Prospect Capital Corporation
Q4 2019 Earnings Call Transcript

Published: 28 Aug 2019

[Operator:]

Good day and welcome to the Prospect Capital Fiscal Year 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 that this event is being recorded. I would now like to turn the conference over to 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 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 forecast due to the impact of many factors.

[John Barry:]

Thank you, Kristin. For the June 2019 quarter, our net investment income or NII is $69.6 million or $0.19 per share, down $0.02 from the prior quarter and exceeding our current dividend rate of $0.18 per share by $0.01. Our ratio of NII to distributions is 105%. In the June 2019 quarter, our net debt to equity ratio is 70%, up 0.9% from the prior quarter. Our net income for the quarter is $89.2 million or $0.24 per share, an increase of $0.42 from the prior quarter, primarily due to realized and unrealized gains from our portfolio. We are announcing monthly cash distributions to shareholders of $0.06 per share for each of September and October, representing 135 consecutive shareholder distributions. We plan on announcing our next series of shareholder distributions in November. Since our IPO over 15 years ago, through our October 2019 distribution at our current share count, we would have paid out $17.52 per share to original shareholders, aggregating approximately $3 billion in cumulative distributions to all shareholders. Our NAV stood at $9.01 per share in June, down $0.07 from the prior quarter. Our balance sheet as of June 2019 consists of 87.4% floating rate interest earning assets and 93% fixed rate liabilities. In recent weeks, we've trimmed our cost of term debt issuance, commensurate with reductions in treasuries. Our percentage of total investment income from interest income is 92.2% in the June 2019 quarter, an increase of 1.6% from the prior quarter. I'll now turn the call over to Grier.

[Grier Eliasek:]

Thank you, John. Our scale business with over 6 billion of assets and undrawn credit continues to deliver solid performance. Our experienced team consists of approximately 100 professionals, which represents one of the largest middle market credit groups in the industry. With our scale, longevity, experience and deep bench, we continue to focus on a diversified investment strategy that covers third-party, private equity sponsor related and direct non-sponsor lending, Prospect sponsored operating and financial buyouts, structured credit, real estate yield investing, and online lending.

[Kristin Van Dask:]

Thanks, Grier. We believe our prudent leverage, diversified access to matchbook funding, substantial majority of unencumbered assets and waiting towards unsecured fixed rate debt, demonstrates both balance sheet strength, as well as substantial liquidity to capitalize on attractive opportunities. Our company has locked in a ladder of liabilities extending 24 years into the future. We are a leader and innovator in our marketplace. We were the first company in our industry to issue a convertible bond, developed a notes program, issue under a bond ATM, acquire another BDC and many other lists of first. Shareholders and unsecured creditor alike should appreciate the thoughtful approach, differentiated in our industry, which we have taken towards construction of the right hand side of our balance sheet. As of June 2019, we held approximately 4.12 billion of our assets as unencumbered assets, representing approximately 71% of our portfolio. The remaining assets are pledged to Prospects Capital funding, where in the past year we completed an extension of our revolver by 5.7 years, reducing the interest rate on drawn amounts to one month LIBOR plus 220 basis points. We currently have 1.1325 billion of commitments from 30 banks with a 1.5 billion total size accordion feature at our option. The facility revolves until March 2022, followed by two years of amortization with interest distributions continuing to be allowed to us. Outside of our revolver and benefiting from our unencumbered assets, we’ve issued at Prospect Capital Corporation, including in the past two 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 Kroll. An investment-grade BBB rating from Egan-Jones and investment-grade BBB negative rating from S&P and an investment-grade BAA3 rating from Moody's. So a total of four investment-grade ratings. We've now tapped the unsecured trend debt market on multiple occasions to ladder our maturities and to extend our liability duration out 24 years. Our debt maturities extend to 2043. With so many banks and debt investors across so many debt tranches, we have substantially reduced our counterparty risk over the years.

[John Barry:]

Thank you. We can now answer any questions.

[Operator:]

We will now begin the question-and-answer session. . The first question will come from Robert Dodd with Raymond James. Please go ahead.

[Robert Dodd:]

Just looking at the current rate outlook environment, obviously you've got a primarily floating rate book and fixed rate liabilities. So if the LIBOR curve is correct currently, and we drop from what was something like 2.5 in the June quarter to something more like 1.5 by the end of next year, what plans can you put into place to kind of mitigate that impact? Obviously, one of the options is leveling up. And can you give us any color on how much of your liability structure still has a one-to-one covenant embedded in it versus just fully at compliance and then what you can do on the asset side as well?

[John Barry:]

Sure. Go ahead, Grier.

[Grier Eliasek:]

Okay. Thank you, Robert, for your question. Obviously, an environment in which LIBOR is decreasing can also signal concerns on an economic basis. So, it starts with a principal protection and credit protection from an underwriting standpoint. So that's always going to be our prioritization on the asset side of the ledger, on the left-hand side the balance sheet. I wouldn't be surprised to see a little bit of a spread give back, because you had spreads dropping as LIBOR was increasing. So a little bit of the opposite dynamic occurring in the inverse, I think it's reasonable to assume to offset. And we do have LIBOR floors in number of our deals, where we act as agent. We've attempted to set LIBOR at close to prevailing rate, so new originations on an agented basis in the last year. So we're in the 200 plus LIBOR category.

[John Barry:]

Okay. Is that helpful, Robert?

[Robert Dodd:]

Yes, that's helpful. If I can two quick follow-ups to that. To your point, Grier, we can see spreads give back and they do tend to widen when rates come down. The ability to kind of capture that depends on how fast a portfolio turns over for the most part, right? And so, over the last year, we've seen relatively lower turnover in your portfolio, I mean about $600 million in repayments, about 10% of the portfolio '19 versus much higher than in '18 and '17. So, that turnover has slowed down asset life , that reduces potentially the ability to capture that spread widening. So, should we expect that your turnover within the portfolio should be accelerating, or -- and/or kind of the asset life shrinking to take advantage of those widening spreads?

[Grier Eliasek:]

Yes. Portfolio turnover is a little bit tricky measure, I think the way you're describing it, Robert, because there are two important pieces to that. One is NPRC as a controlled investment, looks like it never turns over. But in reality on an underlying individual asset basis, we are exiting up to seven assets per annum. That's the tax REIT maximum that's allowed as per the rules, we've been coming close to that. So we actually have been turning over that particular book. Also, in our structured credit business, when we do an extension we actually maintain the same two-step. And so it looks like it's not turning over and it isn't. But the asset is actually changing in a positive way by extending tenor of the deal, which allows us to do one of and ideally two things simultaneously. One, by extending the deal, purchase a wider spread, longer dated assets as per individual indenture weighted average life test. And number two, reduce our cost of liability financing. So -- and there's turnover that happens also in the individual deals where you're seeing spread widening finally on the asset front. I mean 2018 was the year of asset compression and now we've had three straight quarters of asset spread widening that benefits us and of course both liabilities and assets are floating rate. So you only have kind of a stub floating rate exposure for the sort of unhedged portion, which is your investment amount essentially. So we're getting some capture back there. In terms of middle market book and that turnover, we are getting repayments occurring to start increase a little bit. It's been a very tricky market, because every time there's a significant bout of volatility, if you like it, it impacts your M&A that's such a big driver of origination activity of course in our business and you saw things slow down dramatically at the end of last year, then start to pick up again this spring. Then it slowed again with the part seasonality in the summer and then another bout of volatility. So -- and part of it has also been our proactive turnover, because we're doing a lot that we talked about to manage risk and to prepare for the downturn that -- while some people have been predicting it for five years, I guess if you predicted five years ahead of time, you're right eventually. But eventually the cycle turns and we want to have the strongest fortress to handle that and be a net beneficiary of that situation in terms of buying other platforms, buying assets, et cetera. We've benefited significantly from that risk management in the last downturn. It's like we have made our business even better especially with counterparty risk reduction. But we're also trimming our excess concentration exposures we see. You haven't seen us on the new origination front add, kind of multi-hundred-million-dollar exposures. We've been clubbing more. We've been selling down more. We're very reluctant to take on that risk. So there's an element of turnover happening there as well. And traditionally, the kind of more agented middle market business was the more attractive place. We've seen a migration of covenant wide that book. You've seen some unwieldy and not pretty smart capital structures, because that's really where the influx of capital has occurred. It's in the middle markets, not as much in the syndicate market, like you've seen a net withdrawal of capital, because so much was pegged to interest rate expectation. So just a long way of saying, we're saying now a lot more often, to middle market deals that are smaller credits that need to have lower leverage structures and lower adjustments allowed et cetera. And there's a lot of capital that’s been raised, it has to go somewhere. So there's a lot of things that go into the portfolio turnover equation, Robert.

[Robert Dodd:]

Got it. I appreciate it. One quick -- maybe quick…

[John Barry:]

Hey, Robert. It's John. I think you got the gist of it, which is that, there is more than one natural hedge in our business, right? We are funding ourselves to PCF, which is our -- I guess, our incremental swing factor funding source, that's floating rate. So as LIBOR declines that source of funding goes down. Our company -- our portfolio companies are funding themselves primarily with LIBOR based paper. So lowering interest rates is intended to make their life easier and does, all things being equal. So just to mention, just those two items are examples of the natural hedge in our business. It is true, I think, that we would prefer much more inflation and much greater spreads. But I think that would erode the real returns to our shareholders. So as far as our shareholders are concerned, measuring real returns, I believe that they are net winners as interest rates decline.

[Robert Dodd:]

Yes, I appreciate that John. Just one more I got on the REIT. In the past you told us something like the dividends from the REIT correlate with exits because it creates a taxable event, et cetera, et cetera. And in your commentary Grier, John, you said that you've got a number -- you've done a number of exits and got a number that are coming soon. So would it be fair to say that there should be more dividend income from the REIT or is that any gains within that more likely to be reinvested?

[Grier Eliasek:]

So I would describe our outlook for NPRC as a reasonably stable within a band income distribution expectation. And based on assets that we have already exited, as well as ones that are under contract, as well as ones we expect to be under contract soon, we think we have over two years of kind of rough run rate income distributions in effect banked probably more like 2.5 years. And then we would be looking to add to that by exiting other assets as we identify them. And essentially what we do is every quarter reupdate our cash flows and run NPV analysis of the individual assets. Should we exit? Should we refinance? How should we refinance and what tenor and structure should we do a dividend recap, a so-called supplemental financing? Should we stick with the GSE, Fannie and Freddie? The CMBS bid has actually become more competitive off late, in part because the GSEs are reaching some of their regulatory maximums for multi-family. So it's nice to see the private bid come in more strongly. So we do all these things and when that spits out of the analysis to exit, we do so with an optimal fashion. So we feel very good about the sustained cash flow income generation power of that business to get multiple years in effect banked. And we're looking to add to and extend that tenor.

[Operator:]

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

[John Barry:]

Yes, so I think we're all set. Thanks everyone. Bye now.

[Grier Eliasek:]

Thank you.

[Operator:]

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