Prospect Capital Corp

NASDAQ:PSEC

Earnings Call Transcript 2019-Q3

[Operator]

Good day and welcome to the Prospect Capital Corporation Third Fiscal Quarter Earnings 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. [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, Chairman and CEO]

Thank you, Sean. Good morning, everyone.

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, CFO]

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 disclosures, see our earnings press release, our 10-Q, and our corporate presentation filed previously and available on the Investor Relations tab on our website, prospectstreet.com.

Now, I'll turn the call back over to John.

[John Barry, Chairman and CEO]

Thank you, Kristin.

For the March 2019 quarter, our net investment income or NII was $77.3 million or $0.21 per share, down $0.01 from the prior quarter and exceeding our current dividend rate of $0.18 per share by $0.03. Our ratio of NII to distributions was 117%.

In the March 2019 quarter, our net debt to equity ratio was 69.1%, down 5.9% from the prior quarter. Our net income for the quarter was $89.2 million or $0.24 per share, an increase of $0.42 from the prior quarter.

We are announcing monthly cash distributions to shareholders of $0.06 per share for each of May, June, July and August, aggregating 133 consecutive shareholder distributions. We plan on announcing our next series of shareholder distributions in August.

Since our IPO 15 years ago, through our August 2019 distribution at our current shareholder count, we will have paid out $17.40 per share to original shareholders, aggregating $2.9 billion in cumulative distributions to all shareholders.

Our NAV stood at $9.08 per share in March, up $0.06 from the prior quarter.

Our balance sheet as of March 2019, consisted of 88% floating rate interest earning assets and 95.9% fixed rate liabilities. Our percentage of total investment income from interest income was 90.6% in the March 2019 quarter, an increase of 6.5% from the prior quarter.

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. Management and affiliates on a combined basis have purchased at cost over $375 million of stock in Prospect.

Our management team has been in the investment business for decades with experience handling both challenges and opportunities provided by dynamic economic and interest rate cycles.

We have learned, when it is more productive, to reduce risk and to reach for yield. And the current environment is one of those time periods. At the same time, we believe the future will provide us with substantial opportunities to purchase attractive assets, utilizing dry powder we have built and reserved.

Thank you. I'll now turn the call over to Grier Eliasek.

[Grier Eliasek, President and COO]

Thank you, John.

Our scaled business with over $6 billion of assets and undrawn credit continues to deliver solid performance. Our experienced team consists of approximately 100 professionals, representing one of the largest middle market credit groups in the industry. With our scale, longevity, experience and deep bench, we continue to focus on a diversified investment strategy that covers third-party private equity sponsor-related and direct non-sponsor lending, Prospect-sponsored operating and financial buyouts, structured credit, real estate yield investing and online lending.

As of March 2019, our controlled investments at fair value stood at 42% of our portfolio, up 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 the preference for secured lending and senior loans. As of March 2019, our portfolio at fair value comprised 44.6% secured first lien, 23.5% secured second lien, 15.5% subordinated structured notes with underlying secured first lien collateral, 0.8% rated secured structured notes, 0.5% unsecured debt and 15.1% equity investments, resulting in 84% of our investments being assets with underlying secured debt benefiting from borrower pledge collateral.

Prospect’s approach is one that generates attractive risk-adjusted yields. And our performing interest bearing investments were generating an annualized yield of 12.8% as of March 2019. 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 2019, we held a 137 portfolio companies, down 2 from the prior quarter, with a fair value of $5.7 billion. We also continued to invest in a diversified fashion across many different portfolio company industries, with no significant industry concentration, the largest is 13.8%. As of March 2019, our asset concentration in the energy sector stood at 3%, and our concentration in the retail industry stood at zero.

Non-accruals as a percentage of total assets stood at approximately 3.3% in March 2019, down 0.3% for the prior quarter. Our weighted average portfolio net leverage stood at 4.51 times EBITDA down from 4.57 the prior quarter, and the fourth straight quarterly decrease. Our weighted average EBITDA per portfolio company, stood at $59.8 million in March 2019, up from $58.5 million the prior quarter.

The largest segment of our portfolio consists of sole agented and self-originated middle market loans. In recent years, we have perceived the risk-adjusted reward to be higher for agented, self-originated and anchor investor opportunities, compared to the non-anchor broadly syndicated market, causing us to prioritize our proactive sourcing efforts. Our differentiated call center initiative continues to drive proprietary deal flow for our business.

Originations in the March 2019 quarter aggregated $36 million. We also experienced $195 million of repayments and exits, as a validation of our capital preservation objectives, and sell down of larger credit exposures, resulting in net repayments of $159 million. During the March 2019 quarter, our originations comprised 100%, non-agented debt including early look anchoring and club investments.

To-date, we have made multiple investments in the real estate arena through our private REIT strategy, largely focused on multifamily, stabilized yield acquisitions with attractive 10-or-more-year financing.

NPRC, our private REIT has a real estate portfolio that is benefited from rising rents, strong occupancies, 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 12 properties with an objective to redeploy capital into new property acquisitions including with repeat property manager relationships. We expect our exits to continue, and we’ve identified multiple additional properties for potential exit in calendar year 2019 and beyond.

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 March 2019, we held $881 million across 43 non-recourse subordinated structured notes investments. These underlying structured credit portfolios comprised over 1,800 loans and a total asset base of over $18 billion.

As of March 2019, the structured credit portfolio experienced a trailing 12-month default rate of 29 basis points, down 63 basis points from the prior quarter and 64 basis points less than the broadly syndicated market default rate of 93 basis points. In the March 2019 quarter, this portfolio generated an annualized GAAP yield of 15.8%, up 0.3% from the prior quarter.

As of March 2019, our subordinated structured credit portfolio has generated over $1.27 billion in cumulative cash distributions to us, representing around 83% of our original investment. Through March 2019, we've also exited 9 investments, totaling $263 million, with an average realized IRR of 16.8% and cash on cash multiple of 1.49 times.

Our subordinate 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 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 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 22 refis and resets since December 2017. Our structured credit equity portfolio has paid us an average 17.9% cash yield in the 12 months ended December 2018, excluding redeeming and new deal. So far in the current June 2019 quarter, we’ve booked $26 million in originations and received repayments of $62 million, resulting in net repayments of $36 million. Our originations have comprised 65% non-agented debt and 35% agented sponsored debt.

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

[Kristin Van Dask, CFO]

Thanks, Grier.

We believe our prudent leverage, diversified access diversified access to matched-book funding, substantial majority of unencumbered assets, and weighting toward unsecured fixed rate debt demonstrate both balance sheet strengths, as well as substantial liquidity to capitalize on attractive opportunities.

Our Company has locked in a ladder of fixed rate liabilities, extending 24 years into the future, while the significant majority of our loans float with LIBOR, providing potential upside to shareholders as interest rates rise. 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 ATM, acquire another BDC, 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 March 2019, we held approximately $4.15 billion of our assets as unencumbered assets, representing approximately 71% of our portfolio. The remaining assets are pledged to Prospect Capital Funding where we recently completed an extension of our revolver by 5.7 years, reducing the interest rate on drawn amounts to one-month LIBOR plus 220 basis points. We currently have $1.05 billion of commitments from 29 banks with $1.5 billion total size accordion feature at our option.

We are targeting adding more commitments from additional lenders. The facility revolves until March 2022 followed by two years of amortization with interest distributions continuing to be allowed to us.

Outside of our revolver and benefiting from our unencumbered assets, we’ve issued at Prospect Capital Corporation, including recently 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 Kroll, an investment grade rating of BBB rating from Egan-Jones, an investment grade BBB negative rating from S&P and an investment grade BAA3 rating from Moody's, so a total of four investment grade ratings.

We’ve now tapped the unsecured term debt market on multiple occasions to ladder our maturities and to extend our liability duration out 24 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 March 2018 quarter, we repurchased $130 million of our April 2020 notes as well as $24 million of our program notes. We also issued $201 million of a March 2025 convertible bond, issued $33 million of baby bonds through our ATM program, and continued our weekly programmatic internet issuances.

If the need should arise to decrease our leverage ratio, we believe we could slow originations and allow repayments and exists to come in during the ordinary course, as we demonstrated in the first half of calendar year 2016 during market volatility. We now have eight separate unsecured debt issuances aggregating $1.6 billion, not including our program notes, with maturities extending to June 2029.

As of March 2019, we had $755 million of program notes outstanding with staggering maturities through October 2043.

Now, I'll turn the call back over to John.

[John Barry, Chairman and CEO]

Thank you, Kristin. Okay. We are ready for questions.

[Operator]

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

[Robert Dodd, Raymond James]

Hi, guys. On the dividend in the quarter, obviously, the REIT dividend decline from 9 last quarter to 1 this. You talked about identifying additional properties. I guess, I'm just trying to get a feel obviously on that's a decent size contributor in the past. I mean, is this kind of the new near-term run-rate to be quite a low dividend from that business or would you expect that to rebound, if we do, do more exits of properties later in the year?

[Grier Eliasek, President and COO]

John, do you want me take that?

[John Barry, Chairman and CEO]

Actually, I think Robert wants to hear from you, Grier.

[Grier Eliasek, President and COO]

Okay. So, the distributions from NPRC actually didn't change quite as sharply as one might consider just looking at the dividend row, Robert. We’ve recapped our investment or series investments in NPRC to basically -- because of the growth in income, cash flows, strong performance out of the book of around 60 or so properties. We actually increased our -- the amount we have against that portfolio company. And so, there's actually more of our income as Prospect Capital Corporation coming through interest income now in the March quarter, the difference from the December quarter, which I think reflects confidence in the sustainability of net operating income of the underlying portfolio companies.

We would expect, given visibility on how these assets are performing as well as some of our pending exit processes, some of which we've signed contracts on, some of which are very different status in terms of being sold, being marketed. Our model, recall, is to fix up these properties, optimize them, essentially adding value to the common areas, as well as the individual units. And then, sell at an attractive, i.e. low cap rate, high multiple to a buyer that doesn't want to fuss with the substantial operating improvements that we spent the hard time and hard years and hard work, upgrading and optimizing.

So, it’s a long way of saying we feel pretty good about sustainability and visibility for the next year, Robert. Beyond that, it's tough to say for any asset class of course on a multi-year basis, especially given where we are in the cycle. What we try to do is to remove as much as possible from the equation, the financing risk side of things by getting very long-term financing. We first started within NPRC and other predecessors, purchasing and optimizing these assets we were getting like 7 to 8 years financing, maybe two years interest only. We're now getting from our financing sources as much as 12 years of financing, 8 years interest only, and that continues to be attractive as locked in fixed rate financing for the long term. And of course, as we get closer to the end, the likelihood of selling an asset or refinancing, it goes up as well. So, we really don't have any pressing maturities to worry about there, and can be very patient and optimize on the timetable in program that we envision and then sell at the optimal point. Is that helpful, Robert?

[Robert Dodd, Raymond James]

That is that is very helpful, and actually leads into the next question, not about elite. But, I mean you talked about you’re recapitalizing that the financing markets are very favorable right now for other debt. When I look at some of your control positions like Valley Electric, or First Tower, I mean, obviously the equity market out there, they are doing really well. Valley Electric is obviously paying you dividends, et cetera. It's still carrying some pretty high cost debt though. So, what's the thought process or why -- given the third-party debt is pretty cheap right now, what's the thought process on not refinancing some of those successful businesses to lower their cost of debt and maybe increase your equity value?

[Grier Eliasek, President and COO]

Sure. I'll tackle those and then see if John has anything to add on that as well as NPRC. So, regarding -- each one's a little bit different. In the case of First Tower as installment render, it's been in business for decades in half a dozen different U.S. states, long standing management team, sort of founder, CEO, Ron as a substantial honor of the business alongside, us and fully aligned to perform. We already do we think optimize financing which uses a healthy amount of third-party ABL financing from a diversified and long supportive bank group that knows the company well, the management team, the industry quite well. We do explore from time to time our -- and our team spends a lot of time on this on the Prospect side, in addition to the management team, different models for financing the business and it's not all or nothing but an obvious place to look as the securitization markets.

There are drawbacks of that market, including the costs of issuance that need to be amortized over a relatively short-term asset base. So Tower makes in general two-year fully amortizing loans or prepayments, so the duration is substantially less than that. It's not a long time to amortize the fixed cost of issuance, setup costs, legal costs the rating costs, the whatever arranger is arranging liabilities, their costs, which is nontrivial. And you compare and contrast that with say the CLO structured credit market where you're amortizing such costs that are similar in nature over a much longer duration expect a life of say six years. And that looks quite different from amortizing a higher front cost over only a year.

So, we continue to explore that market. It kind of keeps the ABL lenders in check and helps us negotiate more favorable terms with them candidly. It's nice to have options. We feel like we could pivot to that market if we needed to, but we're not sure it's the right move. And also, it’s relatively short-term financing. It's not like you're getting some big benefit from locking in long-term rates as well.

In the case of Valley, it's a little bit tricky on the third-party financing front. We do have an ABL, and we like ABL financing that doesn't tend to have amortization attached to it, allows fully distributions, and we have a maximized distribution model of course. That business that's in the infrastructure management business does have some surety, nontrivial surety and bonding requirements with governmental, institutional and corporate accounts largely in the Pacific Northwest. And that that there's certain ways they look at tangible net worth ratios, equity count, et cetera.

And it tends to limit some of the financing we can actually utilize from third-parties. But, we have grown that successfully and we continue to grow and diversify our base of sureties in addition to ABL lenders. But that company's been performing quite well, as you pointed out.

Let's see, if John has anything to add to the commentary for those three companies, NPRC, Valley and Tower. John?

Okay. While we’ll wait for him. Robert, any follow-ups to that?

[John Barry, Chairman and CEO]

Hold a second. Yes. I was just going to say I was on mute. One of the great blessings of working with Grier Eliasek is that when he's done answering a question, I just can't think of anything to add. So, Robert, if you have any softball questions for me, I'd love to take them.

[Robert Dodd, Raymond James]

That was the last one. So, I appreciate it. Thank you.

[John Barry, Chairman and CEO]

I thought you had another. No? Okay. All right.

[Robert Dodd, Raymond James]

No, sorry.

[John Barry, Chairman and CEO]

Okay. Thank you very much, Robert.

[Operator]

This will conclude our question-and-answer session. I would like to turn the conference back over to John Barry for any closing remarks.

[John Barry, Chairman and CEO]

All right. Well, Grier, thank you very much for answering the questions. It's completely as you did. They don't seem to be any more. I hope everyone has a wonderful day. And we'll see you in approximately four months. Thanks all. Bye now.

[Grier Eliasek, President and COO]

Thanks all. Bye.

[Operator]

The conference has now concluded. Thank you for attending today's presentation. And you may now disconnect.