Prospect Capital Corp

NASDAQ:PSEC

Earnings Call Transcript 2020-Q3

[Operator]

Good day and welcome to the Prospect Capital 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, sir.

[John Barry, Chairman and Chief Executive Officer]

Thank you, Chad. 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, Chief Financial Officer]

Thank you, 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.

Do not undertake to update our forward-looking statements unless required by law. For additional disclosure, please see our earnings press release and our 10-Q 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 Chief Executive Officer]

Thank you, Kristin. We at Prospect have managed investors savings for 32 years. 16 years ago, we brought public Prospect Capital Corporation. Over the decades, we’ve weathered multiple business challenges, stock market crashes, credit market dislocations, hurricanes, liquidity crunches, epidemics, pandemics. Learning something from each challenge readies us for the next one.

We have learned to batten down the hatches when we see storm clouds and to unfurl our sails for maximum speed as the rising sun brings a new morning and new opportunities. During the last recession that sank other boats, we went on offence to purchase Patriot Capital, the first acquisition of any BDC. Purchasing Patriot at 50% of NAV enhanced dividends for years to come. Can we do that again? We’ll see.

We are reviewing new investment opportunities emerging each day. As part of that process, we are seeking shareholder approval for a one-year option to sell shares below NAV, subject to board approval and other conditions. We may not have been able to purchase Patriot without that approval.

For the March 2020 quarter, our net investment income or NII was $68.5 million or $0.19 per share, up a $0.01 from the prior quarter. Our ratio of NII to distributions was 103%. Over the past 10 quarters, our ratio of NII to distributions has averaged 113%, with NII exceeding distributions by $85.7 million during that period.

In the March 2020 quarter, our net debt to equity ratio was 74.1%. Over the past 10 quarters, our ending quarter, net of cash, debt to equity ratio has ranged from 60.2% to 75.1%, averaging 69%.

Over the last two years, other listed of BDCs have increased the leverage, with a typical list of BDC in March 2020 at roughly 114% debt to equity, 40 percentage points higher than us. We have not increased our target leverage, instead electing lower risk.

We recently reduced our minimum, 1940 Act, regulatory asset coverage to 150%. We also elected exemptive relief to provide additional regulatory cushion through December 31st, 2020. We have no plans to increase leverage beyond our historical target of 0.7 to 0.85 debt to equity or 218% to 243% asset coverage.

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 the last 12 years. Unsecured debt was 92.5% of Prospect’s total debt in March 2020, compared to roughly 40% for the typical listed BDC for December 2019, or again 50 percentage points less than us.

Our unsecured and diversified funding profile provides us with lower risk and enhanced investment strategy and balance sheet flexibility. Our NAV stood at $7.98 per share in March, down $0.68 or 7.9% from the prior quarter. That compares to a 40% decline in NAV per share for the typical listed BDC for March 2020.

Our 600 basis point outperformance is a direct result of our decision to de-risk rather than chase leverage. We are staying true to that strategy that served us well since 1988. Controlling and reducing portfolio and balance sheet risk to protect the capital entrusted to us and to protect the ability of that capital to generate earnings for our shareholders.

Our net loss for the quarter was $185.7 million or $0.51 per share, largely due to unrealized depreciation from macro conditions. We are announcing monthly cash distributions to shareholders of $0.06 cents per share for each of May, June, July and August, representing 145 consecutive shareholder distributions.

These four months’ about the same distribution rate as for each of the past 32 months. We plan on our next dividend announcement in August. Since our IPO 16 years ago, through our August 2020 distribution, at our current share count, we will have paid out $18.12 per share to original shareholders, aggregating $3.1 billion in cumulative distributions to all shareholders. Our percentage of total investment income from interest income was 90% in the March 2020 quarter, an increase of 3% from the prior quarter.

Thank you, everyone. I’ll now turn the call over to Grier.

[Michael Eliasek, President and Chief Operating Officer]

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, 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.

Consistent with past cycles, we expect 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 March 2020, our controlled investments at fair value stood at 43% of our portfolio, down 2.8% from the prior quarter. This diversity of strategies 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 loan.

As of March 2020, our portfolio at fair value comprised 44.8% secured first lien, an increase of 3.3% from December, 23.6% secured second lien, a decrease of 1.1%, 13.7% subordinated structured notes with underlying secured first lien collateral and a decrease of 1.3%, 0.9% unsecured debt flat from before and 17% equity investments down point 9%, resulting in 82.1% of our investment, up 0.9% being invested being assets with underlying secured debt benefiting from borrower pledge collateral.

Prospect’s approach is one that generates attractive risk adjusted yield. In our performing interest-bearing investments, we’re generating an annualized yield of 12.4% as of March 2020, down 0.4% from the prior quarter. We also hold equity positions in certain investments that can act as yield enhancers or capital gains contributors as such positions generate distribution.

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 2020, we held 121 portfolio companies, up one from the prior quarter with a fair value of $5.14 billion. We also continue to invest in a diversified fashion across many different portfolio company industries, with no significant industry concentration, the largest is 14.7%, down 2.1% from the prior quarter.

As of March 2020, our asset concentration in the energy industry stood at 1.7% down 0.5% from the prior quarter, our concentration in the hotel, restaurant and leisure sector stood at 0.4% and our concentration in the retail industry stood at 0%.

Non-accruals as a percentage of total assets stood at approximately 1.6% in March 2020, even with the prior quarter. Our weighted average portfolio net leverage, stood at 4.63 times EBITDA, down 0.12% from the prior quarter. Our weighted average EBITDA per portfolio company stood at $72.3 million in March 2020, up from $69.5 million, the prior quarter.

Originations in the March 2020 quarter aggregated $402 million. We also experienced $267 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 $136 million.

During the March 2020 quarter, our originations comprised 62.6% agented sponsor debt, 27.3% non-agented debt, including early look anchoring and club investments, 8.8% rated secured structured notes and 1.3% corporate yield buyout.

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 of financing.

NPRC, our private REIT, has real estate properties that have benefited over the last several years from rising rents, strong occupancies, high returning value-added renovation programs and attractive financing recapitalization, 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, with an objective to redeploy capital into new property acquisitions, including with repeat property manager relationships. We continue to monitor our rent collections, which are holding up well in the current 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 March 2020, we held $704 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 $18 billion.

As of March 2020, the structured credit portfolio experienced a trailing 12-month default rate of 91 basis points, representing 93 basis points less than a broadly syndicated market default rate of 184 basis points. In the March 2020 quarter, this portfolio generated an annualized GAAP yield of 15%.

As of March 2020, our subordinated structured credit portfolio has generated $1.19 billion in cumulative cash distributions to us, representing around 85% of our original investment. Through March 2020, we’ve also exited 9 investments, totaling $263 million, with an average realized IRR of 16.7% and cash-on-cash multiple of 1.48 times.

Our subordinated 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 a 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 over 25 refinancings and resets since December 2017. So far in the current March 2020 quarter, we booked $14 million in originations. Originations have comprised 78% agented sponsored debt and 22% non-agented debt.

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

[Kristin Van Dask, Chief Financial Officer]

Thanks, Grier. We believe our prudent leverage, diversified access to matched-book funding, substantial majority of unencumbered assets waiting toward unsecured fixed-rate debt, avoidance of unfunded asset commitments and lack of near-term maturities demonstrate both balance sheet strength as well as substantial liquidity to capitalize on attractive opportunities. Our company has locked in a ladder of liabilities extending 23 years into the future.

Today, we have zero debt maturing until 2022 or over two years from now. Our total unfunded eligible commitments to non-controlled portfolio companies totaled approximately $15 million or less than 0.3% of our assets. Our combined balance sheet cash and undrawn revolving credit facility commitments currently stand at approximately $785 million.

We are a leader and innovator in our marketplace. We were the first company in our industry to issue a convertible bond, develop 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 2020, we held approximately $3.56 billion of our assets as unencumbered assets, representing approximately 68% of our portfolio. The remaining assets are pledged to Prospect Capital Funding, where in September, 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 continuing to be allowed to us. Of our floating rate assets, 90.1% of LIBOR floors with a weighted average floor of 1.55%.

Outside of our revolver and benefiting from our unencumbered assets that 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 negative rating from S&P, an investment grade Baa3 rating from Moody’s, an investment grade BBB negative rating from Kroll, and an investment grade BBB rating from Eagan-Jones, with the first three 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 March 2020 quarter, we repurchased $47 million of our April 2020 notes, which we subsequently retired in full maturity, $34 million of our July 2022 notes, $655,000 of our June 2024 notes, and $67 million of our program notes.

We also continued 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 environment.

We now have 8 separate unsecured debt issuances, aggregating $1.4 billion, not including our program notes, with maturities extending to June 2029. As of March 2020, we had $673 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 dividend reinvestment plans 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 the same from your broker.

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

[Operator]

Mr. Barry, perhaps your line is muted.

[Michael Eliasek, President and Chief Operating Officer]

Thank you. We can now answer any question.

[John Barry, Chairman and Chief Executive Officer]

Oh, yes, it is. Yes. Thank you, Kristin. We’re all remote, so I apologize to everyone. My line was muted. Thank you everyone and we can take questions now.

[Operator]

Okay, thank you. At this time we’ll begin our question-and-answer session. [Operator Instructions]

[John Barry, Chairman and Chief Executive Officer]

Okay. Thank you, everyone. Have a wonderful morning, wonderful afternoon. Thanks all. Bye.

[Operator]

Thank you, sir. The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect your lines.