Prospect Capital Corp
NASDAQ:PSEC
Earnings Call Analysis
Q1-2024 Analysis
Prospect Capital Corp
In a display of stable performance, the company reported net investment income (NII) of $125.6 million, translating to $0.25 per share, a figure that comfortably exceeds its distribution rate per share by $0.07. This robust NII has led to an impressive 139% coverage of the company's common distribution. The company also takes pride in its cautious yet rewarding investment strategy, which has resulted in outperforming peers during times of economic volatility. This is attributed to their conservative approach, including maintaining a lower net debt-to-equity ratio which stood at 46.5%, a decrease from both March 2020 and June 2023. This underleveraged balance sheet signals a strong financial position that could protect investors against market downturns.
Investors might find assurance in the company's consistency in cash distributions, with a record of 77 monthly payments at $0.06 per share. The portfolio construction continues to evolve, with first-lien debt now representing 57.3% of their portfolio value, indicating a higher preference for secured lending. This alignment with secured lending suggests that the company is putting an emphasis on capital preservation, potentially hedging against future market downturns and providing some degree of protection for investors' capital.
The business has remained discerning in its investment choices, only investing in a small fraction of the numerous opportunities evaluated annually. This disciplined approach is perhaps why their average portfolio company exhibits robust financials, with net leverage considerably below that of peers and substantial average EBITDA. The company's prudence is further underscored by a cautious stance on new credit underwriting in light of uncertain macroeconomic conditions, illustrated by net repayments of $170 million in the September quarter.
The company's investment emphasis has seen a gradual shift, with a particular focus on real estate and structured notes that comprise a significant portion of the portfolio. Significantly, its subordinated structured credit portfolio, representing 8% of total investments, has generated attractive yields and remarkable cumulative cash distributions. The company also highlighted its ability to refinance and reset transactions thanks to controlling stakes in the portfolio, which could enhance shareholder value over the long term.
The company boasts a strong balance sheet with significant liquidity, with a diverse funding base that extends liabilities for up to 29 years, negating near-term maturity risks. With most assets unencumbered, it evidences a strategic effort to maintain balance sheet strength and flexibility. They also highlighted their innovation in financial markets, reflected in their pioneering issuance of various debt instruments and receipt of industry-leading investment-grade ratings with stable outlooks. Such financial prudence and forward-thinking could instill confidence in both present and potential investors.
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Hello, and welcome to the Prospect Capital First Quarter Fiscal Year 2024 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.
Thank you, MJ. Joining me on the call today are Grier Eliasek, our President and COO; and Kristin Van Dask, our Chief Financial Officer. Kristin?
Thanks, John. This call contains forward-looking statements that are not intended to be subject to safe harbor protection. Future results are highly likely to vary materially. We do not undertake to update our forward-looking statements. For additional disclosure, see our earnings press release and 10-Q filed previously and available on our website, prospectstreet.com.
Now I'll turn the call back over to John.
Thank you, Kristin. In the September quarter, our net investment income, or NII, was $125.6 million, or basic NII of $0.25 per common share, exceeding our distribution rate per common share by $0.07. Our basic NII coverage of our common distribution is now 139%. Our annualized basic NII yield is 10.8% on a book basis and 18.7% based on our November 7 stock price close. Our NAV stood at $9.25 per common share in September, up $0.01 or 0.1% from the prior quarter.
Since inception in 2004, Prospect has invested $20.4 billion across 419 investments, exiting 283 of these investments. We have outperformed our peers during past periods of macro volatility as a direct result of our previous derisking, not chasing leverage, as well as other risk management controls, including avoidance of cyclical industries and utilization of longer-dated and unsecured flexible financing.
We are staying true to the strategy that has served us well since 1988: controlling and reducing portfolio and balance sheet risk both to protect the capital entrusted to us and to protect the ability of such capital to generate earnings for our shareholders.
In the September quarter, our net debt-to-equity ratio was 46.5%, down 27.6 percentage points from March 2020 and down 2.3 percentage points from the June 2023 quarter, as we continue to run an underleveraged balance sheet, which has been the case for us over multiple quarters and years.
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 November, December and January. These 3 months represent the 75th, 76th and 77th consecutive $0.06 per share cash distributions. Consistent with past practice, we plan on announcing our next set of shareholder distributions in February.
Since our IPO nearly 20 years ago to January 2024 distribution at the current share count, we will have distributed $20.58 per common share to original shareholders, representing 2.2x September common NAV per share, and aggregating over $4.10 billion in cumulative distributions to all common shareholders.
Since October 2017, our NII per common share, less preferred dividends, has aggregated $4.89, while our common shareholder distributions per common share have aggregated $4.32, with our NII exceeding distributions during this period by $0.57 per share and representing 113% coverage.
I will now turn the call over to Grier.
Thank you, John. Our scale platform with nearly $9 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 120 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 balance sheet flexibility 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 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 nonbank 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 September 2023, our portfolio at fair value comprised 57.3% first-lien debt, that's up 0.8% from the prior quarter; 15.9% second-lien debt, that's down 0.5% from the prior quarter; 8.1% subordinated structured notes with underlying secured first-lien collateral, that's down 0.5% from the prior quarter; and 18.7% unsecured debt and equity investments, up 0.2% from the prior quarter. Resulting in 81.3% of our investments being assets with underlying secured debt benefiting from borrower pledged collateral, down 0.2% from the prior quarter.
Prospect's approach is one that generates attractive risk-adjusted yields. And our performing interest-bearing investments were generating an annualized yield of 12.7% as of September 2023. 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 2023, we held 128 portfolio companies, a decrease of 2 from the prior quarter, with a fair value of $7.7 billion, an increase of approximately $12 million. We also continue to invest in a diversified fashion across many different portfolio company industries with a preference for avoiding cyclicality and with no significant industry concentration. The largest is 18.2%. As of September, our asset concentration in the energy industry stood at 1.6%; for hotels, restaurant and leisure sector 0.3%; and retail industry 0.3%. Nonaccruals as a percentage of total assets stood at approximately 0.2% in September of 2023, that's down 0.9% from the prior quarter.
Our weighted average middle market portfolio net leverage stood at 5.3x EBITDA, substantially below reporting peers. Our weighted average EBITDA per portfolio company stood at $111 million. Originations in the September quarter aggregated $131 million. We also experienced $301 million of repayments, sales and exits, as a validation of our capital preservation objective, resulting in net repayments of $170 million, as we continue to take a cautious approach toward new credit underwriting given macroeconomic conditions.
During the September quarter, our originations comprised 48.5% real estate, 40.6% middle market lending, and 10.9% middle market lending and buyouts. 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, and in the past year, expansion into senior living, with attractive in-place 5- to 12-year financing. To date, on a cumulative basis, we've acquired $3.8 billion in 105 properties across multifamily 81 properties, student housing 8 properties, self-storage 12 properties, and senior living 4 properties.
In the current higher financing cost environment, we're focusing on preferred equity 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 September, and not including partially exited deals where we have received back more than our capital invested from distributions and recapitalizations, has exited completely 45 properties, at an average net realized IRR to NPRC of 25.2% and 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, and providing strong collateral underwriting through primary issuance, as well as focusing on favorable risk-adjusted opportunities.
As of September, we held $627 million across 33 nonrecourse subordinated structured notes investments. We maintained a relatively static to slightly declining signs for subordinated structured notes portfolio on a dollar basis, electing to grow our other investment strategies, and resulting in the structured notes portfolio of now comprising 8% of our investment portfolio. These underlying structured credit portfolios comprised nearly 1,600 loans. In the September quarter, this portfolio generated a GAAP yield of 10.7% and a cash yield of 17.5%, with the difference representing an amortization of our cost basis.
As of September, our current subordinated structured credit portfolio has generated $1.4 billion in cumulative cash distributions to us, representing over 116% of our original investment. Through September, we've also exited 15 investments with an average realized IRR of 12% and cash-on-cash multiple of 1.3x.
Our subordinated structured credit portfolio consists entirely of majority-owned positions. Those positions can enjoy significant benefits compared to minority holdings in the same tranche. In many cases, we receive 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 a 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 refinancings and resets since December of 2017. So far in the current December 2023 quarter, across our overall business, we booked $57 million in originations and experienced $1.7 million of repayments for over $55 million of net originations. Those originations have consisted of 53.5% real estate, 24.5% structured notes and 22% middle market lending.
Thank you. I'll now turn the call over to Kristin. Kristin?
Thanks, 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 29 years into the future.
Our total unfunded eligible commitments to portfolio companies totals approximately $27 million, representing approximately 0.3% of our assets. Our combined balance sheet cash and undrawn revolving credit facility commitments currently stand at approximately $968 million.
We're 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 firsts, 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 our balance sheet. As of September 2023, we held over $4.8 billion of our assets as unencumbered assets, representing over 61% of our portfolio. The remaining assets are pledged to Prospect Capital Funding, a nonrecourse SPV, where in September 2022, we completed an upsizing and extension of our revolver to a refreshed 5-year maturity. We currently have $1.95 billion of commitments from 53 banks, an increase of 11 lenders from August 2022 and demonstrating strong support of our company from the lender community, with a diversified unmatched -- diversity unmatched by any other company in our industry.
Shortly after the well-publicized bank failures in March, we added 2 new banks and upsized an existing bank within our credit facility. The facility revolves 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%.
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 defaults with our revolver.
We enjoy an investment-grade BBB- rating from S&P, an investment-grade Baa3 rating from Moody's, an investment-grade BBB- 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 5 investment-grade ratings more than any other company in our industry. All of these ratings have stable outlooks.
We have 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 nonrecourse debt tranches, we've substantially reduced our counterparty risk over the years.
In the September 2023 quarter, we have continued utilizing our revolving credit and have continued with our weekly programmatic InterNotes issuance on an efficient funding basis. To date, we have raised nearly $1.7 billion in aggregate issuance of our perpetual preferred stock across our preferred programs and listed preferred, including $80 million in the September 2023 quarter and $32 million to date in the current December 2023 quarter. We have 5 separate unsecured debt issuances, aggregating $1.2 billion, not including our program notes, with maturities extending through October 2028.
As of September 2023, we had $359 million of program notes outstanding, with staggered maturities through March 2052. At September 30, 2023, our weighted average cost of unsecured debt financing was 4.08%, an increase of 0.01% from June 30, 2023, and a decrease of 0.25% from September 30, 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 could also elect to DRIP at a 5% discount to the stated value per share of $25.
Now I'll turn the call back over to John.
Okay. Thank you, Kristin. Why don't we go ahead and answer questions?
We will now begin the question-and-answer session. [Operator Instructions] Today's first question comes from Finian O'Shea with Wells Fargo.
First question on NP REIT, trying to get a sense of the underlying mortgage liability profile. First, it looks like a lot of the rates have been stable or per your disclosures. But can you give a breakdown of, say, interest rate caps that might roll off soon or resets that are soon approaching that would lead to more pressure there?
And second part, given the headwinds on CRE debt that we all read about, seeing if you've needed to put more money in for any of your recent refinancings.
Thanks, Finian, it's Grier, I'll take that. So our philosophy with real estate and multifamily as where we've significantly focused in the last several years, not exclusively, but significantly, is -- has been with cap rates at lower than historical averages, it behooves one as a purchaser to finance with a largely fixed rate funding in a matched book fashion in a very attractive when we put on that financing fashion as well.
I would estimate here that 90% of the financing that we have utilized, perhaps more than that in our real estate portfolio company, NPRC, has utilized fixed rate funding. We've also had a philosophy of using long-term funding to reduce not just interest rate risk but maturity risk. And our typical deal done over the last decade plus, we've exited the vast bulk of the earlier vintages, utilized 10-year financing, in some cases, 12 years.
Typically with interest-only IO period, at least 5 years and in some cases 7 years. Of course, these are investments where we deploy capital and enhance net operating income from value-add renovation programs at the unit level and the common areas, and that delevers investments over time through NOI growth. Then you've had on top of that, through inflationary forces, through shortages of workforce housing, which continues in many markets, strong rent growth in occupancy, to drive NOI further even beyond what the value-add programs have generated.
So that's how we've been able to generate so many exits, to 25% IRR as we talked about. The extant book, I'm not aware of any deals where we've had to put in capital from a refinancing need. And we have years to run for the existing book as well.
Right now, it's -- on the new deal front, is, of course, is tricky, because of high financing costs. But hey, that's true across the board in the corporate world too, not just real estate, if you're borrowing money at 12.5% for a first-lien loan in the corporate world and [ worth ] that, that's an 8x multiple, and you're an equity sponsor paying more than 8x to your company, you've got a negative arb or a negative spread in the corporate world, not just in real estate where it's talked about even more. Obviously, want to examine the underlying profit, your underlying business as the case may be, to make sure there's sufficient growth to justify if one were to be that sort of a sponsor.
Within real estate, we viewed it as more attractive to focus on sort of tweener capital, preferred equity solutions, or solutions where there's advantageous tax abatements or other type of situations where we can purchase through a pro forma cap rate that is attractive, to give ourselves a more advantageous spread. We're working on such deals right now.
Did I answer your questions, Finian?
Yes, sure. That's helpful. Just drilling down a bit on adding new capital. The recent additional investment or loan to NP REIT was explained for CapEx and working capital for existing properties, normally, I think that would be handled at the property level. So is that a function of higher interest rates at the property level, say, for the smaller part of your book that's floating rate? And should we expect any more of that near term?
There's 2 things going on. One is the financing the Prospect Capital Corporation has to NPRC, the portfolio company, so that's the dynamic that you saw in the last quarter.
But the second aspect is you'll typically see fundings each quarter that occurs from NPRC, the portfolio company, to individual properties. That's normal and expected because we're deploying CapEx dollars over time in our value-added renovation program, and then other uses for CapEx. So when you spend the CapEx moneys, it's over a multiyear period. You, of course, have occupied apartments, people live in those, and you're only going to renovate upgrade a particular unit when it turns over, of course, not when someone is actually living there.
Because of what's happened with individual housing and what the financing costs look like there, making it prohibitively expensive and causing a sharp downturn in housing volumes and purchasers, folks are staying in their apartments much longer. Our turnover is less -- far less, than in past years. So that's good news from an occupancy standpoint. That's good news from a rent growth standpoint. It does sometimes cause a slower rollout of the renovation programs, at least within the units separate from the common areas, because you do the upgrade when someone moves out. Is that helpful?
Very much so. If I could do a bonus question. On the preferreds, the new issuances fallen quite a bit in recent quarters. So seeing if that's maybe a function of interest rates, if you might need to start offering higher rates there, or if you're happy with this level. And in that context, can you provide a reminder on the sort of target preferred stock composition and your capital structure?
Sure. The year-over-year comparisons are challenging or, let's say, not necessarily apples-to-apples for 2023 compared to 2022. There were a couple of significant liquidity events that happened in the nontraded channel for other issuers in 2022. And what happened was holders of that paper ended up recycling into Prospect's program since we're the #1 market leader and over 50% market share player, we picked up those volumes.
There haven't been such liquidity events which actually occurred in the REIT space in 2023. I'm not aware of any significant ones expected. So comping that year-over-year means, of course, there's been a decline in volumes.
And then the second point you mentioned is a continued increase in prevailing rates, which has also no doubt had an impact on volumes as well. We're not currently envisioning any changes to rates. We manage our cost of capital quite carefully, and we're very happy with our cost of capital, I think your unsecured debt cost of capital is around 4% right now. And even after you factor in the preferreds, we're 5 and change. We're seeing folks out there issue paper much more expensively than that. We're not in a position where we have to necessarily do that, with very little in the way of maturities coming up for the next couple of years.
But as always, we'll examine what the various capital markets offer us for financing. Recall Prospect is the firm that pioneered the vast bulk of liability structures in the BDC industry, going back to being the first convertible bond issuer -- first institutional bond issuer about a decade ago. And then a pioneered medium-term notes, institutional bonds, ATM programs, preferreds, perpetual preferreds, nontraded preferred. So we don't necessarily have certain composition targets. What we do is we focus on the various markets and see what's most attractive for us as an issuer. And when we issue we want to do so as a choice and from a position of strength and also being opportunistic about the climate we find ourselves in.
So we're very happy. A couple of years back in a low rate environment, we were quite proactive in doing 3 bond deals during that time period, and have not been so interested in chasing that market, unlike some of our peers who perhaps have done so out of necessity rather than balance sheet strength, choice. So hopefully, that helps with your bonus question, Finian. Thank you.
The next question is from Sean-Paul Adams with Raymond James.
Touching back on the Series A fixed rate preferred stock. How did you guys quite arrive to the valuation of a 36% discount to par? I know you guys talked about anticipating the future perpetual stock offers to pay a higher dividend, but I mean, it implies like evaluate a dividend pay rate of closer to 8%.
You're referring to our existing tender offer or what we just announced for our traded perpetual preferred? Well, it's a balancing act. And it's an option, of course, not an obligation for any holder should they choose to utilize this option, as opposed to obtaining liquidity in a fairly limited volume issue.
And it's a balancing act. We think the premium offer to what was launched just attractive. But balancing that as an issuer, and it's a perpetual instrument, we want to make sure it's net investment income and net asset value accretive as well. So we struck what we thought was the right balance between the 2. And we'll see what folks think later this month.
Okay. And turning to the NPRC portfolio. Are you anticipating the terminal cap rate, one used to value the common equity, to change materially? Relatively given that the public multifamily REITs are now trading in the 6.5% to 7% cap rate range and you're currently sitting at like a 5.8% terminal cap rate.
Right. We're participants in the private markets, not the public markets. We don't purchase public REIT equity. We don't purchase public REIT securities really of any kind. It's a private equity, private capital investment strategy at NPRC, just like the rest of our business. We invest in private companies almost exclusively. Sometimes we'll make a loan to a microcap public company, but that's usually the exception, not the rule.
There's been a delta between private real estate properties and where they trade and the public REITs for as long as I can remember. But that's -- those aren't the markets in which we participate. And of course, there are other G&A and trading and other costs pertaining to public REITs. And lack of control as well, there's a control premium aspect that's advantageous, of course, when you buy one of these properties and you have the ability to effectuate change through a value-add renovation program like what I described to the last questioner.
We're also not in the prediction business for cap rates, for interest rates, for any of those types of markets. And what is arrived at there is all done on a third-party independent valuation basis approved by independent directors, independent auditors. We think we have best practice governance. And this is what we brought to the industry as the first company in our industry to use 100% every quarter since inception fair valuations in 2004 when we IPO-ed. That did not exist before Prospect Capital brought it to there, and we'll continue to utilize that best practice approach.
Thank you. This concludes our question-and-answer session. I would now like to hand the call back to John Barry for closing remarks.
Okay. Well, thank you, and have a wonderful afternoon, everyone. Bye now.
Thank you all.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.