Prospect Capital Corp
NASDAQ:PSEC
Earnings Call Analysis
Q2-2024 Analysis
Prospect Capital Corp
In the recent quarter, investors have seen the net investment income (NII) reach $96.9 million or $0.24 per share. However, there was a notable decrease in the company's net asset value (NAV) per share, dropping by $0.33 from the previous quarter to $8.92. Despite this dip, the company's net debt-to-equity ratio improved slightly by 0.3 percentage points quarter-over-quarter, totaling 46.2%, signaling a reduction in financial leverage. The portfolio remains robust with $8.9 billion in assets and undrawn credit, promising resilience in a dynamic economic landscape.
Investment selectivity remains paramount for the company, with a disciplined approach enabling it to source and invest in opportunities that offer attractive risk-adjusted yields. A shift toward securing investments is evident, as first lien debt now comprises 58.7% of the portfolio. The firm prudently maintains low concentration in volatile sectors like energy, hotels, and retail, with significant focus on more secure assets, indicative of a strategic hedge against potential market downturns.
Continuing its cautious underlying investment philosophy, the company originated $171 million in new investments while exiting $131 million, leading to net originations of over $40 million in the December quarter. As of the ongoing quarter, the firm has already secured $63 million in originations against $22 million in repayments. A focus on middle-market lending and real estate suggest a balanced investment approach well-suited to the existing economic climate.
The company has strengthened its position through prudent liability management, boasting a robust ladder of unfunded commitments and a substantial amount of combined cash and credit facility commitments. It has successfully navigated the aftermath of the recent banking tumult by adding two new banks to its credit facility, securing a competitive drawn pricing of SOFR plus 2.05%. Moreover, it has an extensive portfolio of unencumbered assets that elevates its financial flexibility.
The company has demonstrated innovation and leadership within its marketplace, attaining five investment-grade ratings and continuing its strategic utilization of unsecured debt. It has impressively raised over $1.7 billion through the issuance of perpetual preferred stock, fortifying its capital structure. Maturities are well-laddered through 2052, reducing refinancing risks and enhancing overall stability.
Looking ahead, the company's management has made it clear that the significant increase in administration expenses in this quarter is not expected to be the norm; rather, expenses are more likely to be in the region of $5 million per quarter. In response to investor inquiries during the call, the company addressed its strategy on preferred stock conversions, real estate exits, and CLO portfolio management, confirming its ongoing strategic intention to maintain a diversified investment approach with a focus on high NPV opportunities.
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Good day, and welcome to the Prospect Capital Second Quarter Fiscal Year 2024 Earnings Release and Conference Call. [Operator Instructions]
Please note, this event is being recorded. I would now like to hand the conference over to Mr. John Barry, Chairman and CEO. Please go ahead.
Thank you, Betsy. Joining me on the call today are Grier Eliasek, our President, and Chief Operating Officer; and Kristin Van Dask, our Chief Financial Officer. Kristin?
Thank you, John. This call contains forward-looking statements that are 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 December quarter, our net investment income or NII was $96.9 million or $0.24 per common share. Our NAV stood at $3.68 billion or $8.92 per common share, down $0.33 from the prior quarter.
Since inception in 2004, Prospect has invested $20.6 billion across 420 investments, exiting 287 of those investments. In the December quarter, our net debt-to-equity ratio was 46.2%, down 27.9 percentage points from March 2020 and down 0.3 percentage points from the September 2023 quarter.
As we continue to run an underleveraged balance sheet, which has been the case for us over multiple quarters and years. 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 significantly below such range. We are announcing monthly cash common shareholder distributions of $0.06 per share for each of February, March and April. These 3 months represent the 78, 79 and 80th consecutive $0.06 per share cash distribution.
Consistent with past practice, we plan on announcing our next share of shareholder distribution in May. Since our IPO nearly 20 years ago, through our April 2024 distribution at the current share count, we will have distributed $20.76 per common share to original shareholders, aggregating approximately $4.2 billion in cumulative distributions to all common shareholders. Thank you. I will now turn the call over to Grier.
Thank you, John. Our scale platform with $8.9 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 nearly 150 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 ones. Unlike many other groups, we have maintained and continue 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 December, our portfolio at fair value comprised 58.7% first lien debt, up 1.4% from the prior quarter, 15.5% second lien debt down 0.4% from the prior quarter, 7.9% subordinated structured notes with underlying secured first lien collateral, down 0.2% from the prior quarter and 17.8% unsecured debt and equity investments, down 0.8% from the prior quarter, resulting in 82.1% of our investments being assets with underlying secured debt benefiting from borrower pledged collateral. That's up 0.8% from the prior quarter.
Prospect's approach is one that generates attractive risk-adjusted yields and our performing interest-bearing investments, we're generating an annualized yield of 12.3% as of December 2023. A decrease of 0.4 percentage points from the prior quarter. Our interest income in the December quarter was 92.3% of total investment income, reflecting a strong recurring revenue profile to our business. We also hold equity positions in certain investments that can act as yield enhancers or capital gains contributors as those positions generate distributions.
We've continued to prioritize senior and secured debt with our originations to protect against downside risk while achieving above-market yields through credit selection discipline and a differentiated origination approach. As of December, we held 126 portfolio companies, a decrease of 2% from the prior quarter with a fair value of $7.6 billion, a decrease of approximately $105 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 17.8%. As of December, our asset concentration in the energy industry stood at 1.4%; hotel restaurant leisure sector, 0.2%; and retail industry 0.3%.
Nonaccruals as a percentage of total assets stood at approximately 0.2% in December. No change from the prior quarter. Weighted average middle market portfolio net leverage was 5.4x EBITDA, substantially below our reporting peers and our weighted average EBITDA per portfolio company was $110 million.
Originations in the December quarter aggregated $171 million. We also received $131 million of repayments, sales and exits as a validation of our capital preservation objective, resulting in net originations of over $40 million, as we continue to take a cautious approach toward new credit underwriting given macroeconomic conditions.
During the December quarter, our originations comprised [ 53.8% ] middle market lending, 30.2% real estate, 10.5% middle market lending and buyouts and 5.5% subordinated structured notes investments. To date, we deployed significant capital in the real estate arena through our private REIT strategy, largely focused on multifamily workforce, stabilized yield acquisitions with attractive in-place and largely fixed rate multiyear financing. To date, on a cumulative basis, we've invested in $3.8 billion in 108 properties, including 3 triple net lease, 81 multifamily, 8 student housing, 12 self-storage and 4 senior living.
In the current higher financing cost environment, which has recently started to abate a bit, our new investment focus includes preferred equity structures with significant third-party capital support underneath our investment attachment points. NPRC or private REIT, has real estate properties that have benefited over the last several years from rising rents, showing the inflation hedge nature of this business segment, solid occupancies, high collections, work from home tailwinds, high-returning value-added renovation programs and attractive financing recapitalizations, resulting in an increase over time in cash yields as a validation of this income growth business alongside our corporate credit businesses.
NPRC as of December and not including partially exited deals where we've received back more than our capital invested from distributions and recapitalization has exited completely 46 properties at an average net realized IRR to NPRC of 25.2%. Average realized net multiple of invested capital of 2.5x and 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 December, we held [ $601 ] million across 33 nonrecourse subordinated structured notes investments. We have focused on amortizing our subordinated structured notes portfolio while electing to grow our other investment strategies. As a result, the structured notes portfolio now comprises less than 8% of our investment portfolio and is expected to decrease over time. These underlying structured credit portfolios comprised nearly 1,600 loans. In the December 2023 quarter, this portfolio generated a GAAP yield of 5.8%, down 4.9% from the prior quarter and a cash yield of 20%, up 2.5% from the prior quarter. The difference represents amortization of our cost basis, that returns capital to prospect that we intend on utilizing for other investment strategies and corporate purposes.
As of December, our current subordinated structured credit portfolio has generated $1.45 billion in cumulative cash distributions to us, representing over 118% of our original investment. Through December, we've also exited 15 investments with an average realized IRR of 12% and cash-on-cash multiple of 1.3x. So far in the current March quarter across our overall business, we've booked [$63 million] originations and experience [ $22 ] million of repayments for approximately [ $41 ] million of net originations.
Originations have consisted of 62.3% middle market lending and
37.7% real estate. 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 [ 28 ] years into the future. Our total unfunded eligible commitments to portfolio companies totals approximately $28 million, representing approximately 0.4% of our assets. Our combined balance sheet cash and undrawn revolving credit facility commitments currently stand at approximately $1.02 billion.
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, issue a listed perpetual preferred, undertake a preferred program and many other lists [ of firsts ]. 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 December 2023, we held approximately $4.7 billion of our assets as unencumbered assets, representing approximately 60% of our portfolio. The remaining assets are pledged to prospect capital funding, a nonrecourse SPV. We currently have $1.95 billion of commitments from 53 banks, 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 2023, 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 and investment-grade BBB rating from Egan-Jones and an investment-grade BBB low rating from DBRS. We currently have 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 28 years. Our debt maturities extend through 2052 with so many banks and debt investors across so many unsecured and nonrecourse debt tranches, which substantially reduced our counterparty risk over the years.
In the December 2023 quarter, we have continued utilizing our revolving credit and have continued with our weekly programmatic Internet issuance on an efficient funding basis. To date, we have raised over $1.7 billion in aggregate issuance of our perpetual preferred stock across our preferred programs and listed preferred, including $66.5 million in the December 2023 quarter and $11.7 million to date in the March 2024 quarter. During the December 2023 quarter, we commenced a tender offer to purchase for cash any and all of 5,882,351 shares of outstanding 5.35% perpetual preferred stock, resulting in 631,194 shares validly tendered at a price of $15.88 plus accrued and unpaid dividends for a total consideration of $16 per share.
We have 4 separate unsecured debt issuances aggregating $1.2 billion, not including our program notes with maturities extending through October 2028. As of December 2023, we had $391 million of program notes outstanding with staggered maturities through March 2052. At December 31, 2023, our weighted average cost of unsecured debt financing was 4.15%, an increase of 0.07% from September 30, 2023, and a decrease of 0.18% from December 31, 2022. Now I'll turn the call back over to John.
Thank you, Kristin. We can now answer any questions.
[Operator Instructions] The first question today comes from Finian O'Shea with Wells Fargo.
First question on the preferred stock. You've been buying down the Series A. Should we anticipate you exercising the issuer optional conversion feature when those Series A preferreds are ultimately out of the way.
Fin, thanks for your question. I'm not sure we mean by buying down the Series[ day ]. I don't think we've been doing that. But we have no plans to exercise such option, and we actually can't exercise such option for another two and half years because of an undertaking related to our listed preferred. But we have no plans to do so. Anyway and actually, moving the other direction. We just launched a new series that's not convertible at all into common stock. So we actually are moving in the other direction.
Okay. I appreciate that. And just a follow-up on the REIT. It looks like you sold a property there this quarter. I hope I didn't get this one wrong as well. But curious, given the market environment, the headlines we all read, like how that exit shook out? Any color you can give on the IRR you experienced, what you sold versus your mark, what the cap rate you sold that was? Would really appreciate color there. And that's all for me.
Sure. Thanks. The asset we sold was an asset in the student lending -- sorry, student housing portfolio. Student housing book is actually performing quite well and there is a significant buyer interest in that segment of the real estate market. So we're happy to have diversification in our real estate portfolio.
I know we sold at close to our mark. I don't have the IRR at our fingertips, but I know it was well into the double digits. Overall, within real estate, our book is doing quite well. Recall, we focus on workforce housing multifamily. We don't invest in office. We don't invest in retail. These are the areas that have been most deeply impacted, of course, within real estate, sort of on the wrong side of the digital divide, if you will. We're on the right side of the digital divide folks need a place to live. Multifamily has benefited significantly from problems and affordability issues in the single-family housing market, keeping people in their apartments to actually see less turnover and folks want to and need to stay in their apartments for a lot longer.
We also have a greater mix exposure into markets like the Midwest, for example, and selected Mid-Atlantic Northeast markets that have had less supply additions compared to the Western states and certain markets in the Southeast, places like Nashville and Austin, for example, have had huge surges of supply. And we've declined to purchase any properties in those areas because of supply concerns. Even in those markets with additional supply, when you look at the forward pipeline past [ 2024 ] sort of falls off a cliff. So most folks in the industry expect absorption to occur. And over the long term for significant positive rent growth to continue from there. So we're very happy to have our real estate book, and it's performing well.
I was just thinking if I'm able to sneak in a third topic we've touched on over the years, of course, which has been sort of running off the CLO book. Just wondering with the sort of resurgence and resets and refis starting to build up. Is there any -- are you compelled to pursue that kind of strategy kind of rebuild the CLO book, extend these out? Or should we still view them as run off or such?
Sure. So what we do with our CLO book is really no different than what we do with any of our positions on an ongoing basis including real estate, including middle market lending, including middle market buyouts. When we examine a range of options for investment, we're looking always at the NPV, the net present value of each potential option, and we're desiring of course, to select the highest NPV option.
With CLOs, the range of options for an existing investment and it is an actively managed book. includes calling and investments, and we get the benefit of having call premium optionality as majority holder in our book here. That's number one.
Number two, refinancing one or more tranches of the liability stack. We're pursuing that in one of our deals, for example.
Number 3 would be, as you referenced extending or resetting a deal. We're looking at -- number four, the selling a position on a secondary basis. So we're constantly looking at all four of those options. Our desire is not a one size fits all sort of tops down, but rather bottoms up. It is a diversified portfolio of over 30 positions. And so what's appropriate for one deal may not be appropriate for another deal.
But in general, expect for that book to be a lesser percentage of our portfolio over time, as other strategies grow and the overall balance sheet grows. We've got a very underleveraged balance sheet with a lot of dry powder. And then on a dollar basis, I would expect for it to decline over time as well. We've got significant amortization occurring. It is true in the last couple of years because of where liability spreads have been activity for refinancings and extensions have been somewhat muted. In the current environment, as you pointed out, liability spreads are starting to tighten up. So there is some more optionality there. And it wouldn't be out of the question to do a refinancing and still continue to amortize with -- at a higher NPV or do an extension and still sell.
So these aren't mutually exclusive exits for us. But over time, I mean this book at one point was almost 20% of our portfolio. And now it's in the 7%, it's declined substantially, and I would expect for that to continue.
The next question comes from Robert Dodd with Raymond James.
You just answered much of the other question. So the other one I had was on the allocation to Prospect's administration, it spiked up this quarter, is that a new normal? Or was there any onetime expense embedded in that, I mean, maybe related to the preferred tender or water. Can you give us any color on that? I mean it was up $10 million sequentially.
Sure. Thank you for your question. It's not the new normal. We should expect a lesser number, probably more in the [ $5 million ] range per quarter going forward, Robert. What you saw there was a couple of things. One, comping it to the past. From time to time, we will have a contra expense that will happily reduce that number. We had a significant litigation settlement in our favor in the past, which reduced that number associated with assisting one of our portfolio companies. And then there's some sort of catch-up allocation on top of that. But the answer is no, that's not the new normal. And we should expect more in the range of $5 million per quarter. Thank you, Robert.
This concludes our question-and-answer session. I would like to turn the conference back over to John Barry for any closing remarks.
Well, thank you, everyone. Have a wonderful day, and we'll see you in 90 days. Thanks all. Bye.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.