Prospect Capital Corporation (NASDAQ:PSEC) Q1 2024 Earnings Call Transcript

Prospect Capital Corporation (NASDAQ:PSEC) Q1 2024 Earnings Call Transcript November 10, 2023

Operator: Hello, and welcome to the Prospect Capital First Quarter Fiscal Year 2024 Earnings Release and Conference Call. All participants will be in listen-only mode. [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: 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?

Kristin Van Dask: 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.

A close-up of a senior executive in a suit, typing away on a laptop to complete the latest investments in debt securities and equity interests.

John Barry: 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 three 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 2.2 times 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.

Grier Eliasek: 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 non-bank structure gives us the flexibility to invest in multiple levels of the corporate capital stack with a preference for secured lending and senior loans.

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 two 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%. Non-accruals 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 eight properties, self-storage 12 properties and senior living four 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 2.5 times 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 non-recourse 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 1.3 times. 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?

Kristin Van Dask: 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 non-recourse SPV, where in September 2022, we completed an upsizing and extension of our revolver to a refreshed five-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 two 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 five 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 five 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.

John Barry: Okay. Thank you, Kristin. Why don't we go ahead and answer questions?

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