Good morning and welcome to the Prospect Capital Third Fiscal Quarter Earnings Release and Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [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.

Thank you, Laura. Joining me on the call today are once again Grier Eliasek, our President and Chief Operating Officer; and Brian Oswal, our Chief Financial Officer. Brian?

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, see our earnings press release, our 10-Q, and our corporate presentation filed previously and available on the Investor Relations tab on our website, prospectstreet.com. Now I’ll turn the call back over to John.

Thank you very much, Brian. For the first nine fiscal months of this year, our net investment income or NII was $279.8 million or $0.79 per share, $0.04 more than our dividends. Our net investment income in the March 2016 quarter was $87.6 million or $0.25 per share. Our recurring income as measured by the percentage of total investment income from interest income was 94% in the March 2016 quarter. We have previously announced monthly cash dividends to shareholders of $0.08333 per share for May, June, July, and August 2016 with the latter representing our 97th consecutive shareholder distribution in our company's history. We plan on announcing our next serious of shareholder distributions in August. We have generated cumulative, distributable income in excess of cumulative dividends to shareholders since Prospect's IPO 12 years ago. Since that IPO through our August 2016 distribution 12 years later at the current share count, we will have paid out $14.96 per share to initial continuing shareholders aggregating $2 billion in cumulative distributions to all shareholders. We have delivered solid returns while keeping leverage prudent. Net of cash and equivalents, our debt to equity ratio was 73.8% in March 2016, down 380 basis points from 77.6% in June 2015. Our net asset value stood at $9.61 per share in March 2016, down $0.04 from the prior quarter and $0.70 from June 2015. We believe this decrease during the fiscal year is primarily due to volatility in the capital markets, rather than to fundamental credit issues. We believe there is no greater alignment between management and shareholders than for management to purchase and own a significant amount of stock, particularly when such stock is purchased on the open market at market prices as with Prospect management. Prospect management is the largest shareholder in Prospect. Prospect management has never sold a share. Prospect management on a combined basis has purchased at cost over $160 million of stock in Prospect, including over $100 million since December 2015. Our objective is to drive future earnings through prudent levels of match book funding. We are currently exploring initiatives to further lower our funding costs including refinancing of existing liabilities at lower rates, opportunistically harvest certain controlled investments at a gain, optimize our origination strategy mix including increasing our mix of online loans, repurchase shares at a discount to net asset value and rotate our portfolio out of lower yielding assets into higher yielding assets while maintaining a significant focus on first lien senior secured lending. Our company has locked in a ladder of fixed rate liabilities extending nearly 30 years into the future. While the significant majority of our loans float with LIBOR providing potential upside to shareholders should interest rates rise. Thank you. I will now turn the call over to Grier.

Thanks, John. Our scale business with over $7 billion of assets and undrawn credit continues to deliver solid performance. Our team consists of approximately 100 professionals representing one of the largest dedicated 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. As of March 2016, our controlled investments at fair value stood at 33% of our portfolio. This diversity allows us to source a broad range and high volume of opportunities, 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 discipline manner in a low single digit percentage of such opportunities. Prospect's originations in recent months have been well diversified across our multiple origination strategies. Prospect closed approximately $1.1 billion of investments during the past four quarters. 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. As of March 2016, our portfolio at fair value comprised 51.6% first lien, 19.2% second lien, 16.6% structured credit with underlying first lien assets, 0.3% small business whole loan, 1.2% unsecured debt, and 11.1% equity investments resulting in 88% of our investments being assets with underlying secured debt benefiting from borrower pledged collateral. Prospect's approach is one that generates attractive risk adjusted yields and our debt investments were generating an annualized yield of 13.4% as of March 2016, an increase of 1.5% over September 2014, 1.0% over March 2015, 0.7%…

Thanks, Grier. We believe our prudent leverage, diversified access to match book funding, substantial majority of unencumbered assets, and weighting toward unsecured fixed rate debt demonstrate balance sheet strength as well as substantial liquidity to capitalize on attractive opportunities. We're a leader and innovator in our marketplace. We were the first company in our industry to issue a convertible bond, develop a notes program, issue an institutional bond and acquire another BDC. Shareholders and unsecured creditors alike should appreciate the thoughtful approach differentiated in our industry, which we have taken towards construction at the right-hand side of our balance sheet. As of March 2016, we held approximately $4.6 billion of our assets as unencumbered assets, representing approximately 76% of our portfolio. The remaining assets are pledged to Prospect Capital Funding, which has a double-A rated $885 million revolver with 22 banks and with $1.5 billion total size accordion feature at our option. The revolver is priced at LIBOR plus 225 basis points and revolves until March 2019 followed by a one year of amortization with interest distributions continued to be allowed to us. Outside of our revolver and benefiting from our unencumbered assets, we've issued at Prospect Capital Corporation multiple types of investment grade unsecured debt, including convertible bonds, institutional bonds and program notes. All these types of unsecured debt have no financial covenants, no asset restrictions, and no cross defaults with our revolver. We enjoy an investment grade rating of BBB+ rating from Kroll and an investment grade BBB- rating from S&P. We now tap the unsecured term debt market on multiple occasions to ladder our maturities and extend our liability duration up to nearly 30 years. Our debt maturities extend through 2043. With so many banks and debt investors across so many debt tranches, we've substantially reduced our…

Thank you, Brian. We're ready for questions now.

[Operator Instructions] And the first question will come from Terry Ma of Barclays.

Hey, guys. I may have missed this, but can you maybe just comment on the lawsuit that was recently filed and also just talk broadly about how you think about the fee structure at Prospect? I think several of your peers have actually reduced base fees and/or incentive fees.

We don't comment on litigation matters on earnings calls. Thanks.

Okay. So can you just talk about how you think about the fee structure going forward seeing how a lot of your peers have actually reduced the fees?

Structure what?

Your fee structure.

Terry, we think the best alignment comes from insider purchases and we focus on increasing our insider ownership pretty substantially recently thinking the stock price offered a compelling value. The management team here has purchased over $100 million of stock since December and it's purchased over $160 million of stock since inception. And we have one of the largest insider ownerships of any business development company; I believe everybody in our company is also a shareholder with no senior manager ever selling a share. So that's our thought for the matter.

Okay. Got it. So I just want to touch on First Tower. If I look at valuation, the fair value has been steady quarter-over-quarter. But I think when I look at public comps and multiple there have compressed three to four turns during the quarter. Can you just comment on what kind of valuation methodology you're using there?

Well, the methodology is unchanged from – since we purchased the company four years ago. And when I say we, as with all of the valuations at our company, it's a third-party process, so the third-party agent uses a variety of typical methods to look at in valuing a business, ranging from not just trading multiple comps and M&A comps, but other types of discounted cash flow performance and we're quite pleased with the performance of Tower. It's a company we remember that’s been in business for, I believe, close to 40 years with a nice recurring revenue stream business model, hundreds of thousands of loans, and nice growth that we've experienced in expanding to multiple states, during the course of the time of our investment over the last four to five years with the CEO owning about 20% of the company and we've seen a solid credit and charge-off profile and pre-tax net income growth occur for that business. One side comment that sometimes creates confusion because we do file financials for that business on an annual basis because of the size of it is we encourage folks to ignore, at least for cash flow purposes, items like goodwill amortization and similar non-cash items that can lead to the wrong conclusions about the robust profitability we see. For that business, which I believe, achieved record profitability in the past year and is paying us cash distributions approaching 20%. So we're quite happy with that business and our financial buyout book in general.

Got it. I only ask on the valuation because I think in the past you guys have marked up investments specifically Harbortouch and referenced public comps multiples there. So I'd think that for First Tower during the quarter, if public comps to come in 3 to 4 turns in terms of multiple, I wouldn’t have expected to see some sort of weakness on evaluation there.

Well, again, when you say you guys, I assume you mean the third-party agent.

Right.

Since we don't pick our own valuations, I feel like I have to underscore that based on the question. Harbortouch is I would say a little bit different in the sense that there's the possibility of an exit there. And we'll see if we have more to announce about that in the coming weeks. It's really premature to say anything right now other than that’s a terrific business with recurring revenue and EBITDA, diversified merchant customers and a strong management team bench.

Okay, got it. Thank you.

Thank you.

And the next question will come from Christopher Nolan of FBR & Company.

Hi. For your American property REIT and national property REIT, it looks like the cost base has went down over the quarter, but the – more so than the fair value. Can you explain what's going on over there?

Sure. A couple of things, Chris. One is we referenced doing some recapitalization transactions, so a great opportunity in the last few weeks and months to basically take distributions out of those business by capitalizing on attractive GSE financing, add-on financing, which is generally done with the same lender, whether it's Fanny or Freddie depending upon the particular property. So that's why you see a decrease in cost basis. At the same time, you've seen very strong operating results out of these businesses. You see not just low cap rates in the multifamily arena, but strong rents and strong occupancies as compared to a historical basis. And also recall that while we acquire properties with a recurring and stabilized yield, there is also a healthy value add component to what we do in focusing on primarily Class B units with a little bit of age to them and with the opportunity to generate positive results from unit upgrades, which takes some time to come to fruition because you can only upgrade a unit when you have a move-out of a tenant. And now as this book is seasoning nicely, we're seeing those strong results come through and the investment thesis in which we embarked on those investments validated by enhancing net operating income at the property level from those upgrades. It's really a combination of all those factors at risk.

Great. And as a follow-up question, management repurchased $100 million of shares in the quarter. But from my observation, does not look like Prospect Capital repurchased any shares in the quarter. And given that S&P put the company's outlook on negative, are those two factors correlated that the company stopped repurchasing shares in the quarter when S&P downgraded outlook?

Well, I think they are related in a sense that the rating agencies have made it quite clear that stock buybacks are negative, not just for ourselves, but other companies in the industry. We think in the world of specially financed companies, non-bank companies, how you manage your indebtedness and ladder maturities is critically important, almost more than just about anything else. And so we've intensely focused on that as we've grown our business with a well laddered maturity by making sure that we keep our leverage with in our target. And in fact you see a – I think we added a slide in our updated corporate presentation you can get on our website that shows that we've been consistently within 7.8, our target band debt to equity in the last several quarters. So we intensively manage that. And when you have substantial volatility, it's maybe easy to forget that on May 11, but on January 11 or February 11, the world was pretty stressed and volatility was pretty high, valuations out there whipsawing. So that made us cautious, not just on the right hand side of the balance sheet, but also on the left-hand side of the balance sheet. We also have carefully built our business, managing items like our 30% basket, RIC diversity tests, control tests, et cetera, where the denominator is very important, numerator and denominator for those ratios. So we have to be thoughtful about the impact of that as well. Having said that, we do have $100 million buyback authorization, we used about a third of it so far. So it's within our option set for sure going forward.

Okay, thanks, Grier.

Thanks.

And the next question will come from Merrill Ross of Wunderlich.

Good morning. Online lending always been a very strong driver of value creation and accounted for about half of your originations in this quarter. And I guess what my question is, that the CFPB has recently taken its first enforcement action in this space, and kind of the prospects are increased regulation appear to be booming. So how do you expect this to impact the growth rate of your online lending initiatives?

Thank you, Merrill. Look, the regulatory backdrop is critically important in really all the industries in which we invest and as part of the risk factors that we look at, and consumer finance and marketplace lending as a close cousin are no different than that. And we think it's important to have a culture of compliance in any business, including those in the consumer finance world and we've sought to reinforce such a culture. None of our controlled financial services companies are pay day lenders, which is I think one of the most significant areas of focus right now. Not the only area, but one of the most significant one. As it relates to online, we've been overall pleased with our counterparty relationships and investment returns. There's been a press in the last few days about one of the larger players in the industry. We at Prospect are not presently aware of any material documentation or other issues pertaining to loans that we've been involved with. And we're interested in furthering and growing our relationship with that company as well as others in the space. I think it validates our strategy of having diversified relationships of starting with small fundings, monitoring progress and results, and then deploying more capital as we are pleased with the results we have. This is a factor that we’ve spent many, many years diligently. We spent time in due diligence in this space before making a single investment all the way from 2007 until I believe 2013. So you are talking about five, six years of intensive work looking at charge-off histories, comping those to credit card receivables going back to the 80s. So we're big believers in doing our research and that's really an ongoing process, not one that's just a one-time upfront endeavor. We look at the customer value proposition of this space. And we think from a governmental and regulatory standpoint, if a consumer has a better experience, can save several hundred basis points in refinancing credit. That's a good thing that should be supported, not torn down. And I think the former is more likely with appropriate regulatory and compliance guardrails of course. So we look at the evolution of that factor and view it as probably expected stop, start, a little bit of growing pains from something that's grown fairly robustly over the last decade.

Thank you. To follow-up, do you think that this online lending will again account for the lines you’ve made basically the 49% of your originations in the June quarter?

I think it's unlikely to be that high in a sustained basis. That's really more a function of pulling back on other lending activities because of volatility, not just ourselves but this is happening, the overall deal arena, a lot of counterparties caught off deals, M&A transactions fizzled, buyers and sellers tried to change the price. It's a pretty typical slowdown that occurs when you have volatility, so not just driven by our own there. So I think it's more a function of that. Already we picked up our pace here in the June quarter and hope and expect for that to continue, so I wouldn't expect that high a number and recall we do have capacity limits overall in our business, 30% basket et cetera limits. We've got some capacity there now but it's really not possible add-in for an item that percentage to hold for a long period of time.

Okay. Thanks for the detailed answered.

Thanks, Merrill.

Next, we have a question from Christopher Testa of National Securities.

Good morning, guys. Thanks for taking my questions. I checked on the multifamily real estate portfolio. Are there any thoughts on potentially rotating out of multifamily a bit given how low cap rates are relative to other types of real estate and possibly diversifying the real estate that you're invested in?

It's a great question. And we've already monetized with a change of control some of our investments there, the Vista one in particular that we closed at the end of December. Yes, we will be – very likely we will be divesting other assets and rotating into newer opportunities, especially as our – I guess a couple of things. There is an opportunistic exit where you get the proverbial offer you can't refuse and then there is an aspect of completing a substantial amount of the value added improvements, boosting cash flow, and then being able to sell once we've wrung out those improvements as the owner of these businesses. We think the multifamily apartment, golden age, whatever you want to call it out there still has pretty significant legs with strong demographic drivers. That includes not just millennials, younger folks, starting families later, staying in apartments, affordability issues, financing issues for houses, but also baby boomers and retiring seniors downsizing into apartments. There continues to be a strong proposition that constrains supply and we benefit from these Class B properties. So really it's not just about buying in a beta sense any asset multifamily. The ones we buy, we’ve turned down a huge multiple of that and our overall book-to-book ratio is a single digit percentage. It's very small and multifamily as well. We are turning down deals all the time and selecting the best ones with a yield in credit orientations we have, multifamily is a very good fit for our business model. Other parts of real estate that have more concentrated tenant risk, lower yields, et cetera aren't really as good of fit. We do have self-storage in our business that we think is a good fit. We've looked at assisted living, we looked at student housing, come close on some deals. It's a very high bar to get deals done around here from a discipline standpoint so we didn't pull the trigger on any of those but they're certainly within the strike zone.

Okay, great. Just curious as to what you see the impact on LIBOR increases being on CLO equity cash yields and also how do reinvestment prices within CLO equity given the volatility in markets compared to your assumptions previously?

Sure. In general, within our structure credit CLO business, we have outperformed against our underwriting expectations and on a net basis built par since inception. The drivers that you’ve talked about just now in terms of the LIBOR forward curve as well as reinvestment spreads have been two positives outweighing the expected uptick in defaults driven by commodities. And as folks know, defaults tend to be a lagging indicator in a cycle and that's no different for the energy cycle we're going through right now. But the forward curve is what matters, not where LIBOR is this very second because that's what goes into the expectation of future returns. And that forward curve has been pushed back pretty consistently in the last couple of years as the fed has not moved quickly. When we underwrote those deals, we used the forward curve. So we already had an expectation of LIBOR going up. So that’s already built in. It's not like oh, wow, what's this negative surprise, the fed just tightened? That's already built in. It's really the movement of the curve that's more important than LIBOR just going up on an expected basis within the curve. From a reinvestment standpoint, we benefited from spreads widening. It's also a function of activity which has been a little bit more muted. You are going to see more opportunities to build par as volume picks up. Last quarter was pretty slow for the reasons I mentioned, not just the middle market but also the broadly syndicated market. Here there's a lot more activity happening now as you've seen reduction involve an increase in activity out there which we think will be a good thing because our management teams among many other positive attributes tend to get outsized allocations on primary issuance which is another value creation opportunity for building par.

Got it. But on the forward curve increasing that impacts your GAAP effective yield, but does it necessarily impact the cash on cash yield or is that based upon what LIBOR actually is?

LIBORs will impact cash yields? We saw a little bit of reduction, the change in LIBOR from the Fed in December reprice loans approximately in April, so this past month. So you see a little bit of a change from a cash yield standpoint. But the mitigant, that's built in to what we expected as we update our models and assumptions on a going forward basis, but we're still – I think we are delivering a 27% cash yield right now so that's obviously a pretty healthy yield.

Absolutely. On the remaining lower yielding investments, are these prices that you'd be willing to sell out today given the kind of bounce back in loan markets and obviously higher marks on those? Or is this still something that you're waiting to just repay and then recycle to the higher yields loans at this point?

It's probably a little bit of each. We are actively selling portions of our books that are lower yielding these Term loan A assets and we've made nice progress with that. We're really just hard sellers, as close to that as possible to the assets. There's no pressing need. It's all about book optimization and we've tended to sell those to more passive up stream types of players that don't have their own internal origination capability. And purchase those assets, sometimes close to the time of closing, sometimes on a season basis. We've received servicing revenues as well which is an additional yield enhancement. And obviously focus on having an appropriate accreditor, et cetera. But that's an activity that we hope and expect to pick up in pace now that the volatility of the late December quarter and early March quarter has dampened somewhat.

Great. That's all for me. Thanks for taking my questions.

Sure.

This concludes our question-and-answer session. I'd like to turn the conference back over to John Barry for any closing remarks.

Thank you. That's all the time we have for questions. As always, please don't hesitate to contact our team if you do have further questions. Thanks, all.

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