Prospect Capital Corporation (NASDAQ:PSEC) Q4 2024 Earnings Call Transcript

Prospect Capital Corporation (NASDAQ:PSEC) Q4 2024 Earnings Call Transcript August 29, 2024

Operator: Good day, and welcome to the Prospect Capital Fourth Quarter Fiscal Year 2024 Earnings Release and Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mr. John Barry, Chairman and CEO. Please go ahead, sir.

John Barry: Thank you, Chuck. 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: 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-K filed previously and available on our website, prospectstreet.com. Now I’ll turn the call back over to John.

John Barry: Thank you, Kristin. Prospect Capital Corporation is celebrating our 20th anniversary as a leading provider of private debt and equity to U.S. middle-market companies. Since 2004, we’ve invested $20.9 billion across 423 investments, exiting 303 investments. Over the past five years, we’ve generated higher total returns than our peer BDC median. In the June quarter, our net investment income, or NII, was $102.9 million, or $0.25 per common share. Our NAV was $3.71 billion, or $8.74 per common share. At June 30, our net debt to total assets ratio was 30.5%. Unsecured debt plus preferred is 80.3% of total debt plus preferred for Prospect. We are announcing monthly common shareholder distributions of $0.06 per share for each of September and October, with the latter representing our 86th consecutive such distribution.

We plan on announcing our next set of shareholder distributions in November. Since inception through October 2024, declared distribution, we will have distributed $4.3 billion, or $21.12 per share, representing 2.4 times June 2024 common NAV per share and 4.1 times our Tuesday stock price. As a majority shareholder in several private companies, we support company investments by providing capital, expertise and guidance. When companies make acquisitions, purchase property, plant and equipment, or need working capital, including community increased demand, we often provide capital by directing such companies to pay for such expenditures using cash on hand, instead of using such cash to make interest payments to us, recording the resulting payment-in-kind interest, or PIK interest, as additional debt.

PIK interest is typically covered by aggregate portfolio company enterprise value. Portfolio company enterprise value, as calculated by third-party valuation firms for June 30, 2024, covers or substantially covers our net debt, including all PIK interest on accrual for substantially all of our controlled company investments, which I’d pick in the last two fiscal years. Thank you. I’ll now turn the call over to Grier.

Grier Eliasek: Thank you, John. As of June 30, our portfolio at fair value comprised 60.3% first lien debt, that’s up 3.8% from the prior year; 13.6% second lien debt, down 2.8% from the prior year; 6.9% subordinated structured notes with underlying secured first lien collateral, that’s down 1.7% from the prior year; and 19.2% unsecured debt and equity investments, up 0.7% from the prior year, resulting in 81% of our investments being assets with underlying secured debt, benefiting from borrower pledge collateral. For the current September quarter-to-date, we’ve exited another $198 million of second lien debt, representing a further 2.3% decline to 11.3%. We’re quite pleased with our continued success in executing our plan to increase our first lien mixed, while reducing our second lien and subordinated structured notes exposure, thereby reducing portfolio risk.

Prospect’s approach is one that generates attractive risk-adjusted yields and are performing interest-bearing investments. We’re generating an annualized yield of 12.1% as of June, no change to the prior quarter. Our interest income in the June quarter was 89.2% of total investment income, reflecting a strong recurring revenue profile to our business. As of June, we held 117 portfolio companies, a decrease of five, primarily due to repayments and exits from second lien loans from the prior quarter, with a fair value of $7.7 billion. We also continue to invest in a diversified fashion across many different portfolio company industries, with a preference for avoiding cyclicality and industry concentration. Our largest industry concentration is below 20%.

As of June, our asset concentration in the energy industry stood at 1.6%, our concentration in the hotel, restaurant and leisure sector stood at 0.3%, and our concentration in the retail industry stood at 0.3%. Non-accruals as a percentage of total assets stood at approximately 0.3% in June, representing a 0.1% decrease from the prior quarter. The weighted average middle-market portfolio net leverage stood at 5.5 times EBITDA, even with the prior quarter and substantially below our reporting peers. Our weighted average EBITDA per portfolio company stood at $107 million, an increase of $1 million from the prior quarter. Originations in the June quarter aggregated $242 million. We also experienced $245 million of repayments and exits as a validation of our capital preservation objective, resulting in net repayments of $3 million.

During the June quarter, our originations comprised 62.9% middle-market lending, 27% real estate, and 10% on middle-market lending and buyouts. To date, we deployed significant capital in the real estate arena through our private REIT strategy, largely focused on multifamily workforce, stabilized yield acquisitions with attractive in-place multiyear financing. To date, on a cumulative basis, NPRC has invested in 110 properties with a $4 billion aggregate initial property value across multifamily 83 properties, student housing 8 properties, self-storage 12 properties, and senior living four properties. In the current higher financing cost environment, we’ve added to our investment focus to include preferred equity structures with significant third-party capital support underneath our investment attachment points.

We’re also focusing on distressed sellers where there is an opportunity to take advantage of the seller’s need to recapitalize a property or generate liquidity to address other issues in their portfolios. NPRC, or private REIT, has real estate properties that have benefited over the last several years from rising rents, showing the inflation hedge nature of this business segment, solid occupancies, high collections, suburban work-from-home tailwinds, high returning value-added renovation programs and attractive financing recapitalizations, resulting in an increase over time in cash yields as a validation of this income growth business, alongside our corporate credit businesses. NPRC as of June has exited completely 49 properties at an average net realized IRR to NPRC of 24.4% and an average realized cash multiple of invested capital of 2.5 times, not including partially exited deals where we’ve received back more than our capital invested from distributions and recapitalizations.

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 favorable risk-adjusted opportunities. As of June, we held $532 million across 32 non-recourse subordinated structured notes investments, a reduction of $41 million from the prior quarter. We expect to continue to amortize our subordinated structured notes portfolio and to reinvest into middle-market senior secured debt and selected equity investments. As a result, the structured notes portfolio now comprises less than 7% of our investment portfolio and is expected to continue to decrease over time.

These underlying structured credit portfolios comprised nearly 1,600 loans. In the June quarter, this portfolio generated a GAAP yield of 4.1%, up 0.8% from the prior quarter, and a cash yield of 22.3%, up 0.2% from the prior quarter. The difference represents amortization of our cost basis, the returns capital to Prospect that we intend to use for other investment strategies and corporate purposes. Our aggregate subordinated structured credit portfolio has generated $2.1 billion in cumulative cash distributions to us through June, representing 126% of our original investment. Through June, we’ve exited 16 investments with an average realized IRR of 11.2% and cash on cash multiple of 1.3 times. So far in the current June quarter, the current September quarter, we booked $161 million in originations and experienced $253 million of repayments for approximately $92 million of net repayments.

Our originations have consisted of 92% middle-market lending and 8% real estate. Thank you. I’ll now turn the call over to Kristin. Kristin?

Kristin Van Dask: Yep. Thank you, 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 $35 million, representing approximately 0.4% of our assets. Our combined balance sheet cash and undrawn revolving credit facility commitments currently stand at $1.4 billion.

As of June, we held approximately $5 billion of our assets as unencumbered assets, representing approximately 63% of our portfolio. The remaining assets are pledged to Prospect Capital Funding, a nonrecourse SPV. In June, we successfully completed and amended an extended credit facility with a new five-year maturity. We currently have $2.12 billion of commitments, an increase of $168 million for March 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%. 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 2052. With so many banks and debt investors across so many unsecured and non-recourse debt tranches, we have substantially reduced our counterparty risk. At June 30, 2024, our weighted average cost of unsecured debt financing was 4.25%, an increase of 0.11% from March 31, 2024 and an increase of 0.18% from the prior year, June 30, 2023. Now, I’ll turn the call back over to John.

John Barry: Thank you, Kristin. We can now answer any questions.

Operator: [Operator Instructions] And the first question will come from Finian O’Shea with Wells Fargo Securities. Please go ahead.

Q&A Session

Finian O’Shea: Hi, everyone. Good morning. A couple of questions on the preferreds to convertible preferreds to start out. Those conversions picked up this quarter, and we want to see what trends you’re seeing post quarter in those. And second part, the PSEC sort of crisis option as described if the Board determines there’s a risk to 40 Act limitations, ratings, liquidity. Can you describe like under what circumstances you envision the Prospect Board forcing the conversion in all of these? Could it be something as simple as one of the rating agencies or a dividend cut or would it have to be a more onerous liquidity constraint? Thank you.

John Barry: Sure. Let me address that question. Is this something in a legal document like break glass here? If your house is on fire, here’s the path out. I mean, why are we talking about something like that?

Finian O’Shea: Well, it’s in the documents that not only the holder can convert them, but the Prospect Board could as well. And it would be at your stock price, it would be very dilutive to common. It was a bit dilutive this quarter.

John Barry: Okay. Well, first, I’m sure there’s lots of things in lots of our documents, our risk controls. I’m not going to just try to list them all here. You found this one. No one’s discussed it with me. I’m on the Board, I’m the Chairman. We’ve never discussed it, never contemplated it, never thought about it.

Finian O’Shea: Okay. So, fair enough, you don’t anticipate evoking that. How about a follow-up on the more standard issuer option conversion when the 5.35% preferred stock is out of the way, I think that’s the hurdle for that. Do you anticipate converting it then or do you want this preferred to remain in place, or do you want to list it or ultimately convert it? Like how do you see that capital structure?

John Barry: Well, if it didn’t broke, don’t fix it, right? If everything is going well, if we’re meeting all of our obligations, if we have 5 investment-grade ratings, if we have over 50 banks in our credit facility, no, we’re not running over and looking at break glass here. I just — I’m amazed at these questions. I’m just amazed. No, we’re not contemplating any of that. We’re not thinking about it. We’re not cogitating on it. We’re not reviewing it. We’re not discussing it. We don’t see any reason to spend time on stuff like that. I’m amazed you are. We have 5 investment-grade ratings. How many banks are in our facility? Do you know?

Finian O’Shea: What was it? 50?

John Barry: You don’t know. You don’t know. You don’t even know, and you cover us. How much should we just increase the bank facility by with how many banks?

Finian O’Shea: I think you mentioned, it was a couple more banks now.

John Barry: No. Hi, why are you relying on me? You’re a research guy.

Finian O’Shea: Okay. Can we go to the — fair enough on this topic.

John Barry: Break glass here. Oh, the building’s on fire. Quick, I’ve got to break glass. How ridiculous.

Finian O’Shea: Can I ask one on the CLOs? There was a lot of movement on realized and unrealized there, less so on earnings and cash flow. But can you talk about the sort of what was underneath, maybe change in assumptions here and what that might mean for the earnings trajectory on those going forward? Thanks.

John Barry: Absolutely. So, how much do you think that affected our net — that reclassification affected our net asset value by?

Finian O’Shea: Can you tell me?

John Barry: You don’t know? And you’re a research guy. And you’re a research guy. Well, but you’re right. You prepared this question like you’re some type of expert. Okay, it didn’t affect the NAV $0.01. Okay? So now you’re asking about another irrelevant, immaterial non-burger. It doesn’t — it’s just called the reclassification, all right? The fair value was at X. It was moved from unrealized to realized. This is what accountants do. They move things from right down to write off, back and forth, it’s very important to them. It doesn’t mean anything to me. It doesn’t affect the NAV of the company $0.01. It doesn’t affect the future or the past $0.01, but you think it’s a big deal, just like break glass here. Well, what else do you want to ask about?

Finian O’Shea: Fair enough. I will do. One more..

John Barry: By the way, why don’t you do the world a favor and do a little research before you come on an earnings call with absurd questions like this? You don’t even know what you’re talking about.

Finian O’Shea: One more on the REIT. Did you guys put, I think, about $20 million into there this quarter? Can you talk about what that went into underneath? Was that for more working capital, CapEx or how do we think of that…

John Barry: Here we go again. Here we go again. We, the REIT, owns a giant portfolio of multifamily properties, giant. The REIT generates huge cash flows up to PSEC, you probably don’t even know what they are. And each time the REIT wants to go buy a new building, Prospect being an investment company injects capital into the REIT to buy a new building. What is complicated about that? What is it about that you don’t understand? I don’t have the numbers right at my fingertips, the repays dividends. It’s like any REIT, they pay dividends. And then when the REIT wants to go buy something else, Prospect Capital Corporation will consider whether or not to inject more capital into the REIT and grow the REIT’s capital base, which, as Grier said, has generated a 21% IRR.

That’s not high enough for you? Where do you get that elsewhere? Nowhere. Well, maybe venture capital. This isn’t venture capital. This is an extremely high-performing REIT. Maybe you missed that because you didn’t do the research.

Finian O’Shea: We’re trying — I appreciate the answers. I’ll hop back in the queue. Thanks, John.

Grier Eliasek: Let me expand on a couple of items here on those three topics. First, with the preferred, there was one chunky conversion from the largest holder institution in Israel. I think we know what’s going on in Israel right now, and there is a need for liquidity, the size of that holders, head and shoulders larger than any other holder in a highly distributed private wealth rate. So that will not be repeated. Second, related to the preferred, we can’t invoke the issuer option conversion that you mentioned because of our new A4 M4 series and not just the a 5.35% listed preferred. So that doesn’t exist. You’re discussing something in the documents that is legacy and cannot be invoked. Number three, you also missed that we’ve been exchanging preferreds as opposed to having conversions.

That’s been quite successful from some of the older 5.5% holders to newer series preferreds. Our current one is a floating rate one and is non-convertible and is non-dilutive. We expect that to continue as well. Related to CLOs, which, as John mentioned, there’s no NAV impact from the reclassification. I think you asked about that every quarter. That’s now less than 7% of our portfolio and amortizing off. It’s a very small part of our book and the reclass had to do with older deals. Again, successful business, for us, it’s generated double-digit IRRs on a cash realized basis, and it’s generating 22% cash yields right now with capital being returned to us. And then finally, on the REITs, and the question about the $20 million investment, two important items.

One, we purchased value-add multifamily. There’s an ongoing multiple year need for value-added capital expenditures that’s ordinary that we’ll be making new investments, generally high IRR investments and upgrading units in common areas, you don’t do all that at time zero when you purchase a property, you do that over multiple years. Again, we’ve exited close to 50 properties at a 24%, 25% realized IRR and 2.5x cash-on-cash multiple, as I discussed. We also did a very attractive preferred investment. That’s been a terrific way to handle the current cap rate financing cost interplay and are quite pleased to expect a mid- to high-teens return on that investment. The REIT is an important portfolio company, but again, less than 20% of our book.

What seems to get lost here is it the vast bulk of what we do is senior secured and first lien middle-market lending as opposed to the smaller businesses being discussed. Thank you.

Finian O’Shea: Thank you, Grier.

Operator: This concludes our question-and-answer session. I would like to turn the conference back over to Mr. John Barry for any closing remarks. Please go ahead, sir.

John Barry: Okay, everyone. Well, we got an early start. Have a wonderful day. Bye now.

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