Prospect Capital Corporation (PSEC) Q4 2018 Earnings Report, Transcript and Summary

Good day and welcome to the Prospect Capital Corporation’s Fourth Fiscal Quarter Earnings Release Conference Call. All participants will be in listen-only mode. [Operator Instructions] 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.

Thank you, Brandon. By the way, you are doing a great job. Joining me on the call today are Grier Eliasek, our President and Chief Operating Officer; and Kristin Van Dask, our Chief Financial Officer. Kristin?

Thanks, John. This call is a 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. We do not undertake to update our forward-looking statements unless required by law. For additional disclosure, see our earnings press release, our 10-K, 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, Kristin. For the June 2018 quarter, our net investment income or NII was $79.5 million or $0.22 per share, up $0.03 from the prior quarter and exceeding our current dividend rate of $0.18 per share. NII increased due to higher interest and other income. As the economic cycle ages, we are not chasing yield, but are instead seeking to reduce risk and protect capital. We remain committed to our historic credit discipline, which has served us well in the past. While we have a robust pipeline of potential investments in our target range for credit quality and yield, we are not chasing risky assets with low returns and so remained underinvested at June 30. We believe our disciplined approach to credit will continue to serve us well in the coming years. In the June 2018 quarter, we also maintained our objective to protect risk with a prudent net debt-to-equity ratio of 65.5%, down 2.6% from the prior quarter and down 4% from the prior year. Our net investment income for the quarter was $114.3 million or $0.31 per share, up $0.17 from the prior quarter, due to increased NII and increased valuations of certain investments, including in the real estate, CLO, and consumer finance sectors. We have multiple disciplined strategies in place with the goal of enhancing our future risk adjusted income. On the asset management side, we plan on executing on a robust pipeline of new originations, improving cash flows in our structured credit portfolio including through extensions, refinancing’s, and cost. Enhancing NPRC’s largely multi-family real estate portfolio, including two [ph] realizations and supplemental financings; increasing results of controlled investments, including improving operating performance enclosing accretive bolt-on acquisitions, and enhancing yields through higher floating rate LIBOR based rates. On the liability management side, we plan on managing our weighted average cost of capital through increased revolver utilization, while protecting against maturity risk through continued liability laddering issuance in a diversified capital markets fashion. We are announcing monthly cash distributions to shareholders of $0.06 per share for each of September and October, representing 123 consecutive shareholder distributions. We plan on announcing our next series of shareholder distributions in November. Since our IPO over 14 years ago through our October 2018 distribution at our current share account, we will have paid out $16.80 per share to original shareholders, exceeding $2.6 billion in cumulative distributions to all shareholders. Our NAV stood at $9.35 per share in June 2018, up $0.12 from the prior quarter. Our balance sheet as of June 30, 2018 consisted of 89.7% floating rate interest earning assets and 98.4% fixed rate liabilities positioning us to benefit from rate increases. Our percentage of total investment income from interest income was 91.8% in the June 2018 quarter, an increase of 2.2% from the prior quarter and demonstrating our continued dedication to recurring income, compared to one-time structuring fees. We believe there is no greater alignment between management and shareholders than for management to purchase a significant amount of stock, particularly when management has purchased stock on the same basis as other shareholders in the open market. Prospect’s management is the largest shareholder in Prospect and has never sold a share. Management and affiliates on a combined basis have purchased at cost over $350 million of stock in Prospect, including over 285 million since December 2015. Our management team has been in the investment business for decades with experience handling both challenges and opportunities provided by dynamic, economic, and interest rate cycles. We have learned when it is more productive to reduce risk than to reach for yield, and the current environment is one of those time periods. At the same time, we believe the future will provide us with substantial opportunities to purchase attractive assets utilizing dry powder we have built and reserved. Thank you. I'll now turn the call over to Grier.

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, representing 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. As of June 2018, our controlled investments at fair value stood at 42% of our portfolio. This diversity allows us to source a broad range and high volume of opportunities, then selected 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. As of June 2018, our portfolio at fair value comprised 43.9% secured first lien, 42.1% secured second lien, 16.8% structured credit with underlying secured first lien collateral, 0.6% unsecured debt, and 16.6% equity investments resulting in 83% of our investments being assets with underlying secured debt benefiting from borrower pledge collateral. Prospect’s approach is one that generates attractive risk-adjusted yields, and our debt investments were generating an annualized yield of 13.0% as of June 2018, up 10 basis points than the prior quarter and the third straight quarterly increase. We also hold equity positions in certain investments that can act as yield enhancers or capital gains contributors as such positions generate distributions. We've continued to prioritize senior and secured debt with our originations to protect against downside risk, while still achieving above market yields through credit selection discipline and a differentiated origination approach. As of June 2018, we held 135 portfolio companies, up one from the prior quarter with a fair value of 5.73 billion. We also continue to invest in a diversified fashion across many different portfolio company industries with no significant industry concentration, the largest is 14.2%. As of June 2018, our asset concentration in the energy industry stood at 3.0% and our concentration in the retail industry stood at zero percent. Non-accruals as a percentage of total assets stood at approximately 2.5% in June 2018, up 1.2% from the prior quarter. Our weighted average portfolio net leverage stood at 4.60x EBITDA, down from 4.65x the prior quarter. Our weighted average EBITDA per portfolio company stood at 55.4 million in June 2018, up from $48.3 million a year prior. The majority of our portfolio consists of sole agented and self-originated middle market loans. In recent years, we perceive the risk-adjusted reward to be higher for agented, self-originated and anchor investor opportunities, compared to the non-anchor broadly syndicated market causing us to prioritize our proactive sourcing efforts. Our differentiated call center initiative continues to drive proprietary deal flow for our business. Originations in the June 2018 quarter aggregated 340 million. We also experienced 362 million of repayments and exits as a validation of our capital preservation objective, resulting in net originations of 22 million. During the June 2018 quarter, our originations comprised 42% agented sponsored debt, 33% agented non-sponsor debt, 15% real estate, 6% structured credit, 3% non-agented debt, and 1% corporate yield buyouts. Today, we have made multiple investments in the real estate arena through our private REITs, largely focused on multi-family stabilized yield acquisitions with attractive 10-year financing. In the June 2016 quarter, we consolidated our REITs into NPRC. NPRC's real estate portfolio has benefited from rising rents, strong occupancies, high returning value-added renovation programs, and attractive financing recapitalizations resulting in an increase in cash yields as a validation of this income growth business alongside our corporate credit businesses. NPRC has exited completely certain properties, including Vista, Abington, Baxley, Mission Gate, Hillcrest, Central Park, St. Marin and Matthews, with an objective to redeploy capital into new property acquisitions, including with repeat property manager relationships. We expect both recapitalizations and exits to continue. Our structured credit business performance has performed largely in-line with our underwriting expectations demonstrating the benefits of pursuing majority stakes, working with world-class management teams, providing strong collateral underwriting through primary issuance, and focusing on attractive risk-adjusted opportunities. As of June 2018, we held 960 million across 44 non-recourse structured credit investments, the underlying structured credit portfolios comprised over 2,000 loans and a total asset base of over 19 billion. As of June 2018, our structured credit portfolio experienced a trailing 12-month default rate of 115 bips, up 5 bips from the prior quarter and 83 basis points less than the broadly syndicated market default rate of 198 basis points. In the June 2018 quarter, this portfolio generated an annualized cash yield of 21.1%, up 7.9% from the prior quarter, due to liability spread reductions from resets, and a GAAP yield of 14.5%, up 1.3% from the prior quarter, also largely due to such resets. Cash yield includes all cash distributions from an investment, while GAAP yield subtracts out amortization of cost basis. As of June 2018, our existing structured credit portfolio has generated $1.16 billion in cumulative cash distributions to us, representing over 76% of our original investment. Through June 2018, we've also exited 11 investments totaling $291 million with an average realized IRR of 16.1%, and cash-on-cash multiple of 1.48x. Our structured credit portfolio consists entirely of majority owned positions, such positions can enjoy significant benefits compared to minority holdings in the same tranche. In many cases, we received fee rebates because of our majority position. As a majority holder, we control the ability to call a transaction in our sole discretion in the future and we believe such options add substantial value to our portfolio. We have the option of waiting years to call a transaction in an optimal fashion rather than when loan asset valuations might be temporarily low. We, as majority investor can refinance liabilities on more advantageous terms, remove bond baskets in exchange for better terms from debt investors in the deal, and extend or reset the investment period to enhance value. We've completed 25 refi’s and resets in the past two years. Our structured credit equity portfolio has paid us an average 17.6% cash yield in the 12-months ending June 30, 2018. So far in the current quarter, the current September 2018 quarter, we have booked 181 million in originations and received repayments of 20 million, resulting in net originations of 161 million. Our originations have comprised 66% agented sponsor debt, 24% non-agented debt, 6% structured credit, and 4% real estate. Thank you. I'll now turn the call over to Kristin.

Thanks, Grier. We believe our prudent leverage diversified access to mass book funding, substantial majority of unencumbered asset, and waiting toward unsecured fixed rate debt demonstrate both balance sheet strengths, as well as substantial liquidity to capitalize on attractive opportunities. Our company has locked in a ladder of fixed rate liabilities extending 25 years into the future. While the significant majority of our loans flow with LIBOR providing potential upside to shareholders as interest rates rise. We are 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, acquire another BDC, and many other lists of first. Shareholders and unsecured creditors 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 2018, we held approximately 4.5 billion of our assets as unencumbered assets, representing approximately 77% of our portfolio. The remaining assets are pledged to prospects capital funding, where we recently 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 770 million of commitments from 19 banks with a 1.5 billion total size accordion feature at our option. We are targeting adding more commitments from additional lenders. 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 recently 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 an investment grade BBB negative rating from S&P. We've now tapped the unsecured term debt market on multiple occasions to latter our maturities and to extend our liability duration out 25 years. Our debt maturities extend through 2043. With so many banks and debt investors across so many debt tranches, we've substantially reduced our counterparty risk over the years. We have refinanced five non-program term debt maturities in the past three years, including our 100 million baby bond in May 2015, our 150 million convertible note in December 2015, our 167.5 million convertible note in August 2016, our 50.7 million convertible note in October 2017, and our 85.4 million convertible note in March 2018; the latter two which we had also significantly repurchased in the June 2017 quarter. In the past fiscal year, we not only repaid our remaining October 2017 and March 2018 convertible notes at maturity, but also repurchased 269.4 million of our program notes. And we recently repurchased additional program notes. In May 2018, we repurchased 98.4 million in principle amount of our January 2019 convertible notes and issued an additional 103.5 million of our July 2022 convertible notes. In June 2018, we repurchased 146.5 million in principle amount of our 5% coupon July 2019 notes issued 70 million of our March 2023 notes and issued 55 million of our June 2028 notes. If the need should arise to decrease our leverage ratio, we believe we could slow originations and allow repayments and exits to come in during the ordinary course as we demonstrated in the first half of calendar year 2016 during market volatility. We now have seven separate unsecured debt issuances aggregating 1.6 billion, not including our program notes with maturities ranging from January 2019 to June 2028. As of June 30, 2018, we had 761 million of program notes outstanding with staggered maturities through October 2043. Now, I'll turn the call back over to John.

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

We have Robert Dodd with Raymond James. Please go ahead.

Hi guys, congrats on the quarter. The big step up in interest income from – sequentially from the prior quarter, can you give us any color on – obviously some of that was the improvements you’ve worked on financing the CLOs and we can see that in the structured product income, but was there anything else this quarter in terms of one-time accelerated amortization or make-whole premium or anything like that because obviously that was a big step-up sequentially in net [ph] interest income.

Grier, why don’t you take that, because nothing jumps to mind for me, maybe you or Kristin can identify a single item.

Yes, Robert it is really, I think what we are seeing is, reaping the benefits of capital structure that we put in place some years ago with floating rate assets when LIBOR was near zero and having a predominantly fixed rate liability structure. So, we are a full quarter beneficiary of upward movement in the Fed funds rate and correspondingly a LIBOR that [indiscernible] near to our benefit, that in addition to the boosting of structured credit cash and GAAP yields as a function of primarily reducing our liability spreads were big, big drivers in the quarter for revenue.

Okay. I mean, that’s surprisingly large benefit. It's just a business sense, obviously on the structured credit you’ve 4 million sequentially to your point on restructuring the finance on those and another 10 million from other sources and yields were up pretty – just simple calculated yields, pretty significantly sequentially, but rates certainly up 40 basis points on average for three months, but I understood. The other one, just a housekeeping one, could you tell us what your spillover income is now that’s undistributed taxable income rather than just I can find the undistributed NII on the balance sheet?

I will let Kristin to tackle that, tax is always tricky because it’s such a lag to calculating out for our business predominantly because of the structured credit book and the lag of getting in trustee reports, et cetera, et cetera. We might not have that in our fingertips. Kristin, you want to take that one?

Yes. I don’t want to mis-speak on the spill back, there might be something that we want to check and respond back. I don't have it at my fingertips actually.

Not a problem. I appreciate that. It is complicated. Last one for me…

Robert, sorry, I will just add that – when you – just to give you a general sense. When you do a reset or an extension in structured credit business, there is an upfront investment required to pay the lawyers and bankers to place the debt, and that is a direct cost associated with it. For GAAP purposes, that cost is amortized over the life of the deal. For tax purposes, that is an immediate charge from a tax standpoint and the deduction against taxable income. That means it is not a good investment. In many cases, we’ve had over 100% IRR’s from fulfilling these resets, but on a short-term temporary basis, there is a deduction against taxable income. Another tax effect that’s been in place for several years in our business is with First Tower that we bought just over six years ago, where there is an amortization of goodwill that acts as a deduction for tax purposes, but which has no impact from a cash standpoint. So, those effects have depressed taxable income. From a dividend standpoint, we’ve moved over the years, more the direction of economic return and looking at net investment income from a dividend standpoint and coverage standpoint and a bit away from a tax standpoint and the minimum required distribution. I think it is safe to say, we are reasonably above any minimum required distributions. Is that helpful?

Got it. Very helpful. Thank you. Last one, if I can? I mean, you are doing a lot of work on the liability side of the BDC, lowered the cost of the revolver, et cetera. Is there a – during the process of that work in terms of refinancing some of the converts in the revolver, are you restructuring those as well to adjust covenants with respect to potentially double leverage, and when I say double leverage, I mean, obviously the change in the asset coverage ratio later. Obviously, you say you're not going to do that imminently, but is that part of the work of restructuring those today, so that you’ve got more flexibility in future?

I would say partially. In the case of our capital markets issuance, two of the deals we did were simple add-ons to existing deals last quarter for convert and a straight institutional, primarily bond, and then we issued a new baby bond. This continue not to have any financial covenants associated with them. In the case of our recently closed cost of capital funding ABL revolving credit facility, we actually removed a certain – and that is a non-recourse bankruptcy remote deal, so there is certain covenants pertaining to the originator and seller of loans down into that entity, there was Prospect Capital Corporation. We still have, I believe a tangible net worth covenant, but we no longer have a leverage covenant. That being said, you could say that improves financial flexibility. That being said, as we’ve stated pretty clearly and consistently in the last several months, our interest in desire is to adhere to rating agency preferences, adhere to our preferences, which is not to change the leverage profile of the company and in fact the sort of moves if you want to call them that in March pertain to just flexibility around the 40 Act test as opposed to an actual desire to increase our leverage. If anything, we’re focused on risk management and de-risking the business and these capital market transactions are part of our ordinary course lettering designed to extend tender, extend maturity, demonstrate balance sheet strength by being able to issue in multiple markets, including after, you know there was a change a bit in the backdrop for liability investors in our sector with March, and in fact we were the first company to go and issue in a significant way in multiple markets, having said something positive about our leadership with the liability management and how we come across to those investors. We now, as we said in our prepared remarks have no debt due termed out for the rest of the year, 2019 is only 100 million. We started calling some of our program notes in 2020 and cleaning that out, I think we only have one term deal that particular year. If we do go through an economic downturn, I mean we are credit people right. So, we are always looking at the glass half empty and managing our risk accordingly. And there is an economic downturn. We won’t – our intention is to have very few debt maturities to have to take care of during such downturn even if the capital markets where to shut entirely. We think we will be in a good position to handle that with our revolver with other sources of liquidity along the way. So, that’s really the logic behind it more than anything else Robert.

I appreciate it. Thank you.

Let's see if John or Kristin have anything to add to that as well.

I guess the one thing I would add to it is to me is blocking and tackling both on the asset and liability side of the balance sheet, yet these – one apparently modest item after another cumulatively adds up. Robert, one reason I said, I can't think of anything beyond what you had mentioned, I think maybe the most important thing you did mention, which was resetting these CLO's, right, in terms of dollars.

Yes, that was material.

Yes, in terms of – each one individually is a lot of work in providing and each one individually is a few million dollars, but cumulatively they have really added up to significant dollars. Kristin, do you have anything to add to that? Okay.

One other addendum Robert, I think in the last quarter you had some excellent questions pertaining to real estate book, we are very happy with the results we are getting out of our real estate business. As we said in our prepared remarks, we just monetized another asset, this one in Charlotte with an NPRC called Matthews. We have got other dispositions that we are working on at real-time at the recycling approach where we look at the MPV’s of retaining an asset, recapitalizing assets, selling in assets and then of course we are looking at new deals as well from our recycling standpoint, and we are feeling increasingly confident about ability to sustain dividends from NPRC not just to sustain them, but actually potentially grow them as well in the not-too-distant future. So, I don't have any specific guidance to give you on that at the moment, but we think we’re positive about NPRC.

If I can – the NPRC clearly has performed well. I asked about the dividend last quarter and you indicated stability, you have done that here now. Not trying to – well I'm trying to back through the end of the quarter, but when you say the not-too-distant future, I mean, how could we conceivably looking in the next 12 months or is it a longer-term potential where you think you could grow the distribution from that REIT to the BDC?

In the next 12 months. We have gotten some real time exits we’re working on that could result an increased distribution.

Got it. Thank you.

Say Robert, so if I were in your shoes, I would be thinking, rising tides with solved boats, interest rates have been declining, no surprise that the rather large multi-family book prospect has built – is benefiting from that rising tide. But tides come in and tides go out. So, that has been my position for a while and I have just thought these dividends now are merely stealing from the future. But I have to commend our real estate team and Grier, again just day-to-day blocking and tackling intensive management of that C2B, it is really a largely C2B book. We – I still hesitate to say this because I don't want to change anything, but we seem to have and it is great credit to Ted Fowler and Scott and all the team, Peter, Dan, Curtis, that they are able to repeat, right. Repeating these things is something you don't see often. Repeat a, what I would call a value-add strategy more than once. And Grier, does it surprise you? It does surprise me.

Well, multi-family, I mean there is some meaning to put in place, one is, we’ve declined to do short-term floating rate financing for the multifamily assets that can create refi that we have locked in 10 years, and I my guess is 12 years of financing for those assets. Secondly, so-called workforce housing as we do multifamily Class B, Class C with reasonably low monthly average rents, it tends to be historically a much more stable part of the real estate spectrum than let’s say suburban office to make something more volatile and that is the big reason why we expanded into that sector 6, 7 years ago or so, in addition to the attractive current cash yield. The attractive current cash yields, growth potential, capital gains potential, and resilience during downturns, all positives. I would say that of course more capital flows into that sector during bull markets, like just about every other sector, you can think of with a little bit about difference about real estate compared to middle market private credit is a real estates – I think multifamily having a normal cyclical boom, middle market credit, our largest plurality core business is experiencing both cyclical inflows and secular inflows from a lot of institutions allocating more to the space they did, compared to a decade ago during the last October, which creates its share of challenges in finding attractive risk award opportunities. So, it is a long way of saying, we found real estate to be more attractive on a relative value basis in many cases, but we are doing deal sizes are generally 10 million to 20 million that adds to diversity with non-recourse financings, but it also means we're not going to have, generally speaking large swings in portfolio composition because we're not doing a large portfolio acquisition. We look at those, but we tend to find more value in the one of deals the sort of middle market equivalent within that space.

I appreciate the color.

Again Robert, I have to comment Ted Fowler and his whole team in that. It is a lot of blocking and tackling. We drive this team very hard. They can always do better if the attitude of Grier, myself, and they do, do better and it is everything from the signs that these buildings, how often you paint them, change the roof, change the refrigerator, and the stove, the ROE on the upgrades, and the great news about real estate is that when you inevitably make a mistake you still have an asset that you can work with. Whereas on the loan side, if you have made a mistake you may discover that you have no power to do anything about it. So, we are very happy with the real estate booking, just for myself, I would love to see us be doing more in real estate. I think it is a good place to be, if as and when the inevitable downturn comes right. It’s 100% likelihood. We just don't know when.

Yes. Understood. Thank you.

Our next question is from Christopher Testa with National Securities Corporation. Please go ahead.

Hi, good morning. Thank you for taking my questions. Just wanted to ask you guys a couple of questions about InterDent. So, at September, 30, 2017 you guys had pushed out from maturity from August 3, 2017 to December 31, 2017, term loan B was marked down very modestly than was marked back up to cost for the next quarter. Then March 31, 2018, the term loan B, the spread was reduced by 425 bips and it was marked down by about 2.5 points. Now there is customer attrition sided and it was marked down further. So, I'm just curious over that time line kind of what’s been the ebb and flow in that business, and what changed and what caused the reduction in spread and push out the maturity last year as well?

You want to take that Grier?

Sure. So, InterDent, is a dental services company that has two primary parts: one, is a more northwest centric Medicaid business that is a reasonable concentration in that business and the other is, in other larger contiguous states and more of a private pay program, we had looked to potentially exit that business through a sale process for the overall company, but decided we are more likely to keep the company and invest in projects for growth really reinvest for profit growth. The team is pretty excited about the potential payoff of investments in the business. So, adjusting the capital structure in ultimately higher IRR projects than debt service and that’s where we see a picking component, that can grow value is we’re concluding the ride prioritization for that business. Obviously, dental services are an area that is recurring revenue business model, not going away or subject to extreme cyclicality. So, with the right execution, we’re cautiously optimistic on where we can take that business.

Got it. But was the spread over LIBOR, was that reduced by 425 bips before after you controlled the business?

I forgot the exact timing, but the general construct is to grow value by having reduced cash spread so if we can reinvest in the projects. I don’t recall the exact timing of that change. We did assume, you know control the business in the last few months.

Okay, got it. And just wanted to talk about NPRC. So, during this fiscal year, you guys recognized 8.8 million or other income, there was no other income recognized from this since fiscal 2017, just wondering if you could give some color on what drove this?

Sure. So, from an NPRC standpoint, we talked about the dividend distributions. We also have fee income from NPRC as well. There has been quite a robust array of activity both in new deal activity, as well as exit activity. That’s generally, correct me if I'm wrong, Kristin, it shows within other income, separate and distinct from dividend income for NCRC. Let's see if Kristin has any other collaborations there. Kristin?

No, it is good to see restructuring fees for our different investments. I don't think there is anything else, the royalty kickers?

Yes, that’s right. We also collect certain royalty kickers on top of our interest income, which shows up in other income, as well, which is a yield edition. One note is when a dividend is paid it is recognized as income when paid out of taxable earnings and profit. So, that is something that occurs across the board whether it’s a real estate investment like NPRC or any other investment controlled or uncontrolled has to go through all of the tax hoops as well.

Got it. So, it seems like activity is driving this and given your commentary on the likelihood of more sales and then recycling, should we expect other income to remain elevated for NPRC over the next fiscal year?

I think that’s a reasonable assumption. Those give me some perhaps some more variability to that one than in the interest, as well as dividend side of things, but I think that is a reasonable assumption Chris. We are, as you can imagine, as we look through and optimize, look at each asset, so it doesn’t make sense to start the process or not. We are finding an increasing number of candidates that are attractive from an exit standpoint, and one reason for that is that consistent with our corporate credit underwriting and other businesses, generally in base cases, we’re assuming some sort of economic downturn in the next couple of years, call it 2020. And no one has a crystal ball in this, of course, but we just think that is a reasonable risk management and expected value way to plan our lives and to the extent there are any other actors, financial, strategic buyers otherwise that assume a recession free future. Then that can be a reason why each of the buyer and seller are happy, at least at the time of closing. So, that’s what’s transpiring and M&A processes can be uncertain, you don't know exactly where they will end up if you will get the value that you hope for, but we have now banked I think eight realizations within NPRC and more we hope to come.

Got it. Okay. And that was 3 percentage points of PIK that was added to the First Tower loan during the quarter, can you guys just give some color on what induced that?

Sure. So, First Tower, it’s really to factors Chris. One is, we’ve seen significant improvements in the business. The core business of First Tower, I mean this goes back, there has been build up improvement for at least 18 months now, where we have seen an increase in pre-tax net income led by a reduction in charge-offs and solid originations. Tower, when we bought the business was in really 3 primary states and we've since expanded into other states. There is a learning curve aspect when you expand into a new state to optimize, not only the business model for how to lend from regulatory standpoint, but also to get your staffing right, your human resource space right to manage what can be a reasonable turn over type of branch-based role and position; and that started to really connect and some of the states have become much more profitable now then in sort of year one of entry. So, that is item one. Item two is that Tower completed an add-on acquisition purchasing Harrison, a few months ago, which has gone quite well from an integration standpoint and a result standpoint. So, we are able to move up what we’re able to take out of tower. In the case of tower, adding, this is going to be the case from time-to-time elsewhere as well, adding a PIK instrument often means that there is an option at PIK, but in general we prefer to receive cash as a payment and so the – there is an election for the interest to be paid in cash even though there is an option to pick the payment. There is some decent seasonality to that kind of a business. So, it is good to have at least a partial PIK construct in place because you get a surge in borrowings for the holiday season and then repayments when the tax refunds come in. That is the case of a lot of consumer businesses been in place for a long, long time. So that’s really the rationale for the positive capital structure adjustment you saw there Chris.

Okay. And on the structured credit front, obviously the reset and refinance has been beneficial to you guys, as well as the sector as a whole, would you say that most of your vintages that have been set to be refi-ed over, let's call this year and through the next year have already been refinanced? So, should we expect less upfront cost in the cash yields to remain around where they are or do you guys still have a significant amount of vintages in the book that might cause some upfront cost that will benefit you down the road further through fiscal 2019?

Yes, we expect more resets to continue, and what happens is, you reset a deal and there is generally two-year non-call period, and then by the time get to the end of two years, there’s a rational to reset again. So, these aren't one and done features, it is a constant optimization. So, we have more deals that we’re interested in potentially resetting. I would say the activity occurred at a, did I see frenetic pace during the last – during the first six months of the year. It took a little bit of a pause in July and August. I think we have done one reset quarter to date. We’ve got a bunch teed-up potentially September 1, in-part that’s because the way the documents work for some of the deals you have got to match up with a payment date. In part, it is because the asset spread compression dynamic has slowed a little bit in recent weeks as there has been kind of a digestion period and liability spreads have been a bit sticky. So, we're not going to reset our deal unless the numbers are favorable to do so. And you become a little bit less favorable, it’s kind of an overall statement, every deal is going to be a little bit different and we have a number of candidates where the numbers are penciling out. The recent aspect is a significant validation of our majority strategy within PSEC because obviously the majority equity investor has the most to gain from a reset or lose from a non-reset if that economically advantages to do so because we speak for so much of the equity and the votes, we can be highly organized to drive prioritization in the queue and there is a queue out there, a digestion period of getting deals done with liability providers with desks et cetera. So, we’ve been positively aggressive about getting these deals down and we're seeing the results in real time. We had message for folks to expect an improvement in our yields in the structured credit book and that has come through. So, it’s hard to tell exactly when the next wave will unfold, a little bit of summer slowdown as well and we’ll see what happens when we get to September and beyond.

Got it. And was the contract to manage priority income sold?

That’s a fund separate and distinct from Prospect Capital Corp, so we are subject to confidentialities. I mean that’s not something I can cover unfortunately on a completely different agenda call here.

Okay. And just one more if I may. The 30% basket seems to be kind of the earnings driver for you guys between NPRC and between CLO equity, obviously if you guys were to reduce asset coverage you would greatly expand that basket, which would contribute greatly towards kind of your bread and butter, which has become NPRC and CLO equity. So, I'm just wondering, you know we’ve had a couple of your peers, Ares and TPG, have increased the available leverage without a ratings downgrade triggered by S&P, which seems to be your concern earlier in the year when you guys went through when you initially had gotten a board approval for the reduced leverage. So, my question is, why not reduce the asset coverage and then grow NPRC and the CLO equity book further?

Well there are few things there. First, as a predicate. NPRC clarifies not a 30% basket investment. Mortgage REITs are, but NPRC is a property REIT. Property REITs are 70% basket, good qualifying assets for BDC assuming they are private companies right and not public companies with more than 250 market cap, this of course is a private portfolio company. So, that’s not really a driver. We have unutilized 30% basket capacity. We’re comfortable with the percentage that CLO's represent of our book. I would say, it’s unlikely to see us – highly unlikely to see us increase that percentage meaningfully from where it is today and we have certain understandings as you can imagine in discussions with rating agencies et cetera. You mentioned other actors in the industry, I mean every issuer is going to be little bit different in a rating agency, even same rating agency responds to an issuer might be different as well as some people didn't like the results so they just dropped the rating agency I noticed. Other people have come back in with much more constrains self-imposed or jointly imposed restrictions on leverage that aren't meaningfully that much greater perhaps then where they are today. So, we just look at it from a risk management stand point Chris and just don't view it as necessary or desirable to take on more risk. I guess on paper you'll lever out more, you can enhance your return on equity, but it doesn't seem like the right time in the business cycle for us at least when we take the long view to be doing something like that. I don't know if John wants to add any other commentary here.

Well, I guess I would share with people my surprise that merely adding an option in our arsenal that we viewed as risk reducing would generate the response it did. The option to go beyond the statutory, the prior existing statutory limit, we view it as risk reducing for sure, and that you could have a situation where in an economic downturn, with a balance sheet loaded with mark-to-market assets did a mark-to-market valuation could take us from leverage of whatever it is, say 70% or now in the 60s, but maybe we might be at some point higher in the 70s, and a sudden mark-to-market valuation takes us above 80, above the one-to-one. So, we thought having this option would give us more flexibility to deal with such a situation. Without any, not having any intent one-way or the other to simply go beyond the existing statutory limit. Well, we were unable to obtain that option without a cost that struck us as too high for the value of the option. So, that’s why we’ve decided, we will live without the option for the time being. Every day is a new day, there is new incoming data. We will relook at our book. We will relook at the industry, we will relook at our economic projections, and we often rethink things. But right now, as Grier said, we’re comfortable where we are. We wish we could have the option on a costless basis, but it's not costless or at least currently. When it becomes costless, maybe – it should become costless, may we will re-examine that. Thank you.

Okay. All right, thank you.

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

Sure. Well, Brandon thank you very much and we thank people for joining us on our year-end call. Have a wonderful afternoon everyone. Bye now.

Thank you all.

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