origination approaches allows us to source a broad range and high volume of opportunities, then select in a disciplined bottoms up manner the opportunities we deemed to be the most attractive on a risk adjusted basis.

Our team typically evaluates 1000s of opportunities annually and invest in a disciplined manner and a low single-digit percentage of such opportunities. Our non-bank structure gives us the flexibility to invest in multiple levels of the corporate capital stack, with a preference for secured lending and senior loans. Consistent with our investment strategy, our secured lending and first lien mix has continued to increase. As of March our portfolio at fair value comprised 54.4% first lien debt up 1.4% from the prior quarter, 17.6% second lien debt down 0.9% from the prior quarter, 9.2% subordinated structured notes with underlying secured first lien collateral, up 0.2% from the prior quarter, and 18.8% unsecured debt and equity investments down 0.7% from the prior quarter, resulting in 81.2% of our investments being assets with underlying secured debt, benefiting from borrower pledge collateral. That’s up point 7% from the prior quarter.

Prospect’s approach is one that generates attractive risk adjusted yields and are performing interest bearing investments, were generating an annualized yield of 13.4% as of March, an increase of 0.5 percentage points from the prior quarter, as we continue to benefit from increases in short-term rates. We also hold equity positions in certain investments that can act as yield enhancers or capital gains contributors as such positions generate distributions.

We’ve continued to prioritize senior and secured debt with our originations to protect against downside risk, while still achieving above market yields through credit selection discipline, and a differentiated origination approach.

As of March, we held 127 portfolio companies, down three from the prior quarter with a fair value of 7.6 billion, a decrease of approximately 178 million. We also continued to invest in a diversified fashion across many different portfolio company industries, with a preference for avoiding cyclicality, it was no significant industry concentration, the largest is 18%.

As of March our asset concentration in the energy industry stood at 1.7%, Hotel Restaurant leisure sector 0.3% and retail 0.4%. Non-accruals as a percentage of total assets stood at approximately 0.2% in March 2023 down 0.3% from the prior quarter and down 0.7% from June of 2020. Our weighted average middle market portfolio net leverage stood at 5.3x EBITDA, which is substantially below our reporting peers. Our weighted average EBITDA per portfolio company stood at 114 million.

Originations in the March quarter aggregated 92 million. We also experienced 114 million of repayments and exits as a validation of our capital preservation objective, resulting in net repayments of 22 million, as we continue to take cautious a cautious approach toward new credit underwriting given macroeconomic conditions.

During the March quarter, our originations comprised 42.8% middle market lending and buyouts. 30.4% real estate and 26.1% middle market lending. Today, we’ve deployed significant capital in the real estate arena through our private REIT strategy, largely focused on multifamily workforce stabilized yield acquisitions and in the past year an expansion into senior living.

With attractive in place five to 12-year financing. To date we’ve acquired 3.8 billion in 105 properties across multifamily, 81 properties student housing, eight properties self-storage, 12 properties, and senior living 4 properties. In the current higher financing cost environment, we’re focusing on preferred structures with significant third-party capital support underneath our investment attachment points.

NPRC, our private REIT, has real estate properties that have benefited over the last several years and more recently from rising rents showing the inflation hedge nature of this business segment. Strong occupancies, high collections, suburban work from home dynamics, high returning value-added renovation programs, and attractive financing recapitalizations resulting in an increase in cash yields as a validation of this income growth business alongside our corporate credit businesses.

NPRC as of March and not including partially exited deals where we have received back more than our capital invested from distributions and recapitalizations as exited completely 45 properties, at an average net realized IRR to NPRC of 25.2%. And an average realized cash multiple of invested capital of 2.5x, with an objective to redeploy capital into new property acquisitions, including with repeat property manager relationships.

Our structured credit business has delivered attractive cash yields, demonstrating the benefits of pursuing majority stakes, working with world-class management teams providing strong collateral underwriting through primary issuance, and focusing on favorable risk adjusted opportunities.

As of March, we held 698 million across 35 non-recourse subordinated structured notes investments. We maintained a relatively static size for our subordinated structured notes portfolio on a dollar basis electing to grow our other investment strategies and resulting in a structured notes portfolio now comprising less than 10% of our investment portfolio. These underlying structured credit portfolios comprised more than 1600 loans.

In the March quarter, this portfolio generated a gap yield of 13.8%, down 1.1% from the prior quarter. As of March, our current subordinated structured credit portfolio has generated 1.43 billion in cumulative cash distributions to us, representing around 110% of our original investment. Through March, we’ve also exited 13 investments, with an average realized IRR of 13.7% in cash-on-cash multiple of 1.39x. Our subordinates structured credit portfolio consists entirely of majority owned positions. Such positions can enjoy significant benefits compared to minority holdings in the same tranche.

In many cases, we received fee rebates because of our majority position. As majority holder, we control the ability to call a transaction in our sole discretion in the future. And we believe such options add substantial value to our portfolio. We have the option of waiting years to call a transaction in an optimal fashion, rather than when loan asset valuations might be temporarily low. We as majority investor can refinance liabilities on more advantageous terms, remove bond baskets in exchange for better terms from debt investors in the deal and extend or reset the investment period to enhance value. We’ve completed 32 of these refinancings and resets since December of 2017.

So far in the current June 2023 quarter across our overall business, we booked 136 million in originations and experienced 27 million of repayments for 109 million of net originations. Our originations have consisted of 51.5% middle market lending, 34.5% real estate, and 14%, middle market lending and buyouts.

Thank you. I’ll now turn the call over to Kristin. Kristin?

Kristin Van Dask

Thanks, Grier.

We believe our prudent leverage diversified access to match book funding substantial majority of unencumbered assets waiting toward unsecured fixed rate debt, avoidance of unfunded asset commitments, and lack of near-term maturities demonstrate both balance sheet strength as well as substantial liquidity to capitalize on attractive opportunities.

Our company has locked in a ladder of liabilities extending 29 years into the future. Our total unfunded eligible commitments to non-control portfolio companies totaled approximately 53 million, representing approximately 0.7% of our assets. Our combined balance sheet cash and undrawn revolving credit facility commitments currently stand at approximately 864 million.

We are a leader and innovator in our marketplace. We were the first company in our industry to issue a convertible bond, develop a notes program, issue under a bond and equity ATM, acquire another BDC and many other lists of firsts.

In 2020, we also added our programmatic perpetual preferred issuance to that list of first followed in 2021 by our listed perpetual preferred as another first in the industry. Shareholders and unsecured creditors alike should appreciate the thoughtful approach differentiated in our industry, which we have taken toward construction of the right-hand side of the balance sheet.

As of March 2023, we held over 5.1 billion of our assets as unencumbered assets, representing over 66% of our portfolio. The remaining assets are pledged to Prospect capital funding, a non-recourse SPV were in September 2022, we completed an upsizing, an extension of our revolver to a refreshed five-year maturity. We currently have 1.78 billion of commitments from 51 banks, an increase of nine lenders from August 2022 and demonstrating strong support of our company from the lender community with the diversity unmatched by any other company in our industry.

Shortly after the well-publicized bank failures in March, we added two new banks and upsized an existing bank within our credit facility. That facility revolved until September 2026, followed by a year of amortization, with interest distributions continuing to be allowed to us. Our drawn pricing is now SOFR plus 2.05%. Of our floating rate assets 94% have LIBOR or SOFR floors with a weighted average floor of 1.21%. Short-term rates have now exceeded these floors, giving us the benefit of increased asset yields from Fed rate hikes.

Outside of our revolver and benefiting from our unencumbered assets, we’ve issued at Prospect Capital Corporation, including in the past few years, multiple types of investment grade unsecured debt, including convertible bonds, institutional bonds, baby bonds, and program notes. All of these types of unsecured debt have no financial covenants, no asset restrictions, and no cross default with our revolver.

We enjoy an investment grade BBB minus rating from S&P, an investment grade BAA three rating from Moody’s, an investment grade BBB minus rating from Kroll, an investment grade BBB rating from Egan-Jones, and an investment grade BBB low rating from DBRS.

In 2021, we received the ladder investment-grade rating, taking us to five investment grade ratings, more than any other company in our industry. All of these ratings have stable outlooks.

We’ve now tapped the unsecured term debt market on multiple occasions to ladder our maturities and to extend our liability duration out 29 years. Our debt maturities extend through 2052. With so many banks and debt investors across so many unsecured and non-recourse debt tranches, we’ve substantially reduced our counterparty risk over the years.

In the March 2023 quarter, we have continued utilizing our low-cost revolving credit with an incremental 6.71% cost. We also have continued with our weekly programmatic InterNotes issuance on an efficient funding basis. To date, we have raised over 1.5 billion in aggregate issuance of our perpetual preferred stock across our preferred programs and listed preferred, including 138 million in the March 2023 quarter and 53 million to date in the current June 2023 quarter. With the ability potentially to upsize such programs based on significant balance sheet capacity.

We now have five separate unsecured debt issuances aggregating 1.2 billion, not including our program notes, with maturities extending through October 2028. As of March 2023, we had 355 million of program notes outstanding with staggered maturities through March 2052.

At March 31, 2023, our weighted average cost of unsecured debt financing was 4.07% a decrease of 0.26% from December 31, 2022 and a decrease of 0.28% from March 31, 2022.

In 2020, we added a shareholder loyalty benefit to our dividend reinvestment plan, or DRIP that allows for a 5% discount to the market price for DRIP participants. As many brokerage firms either do not make DRIPs automatic or have their own synthetic DRIPs with no such 5% discount benefit. We encourage any shareholder interested in DRIP participation to contact your broker. Make sure to specify you wish to participate in the Prospect Capital Corporation DRIP plan through DTC at a 5% discount and obtain confirmation of same from your broker. Our preferred holders can also elect to DRIP at a price per share of $25.

Now I’ll turn the call back over to John.

John Barry

Thank you. We can now take any question.

Question-and-Answer Session


[Operator Instructions]. Our first question comes from Sean Adams with Raymond James. Please go ahead.

Sean Adams

My only question is, do you guys have any realized gains in the pipeline, such as about incremental earnings for the quarters looking forward?

John Barry

Hey, Grier, why don’t you take that?

Grier Eliasek

Sure. Well, realized gain would be based in the future — on a future — a realization hasn’t happened yet. So if we’re quote in the pipeline, it would already have an executed agreement with maybe a closing, pending same. Not aware of any in that category right now, but over the years in our equity-oriented book, we call middle market lending and buyouts. Our realizations have generated around a mid-30s percent IRR across all of our capital that includes debt as well as equity.

And then, within our real estate business, although the flows work a little bit differently, coming back to Prospect Capital Corporation. But within NPRC those IRRs is just discussed in our prepared remarks have been in the mid-20s.

So we’ve actually over the last year or two been spending more time prioritizing deals, they tend to be a little bit smaller than our average portfolio company with an EBITDA of over 110 million. So more than middle market or even lower middle market, we’ve been evaluating equity linked deals, we can purchase equity, not necessarily majority equity, but also minority equity [Luxaire] [ph] and RK Logistics are two deals that come to mind that we’ve closed in the last year and a half.

We’ve also been active with add-on acquisitions for our platform deals in that particular segment of our portfolio. It’s been a frothy M&A market, as we know for quite some time. Until recently, and many buyers are previously competing buyers are sitting more on their hands hesitant to act or have financing costs that are perhaps prohibitively expensive, because we bring our own financing to bear with these investments. We have a bit more flexibility and in general would expect that sort of one stop buyout, or equity linked business to have more not fewer opportunities, when markets get more seized up in their economic downturns et cetera.

So we think the future is promising at particular segment but again we’re prioritizing but nothing imminent, I would say comes to mind for realization. Anything to add to that John?

John Barry

Well, I have nothing to add. So how about the next question?


There are no more questions at this time. This concludes the question-and-answer session. I would like to turn the conference back over to John Barry for closing remarks.

John Barry

Okay. Thank you, everyone. Have a wonderful day. Bye now.

Grier Eliasek

Thank you all. Bye.


The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.