Prospect Capital Q1 2025 Earnings Call Transcript

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November 8, 2024

There are 5 speakers on the call.

Operator

Good day, and welcome to the Prospect Capital First Fiscal Quarter Earnings Release and Conference Call. All participants will be in listen only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to John Barry, CEO.

Operator

Please go ahead.

Speaker 1

Thank you, Dave. Joining me on the call today are Grier Eliasek, our President and Chief Operating Officer and Kristin Van Dask, our Chief Financial Officer. Kristin?

Speaker 2

Thanks, 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.

Speaker 2

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

Speaker 1

Thank you, Kristin. Before we get started, I wanted to apologize to Finian O'Shea for what I said on our last earnings call. When the love of your life tells you after an earnings call, John, you shouldn't have said that. You instantly know you shouldn't have said that. When you've been doing this for 37 years like I have and founded Prospect from scratch, sometimes criticism of our people can feel unfair.

Speaker 1

But a prospect we have a saying, blast furnaces temper the best steel. Finney and I appreciate your tough questions on our business and from other people at Wells and other firms, and we look forward to working with all of you in the years to come. Now on to official business. In the September quarter, our net investment income or NII was $89,900,000 or $0.21 per common share. Our NAV was $3,510,000,000 or $8.10 per common share.

Speaker 1

At September 30, our net debt to total assets ratio was 29.7%. Unsecured debt plus preferred is 86% of total debt, plus preferred for prospects. Since inception over 20 years ago, through our January 2025 declared distribution, we will have distributed 4.4 $1,000,000,000 or $21.25 per share, representing 2.6x September 20 24 common NAV per share and 4.1 times our Wednesday stock price closing. We are announcing monthly common shareholder distributions of $0.045 per share for each of November, December January. We plan on announcing our next set of shareholder distributions in February.

Speaker 1

We are rightsizing our common shareholder distribution rate as we continue to execute our long term income and total return strategies by rotating structured credit, CLO equity and real estate investments into our core business of 1st lien senior secured middle market loans, including sometimes with selected equity co investments. Our preferred shareholder cash distributions continue

Speaker 3

at

Speaker 1

the contractual rates of such distributions. CLO Equity and Real Estate Investments have generated attractive unlevered investment level gross cash IRRs, 12% for CLO equity and 24% for real estate property exited investments since inception of such strategies in 2011 2012 respectively, but with more variability compared to our core business. As we rotate into lower variability middle market corporate investments, our recurring income as shown by interest income as a percent of total income has reached 94%, an increase of over 800 basis points for the year over year quarterly period. We still perceive CLO equity and real estate investments as attractive risk adjusted strategies. We intend another fund to be developed and to be managed by an affiliate of Prospect Capital Management to continue to focus on new CLO Investments with less targeted Prospect Capital Corporation balance sheet investment in this strategy going forward.

Speaker 1

Similarly with real estate, CLO equity has decreased to 6% of our assets versus 18% as of September 30, 2017. As we execute on our rotation strategy to emphasize 1st lien senior secured lending with such mix growing significantly for us. CLO equity typically generates attractive cash on cash yields, but such yields tend to be higher in the initial years while lower in the later years, thereby resulting in variability that we seek to reduce by focusing more on our core business at Prospect Capital Corporation. Real Estate Investing is a total return strategy that has been a solid fit for Prospect Capital Corporation during periods of low short term and medium term interest rates. We have exited dozens of our value add properties in the past several years after achieving strong rent and net operating income performance.

Speaker 1

We have also generated substantial exit related income from real estate property sales over the years with such exit related income decreasing recently as we have had fewer exits. While we expect to monetize further real estate property investments with attractive returns, we are cautious about the pace of future exit related income. Over the last 7 weeks, the Fed has reversed 75 basis points of prior short term interest rate increases that hurt our book with market expectations for more reductions going forward, which may lower future shareholder distribution rates across all related credit industries. We have already factored in the declining forward curve for short term interest rates for our common shareholder distribution declaration today. Thank you.

Speaker 1

I'll now turn the call over to Greer.

Speaker 3

Thank you, John. Over the past 2 decades, Prospect Capital Corporation has invested $11,400,000,000 in over 300 exited investments that have earned a 13% unlevered investment level gross cash IRR to Prospect Capital Corporation. This 2 decade time period includes the GFC and has been dominated in general by low reference interest rates. The majority of peer BDCs have not been battle tested by such general economic downturn in other headwinds. Our core business of directly originated, non syndicated 1st lien senior secured loans to U.

Speaker 3

S. Middle market companies, sometimes with selected equity co investments, offers multiple compelling attributes. 1st lien loans as a percentage of total investments have now reached 65%, an increase of over 700 basis points for the year over year quarterly period. Such core business with proprietary opportunity flow offers higher spreads than lending to much larger companies, which loans are experiencing significant spread compression for other lenders focused on that more competitive and commoditized larger end of the market. Middle market loans by comparison offer higher interest rate floors often 250 basis points to 400 basis points versus loans to larger companies which often have only 0 to 100 basis point floors, thereby providing better protection for yield and income when short term interest rates decline.

Speaker 3

Such higher floors benefited Prospect Capital Corporation greatly when the Fed last sharply reduced such rates during the GFC. 1st lien senior secured middle market loans, different from CLO equity and real estate investments, also are eligible for favorable financing with our efficient cost revolving credit facility, helping to further enhance our net investment income. With such core business middle market investments, we also sometimes have an opportunity to structure investments with equity upside, including through warrants, convertible debt and 2x liquidation preferences with an objective to maximize current yields and total returns in a prudent and risk adjusted fashion. Many such investments that we are currently underwriting have targeted unlevered double digit current yields and unlevered total returns of 12% to 15% or more with such yields and total returns further enhanced by our credit facility to lift targeted levered returns to 18% to 20% or more. Recent investments like RK Logistics, Discovery Point and Druid City illustrate such non syndicated middle market focus where we also capture equity upside.

Speaker 3

Our middle market portfolio companies also have the potential to drive substantial synergistic value creation with add on acquisitions, with examples including Valley purchasing Comet and RV Industries making multiple acquisitions. With such middle market investments, we have a greater ability to add value to management teams that benefit from our experienced prospect team of over 130 professionals in areas like Board supervision, operational assistance, strategic planning, executive recruiting, add on acquisition sourcing and other important areas. Our pipeline continues to build with additional non syndicated 1st lien senior secured middle market loans with selected equity co investments, which we expect to deliver substantial benefits to Prospect Capital Corporation and its shareholders going forward. For the September quarter, our portfolio at fair value comprised 64.9 percent 1st lien debt, that's up 7.6% from the prior year, 11.1% second lien debt that's down 4.8% from the prior year, 6.2% subordinated structured notes with underlying secured 1st lien collateral that's down 1.9% from the prior year and 17.8% unsecured debt and equity investments, that's down 0.9% from the prior year, resulting in 82.2% of our investments being assets with underlying secured debt, benefiting from borrower pledged collateral. We're pleased with our continued success in executing our plan to increase our 1st lien mix, while reducing our 2nd lien and subordinated structured notes exposure, thereby reducing portfolio risk.

Speaker 3

Prospect's approach is one that generates attractive risk adjusted yields and are performing interest bearing investments. We're generating an annualized yield of 11.8% as of September. Our interest income in the September quarter was 94% of total investment income, reflecting a strong recurring revenue profile to our business. As of September, we held 117 portfolio companies with a fair value of $7,500,000,000 We also continue to invest in a diversified fashion across many different portfolio company industries with a preference for avoiding cyclicality and industry concentration. As of September, our asset concentration in the energy industry stood at only 1.5% in hotel, restaurant and leisure sector stood at only 0.3% and in the retail industry stood at only 0.1% as examples of cyclical industries where we have low exposure.

Speaker 3

Non accruals as a percentage of total assets stood at approximately 0.5% in September. Weighted average middle market portfolio and net leverage stood at 5.7x EBITDA. Our weighted average EBITDA per portfolio company stood at 105,000,000 dollars Originations in the September quarter aggregated $291,000,000 We also experienced $282,000,000 of repayments and exits as a validation of our capital preservation objective, resulting in net originations of $8,000,000 During the September quarter, our originations comprised 80 5.8 percent middle market lending, 7.8 percent real estate and 6.1% middle market lending and buyouts. So far in the current December quarter, we've booked $42,000,000 in originations and experienced $163,000,000 of repayments. Thank you.

Speaker 3

I'll now turn the call over to Kristin. Kristin?

Speaker 2

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 $48,000,000 representing approximately 0.6% of our assets. Our combined balance sheet cash and undrawn revolving credit facility commitments currently stand at $1,500,000,000 As of September, we held $4,900,000,000 of our assets as unencumbered assets, representing approximately 64% of our portfolio.

Speaker 2

Remaining assets are pledged to Prospect Capital Funding, a non recourse SPV. In June, we successfully completed an amended and extended credit facility with a new 5 year maturity. We currently have $2,120,000,000 of commitments from 48 banks, demonstrating strong support of our company from the lender community with a diversity unmatched by any other company in our industry. The facility revolves until June 2028 followed by a year of amortization with interest distributions continuing to be allowed to us. Our drawn pricing continues to be SOFR plus 2.05%.

Speaker 2

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 currently have 5 investment grade ratings more than any other company in our industry. We've now tapped the unsecured term debt market on multiple occasions to ladder our maturities and to extend our liability duration out 28 years with our debt maturities extending through 2,052. With so many banks and debt investors across so many unsecured and non recourse debt tranches, we have substantially reduced our counterparty risk.

Speaker 2

At September 30, 2024, our weighted average cost of unsecured debt financing was 4.42%. Now, I'll turn the call back over to John.

Speaker 1

Thank you, Kristin. I think it's time for us to take questions if we have any. Thank you very much.

Operator

Our first question comes from Finian O'Shea with Wells Fargo Securities. Please go ahead.

Speaker 4

Hey, everyone. Good morning. I appreciate the opening remarks, John. Just wanted to

Speaker 1

Welcome back. We're delighted to hear your voice.

Speaker 4

Likewise, I know we both always like to have a good time when talking about BDCs. So just one this quarter on the dividend. So it feels more right sized now, but it's still a comparatively low yield on book. And of course, that weighs on valuation for a BDC, which isn't ideal. So you touched on some things, I think CLO rotation, but can you help outline or quantify like how much you can rotate, where those pockets are and what you can what you sort of strive for on driving an improved book return?

Speaker 4

Thanks.

Speaker 1

I'd love to, but I'm not allowed to answer any questions. Actually, I gave my little precis at the beginning. Grier, why don't we hear from Grier because I'm sure he'll have a slightly different perspective?

Speaker 3

Sure. Finney, thank you for your question. So in the CLO segment, we talked about how income and yield tends to be front end weighted during the life of the deal. And while we are enjoying reasonably robust cash flows, we are actually not recognizing much income from a GAAP standpoint. And that book is therefore amortizing significantly.

Speaker 3

I think we're getting somewhere along a 2% or 3% GAAP yield off of CLOs, which obviously is well below the double digit yields plus equity upside in many cases that we can earn on our core business of middle market lending, which has been quite robust with successful recent investments. So by continuing to amortize that book and you see every quarter, it continues to amortize and drop as a percentage of the portfolio, we are now at about 6% of the book in CLOs. That should provide an earnings boost. That's area number 1. Area number 2, which we also highlighted, is real estate, which is a terrific total return strategy, but a lot of the return is more exit driven as opposed to on a current basis.

Speaker 3

When SOFR was near 0 and maybe we'll return to that at some point depending upon the pacing of Fed cuts, we've obviously had 75 bps in only 7 weeks here. Getting a sort of high single digit yield on real estate was competitive with middle market lending, plus we had upside beyond that. In the current environment, that's not as competitive. And we think monetizing our real estate as we've continued to do and expect to do in a prudent and orderly fashion to again rotate into our core business of middle market lending with equity upside is prudent and much of that real estate has appreciated through our successful investing in value add workforce housing. So that's area number 2.

Speaker 3

Area number 3 would be exiting again in a prudent fashion, successful middle market deals where we also hold equity and we think that it's the right time to exit was often appreciated equity and rotate once again into a slate of new deals to produce a higher current income and total return. Running a permanent capital business, what we do from a capital efficiency and discipline standpoint is to examine our foregone return were we to potentially hold a particular investment And if we've concluded foregone IRR to foregone yield, we examine both are below our hurdle rates, then we'd rather sell to a 3rd party and then rotate. So we think this provides significant upside to our business going forward to boost our return on equity, which we're relentlessly focused on. Thank you.

Operator

Thank you, guys. This concludes our question and answer session. I would like to turn the conference back over to John Barry for any closing remarks.

Speaker 1

Okay. Well, thank you everyone. Have a wonderful morning and we'll see you in a quarter. Thanks so much. Bye now.

Speaker 3

Thank you all.

Operator

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

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Key Takeaways

  • Prospect declared a monthly common shareholder distribution of $0.045 per share for November through January and has distributed $4.4 billion since inception (or $21.25 per share), reflecting a rightsized rate that factors in anticipated Fed rate cuts.
  • The company is rotating out of higher-variability structured credit, CLO equity (now 6% of assets) and real estate into its core business of 1st lien senior secured middle market loans, boosting recurring interest income to 94% of total (an 800 bp increase YoY).
  • First-lien senior secured loans now comprise 65% of the portfolio (up 700 bps YoY), generating an 11.8% annualized yield, with new deals targeting unlevered returns of 12–15% and levered returns of 18–20%.
  • Prudent balance sheet strength is reflected in a net debt to total assets ratio of 29.7%, 64% of assets unencumbered, a $2.12 billion revolver maturing in 2028, five investment-grade ratings, laddered debt out to 2052 and a 4.42% cost of unsecured financing.
  • As of September, the portfolio included 117 companies at $7.5 billion fair value, with non-accruals at approximately 0.5%, average leverage of 5.7x EBITDA and minimal exposure to cyclical sectors.
AI Generated. May Contain Errors.
Earnings Conference Call
Prospect Capital Q1 2025
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