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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning, and welcome to Prospect Capital's First Quarter Release and Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. Please note that this event is being recorded.
I'd now like to turn the conference over to Mr. John Barry, Chairman and CEO. Please, go ahead.
Thank you very much, Nick. Joining me on the call today are as usual, Grier Eliasek, our President and Chief Operating Officer; and Kristin Van Dask, our Chief Financial Officer.
Thanks, John. This call is the property of Prospect Capital Corporation. Unauthorized use is prohibited. This call contains forward-looking statements within the meaning of the securities laws that are intended to be subject to Safe Harbor protection. Actual outcomes and results could differ materially from those forecasts, due to the impact of many factors. We do not undertake to update our forward-looking statements, unless required by law. For additional disclosure, see our earnings press release and our 10-K filed previously and available on the Investor Relations tab on our website, prospectstreet.com.
Now, I'll turn the call back over to John.
In the September quarter, our net investment income or NII was $57.5 million, or $0.15 per share, as we continue our cautious approach to originations amidst the pandemic. Our net income was $167.7 million, or $0.45 per share, as a combination of positive company-specific and macro factors increased the valuation of our book.
In the September quarter, our net debt-to-equity ratio was 69.8%, down 430 basis points from March and similar to the June quarter, as we continue to run an under leveraged balance sheet, which has been the case for multiple quarters.
Over the past two-and-a-half years, other listed BDCs overall have increased leverage, with a typical list of BDC in September at around 115% debt-to-equity, or about 450 percentage points higher than for Prospect. Prospect has not increased debt leverage instead of electing lower risk from lower debt leverage with a cautious approach given macro dynamics.
In May, we moved our minimum 1940 Act regulatory asset coverage to 150%, equivalent to 200% debt to equity, which increased our regulatory cushion and gave us flexibility to pursue our recently announced junior capital perpetual preferred equity issuance, which counts toward 1940 Act asset coverage, but which also gets significant equity treatment by our rating agencies.
We have no plans to increase our actual drawn debt leverage beyond our historical target of 0.7 to 0.85 debt to equity, and we are currently below such target range. Prospect's balance sheet is highly differentiated from peers with 100% of Prospect's funding coming from unsecured and non-recourse debt, which has been the case for over 13 years.
Unsecured debt was 88.6% of Prospect's total debt in September, compared to about half that for the typical listed BDC. Our unsecured and diversified funding profile provides us with significantly lower risk and significantly more investment strategy and balance sheet flexibility than many of our BDC peers enjoy.
Our NAV stood at $8.40 in September, up $0.20, and 3% from the prior quarter. We have outperformed our peers during the past multiple quarters of macro pressures as a direct result of our previous derisking from not chasing leverage as well as other risk management controls. We are staying true to that strategy, one that has served us well since 1988, controlling and reducing portfolio and balance sheet risk both to protect the capital and trust it to us and to protect the ability of such capital to generate earnings for our shareholders.
We are pleased to report the Board's declaration of continued, steady monthly cash distributions once again. We are announcing monthly cash distributions of $0.06 per share for each of November, December and January. These three months represent the 39th, 40th and 41st in a row, $0.06 distributions, as we close in on the three-and-a-half-year mark for unchanged monthly cash distributions. Consistent with past practice, we plan to announce our next set of shareholder distributions in February.
Our goal over the long-term is to maintain and ideally grow steady monthly cash distributions. As we seek to provide low volatility stability to our shareholders amidst a macro market backdrop that delivers greater volatility elsewhere.
Since our IPO over 16 years ago through January 2021 through our distribution in January 2021 at the current share count, we will have paid out $8.36 per share to original shareholders, aggregating over $3.2 billion in cumulative distributions to all shareholders.
Since October 2017, our NII per share has aggregated $2.34, while our shareholder distributions per share have aggregated $2.16, resulting in our NII exceeding distributions over this period by $0.18 per share.
We are also pleased to announce our first preferred shareholder distributions on the heels of a successful launch of our $1 billion 5.5% preferred program. We are currently focused on multiple initiatives to enhance NII, return on equity and NAV in an accretive fashion, including: first, our recently announced $1 billion targeted perpetual preferred equity program; second, a greater utilization of our cost-efficient revolving credit facility with an incremental cost of approximately 1.3% at today's one-month LIBOR; third, retirement of higher cost liabilities; and fourth, increased originations in senior secured debt and selected equity investments to deliver targeted risk-adjusted yields and total returns as we deploy available capital from our current under-leveraged and under-invested balance sheet.
We believe there is no greater alignment between management and shareholders than for management to purchase a significant amount of stock, particularly when management has purchased stock on the same basis as other shareholders in the open market.
Prospect management is the largest shareholder in Prospect and has never sold a share. Senior management in calendar 2020 has purchased over $140 million of Prospect shares, increasing cumulative purchases to over $540 million. Senior management and employee insider ownership is now over 27% of shares outstanding.
Thank you. I will now turn the call over to my friend, Grier.
Thank you, John. Our scale platform with over $6 billion of assets and undrawn credit continues to deliver solid performance in the current challenging environment. Our experienced team consists of approximately 100 professionals, which represents 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 one.
As of September 2020, our controlled investments at fair value, stood at 42.8% of our portfolio, down 0.4% from the prior quarter. This diversity allows us to source a broad range and high-volume of opportunities, then select in a disciplined, bottoms-up manner, the opportunities we deem to be the most attractive on a risk-adjusted basis.
Our team typically evaluates thousands of opportunities annually and invests in a disciplined manner in 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.
As of September, our portfolio at fair value comprised 45.9% secured first lien, 24.1% other senior secured debt, 13.6% subordinated structured notes with underlying secured first lien collateral, 1.0% unsecured debt and 15.4% equity investments, resulting in a stable 83.6% of our investments being assets with underlying secured debt benefiting from borrower pledged collateral.
Prospect's approach is one that generates attractive risk-adjusted yields. And our performing interest-bearing investments were generating an annualized yield of 11.6% as of September, up 0.2% from the prior quarter. We achieved this increase despite a headwind from the current calendar year decline in LIBOR, though we expect stability now due to our LIBOR floors.
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 September, we held 122 portfolio companies, up one from the prior quarter with a fair value of $5.39 billion, an increase of $154 million from the prior quarter. We also continue to invest in a diversified fashion across many different portfolio company industries with no significant industry concentration. The largest is 15.4%.
As of September, our asset concentration in the energy industry stood at 1.2%, down 0.4% from the prior quarter. Our concentration in the hotel, restaurant and leisure sector stood unchanged at 0.4%, and our concentration in the retail industry stood unchanged at 0%.
Non-accruals as a percentage of total assets stood at approximately 0.7% in September, down 0.2% from the prior quarter. Our weighted average portfolio net leverage stood at 4.40 times EBITDA, down 0.11 from the prior quarter and substantially below our reporting peers. Our weighted average EBITDA per portfolio company stood at $78.5 million in September, an increase from $72 million in the prior quarter.
Originations in the virus muted September quarter aggregated $177 million. We also experienced $145 million of repayments and exits as a validation of our capital preservation objective and sell-down of larger credit exposures, resulting in net originations of $32 million.
During the September quarter, our originations comprised 52.8% real estate, 35.8% agented sponsored debt, 8.5% corporate yield buyouts and 2.9% rated secured structured notes. To-date, we've deployed significant capital in the real estate arena through our private REIT strategy, largely focused on multifamily workforce, stabilized yield acquisitions with attractive 10-plus year financing.
NPRC, our private REIT, has real estate properties that have benefited over the last several years from rising rents, strong occupancy, 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 has exited completely over 30 properties at a more than 20% IRR with an objective to redeploy capital into new property acquisitions, including with repeat property manager relationships. We continue to monitor our rent collection which are holding up well in an environment.
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 attractive risk-adjusted opportunities. As of September, we held $731 million across 39 non-recourse subordinated structured notes investments. These underlying structured credit portfolios comprised around 1,700 loans and a total asset base of around $17 billion.
As of September, the structured credit portfolio experienced a trailing 12-month default rate of 220 basis points, which represents 197 basis points less than the broadly syndicated market default rate of 417 basis points. In the September quarter, this portfolio generated an annualized GAAP yield of 13.6%. As of September, our subordinated structured credit portfolio has generated $1.22 billion in cumulative cash distributions to us, which represents around 88% of our original investment.
Through September, we've also exited 9 investments, totaling $263 million with an average realized IRR of 16.7% and cash-on-cash multiple of 1.48x. Our subordinated
structure credit portfolio consistently highly in majority owned position, such position can enjoy significant benefit compared to minority holding in the same tranche.
In many cases we receive fee rebate because of our majority position. As a majority holder we control the ability to call transaction in our sole discretion in the future and we believe such options can add substantial value to our portfolio.
We have the option of waiting the years to call a transaction in an optimal fashion rather than win loan asset valuations might be temporarily low. These majority investors can refinance liabilities on more advantageous terms. Remove bond baskets and exchange for better terms and debt investors in the deal and extend or reset the investment period to enhance value. We've completed 27 reifies and resets over the last three years.
So far in the current December 2020 quarter, we have booked $89 million in originations and experienced $82 million of repayments for $7 million of net origination. Originations have comprised 64.4% agented-sponsor debt, 19.1% non-agent debt and 14.4% real estate.
Thank you. I'll turn the call over to Krista.
Thank you, Grier. We believe our prudent leverage, diversified access to matched book funding, substantial majority of unencumbered assets weighting 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 23 years into the future.
Today we have zero debt maturing until July 2022 or around two years from now. Our total unfunded eligible commitments to non-controlled portfolio companies totaled approximately $22 million or less than 0.5% of our assets. Our combined balance sheet cash and undrawn revolving credit facility commitments currently stand at approximately $501 million.
We are a leader and innovator in our marketplace. We were the first company in our industry to issue a convertible bond, development notes program, issue under a bond ATM, acquire another BDC and many other lists of firsts. Now we've added our programmatic perpetual preferred issuance to that list of first. Shareholders and unsecured creditors alike should appreciate the thoughtful approach differentiated in our industry, which we have been toward construction of the right-hand side of our balance sheet.
As of September 2020, we held approximately $3.91 billion of our assets as unencumbered assets, representing approximately 72% of our portfolio. The remaining assets are pledged to prospect capital funding, where in September 2019, we completed an extension of our revolver to a refreshed five-year maturity. We currently have $1.0775 billion of commitments from 30 banks with a $1.5 billion total size accordion feature at our option. The facility revolves until September 2023, followed by a year of amortization with interest distributions continued -- continuing to be allowed to us.
Of our floating rate assets, 83.5% have LIBOR floors with a weighted average LIBOR floor of 1.66%. Outside of our revolver and benefiting from our unencumbered assets, we have 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 defaults with our revolver. We enjoy an investment-grade BBB negative rating from S&P, an investment-grade BAA 3 rating from Moody's, an investment-grade BBB negative rating from Kroll and an investment-grade BBB rating from Egan Jones, with all of these recently reaffirmed.
We have now tapped the unsecured term debt market on multiple occasions to ladder our maturities and to extend our liability duration out 23 years. Our debt maturities extend through 2043. With so many banks and debt investors across so many debt tranches, we have substantially reduced our counterparty risk over the years.
In the September 2020 quarter, we completed a successful tender offering for our July 2022 notes, retiring around $29 million and then just after quarter end, retired through a tender process another $6 million of such notes. Thereby taking that tranche down to $222 million and substituting more expensive 5% term debt with significantly lower cost revolving credit with an incremental 1.3% cost. We also have continued with our weekly programmatic internotes issuance.
In the first half of calendar year 2016 during market volatility, we reduced our leverage ratio by slowing originations and allowing repayments and exits to come in during the ordinary course, and we expect a similar benefit in the current dynamic environment. We now have seven separate unsecured debt issuances aggregating $1.2 billion, not including our program notes, with maturities extending to June 2029.
As of September 2020, we had $718 million of program notes outstanding with staggered maturities through October 2043. We also recently 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. Please 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 the same from your broker.
Now I will turn the call back over to John.
Thank you, Kristin. I hope you've enjoyed your 12th anniversary with us, getting this 10-Q out. Hello?
Thank you, John.
Okay. I thought I might have been cut off. Okay. So now we can take questions.
Now, we will begin the question-and-answer session [Operator Instructions] First question comes from Finian O'Shea of Wells Fargo Securities. Please go ahead.
Hi, everyone. Thanks for having me on. First question on the CLOs, I think, Grier, you talked a little bit about maybe calling some deals. Given the cash return has come down a little bit, is that something you're more actively thinking about turning over the CLO portfolio?
Hi. Thank you for your question, Finian. I talked about the optionality to call deals. In terms of actually calling deals in the current environment, I see that as somewhat unlikely compared to other potential options we've been selectively refinancing tranches, for example, which again is another benefit of the position that we hold.
For example, certain of our deals had fixed rate tranches as opposed to floating rate. And of course, in the current low interest rate environment compared to prior years for the modest cost upfront of such a refinancing at extremely high internal rate of return investment attached to it, triple-digit in many cases, quadruple digit IRR.
So we’ve been pursuing that type of optimization. In general, our CLO book, these deals, in my opinion, worked as advertised in the sense that when you have a dislocation in the marketplace like what we saw with a spike in default and stress created, especially in certain industry segments from the virus, you did have a selected number of deals that tripped their overcollateralization tests and had a diversion of cash flows away from the equity tranche that we hold, but these are -- they worked as advertised, I said, because these are self-feeling vehicles where then the deals get on size again. And cash flows get restored to said equity tranche without any foreclosure, any problems that created by simply borrowing a loan or even a bond. And we think the September quarter was a navier from such a diversion standpoint, and we've already seen improvement since then.
So far in October, for example, the cash distributions have exceeded expectations, in many cases, by 10% and 20% from what had been previously modeled. And we've seen an increase in our GAAP yields and, of course, expected cash yields based on diversion ceasing and cash flows coming in better than expected. So we're happy with how the deals have worked out, again, as advertised. And we continue, as I mentioned in the prepared remarks, to outperform the industry with a default rate of only about half of the overall market.
Okay. That's helpful. And then just one more on the preferred stock issuance. I know this was launched in the quarter, just I think, more recently getting off the ground, correct me if I'm wrong. But just an update on how that program is going, how it's being received in the market so far?
Absolutely. We're very excited about this program, adding to our many list of first, as a leader in the business development industry. And this is a significant benefit from a 150% election from a few months ago. We view this as an accretive and ratings neutral driver for our business. It's a programmatic type of offering in which we expect to raise this $1 billion of capital in an accretive fashion over a multi-year period, which is fine because that allows for much like with our programmatic debt issuance that we do through in capital today.
We, just-in-time capital that comes into to fund our capital needs and originations and transactions that we're doing in the marketplace, and obviously, this would enhance and grow our balance sheet. It also provides another capital source for us that isn't as dependent on the more volatile traded capital markets that highly beneficial when you go through bouts of volatility. It's nice to have a valve that's turned to on where capital is flowing in that we can then utilize to fund deals. I think everybody in the credit space wish they could go back to March and buy everything they can. Some of those discounts were quite fleeting indeed.
So the process as is typical for a non-traded programmatic issuance as you go through a period of materials preparation, third-party due diligence report generation, selling agreement, signing and then you get capital raises that start. We've had a modest influx of capital to date, but we're really, I would say, laid the groundwork in the last several weeks with some excellent work done by our team and our distributor, preferred capital securities, that then puts us in a position to start bringing in greater capital.
So I hope you'll see increases here in the December quarter with more of a significant impact from an accretion and number standpoint in calendar year 2021. Is that helpful, Finian?
Very much so. And that's all for me. Thank you.
Thank you. Next question is from Robert Dodd of Raymond James. Please go ahead.
…you said that the target leverage for the overall business would remain debt to equity, 0.7 to 0.85. I mean, can you clarify, with this preferred would be treated as equity in that calculation? And if that's the case, do you have a target regulatory leverage that you'd like to get to separate from -- because obviously, to your point, the preferred cancers as debt in the regulatory leverage calculation, but it's treated differently for rating agencies. So could you clarify that for us?
Sure, Robert. The first part of your speaking got cut off, but I think you were asking about whether or not the preferred is part of the 0.7, 0.85 leverage that was quoted and where we would get to after giving effect to the preferred. So the preferred is not part of the 0.7 to 0.85. It's not a substitute for historical drawn leverage. But in addition to, in a ratings neutral -- from a ratings neutral standpoint, because it is a perpetual instrument where there's not a cash drain requirement. So this is attractive from a risk management and liquidity standpoint for our business as well.
If you take the $1 billion of target issuance and then assume that in full, Robert, it would add about, call it, 0.3 to a prefer to comment. So 0.3 on top of the -- wherever we are on the debt side of 0.7 to 0.85 that's approximately where we would end up.
Got it. Got it. Very helpful. Thank you. Just one more on dividend income in the quarter, obviously, not that I want to necessarily focus on one portfolio company, but Valley Electric has historically been a dividend payer for you. This quarter, it didn't pay a dividend, but the equity got marked up. So can you give us any color on why no dividend from that source? And what the prospects are dividend income from that source or some other portfolio companies to return maybe in the latter part of this year or more likely next calendar year? Can you give us any color there?
Sure. I mean, in general, we have, over the years, I would say, transition a bit more from a dividend distribution strategy where we hold deeper into the capital structure and have greater equity and economic ownership of businesses that we've looked for income drivers, more through what we hold on the debt side as opposed to equity. Valley has been a strong contributor over the years.
For those that may not be aware, this is an infrastructure services provider in the Pacific Northwest in particular, Washington state that's involved in both corporate as well as governmental and institutional installations. There's quite the tech boom that continues in Seattle and surrounding areas and Valley is a beneficiary of that growth and has grown substantially over the years of our ownership in conjunction with management, which has done a terrific job as well.
Dividend income can be episodic and -- and not quite as recurring as one might like, which is a reason for having a preference for it in prioritizing the debt side of the equation, because equity distributions as you might and probably know are capped at whatever tax based earnings and profits are for a particular portfolio company. And you can have other -- in many cases, not the economic factors that can change the tax characteristics of a particular business. Sometimes it's just timing related aspect as well.
So we're happy with how Valley is doing from a valuation standpoint. There are many factors that go into the value of a business. Part of it is company-specific for how a business is performing. Part of it is macro specific in terms of overall interest rates and multiples, and credit spreads, and risk on and risk off, and other drivers. And in general, I think you've seen in our book, and of course, many other portfolios out there in the September quarter, in general, a macro uptick just about every -- well, every business segment within our book, whether you're talking about corporate credit, control deals, non-controlled deals, structured credit, real estate, the small online lending book do we hold, every single line of business was up this quarter. And the vast, vast bulk of the company as well were up this quarter as well.
So, in general, an uptick in the market and some factors, you have a little bit more control over in terms of helping to drive individual company performance versus other factors. But -- so we're always measured in that and take a long-term view, Robert. Is that helpful…?
That is helpful. And it actually ties into kind of the next question. I mean, historically, my last question, for -- historically, you've relied more control investments haven't recently made a lot of incremental new control investments is -- given that the status of the market and companies that are out there in the M&A markets rebanding, et cetera. But would you expect over, say, the next 18 months to get your control book as a percent of, say, the overall book to grow or decline in size or stay the same? I mean any appetite for increasing the control exposure right now?
Well, it's an interesting and highly relevant question, Robert, because that the discussion and debate we have frequently. As you can imagine, as a dividend payer, as a company focused squarely on principal protection, downside protection and primarily a lender, we are simply focused on that preservation of capital.
At the same time, when you're in the par lending business, absent special dislocated period where you can buy assets at discounts, in general, a par lender has one direction to go down through default. So it's nice to have offsetting equity upside to compensate, hopefully more than compensate for what might happen on straight lending side of things. We have seen that primarily in our business and where we've been driving that upside through our real estate business, which is in equity, in any cases, preferred equity with upside type of business because we have first lost subordination by a third-party property management team. But we get ups from that, and that's how we've delivered north of 20% internal rates of return on more than 30 exits.
But we have had a very active discussion on the corporate side of things because we've had nice successes there. It's been a frothy market, of course, for M&A. The multiple that we desire to pay and seek to pay, in general, tend to be lower than where deals clear the market, because we're trying to find yields and structure deals where we have both downside protection and upside and generate an attractive current yield.
So we're trying to balance the short-term, medium-term and long-term, at the same time and only a small percentage of deals will pass muster. You've seen an increase in size in our portfolio companies and we're up to, I think, a record level of $79 million of average EBITDA in general and credit bigger is better.
But we are selectively looking at smaller companies than that where we could potentially be a one-stop buyer as we've done historically, at a low multiple of cash flow leading with the debt instrument, also holding equity, ideally not all of the equity, but having a significant ownership of the management team as well for good alignment. And that is an active part of our business, Robert. I would just say it's episodic. You don't know when you're going to connect on a deal, but we have a lot of dry powder at the moment. And particularly when you have markets that get seized up in volatile time periods.
So I mean here in 2020, there was a relatively rapid healing on the lender side, mainly because the credit markets and capital markets recovered swiftly. Otherwise, you saw a lot of folks that simply stop doing deals. This is another period like that, and it's just a question of when, not if and a pullback, then sponsors won't be able to get their deals financed and the power of the one-stop becomes much stronger and the connectivity connect rate, if you will, of our deals and our capital is likely to go up. So it's hard to predict, to answer question, will be higher, will be lower 18 months from now? Not really sure. It kind of depends on market conditions, what we find.
We've got a pretty attractive pipeline right now of deals of real estate is active right now. We've got some corporate control deals in the pipeline right now. And I'm talking new platforms and not just add-ons to existing companies, which have been another, of course, driver for us over the years. So it's a vibrant and very much active part of our business, Robert, and I appreciate the question.
Okay. Thank you.
John, anything you would add to that?
No. I think you said everything that there was to be said. Thank you.
This concludes our question-and-answer session. Now I'd like to turn the conference back over to Mr. John Barry for closing remarks.
Okay. Thank you, everyone. Have a wonderful afternoon. Bye now.
Thanks all.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.