Prospect Capital Corporation
Q3 2021 Earnings Call Transcript

Published: 11 May 2021

[Operator:]

Good day, and welcome to the Prospect Capital Third Fiscal Quarter Earnings Release and Conference Call. All participants will be in a 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, Chairman and CEO. Please go ahead.

[John Barry:]

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

[Kristin Van Dask:]

Thanks, 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. We do not undertake to update our forward-looking statements, unless required by law. For additional disclosure, please see our earnings release and our 10-Q filed previously and available on the Investor Relations tab on our website prospectstreet.com.

[John Barry:]

Thank you, Kristin. Before reviewing the quarterly results, I would like to accentuate the obvious by thanking the multiple teams at Prospect. They helped us produce the numbers that everyone sees this quarter. I can start with Kristin and her accounting team, who worked all weekend to take care of some last minute items, that would otherwise be a thankless task, but I'm thanking Kristin and her team - her large team for that; our lawyers led by Jon Li protect our firm and our shareholders every step of the way; on our investments; on any disagreements we may have with counter parties, fortunately they are rare; our investment professionals from structured credit to aircraft leasing to real estate led by Ted Fowler. These business units have been firing on all 8 cylinders, the last 10 quarters, which is when our NAV was last at this level. And I want to thank all of the people who work at Prospect for making this happen and for their dedication and devotion to the shareholders that trust us. Shareholders, many of whom, have been with us since our initial public offering in 2004. So on behalf of all shareholders, I am thanking all the people that work at Prospect for a job well done. Many of them are shareholders along with me' and people listening to this call, and are benefiting from their hard work financially. So let's turn to the results for the quarter. In the March quarter, our net investment income was $73.4 million, $0.19 per common share, exceeding our distribution rate per common share by $0.01. Our basic net income, attributable to common stockholders was $246 million or $0.64 per common share, as the overall value of our investment portfolio increased for the fourth consecutive quarter due to a combination of positive company-specific and macro factors. Our NAV stood at $9.38 per common share in March, up $0.42 and 5% from the prior quarter, our fourth consecutive quarter with NAV growth. Our NAV per common share is now at the highest level since June 2019. We have outperformed our peers during the past multiple quarters of macro pressure as a direct result of our previous derisking from not chasing leverage as well as other risk management controls. 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 future earnings for our shareholders.

[Grier Eliasek:]

Thank you, John. Our scale platform with over 6.4 billion of assets and undrawn credit continues to deliver solid performance in the current challenging environment. Our experienced team consists of around 100 professional, 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. This diversity allows us to source a broad range in high volume of opportunity, 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.

[Kristin Van Dask:]

Thank you, Grier. We believe our prudent leverage, diversified access to match 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 22 years into the future. To-date, we have 0 debt maturing until July 2022. Our total unfunded eligible commitments to non-control portfolio companies totals approximately $24 million or 0.4% of our assets. Our combined balance sheet cash and undrawn revolving credit facility commitments currently stand at approximately $814 million.

[John Barry:]

Thank you, Kristin. We can now answer any questions.

[Operator:]

Our first question comes from Robert Dodd with Raymond James.

[Robert Dodd:]

Congrats on the quarter. A couple of questions about specific assets, if I can. First on the First Tower, it was one of your bigger line-ups this quarter, not a lot of disclosure in the Q about why - I mean, just financial performance was better. Can you give us any metrics there on revenue growth, receivables outstanding, any kind of metrics to give us some information on how much the financial improvement was better, et cetera?

[John Barry:]

Yes, Grier can do that. Go ahead, Grier.

[Grier Eliasek:]

Robert, so to describe the boost in value for First Tower, which was about $48 million for our position as - in significant part due to underlying performance and in a partial part due to improvement in metrics and values for comparable companies, including public comps that help to drive the valuation. These types of companies are - have been trading quite well in the March quarter. From a fundamental standpoint, which, of course, is what we focus very hard on, we've seen an improvement in multiple areas. We've seen improvement in same-store sale, we've seen an improvement in charge-offs, really in all the states in which First Tower operates. And we've also received a benefit in our financing costs, which is our floating rate with a strong and supportive bank group that has been with the business for years - really decades and know the company well and underwrite. So, with Libor at a very low level - our financing cost have been low for the company as well. Obviously, the macro backdrop is constructive with strong consumer wallet helped in significant part by fiscal spending, which has the important driver in consumer credit across the board. But we credit the management team led by Frank Lee, whose family founded the company decades to go. Frank is a wonderful business person, leader and 20% equity holder and has done a strong job along with the rest of the management team in sustaining and increasing improving performance, including in states where First Tower has expanded in recent years. And whenever you expand into a new geography, there's always a micro learning curve associated with the particular nuances of that area and individual management teams at the branch level that need to be managed. So we're very happy with the across-the-board performance, we've now been an 80% owner of this business and lenders to the company as well for almost 10 years, about 9 years and it's been a strong long-term of hold cash produced there and highly tax efficient as well, tax partnership, no taxation downstairs and tax rate compliance of no taxation upstairs. So very pleased with First Tower.

[Robert Dodd:]

Got it, thank you. I mean, just on that - I mean, given the valuation, I mean, it's a very sizable asset on your books, under what - I mean, I know good income contributed as well. Very good. Under what conditions would you consider selling that asset and re-deploying the capital into a more diversified pool maybe other than one large single asset?

[Grier Eliasek:]

Well, we view it as a diverse granular pool actually not a large singular asset. There are hundreds of thousands of loans that underpin that book, so it's arguably more diversified than a corporate credit book with 100 to 200 names, and geographically diversified as well. So we view it in a look-through diversified fashion. We, from a long-term hold standpoint, evaluate this asset as we would any other in the book. For example, in our real estate business, we do this regularly where we update, on a quarterly basis, NPVs of each asset. Should we hold this asset? Should we divest it with the foregone IRR from divesting it? Should we optimize the financing or in some other fashion with the NPV maximizing strategy? And where can we profitably redeploy the proceeds? It would take a lot in order to sell this asset, because it is so wonderfully tax efficient for us, we are the lowest cost of capital, most tax efficient owner of this business. We've already become a standalone public company, which certainly is of scale and stature to do with the north of $100 million EBITDA business. It would be a corporate taxpayer and perhaps, corporate tax rates are going up, we'll see, but there's certainly a non-0 out there. There is 0 for us taxed as a flow-through partnership. So that would be a very challenging endeavor, because the bar of high volume public - that would super impose a higher cost structure than where we hold the business today. So we're happy with the business, we haven't focused on hyper growth, we focused on proper underwriting, really using the theme, tried and true fundamental old fashion values of consumer credit underwriting that have underpinned this A loan instalment lender, that's a bit higher up on the quality spectrum than others in the space. And do not have any immediate plan to exit the position.

[Robert Dodd:]

Okay, got it. Thank you for that. On - one - on the - REIT, I mean, in the Q, one of the reasons for the mark up in the REIT was obviously cap rate compression. John, in your prepared remarks, you talked about, obviously enough of the potential for rising inflation, I wouldn't necessarily think that would impact cap rates in the short run, but what's your view of the potential for longer-term inflation and how would that influence cap rate at the REIT - under all REIT parallels?

[John Barry:]

Okay. Well, Robert, I'm glad we give Grier rest for a second. Just before I do, just more on First Tower. It's rare that we can find a management team and buy a business run by a management team that is experienced and expertise as Frank Lee's team, Darryl Schroeder, Jody Macon. And frankly, Frank has been running that business with his team for decades through thick and thin. So knowing how hard it is to find great managers, I would be very slow to vote to sell First Tower and attempt to deploy the proceeds into another business. What we wouldn't be more likely to do is hopefully find another great manager like Frank Lee and bag that manager and build that business. Under Frank's tutelage, First Tower has grown significantly. Our internal team, Denis, Aderly and Edward have helped Frank do that by optimizing the capital structure, helping to analyze additional acquisitions, horizontal extensions. And so, we have a good situation with our internal team and with the external team. And so, Robert, I - if you find a company that we should buy, we'd love to buy it, but I don't think we are going to need to sell First Tower as I think you know, we are significantly underlevered, at least compared to other BDCs. So we have a war chest of capital that we're just sitting on and waiting for the - now, I'm getting to your question, right? It's like Alice's Restaurant, I'll finally get there. We see - I mean, I think you put your common sense head on and ask yourself the U.S. government spend how many trillions? Is it $6 trillion in less than a year, I was just mailing checks to people and expect that there would not be inflation. Of course, there will be inflation and we're seeing it everywhere, lumber, commodities, housing prices, bitcoin. So we are sitting on a war chest, because we believe this will be very similar to what happened during the Carters years and the Fed will have to chase the inflation. Raising interest rates won't be helpful to anybody, but our job as stewards of our shareholders' capital is to see reality for what it is, not for what people want to tell us it is. And yes, investors' worst enemy is at the door, inflation. Because what happens is, first, you are being taxed on returns that are - that may not even be positive on a real basis. Fortunately, investors in our company are receiving the high, real as well as nominal returns, but investors in some of these tech companies are going to see inflation and higher interest rates significantly erode the outyear value as discount rates compound up and diminish the value of the gold at the end of the rainbow 10 years from now. So the way we see it, our war chest of capital, our low leverage, our expertise and dedicated, really devoted origination team is ready for what comes next. We believe that there will be companies in distress as there have been in the past and that we will be able to purchase those companies at distressed prices. So that's why we've been keeping our leverage well, even though some people would argue, if you can borrow at 1.76% and reinvest at 10%, why aren't you doing more of that? Well, if you read the book Built to Last, you will see that if you want to build a company to last, you remain disciplined through all cycles and get ready for the next one. So that's why I added to my remarks, my concern about upcoming inflation and the need for really all investors to be ready for it. Is your view different, Robert?

[Robert Dodd:]

I wouldn't say it's substantially different, but you're the one running the company. So I just wanted to get your opinion on that point.

[John Barry:]

I just have to evaluate it, not run it.

[Grier Eliasek:]

Just - so you had asked about real estate, Robert. And real estate is a classic inflation hedge, especially multi-family and why is that? Well, because one can reprice the rent frequently, because the leases are 1-year typical duration. At the same time, financing costs are locked in for the long term and we have essentially almost entirely fixed rate long term financed book. So your financing costs and debt service payments are fixed, while rents go up in an inflationary environment and net operating income goes up. It is possible there is a give back to your question about cap rates if the Fed respond as inflation fighting in terms of increasing short term rate to the extent that increases a typical benchmark like a 10-year treasury to which financing costs would often be pegged. And it is possible that there could be some cap rate increases that occur as a result, but the net operating income will surely be growing in that inflationary environment. So, I like that those are significant offsetting trends, maybe NOI growth is actually greater because you get an investor rotation into the sector fleeing fixed income in other areas that are having issues. So you may not have the change in cap rates at all and you get the NOI boost, so the best of both worlds. So we view that as the leading light and really bright star in the portfolio that differentiates us substantially from our peers in an inflationary environment or potential for substantial increase and inflation due to the Fed's printing of money and are very, very happy with the performance of our real estate book. It also acts as a significant diversification benefit relative to the rest of the book, low correlation, dampens volatility, efficient frontier, attractive addition to the investment portfolio construction. So, we're quite pleased with that business and we continue to make new investments and we continue to exit investments selectively, utilizing that quarterly NPV maximization, disciplined capital allocation methodology that I articulated previously.

[John Barry:]

So Robert, as you remember, in the 1970s and early '80s, the real estate investors were the people that survived the huge inflation then with more of their capital than anyone else. So we do regard our large multi-family book as an anchor to win with. Okay. Well, thanks everyone. Have a wonderful afternoon. Bye now.

[Operator:]

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