Q1 2025 Prospect Capital Corp Earnings Call

Good day and welcome to the prospect capital first fiscal quarter earnings release and conference call. All participants will be in listen only mode should you need assistance.

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Speaker Change: This event is being recorded I would now like to turn the conference over to John Barry CEO. Please go ahead.

John Barry: Thank you Dave.

Joining me on the call today are Greer logic, our president and Chief operating officer.

John Barry: And Christian Vande ask our Chief Financial Officer Kristin.

Speaker Change: Thanks, Jon This call contains forward looking statements that are intended to be subject to safe Harbor protection.

Speaker Change: Future results are highly likely to vary materially.

Speaker Change: We do not undertake to update our forward looking statements.

Speaker Change: For additional disclosure see our earnings press release, and 10-Q filed previously and available on our website prospect Street Dot com.

Speaker Change: Now I'll turn the call back over to John.

John Barry: Thank you Christian.

Before we get started I wanted to Paula Josh to Finian O'shea from what I said on our last earnings call.

John Barry: When the love of your life tells you Afternooner 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.

But if prospect we've is saying.

John Barry: Blast furnaces tempered the best steel.

John Barry: And I appreciate your tough questions on our business.

John Barry: And from other people at wells in other firms and we look forward to working with all of you in the years to come.

Now.

John Barry: Onto official business.

John Barry: In the September quarter, our net investment income, where NII was $89 $9 million were 21 cents.

John Barry: Common share.

A N a V was $3.51 billion or 810th $8.10 per common share.

John Barry: At September 30.

Our net debt to total assets ratio was 29.7%.

John Barry: Unsecured debt.

John Barry: Preferred is 86% of total debt plus preferred for prospect.

John Barry: Since inception over 20 years ago.

John Barry: Through our January 2025 declared distribution.

John Barry: We will have distributed $4.4 billion were $21 25 per share rep.

John Barry: Representing 2.6 times September 202 for Com.

Common N a V per share and four one times, our Wednesday stock price closing.

John Barry: We are announcing monthly common shareholder distributions.

John Barry: Our 4.5 cents per share for each of November December and January.

John Barry: We plan on announcing our next set of shareholder distributions in February.

John Barry: We are right sizing 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.

John Barry: Into our core business, our first doing senior secured middle market loans, including sometimes with selected equity co investments.

Our preferred shareholder cash distributions continue at the contractual rates of such distributions.

John Barry: Yellow equity and real estate investments have generated attractive unlevered investment level gross cash IRR of 12% for CLO equity.

24% for real estate property exited investments.

and 2012, respectively.

but with more variability.

compared to our core business.

John Barry: 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.

John Barry: We still perceive CLO equity and real estate investments as attractive, risk-adjusted strategies.

John Barry: We intend another fund to be developed and to be managed by an affiliate of Prospect Capital Management to continue to focus on new CLL investments.

John Barry: with less targeted prospect capital corporation balance sheet investment in this strategy going forward.

Similarly, with real estate.

CLO equity has decreased to 6% of our assets.

John Barry: versus 18% as of September 30, 2017. As we execute on our rotation strategy to emphasize first lien, senior secured lending.

with such mix growing significantly for us.

CLO equity typically generates attractive cash-on-cash yields.

John Barry: but such yields tend to be higher in the initial years while lower in the later years.

John Barry: thereby resulting in variability that we seek to reduce by focusing more on our core business at Prospect Capital Corporation.

real estate investment, investing,

John Barry: 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.

John Barry: We have exited dozens of our value-add properties in the past several years after achieving strong rent and net operating income performance.

John Barry: 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.

John Barry: While we expect to monetize further real estate property investments with attractive returns, we are cautious about the pace of future exit-related income.

John Barry: Over the last seven weeks, the Fed has reversed 75 basis points of prior short-term interest rate increases.

John Barry: that heard our book, with market expectations for more reductions going forward, which may lower future shareholder distribution rates across all related credit industries.

Speaker Change: We have already factored in the declining forward curve for short-term interest rates for our Common Shareholder Distribution Declaration today. Thank you. I'll now turn the call over to Greer.

Greer: Thank you, John. Over the past two decades, Prospect Capital Corporation has invested $11.4 billion in over 300 exited investments.

Greer: that have earned a 13% unlevered investment level gross cash IRR to Prospect Capital Corporation.

Greer: This two-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.

Greer: Our core business of directly originated, non-syndicated, first lien, senior secured loans to U.S. middle market companies.

sometimes with selected equity co-investments offers multiple compelling attributes.

Greer: First lien loans as percentage of total investments have now reached 65%, an increase of over 700 basis points for the year-over-year quarterly period.

Greer: Such core business with proprietary opportunity flow offers higher spreads than lending to much larger companies.

Greer: which loans are experiencing significant spread compression for other lenders focused on that more competitive and commoditized larger end of the market.

Greer: Middle market loans, by comparison, offer higher interest rate floors, often 250 to 400 basis points.

Greer: versus loans to larger companies, which often have only 0 to 100 basis point floors.

Greer: thereby providing better protection for yield and income when short-term interest rates decline.

Greer: Such higher floors benefited Prospect Capital Corporation greatly when the Fed last sharply reduced such rates during the GFC.

Greer: First 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.

Greer: 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 two-times liquidation preferences.

Greer: with an objective to maximize current yields and total returns in a prudent and risk-adjusted fashion.

Greer: Many such investments that we are currently underwriting have targeted unlevered double-digit current yields

Greer: 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

Greer: Discovery Point, and Druid City illustrate such non-syndicated middle market focus where we also capture equity upside.

Greer: Our middle market portfolio companies also have the potential to drive substantial synergistic value creation with add-on acquisitions.

Greer: with examples including Valley purchasing Comet and RV Industries making multiple acquisitions.

with such middle market investments.

Greer: 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,

Greer: strategic planning, executive recruiting, add-on acquisition sourcing, and other important areas.

Greer: Our pipeline continues to build with additional non-syndicated first lien senior secured middle market loans, with selected equity co-investments,

Greer: 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% first lien debt.

Greer: That's up 7.6% from the prior year, 11.1% second lien debt, that's down 4.8% from the prior year.

Greer: 6.2% subordinated structured notes with underlying secured first lien collateral. That's down 1.9% from the prior year.

Greer: And 17.8% unsecured debt and equity investments, that's down 0.9% from the prior year.

Greer: resulting in 82.2% of our investments being assets with underlying secure debt benefiting from borrower-pledged collateral.

Greer: We're pleased with our continued success in executing our plan to increase our first lien mix while reducing our second lien and subordinated structured notes exposure, thereby reducing portfolio risk.

attractive risk-adjusted yields, and are performing interest-bearing investments.

were generating an annualized yield of 11.8% as of September.

Greer: Our interest income in the September quarter was 94% of total investment income, reflecting a strong recurring revenue profile to our business.

with a fair value of $7.5 billion.

Greer: We also continue to invest in a diversified fashion across many different portfolio company industries, with a preference for avoiding cyclicality and industry concentration.

Greer: 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%.

Greer: and in the retail industry stood at only 0.1% as examples of cyclical industries where we have low exposure.

non-accruals as a percentage of total assets.

Greer: stood at approximately 0.5% in September. Weighted average middle market portfolio net leverage stood at 5.7 times EBITDA. Our weighted average EBITDA per portfolio company stood at $105 million.

Originations in the September quarter aggregated $291 million.

Greer: We also experienced $282 million of repayments and exits as a validation of our capital preservation objective, resulting in net originations of $8 million.

Greer: During the September quarter, our originations comprised 85.8% middle market lending, 7.8% real estate, and 6.1% middle market lending and buyouts.

Greer: So far in the current December quarter, we've booked $42 million in originations and experienced $163 million of repayments.

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

Thanks, Greer.

Kristin: We believe our prudent leverage, diversified access to matched book funding, substantial majority of unencumbered assets,

Kristin: waiting toward unsecured fixed-rate debt, avoidance of unfunded asset commitments, and lack of near-term maturities demonstrate both balance sheet strengths as well as substantial liquidity to capitalize on attractive opportunities.

Kristin: Our company has locked in a ladder of liabilities extending 28 years into the future.

Kristin: Our total unfunded eligible commitments to portfolio companies totals approximately $48 million, representing approximately 0.6% of our assets.

Kristin: Our combined balance sheet cash and undrawn revolving credit facility commitments currently stand at $1.5 billion.

Kristin: As of September, we held $4.9 billion of our assets as unencumbered assets, representing approximately 64% of our portfolio.

Kristin: The remaining assets are pledged to Prospect Capital Funding, a non-recourse SPV.

Kristin: In June, we successfully completed and amended an extended credit facility with a new five-year maturity.

Kristin: We currently have $2.12 billion 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.

Kristin: 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%.

Kristin: 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.

Kristin: All of these types of unsecured debt have no financial covenants, no asset restrictions, and no cross defaults with our revolver.

Kristin: We currently have five investment grade ratings more than any other company in our industry.

Kristin: 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 2052.

Kristin: With so many banks and debt investors across so many unsecured and non-recourse debt tranches, we have substantially reduced our counterparty risk.

Kristin: 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.

Thank you, Kristin.

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

Speaker Change: We will now begin the question and answer session. To ask a question, you may press star then 1 on your touch-tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star and then 2.

Speaker Change: Our first question comes from Thinian O'Shea with Wells Fargo Securities. Please go ahead.

Thank you. Bye.

Speaker Change: Hey, everyone. Good morning. I appreciate the opening remarks, John. Welcome back. We're delighted to hear your voice.

Speaker Change: Likewise, I know we both always like to have a good time when talking about BDCs, so just won this quarter on the dividend.

Speaker Change: are right-sized now, but it's still a comparatively low yield on book, and of course that 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?

Speaker Change: outline or quantify like how much you can rotate, where those pockets are, and what you sort of strive for on driving an improved book return. Thanks.

Speaker Change: I'd love to, but I'm not allowed to answer any questions. Actually, I gave my little praise to you at the beginning.

Speaker Change: income and yield tends to be front and weighted during the life of a deal. And while we're enjoying reasonably robust cash flows, we're actually not recognizing much income from a gap standpoint.

Speaker Change: and that book is therefore amortizing significantly. I think we're getting somewhere along a 2% or 3% gap yield off of CLOs, which obviously is well below the double-digit yields plus equity upside in many cases.

Speaker Change: that we can earn on our core business of middle market lending, which has been quite robust with successful recent investments.

Speaker Change: So, by continuing to amortize that book, and you see every quarter it continues to amortize and drop as the percentage of the portfolio, we're now at about 6%.

Speaker Change: of the book in CLO's that should provide an earnings boost. That's area number one.

Area number two, which we also highlighted, is real estate.

strategy

Speaker Change: When SOFR was near zero, and maybe we'll return to that at some point, depending upon the pacing of fed cuts. We've obviously had 75 bips and only...

Speaker Change: seven 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.

Speaker Change: and we thank monetizing our real estate as we've continued to do.

Speaker Change: 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.

Speaker Change: through our successful investing in value-add workforce housing. So that's area number two. Area number three would be...

exiting again in a prudent fashion.

successful.

Speaker Change: and we think that it's the right time to exit was often appreciated.

and Rotate.

a higher current.

income and total return.

Speaker Change: 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

Speaker Change: And if we've concluded foregone IRR to foregone yield, we examine both.

Speaker Change: then we'd rather sell to a third party and then rotate.

Speaker Change: So we think this provides a significant upside to our business going forward to boost our return on equity, which we're relentlessly focused on. Thank you.

Thank you, guys.

Speaker Change: This concludes our question and answer session. I would like to turn the conference back over to John Barry for any closing remarks.

John Barry: Okay, well thank you everyone. Have a wonderful morning and we'll see you in a quarter. Thanks so much, bye now. Thank you all.